|Shares Out. (in M):||419||P/E||91.0x||25.0x|
|Market Cap (in $M):||5,251||P/FCF||42.0x||15.0x|
|Net Debt (in $M):||120||EBIT||0||0|
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Harmony Gold 4.875% Convertible Bonds maturing in May 2009 ("Bonds") look extremely cheap, are low risk and as they mature in approximately 3 months have a short term catalyst that will allow the 'cheapness' to be realized quickly.
Harmony Gold is one of the largest gold mining companies in the world with the majority of its producing assets in South Africa. The Company has a market capitalization of approximately ZAR52 billion (~US$5.2 billion) with a primary listing on the Johannesburg stock exchange and ADRs listed on the New York Stock Exchange. In FY08 the Company produced 1.55 million ounces of gold and it currently has over 53 million ounces of proved gold reserves and over 281 million ounces of gold resources.
At 31 December 2008, Harmony had net debt of approximately ZAR1.2 billion (~US$120 million). Net Debt / 2009E EBITDA is 0.3x (EBITDA based on Bloomberg Consensus). The Company's next debt maturity is the Convertible Bond in May 2009.
To further strengthen its balance sheet, Harmony completed the sale of certain Uranium assets in November 2008. All conditions precedent to the sale were fulfilled in November 2008. The payment due to Harmony under the sale agreement is payable in three instalments:
(1) US$40 million on the effective date of the transaction - this was received on 21 November 2008;
(2) US$157 million plus interest of 5% p.a. on 22 April 2009; and
(3) US$12 million as soon as the second stage of the transaction related to the old Randfontein assets is completed (expected shortly after 22 April 2009)
Receipt of the second and third instalment of the sale proceeds will take Harmony into a pro forma net cash position. A summary of Harmony's net debt at 31-Dec-08 (and pro forma debt position adjusted for the Uranium asset sale) are shown in the table below.
|Westpac Bank Limited||209|
|Africa Vanguard Resources||748|
|Africa Vanguard Resources||32|
|Net Debt / (Cash)||1,214|
|Sale Proceeds (Uranium Assets) - 2nd Instalment||(1644)|
|Sale Proceeds (Uranium Asets) -3rd Instalment||(126)|
|Net Debt / (Cash)||(555)|
Convertible Bond Overview
Key Features of the Bond:
Repayment of the Bonds
Harmony has stated publicly that it intends to be debt free by June 2009 after the Bonds have either converted into equity or have matured (i.e. repaid by Harmony with cash). Once the second instalment of the Uranium sale proceeds are received Harmony will have sufficient cash to repay the Bond maturity. Additionally, based on the current gold price, Harmony should generate in excess of ZAR500 million of free cash flow (after capex and taxes) each quarter. This in addition to current cash in hand of ZAR1.6 billion will be sufficient to repay the Bonds.
However, in the (unlikely) event that the second instalment of the Uranium sale proceeds are not received and Harmony is not cash flow positive in H109, the Company still has several options available to generate liquidity to repay the Bonds. Some of these include:
The Bonds are currently trading at 104.
There are three ways I think about valuation:
1) Parity (current share price x Conversion Ratio) is approximately 106 (based on a share price of ZAR128 which is today's closing ADR price converted to ZAR). The Bonds are currently convertible at the option of the holder. Therefore, if you purchased one bond today and simultaneously shorted 8,264 shares you could realize 2 bond points of arbitrage (gross) (note: this is not the optimal trading strategy because it does not allow you to fully realize the value of the embedded call option. It does however illustrate the cheapness of the Bonds);
2) Monetize the call option - there is an actively traded option market for Harmony's ADRs. Therefore, it is possible to monetize the call option embedded in the Bond by selling May 2009 $12.5 strike call options (note: $12.50 strike options equate to a strike price of approximately ZAR128 at current FX rates). The current price for one $12.50 strike call option is $1.75. Therefore an investor can monetize approximately ZAR148k for each ZAR1m Bond by selling call options over the shares the Bond is convertible into (i.e. $1.75 per option x 8,264 options x 10.25 USDZAR FX rate). Monetizing the call option as described above reduces the purchase price of the Bond to approximately 89.2 (i.e. 104 purchase price - 14.8 realized from the sale of the call options).
Returns in this scenario are as follows:
(Note: an investor does take some FX risk if monetizing the call option, however this can also be hedged if the investor chooses to do so)
|(All Amounts in ZAR Million)||Harmony ADR Price|
|Date||Call not exercised||Call Exercised|
|Call Option proceeds||Feb'09||148,236||148,236|
|Net Bond Purchase||Feb'09||-891,765||-891,765|
|Cash proceeds at maturity||May'09||1,000,000||0|
|Call Option exercise proceeds||May'09||0||1,058,825|
While I currently see lots of instruments that look cheap, I believe a large advantage of these securities is that the existence of traded call options allows approximately ZAR148k of the value of these instruments to be monetized immediately. This allows you to both de-risk the investment and also crystallize/monetize the increased volatility the underlying stock has been realizing recently. Further, the remainder of the value will be crystallized no later than May 2009 when the Bonds mature (or earlier if the market mispricing of the instrument is reversed).
The major risks I see with this investment are as follows:
Overall, given the 3 month maturity of the Bonds and the Company's strong capital structure I regard the overall risk to this investment as very low.
Considering the short term catalyst, ability to immediately monetize the embedded value of the call option in the Bonds and Harmony's low leverage / low risk capital structure the Bonds are a very low risk investment that is trading well below intrinsic value.
Bonds mature in May 2009.
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