Gold Update: Petropavlovsk PLC Shareholders Face Dilution To Fund Bond Swap

goldThe price of gold for immediate delivery hit a 2014 low of $1,225 per ounce on Monday, before strengthening slightly to $1,235 per ounce on Tuesday morning, leaving it down by 3.6% over the last week.

As a result, physical gold ETFs have also drifted lower.

The $33bn SPDR Gold Trust (NYSE: GLD.US) ETF has fallen by 2.8% to $118.64 since last Tuesday, cutting its gains for the year to date to just 2.2%. Over the same period, London-listed Gold Bullion Securities (LSE: GBS) has slipped 2.5% to $118.48, leaving the fund’s shares just 2.4% higher than they were at the start of 2014.

Petropavlovsk debt update

Russia-based gold miner Petropavlovsk (LSE: POG) fell 16% to 33p when markets opened this morning. The reason was the firm’s long-awaited update on its refinancing plans — and the news is not good for shareholders.

As I warned at the end of August, the pressing burden of the Petropavlovsk’s $924m net debt means that the firm’s banks are in the driving seat. Petropavlovsk is planning to swap the $300m of convertible bonds due for repayment in February 2015 for new convertible bonds due in 2019.

The severity of the situation is clear; while the outgoing bonds were issued with a coupon (interest rate) of 4%, the new ones will have a coupon of 7.5%, such is the increased risk that bondholders won’t get their money back.

Shareholders may be wiped out

To persuade bondholders to accept this deal, it will include a cash element, which will be raised with a rights issue.

This gives existing shareholders two equally unappealing choices: put more money into a business that’s struggling to survive, or face significant dilution. To underline the severity of the situation for shareholders, one of Petropavlovsk’s main banks has ruled that the firm cannot use any of its existing cash reserves to fund the planned bondholder payment — the money must come from a rights issue (i.e. from shareholders).

What’s happening is simple: shareholders are being milked, diluted, and potentially wiped out, in order to help Petropavlovsk regain control of its debt mountain. This is a completely normal process, as the rights of debt holders always take priority over shareholders’ rights — hence the huge risks involved in buying shares in companies with debt problems.

What next?

Cheap shares aren't always bargains: sometimes, as with Petropavlovsk, they are cheap for a reason.

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Roland Head has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.