Shares in Yorkshire potash miner Sirius Minerals (LSE: SXX) rose this morning after the company announced it had secured $300m of funding towards the $1,090m required to begin construction of the mine.
The deal is with the UK subsidiary of Australian group Hancock Prospecting Pty Ltd. Hancock is controlled by iron ore heiress Gina Rinehart, Australia’s richest woman.
What’s the deal?
Hancock Prospecting will pay $250m to Sirius Minerals in exchange for a 5% lifetime royalty payment on revenues from the York Potash mine. Hancock will also subscribe for $50m of new Sirius shares, giving a total contribution of $300m.
That’s 27% of the $1,090m the firm needs to complete Stage 1 financing and complete the most challenging stages of the mine’s construction.
The catch is that Hancock won’t provide any cash until Sirius can show that it’s already spent $630m on construction. Ms Rinehart is known as a tough businesswoman. This structure should mean that Hancock doesn’t have to provide any cash until it’s clear that the mine is going ahead as planned.
Is it a good deal?
I don’t think this is a bad deal for Sirius, which appears to be finding it more difficult than expected to raise the $1,090m needed to begin construction. Chief executive Chris Fraser had previously targeted a construction start date in September. We’re now at the end of October, and Sirius is still short of $790m needed to begin work.
Hancock Prospecting has a long history of investing in other people’s mines through royalty deals. Today’s news appears to be a significant endorsement of the York Potash project.
Of course, it’s clear this royalty financing agreement has been structured to protect Hancock from much of the risk of this early-stage investment, while still providing potentially huge returns.
In a presentation published in July 2016, Sirius estimated that the mine could generate annual revenues of about $3,000m when production reaches planned levels. Hancock’s share would come straight off the top of this and would equate to $150m each year.
Hancock’s financing agreement is for “the life of the project or 70 years, whichever is longer.” It’s obvious that over the long term, Ms Rinehart could easily enjoy a return of several thousand percent on her initial $300m investment.
Are Sirius shares a buy?
In my opinion, the structure of this deal means that Hancock’s interests will be very much senior to those of shareholders. Hancock could enjoy fantastic returns, even if Sirius never manages to turn a profit.
What’s more, Sirius still needs to raise a further $790m to begin construction. Back in the summer, the company indicated that it expected about $550m of Stage 1 financing to come from issuing new equity. If that’s still the plan, then the firm still has to find buyers for $500m of new shares and $290m of debt or other financing.
My view is that Sirius Minerals’ current valuation is high enough, given the level of dilutive funding that may be required to develop this project. I believe there will be much better buying opportunities over the next few years.
