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Friday, 26 September 2008

A mining windfall tax in tatters, 2nd Edition

An interesting Minesite article suggests that the government may well be playing a more complicated game with respect to the mining regime. In particular, it might be ready to readjust the fiscal regime, if the government’s own 87 per cent owned Zambian Consolidated Copper Mines (ZCCM) started to receive meaningful dividends from its joint ventures. (Hat tip - Mine Watch Zambia):

There have been some significant developments down in Zambia in the wake of Minesite’s earlier story that the Zambian government might be prepared to reconsider the new levels of mining tax that it’s imposing, if the government’s own 87 per cent owned Zambian Consolidated Copper Mines (ZCCM) started to receive meaningful dividends from its Copperbelt joint ventures. A particular emphasis was laid on the Kansanshi project.

We now understand that First Quantum, the Canadian miner which operates Kansanshi, has entered into discussions with ZCCM about the payment of dividends from ZCCM’s accumulated but undistributed share of Kansanshi’s profits. These, after taking account of ZCCM’s share of Kansanshi development and capital spending, are believed to be well north of US$100 million and rising fast. The problem that has arisen for ZCCM is that when the Zambian copper industry was restructured in the early part of the decade, the joint venture agreements between the new foreign operators, ZCCM, and the government did not address the payment of dividends to the minority shareholder, ZCCM. Some operations, such as Mopani and Konkola, have occasionally paid dividends, but as the copper price has stayed high the profits flowing to the foreign operators have risen sharply, far outpacing any dividends flowing to ZCCM.

In November of last year ZCCM’s then chief executive, Joseph Chikolwa, addressing a conference in London, revealed that he believed that ZCCM’s net asset value was around US$1 billion or US$11 per share. This figure derives from a valuation done for the company by, we believe, Rothschild. ZCCM is mainly traded in Paris where it is priced in Euros. The US$11 figure was then equivalent to around €8.00 per share (the current price is around Euros €2.50; in October 2007 the share price reached Euros €6.40). Those who know both ZCCM and First Quantum generally consider that Kansanshi is the most valuable and profitable of the current Copperbelt mines.

However, in the last week or so, an intriguing transaction has been proposed in India concerning Vedanta’s Konkola copper operation. The Anglo-Indian group now owns a 79 per cent stake in Konkola following the controversial acquisition of ZCI’s 28.4 per cent holding. Following the recently announced re-structuring of the Vedanta group, Sterlite Industries India (SII), 60 per cent owned by Vedanta, is to acquire Vedanta’s 79 per cent stake in Konkola, in exchange for 364 million Sterlite shares. Currently Sterlite shares trade in Bombay at Rs505 (US$11.20), but as part of the Vedanta restructuring SII is getting rid of its stake in Madras Aluminium (MALCO) so, with the issue of new shares to Vedanta as well, SII’s residual value will have to be adjusted.

The Indian broking firm, Emkay Shares, has calculated a residual per share value for SII, once all the restructuring has been completed, of Rs355. MacQuarie suggests a slightly lower figure. This translates into a value for the Konkola asset of Rs355 times 364 million new SII shares, or Rs129 billion. Since that value is for 79 per cent of Konkola, it follows that if a similar value is attributed to ZCCM’s residual 21 per cent stake, the residual stake would be worth Rs34 billion, or €530 million, or €5.88 per ZCCM share.

It’s worth pointing out in passing how these figures compare with Vedanta’s US$213 million take-out price for ZCI’s 28.4 per cent stake in Konkola. In today’s circumstances ZCI’s holding would have been worth around US$990 million! It’s little wonder that ZCI fought so long and hard, if unsuccessfully, to get its’ stake valued on a current market basis, rather than on the 2003 copper price basis that was used.

Getting back to ZCCM, if it was interested in selling its Konkola stake the price would have to reflect current copper prices, as SII stake clearly does. But of course Konkola is not considered the jewel in ZCCM’s crown. That honour undoubtedly falls to Kansanshi. Last quarter ZCCM’s share of Kansanshi’s after tax profits was US$31million, or US$124 million annualised. If one applies the earnings multiple which operator and majority Kansanshi shareholder, First Quantum, currently sells on in the Canadian market - around five times - then ZCCM’s Kansanshi stake is worth US$620m, or €440 million, or €4.90 per share.

So we already have ZCCM, using reasonable market assessed values, with a net asset value of €10.78, against a current share price on the Paris Marche Libre of €2.50, and we have not yet ascribed a value to ZCCM’s holdings in Konkola North, Mufulira/Nkana or any of the other Copperbelt interests, such as Chambishi, Chibuluma and Luanshya, not mention its stakes in Ndola Lime, Maamba Collieries, Copperbelt Energy, Equinox Minerals and Albidon.

So what is ZCCM itself up to in order to try and encourage a higher market value for its shares, and what problems does it face in achieving this? The first thing to say is that ZCCM’s management was only vaguely aware that its shares traded in Paris and did not have up-to-date information on price movements there. This is because the Government has 87 per cent of the company and private shareholders are largely unknown as their holdings are mainly in nominee names. ZCCM shares are also listed in London and ZCCM pays fees to Cazenove to maintain that listing, but don’t hold your breath whilst the switchboard locates the responsible Caz executive! ZCCM is considering what to do about its London listing and whether its Paris trading facility can be expanded, but since it has not filed accounts for 2006, 2007 or 2008 (year to June)it may have difficulty in achieving anything in the near future.

The accounts for both 2006 and 2007 have been prepared but we understand that there is a problem between ZCCM’s board and the company’s auditors regarding certain balance sheet asset valuations. The 2006 accounts are promised in a few weeks, not a new promise unfortunately. Following the publishing of the 2007 accounts it would be possible for ZCCM shares to be elevated to the next rung of Paris trading where there would be continuous session trading rather than the unreliable and quixotic daily call over on the Marche Libre. Whilst the market in ZCCM shares would remain thin in the circumstances of continuous trading, it would,
nonetheless, be reasonable to expect daily volume to rise from a few thousand shares at best via the present calling-over facility, to around 50,000, which would be equivalent to around 100 per cent turnover of the minority stake annually.

Another issue that remains unresolved is the level of ZCCM’s debt, which stands at around US$500 million. This all relates to its past role as the operator and owner of Zambia’s copper mines. Whilst this figure appears on the face of it to be an enormous burden to ZCCM in its present reduced circumstances, it needs to be borne in mind that the debt is almost entirely attributable to the Zambian government, and it carries neither repayment date nor interest rate. There are some at ZCCM who believe that since the Zambian government has had most of its foreign debt forgiven by the international community, the Government in turn should cancel ZCCM’s debt. This the government refuses to do, but it has intimated to the company that it would consider converting the debt into preferred capital, which would carry a right to convert into new ZCCM equity. Some of this new equity could then be sold to local and foreign investors to raise cash for the government. ZCCM’s proposals on this have been with the government for over a year now and an early resolution of the issue seems unlikely!

The company has been talking to a group of French investors, the first time it has ever acknowledged the existence of its 13 per cent largely private investor minority. Whilst these discussions have been wide ranging they have laid particular emphasis on matters of investor relations and communications, where ZCCM is very weak. The company has engaged a South African IR firm to do an audit of ZCCM’s current IR practices, such as they are, and make recommendations. This is not the first time that an IR audit has been performed and it is unlikely that the South Africans will come up with anything that is not pretty clear already to the French ginger group.

Whilst is also pretty clear is that ZCCM is being right royally shafted by its foreign partners on the issue of dividends from the Copperbelt mines, the company unfortunately lacks aggressive and motivated management, which doesn’t help. For many years now its staff have acted as administrators dealing with issues, such as pensions, relating to its historic position as operator of the Copperbelt mines. ZCCM is anxious to develop its role as an investment holding company and to manage its current assets. Therefore the imperative now is for ZCCM to strengthen its management in order to fulfil these ambitions.

At the same time the Zambian government is prone to drag its feet and has recently said that it has no intention of selling a share of its 87 per cent holding, even though locals have suggested that this would reinvigorate its practically dormant local quote on the Lusaka Stock Exchange. This refusal, which goes against previous government policy to realise value from the ZCCM stake at the right time, also creates problems with regard to the debt issue and the proposed preferred share swap and subsequent sale.

There is clearly considerable and uncaptured value in ZCCM, but the company lacks good investment banking advice, if that’s not an oxymoron in today’s world! Publishing the 2006 and 2007 accounts is a minimum requirement for starting the revival process; a regular flow of dividends in respect of ZCCM’s minority Copperbelt holdings and action on the debt issue would also materially help. At the moment ZCCM gives the lie to those who believe that the time has come to make ‘shedloads’ of money investing in African companies.

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