Re: FWL - Ferrowest Limited
Hi guys,
I’ve heard a lot of people talking about the SP is going to be diluted like hell once more shares are issued to raise money for the CAPEX. I’ve been trying to crunch a few rough numbers to guesstimate what the effect of the further capital raising will be on the SP. I’ve decided to calculate it as if all money were raised through issuing equity. I know this isn’t the only option to raise capital but the managers are going to choose the option that’s best for the current shareholders – and if I calculate how bad this strategy is then logically it couldn’t be any worse than that.
This gets a bit complicated and is based on a few assumptions:
(These numbers are very rough especially since PFS isn’t out yet. Because the numbers are so rough I’ve tried to use VERY conservative numbers in a “worst case” basis just to get idea of the worst scenario I could expect from the SP.)
If you think any of these numbers are either downright wrong or even just unreasonable then share me your ideas
CAPEX – 350M (taken from 330M on website and jacked up for some breathing space)
Annual Pig iron production - 500,000tpa (from website – it’s planed to eventually be scaled up to 2M tpa but ill keep it at 500000tpa to be conservative, plus that’ll probably involve additional capital expenditure which makes things more complicated)
Operating Surplus Per Tonne - $165.88 from company website (this could be eroded by the exchange rate being high but then again iron ore prices are currently higher than original estimate – besides it’s too hard to tell in the long term. I think this can be used as a rough guide since these managers don’t seem to be in the game of talking themselves up too much (remember how the JORC busted their initial target by 50%). Though PFS will give a much better idea of this figure!
This gives us an EBIT of approx - $82.5m
# of shares on issue before new equity issue - 54,000,000 + APPROX 30,000 000 options
if all options are exercised this will mean about 84M shares on issue.
Now to figure out the theoretical new value after capital raising I did the following – (note these techniques are just my own guesses, I’m not an expert at valuation so I’ve just used methods that seem to make sense to me)
I figured it was too difficult to try NPV analysis so I thought a rough guide could be found be using PE ratio’s based upon diluted EPS multiplied by the PE ratio. NOTE that I’ve used EBIT (which should be taxed) not net income originally because I forgot about tax! To get net income of 82.5 at 30% tax I think you would need an output of approx 720 thousand tpa which is in my view still a fairly reasonable and conservative figure seeing as how they may be planning to scale up to 2M tpa. (sorry I didn’t want to do all the analysis again once I realized this).
82.5 is the EBIT, S1 is the new diluted theoretical SP, S0 is the price of the shares offered under the capital raising. Note that the mkt. share price is irrelevant since we cant know what the company’s real value is, we can only have a good guess.
These two conditions must hold:
S0< mkt SP (in order to make the offer attractive to investors)
S0 < S1 (for the same reasons)
I wasn’t sure what PE ratio’s for the to use since I cant find any good comparisons, I’ve read some places (although I don’t know whether it’s a reliable source) that small companies in the industry have PE ratios of 7-15 and I’ve seen some producers in the industry with PE ratios of 15.
Anyway once I plot those graphs of S1 against S0 I come up with these plots (see below) using different PE ratios. I’ve got S0 on the x axis and S1 on the y axis. The black line is drawn because in theory nobody would buy new shares below this line because the diluted price would be lower than what they bought it at. Now its plausible that S0 could be anywhere along the x-axis but logically it makes sense that shareholders before capital raising would also have a good idea of S1, hence they would push the SP up since it makes them better off – the logic is the higher the market SP the higher price new equity can be issued at meaning less equity needs to be issued to raise the 350M. I.e. The pie is divided into fewer and bigger pieces. Thus the S0 should be towards the right side of the arc.
One thing I’ve noticed though that even though these numbers are what I thought to be conservative there is enormous upside even in some of the worst cases. The higher the PE ratio I use has an exponential effect on what the diluted SP is – this seems to mean that if this project gets off the ground and all the risk and uncertainty about the project going ahead is overcome, the upside is HUGE! But also i've notced that if my number go any lower than my most conservative estimate the analysis is so sensitive that it looks like no capital would be able to be raised at all (since S1 becomes less than S0 for all prices - violating the original condition) this happened when used the EBIT of 82.5 and taxed it at 30% and used a PE ratio of 7. However those numbers are in my view ultra conservative and not too much to be concerned about.
In the good scenarios it looks like some sort of fantasy but i don't know what else to make of it?
I’m not sure if my numbers are wrong or if it really is that good (as long as the project gets of the ground that is).
Any ideas?
Please feel free to tear this analysis to shreds in a constructive way – we’ll all learn more if you do.