Buying bombed-out shares in companies that have previously run as successful businesses can be very lucrative if they somehow manage to turn things around, but it also offers a very high chance of losing all your money if you are proven wrong and hold to the bitter end. There are plenty of companies on the stockmarket that have been at death’s door but have managed to survive and have subsequently gone on to do quite well, but there are also a large number of others that went bust and where investors lost all their money, and there is a very fine line between the two if you do decide to take a risk on a company that finds itself in this situation. Knowing when to exit and accepting that you were wrong and it actually won’t recover is important, and will save you a lot of money potentially by limiting your risk. If you are buying right at the death then you are basically gambling, and with most companies when they reach that stage it is fairly obvious that they are terminal – yet you still seem to get PIs buying. One which I got wrong a year or so ago was South African diamond miner Petra Diamonds (PDL), as I was expecting diamond prices to at least recover to some extent when the world’s biggest mine, Argyle, closed.
I was also encouraged by that its lenders had always supported the company and, even though the situation didn’t look good, were still prepared to extend further banking facilities to it, plus it had a plan in place to significantly reduce debt over a period of a couple of years, and in time for when the outstanding bonds would need to be refinanced. On top of that, it also owned one of the most famous diamond mines in the world, Cullinan, and had spent large sums on its assets in recent years. So I did see potential for it to at the very least survive and had it as a possible recovery play based on the fact that it was effectively being priced to fail – on that basis I held shares in this one for a while myself, before eventually taking a loss. It became clear that diamond prices weren’t going to recover any time soon - even prior to the arrival of Covid-19 - and that its Project 2022 initiative to substantially reduce debt wasn’t going to work. In hindsight, I probably should have avoided it in the first place due to the discount and yield to maturity that the bonds were trading at - as highlighted by Waseem Shakoor - as that suggested that even the debt holders viewed it as highly risky and with a fair chance of not recouping their investment, even if the assets were liquidated. Since then the share price has fallen around a further 70%, and the latest news from the company this week looks very bad for equity holders, given that net debt stood at $601 million as at the end of March 2020, compared to a market cap of just £16 million.
The writing was on the wall at the end of May when it released its quarterly update, and revealed that interest and capital repayments on both its senior secured notes and BEE credit facility had been missed. It did manage to come to an agreement with both parties not to trigger various clauses that could have come as a result of these defaults, but having to rely entirely on the good will of its lenders was a major concern. Petra has now notified shareholders that it has entered into a formal sales process to seek offers for either the whole business or some of the assets, but that it hasn’t actually received any approaches. It also states that it has been exploring all options for the $650 million 7.25% senior secured notes, which become due for repayment on May 1 2022, in order to maximise value for its stakeholders. Given the size of the debt and current state of the diamond market, and even allowing for the fact that Cullinan in particular could prove attractive to the right buyer, I find it hard to see how it will get anywhere close to the $950 million that the property, plant and equipment was valued at on the balance sheet, as at the last accounts.
Some will be looking at the value of the assets on paper and then even once debt is deducted will come to the conclusion that what is left is significantly more than the market cap, and therefore will view this as a buy. But what you need to ask yourself is, in the current market conditions and with any buyer knowing the financial difficulties that Petra is in, how much is it really likely to raise from a sale of the assets and will that cover the debt? I strongly suspect that it wouldn’t do and that any sale of the assets would effectively wipe out equity holders. I also see an extremely low chance that any party would come in and make a bid for the company as a whole, as that would involve taking on the debt that it currently has, and even assuming that anyone would want all of the assets, as opposed to cherry picking the best. So, barring some sort of miracle, I see the news this week as likely being the final nail in the coffin for equity holders – although given the size of the company now, and that it has been a popular target for a pump in recent times, there is a fair chance that there will be the odd spike upwards from the current level of around 2p before its ultimate demise. Personally I wouldn’t touch it though, even for a trade, as bad news for equity holders could drop at any time.
Filed under: Petra Diamonds, Shareshow, Versarien, British Land, Sainsbury, Smith & Nephew, [email protected]
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