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Why I’m Steering Clear Of Lonmin plc

Let’s face it, there is plenty of money to be made fishing around in the pool that contains the LSE’s biggest losers. However, those that choose to play in this pool face the risk of a total loss versus the potential of double-, even triple-digit gains.

It is easy to see the attraction given the huge potential coupled with the fact that we all like a bargain. However, I often wonder whether investors’ judgement is clouded by the potential rewards on offer, leaving them wide open to the risks involved.

As those of us that have played in this pool well know – some shares are cheap for a reason!

Today I’m taking a look at the London-listed miner Lonmin (LSE: LMI). As can be seen from the 12-month chart, investors have suffered an almost total loss. However, on Monday management announced a 46 for 1 rights issue alongside the final results. The market didn’t like the announcement and the shares have sold off – but has this created an opportunity or are investors about to throw good money after bad?

Significant dilution

I nearly broke my abacus calculating how many new shares were to be issued by the company — for those interested, the actual number is 26,997,717446!

Whilst that is a large number, the more interesting one for my money is the number 97.87 — this is the percentage by which existing shareholders will be diluted… that’s almost a total wipe-out.

Though the rights issues is underwritten by HSBC, J.P. Morgan Cazenove and Standard Bank, it is coming at a significant cost to shareholders. Gross proceeds are expected to be around US$407m; however, net proceeds after costs are expected to be around US$369m.

In addition, management have agreed to pay US$135m off the company’s banking facilities, which means that around US$234m will go to the business itself.

A glimmer of hope?

The rationale behind the rights issue is to enable management to execute the business plan, under which investors would see the company in better shape to be able to deal effectively with the effects of a continuation of current low prices, aim to achieve positive cash flow after capital expenditure, whilst preserving the long-term value of the group.

Indeed, management seemed confident in the potential of the group, making reference to its high-quality asset base and long-term mining rights, and the medium- to long-term fundamentals of the industry. They stated that they were focused on preserving and enhancing value for all shareholders.

The cynic in me would say that investors have been here before… indeed, the company has raised over US$1bn but the current market capitalisation is less than £100m. That’s a bitter pill to swallow and, as an investor, would make me very sceptical regarding management’s ability to turn this situation around given the extremely challenging market conditions in the resources sector.

You pay your money…

…you take your chance.

Here we have a company that has little in the way of pricing power, operating in an extremely challenging business environment. Commodity prices are depressed across the sector and, even after the rights issue, the company will still need to navigate its way through bank debt, further potential industrial relation issues and the possibility of further price weakness.

I think there are far safer places to fish – the shares are not for me.

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Dave Sullivan 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.