SRL is currently undergoing (i) a de-merger; and (ii) an agreed takeover offer for some of its assets.  Post the completion of the de-merger and takeover offer (late Feb'11/early Mar'11) SRL shareholders will be left with shares in an entity that (based on current market prices for SRL) is trading at approximately the value of cash on balance sheet plus shares it owns in other listed entities (i.e. almost zero implied enterprise value) despite having two producing operating assets that generate >$50m of EBITDA.  In my opinion, these operating assets do have value creating upside potential with limited downside risk due to the cash and listed equity net asset backing of MetalCo. 

Summary Economics:

• (A) Current Share Price: $2.18/share
• (B) Takeover Offer for Coal Assets: $1.72/share
• (C) Implied Value for MetalCo (i.e. A - B): $0.46/share
• (D) Cash and Listed Equities held by MetalCo: $0.41/share
• (E) Implied Value of Other MetalCo Assets (i.e. C - D): $0.05/share
• Estimated Value of Other MetalCo Assets: $0.79-$1.09/share

I believe the complexity of this situation and SRL's current organizational structure has led to this mispricing and this will correct as the value of MetalCo becomes clear upon completion of the de-merger (or shortly thereafter) (i.e. within 3-4 months from today).  

 

Transaction Overview

Very briefly, SRL has two groups of assets: (i) coal assets, which are held in a JV with PTT Group, a large Thai energy company ("Coal Assets") and (ii) a collection of Mining and Other Assets (see below for a more detailed description of these assets) ("MetalCo").  The largest single asset in the Coal Assets is a shareholding in another publicly listed company, Straits Asia Resources.  For over 12 months the value of SRL traded at a significant discount to the value of its shareholding in Straits Asia Resources plus SRL's cash on balance sheet.  The chart on the final slide of this presentation illustrates this very well: http://asx.com.au/asxpdf/20101115/pdf/31tw5ggx2kk8zq.pdf  

On 2 November 2010, SRL announced a de-merger of the Coal Assets and MetalCo (i.e. post de-merger, shareholders in SRL would own 1 share in a company that owned the Coal Assets and 1 share in MetalCo for each share they held in SRL pre de-merger).  The purpose of this transaction was to address the significant discount described above by simplifying the corporate structure (and making it easier for a corporate transaction to take place). 

On 11 November 2010, SRL announced that it had agreed to sell the Coal Assets for $1.72 per SRL share in cash to PTT (its joint venture partner in the JV).  This sale transaction will take place shortly after the de-merger described above is completed. 

Expected Timetable

• Scheme meetings to approve the de-merger and PTT acquisition: late January / early February
• Implementation of the de-merger: early February
• Implementation of the PTT acquisition: late February / early March 

Additional information on the structure of the transaction:

1)      This presentation provides a good overview, including pre and post organizational structure diagrams: http://asx.com.au/asxpdf/20101115/pdf/31tw5ggx2kk8zq.pdf

2)      Coal Assets sale transaction announcement (which includes the complete agreement with PTT): http://asx.com.au/asxpdf/20101111/pdf/31ttmpb88dhgzm.pdf

 

Economics / Valuation

(Please note all per share amounts referenced below are based on fully diluted shares including conversion of the convertible bond)

At Friday's closing SRL share price of $2.18/share the implied value of MetalCo was $0.46/share (i.e. $2.18/share less the $1.72/share to be received from PTT for the Coal Assets).  So what do SRL shareholders get for $0.46/share?

1. Cash: $100m ($0.32/share).   At 30-Sep-10 SRL had $170m of cash on hand.  SRL states in the Coal Assets sale announcement (see link above) that it will  leave $50m of cash behind for PTT as part of that deal.  Additionally, SRL is currently recapitalizing the Tritton and Mt Muro mines which is estimated to result in cash outflows of c.$40-45m in the 2011 financial year (note: SRL's financial year ends 30-Jun-11).  Since 30-Sep-10 SRL has divested shareholdings in some listed equities - MetalsX (ASX: MLX) and Lachlan Star (ASX: LSA) - for net cash proceeds of >$20m and finally SRL sold a business (Gfe) for which it will receive cash proceeds of $3m before year end.  Being conservative and assuming all capex for Tritton and Mt Muro occur before the de-merger date (which is Feb'11 vs. the financial year end of Jun'11) and also assuming that the remaining operations generate zero cash flow, this results in cash on hand at de-merger date of approximately $100m
2. Listed Equities: $30m ($0.09/share).  SRL is retaining the following from its listed equity portfolio: (i) 17% shareholding in Venturex Resources (ASX: VXR); (ii) 11% shareholding in Flinders Resources (ASX: FND); and (iii) 71% shareholding in Goldminco (TSE: GCP).  The remaining listed equities it held at 30-Sep-10 have been sold for >$20m (see (1) above);
3. Other Assets: Tritton Copper Mine, Mt. Muro Gold Mine, Hillgrove Antimony Mine, Magontec, Exploration Portfolio (see below for more details including estimated valuation)

The other important thing to note is that SRL should be debt free at de-merger date.  At 30-Jun-10 SRL's debt was comprised (i) Convertible Bond with face value of $80m and (ii) other debt of approximately $30m.  As part of the de-merger the Convertible bond holders have agreed to convert all bonds outstanding into ordinary shares (the per share amounts above include the impact of this dilution).  Additionally, the very large majority of the remaining debt was non-recourse trade financing for a business called Gfe.  Gfe has been sold (announced in Nov'11) and as part of the sale the debt relating to this business has been transferred to the new owner (see here for more detail: http://www.straits.com.au/files/News/2010/11_10/Straits%20Divests%20GfE%20Trading%20Business.pdf) 

As the math above illustrates you are 'creating' the assets listed in (3) above for nominal value only, which raises the question of what are these assets worth?

What Are the 'Other Assets' and What Are They Worth?

1. Tritton Copper Mine (100% owned).  Copper mine located in Australia.  Current production of 25,000 tonnes p.a. with a life of mine (based on Measured and Indicated Resources) of 10 years.  At the current copper price this mine will produce approximately $50m of EBITDA.  Importantly, this mine is subject to a contract that imposes a very high treatment and refining charge on copper sales (the charge is based on a sliding scale but at high prices such as those at the moment it is 1/3 of revenue).  This contract (which requires a total number of tonnes to be delivered into it in aggregate) will end in 2012 at current production levels.  The economics of this mine improve materially when this contract ends (especially relevant / important as there is currently a 10 year mine life, with exploration continuing and providing additional potential upside).  To give you some idea, if this contract was not in place EBITDA at current copper prices (assuming the same 25Ktpa of production) would increase from $50m to $100m.  A conservative valuation for Tritton is $200-250m, or $0.63-$0.79 per share (you will see this is very conservative as a multiple of EBITDA if you look where publicly listed copper miners are currently trading);
2. Mt Muro (100% Owned).  Gold mine in Indonesia which because of its small footprint and historical underinvestment has been at the higher end of the cost curve.  Muro is currently producing approximately 45 thousand ounces of gold per annum (has done so for the past 5 years) and has approximately 575 thousand ounces of Resources.  SRL has committed to recapitalize this mine which will involve both an exploration program and the development of larger pits and an underground operation.  The net result of this will be to increase production and lower per ounce operating costs.  SRL is targeting 300,000 ounces of production over the next 5 years at $600/oz from this operation and has ambitions to grow production further depending on the success of exploration activities.  SRL has experienced some difficulties and delays in completing the underground operations but they are taking steps to address this (see most recently quarterly report for more details).  The NPV of this asset is in excess of $100m.  I am being conservative and assuming a valuation of $40-60m or $0.13-$0.16 per share (please note, I understand this asset was marketed for sale by SRL in 2008 and offers of c.$40m were rejected.  Since then the gold price has appreciated and SRL have invested capital including exploration expenditure to increase the size of the Resource)
3. Magontec (100% owned).  Producer of magnesium products (alloys and anodes).  Products are primarily magnesium alloys for die casting and cathodic corrosion protection products for the water heater industry.  SRL is seeking to divest this asset in the next 12 months.  This business will probably generate c.$5m of EBITDA this year.  I am assuming a valuation of $10-20m or $0.03-$0.06 per share.
4. Hillgrove (100% Owned). Antimony mine located in Australia.  Production has been suspended due to technical issues.  The facility requires more capital to be expended in order for production to recommence.  SRL say they are investigating a sale or some other corporate transaction (e.g. JV, royalty agreement, etc.).  The hard assets alone (plant, etc.) have some value and I understand some Chinese firms are kicking the tyres at the moment.  To be conservative assume this asset has zero value in a base case, but there is probably some upside to this.
5. Exploration Portfolio.  SRL has a series of exploration projects (see here for more information: http://www.straits.com.au/exploration.html).  These assets are probably worth something (think about where junior miners are currently trading) but be conservative and assume zero value as a base case (but again there is probably some upside to this).

Conclusion

In summary, you are 'creating' these Other Assets in MetalCo for around $0.05/share and they are probably worth >$0.80 per share (with some upside).  Given the net asset backing provided to MetalCo by the cash and listed equities, perhaps the other way to think about this that you are buying a very cheap call option on the value of these assets.   Regardless, the upside / downside is very good at current prices, especially as the $1.72/share for the Coal Assets and the value of the cash and equities in MetalCo should provide a valuation floor.   

• I think the de-merger is the obvious catalyst as the valuation discrepancy will become obvious (if this does not happen beforehand)
• In advance of the de-merger, the release of the scheme documentation could provide a catalyst as this documentation will contain detailed information about the various assets and the balance sheets of both companies.