I follow all of my investments very closely, and therefore, I speak with most of the CEOs of the companies in which I invest. At the same time, I read comments made by other investors on various Internet message boards. What amazes me the most is how quickly these investors jump to various conclusions based on very little or no information. The perfect example is the most recent announcement of the Mengapur project that the management of Monument Mining (TSXV: MMY.V) is trying to acquire. I have heard all kinds of criticisms of the management accusing them of being incompetent, unethical and even fraudulent.
I was very unhappy to see the management’s announcement that they intended to acquire the Mengapur project by issuing lots of shares. Therefore, I decided to write a public letter to the company’s management discussing my reservations towards the project. While some investors thought that the management was simply going to ignore my letter, I received a phone call from Bob Baldock, Monument Mining CEO, within 24 hours. I brought up many points that bothered me about the deal, and in this article, I want to share with everyone what I learned. After you finish reading it, you can then decide on your own whether you want to vote “yes” or “no” for the deal.
Baldock’s mission for Monument Mining is to build a company that has a sustainable production profile comprising various projects in order to support sustainable dividend payments. The reason for this is to attract institutional investors who are going to be long-term shareholders and who are going to price the stock of the company with a proper multiple over earnings or cash flows.
To accomplish this goal, they discovered and pursued the Mengapur project. Aside from various press releases, the only other source of information about this project is an outdated NI 43-101, which is based on the results of the Mengapur Project Feasibility Study of 1993. This was almost 20 years ago. The price of gold was approximately $350 per ounce. Today, it is approximately $1,600 per ounce. The price of copper was less than $1 per pound. Today, it is more than $3 per pound. The price of silver was $5 per ounce. Today, it is approximately $30 per ounce. These are some major differences.
Based on this outdated NI 43-101, the Mengapur project is estimated to bring revenues of $100 million with cash flows of approximately $40 million over the next two decades. To bring this project into production, it will cost approximately $179 million. When I substituted the old commodity prices with the most recent prices, I estimated revenues of more than $300 million. This would probably translate into cash flows of about $85 million.
Most investors, including myself, are comfortable with the project but not with the way the company is financing its acquisition. I am not opposed to dilution if it is done for the right reason. Until I spoke with Baldock, I was completely opposed to it. I am not 100 percent convinced yet, but at least I have a better understanding of what it is that we are getting by purchasing the Mengapur project.
First, it appears that even after I arrive at $300 million of top line revenues, I am way too conservative. The Mengapur project was owned by the Malaysian government with the intention of mainly producing sulphur, which is used to make fertilizer. The 43-101 was prepared for this reason. However, we are almost in 2012, and since 1993, the world has changed and the prices of commodities have increased significantly. Consequently, the management has much bigger plans for the Mengapur project than simply producing sulphur. It still plans to produce sulphur but it will not be as significant of a contribution to total revenue anymore. With that being said, the Malaysian government is still interested in seeing Monument Mining produce sulphur for its fertilizer industry, and as an incentive, it will provide the company with a 10-to 20-year tax break, which is pretty significant. It appears to me that what all of this means to us is that the Mengapur project has the potential to generate revenues that will be much higher than $300 million per year. It could even be $500 or $600 million per year (I am purely guessing here). All I know is that it will likely be higher than $300 million. You can make your own estimates.
Second, the sellers of the Mengapur project are in default with their bank. It is the bank that is in control of the disposition process. When the management approached the bank with the offer to buy the Mengapur project, the bank put certain restrictions on them. Because of the small size of Monument in relation to the Mengapur project, the bank will not allow the company to close the deal by taking on debt. The company also has a limited time frame to come up with the money. Consequently, the management sees raising money by issuing shares as the best way to come up with money for the transaction. The price tag for the project is $60 million. If Monument does not come up with the money, the Mengapur project will go into receivership. I get the sense that it could sell for as much as $270 million. Of course, we will never know until someone else buys it for that price.
Many investors including myself are puzzled why the company would not pay for the acquisition with cash in the bank. The company should have enough to close the deal. Baldock’s response was, “Because we would be totally broke.” With the ongoing expansion of the Selinsing project, drilling activities on other properties, the company needs money to continue to grow its resource base. In the mining business, you never want to get rid of all of your cash and find yourself forced to rely on capital markets should you need help.
Some investors believe, and I was one of them, that if Monument acquires the Mengapur project, it will take a long time to put it into production. I was surprised to learn that the management believes that the first cash flows can be generated by the end of 2012. Currently, there is a plant designed for production of iron ore. It was commissioned in November 2010 and operated until July 2011. It was shut down because of a lack of capital. The management believes that they can restart the production of iron ore by the end of 2012 after some modifications and modernizations to the plant. At this point, I have no idea how much it will cost but I was told that it is within Monument’s capacity. Then, the cash flows from iron ore, gold production from Selinsing, and warrant exercises should be enough to build out the rest of the Mengapur project.
Another point that I brought up in the conversation is the way the proposed private placement is being structured. The company announced that it would conduct a non-brokered private placement of up to 140,000,000 units at a price of $0.50 per unit resulting in gross proceeds of up to $70,000,000. The company expects that Tulum Corporation will subscribe to purchase all of the units under the private placement. What angers many investors is the fact that Tulum Corporation is run by Francois Marland who is a director of Yukon-Nevada Gold Corp, another company run by Baldock. Immediately, this deal looks fishy and investors question why Baldock is giving a deal to his buddy Marland while some current shareholders wanted in on the deal but were rejected.
Instead of jumping the gun and accusing Baldock of being unethical, I chose to ask him directly and give him a chance to explain himself. Because Monument currently has approximately $70 million in the bank and generates another $70 million in cash flow per year while trading for a market cap approximately $70 million, it is a prime candidate for a takeover. Wouldn’t you want to gain control over a company with $70 million in the bank and $70 million in yearly cash flow, for $70 million? It is like paying $70 million, getting it back right away, and keeping $70 million in cash flow per year. Just show me where to sign.
By allowing Marland to buy all the shares from the secondary offering helps the company stay independent and not be bought out for a song. While Baldock did not specifically tell me that there are entities trying to acquire Monument on the cheap, I am connecting all the dots and I don’t believe that they would be structuring the deal this way if there wasn’t a threat of a takeover.
Now that I laid out the major points that I wanted to cover, you as an investor have some choices. You can disagree with the management and vote “no” for the Mengapur project or sell your shares. Or you can stay invested in the company for the long haul, let the management go ahead with its plans and vote “yes” for the Mengapur project. I can’t solve this problem for you. All I can do is to try to clear up some misunderstandings and confusions by allowing Baldock explain himself. Now, you have more information to make your voting decision.
What are your thoughts? I encourage you to leave a comment below.
About the author:
Mariusz SkoniecznyMariusz Skonieczny is the founder and president of Classic Value Investors, an investment management firm. He is also the editor of Ultimate Value Finder, a monthly newsletter that features three underfollowed, unknown, and undervalued companies ignored by Wall Street.