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Not all alternative financings are death spirals - the case of Red Rock Resources

By Tom Winnifrith | Friday 30 June 2017

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from ShareProphets). I have no business relationship with any company whose stock is mentioned in this article.

The other day Red Rock Resources (RRR) announced a deal to fund the Steelmin smelter in Bosnia which involved some alternative financing from Yorkville. At once the critics of boss Andrew Bell - of whom there are more than a few - screamed "death spiral, dilution, the man hads gone mad." A few critics disagreed, arguing that Bell had always been mad. But perhaps before leaping to conclusions it is worth looking atnthe actual structure of the deal?

Steelmin operates in Red Rock’s field of steel feed, and replaces the manganese producing asset held through Jupiter, which is to be sold or listed shortly, providing capital to be redeployed. It has quality management and customers, like Jupiter, and will like Jupiter be a significant player in its field. It is therefore a suitable new investment as part of the Red Rock portfolio.

Steelmin is a real company with a real asset and clear short term pathway to cash flow generation. It is very difficult to find a near producing asset that is within range of Red Rock's funding capability.

Steelmin's key asset is the Ferrosilicon plant in Bosnia. Bosnia is a reasonable emerging market due to its progression to EU and Nato. It is at least as reasonable as many of the jurisdictions in Africa that are perfectly acceptable to AIM investors. Bosnia (according to the political stability index of the World Bank ranks 133 out of 194 countries and above Congo, Peru, Saudi Arabia, China, Angola, Indonesia, Phillipines, Mexixo, Eritrea, India, Russia, Turkey. Most AIM companies are operating in countries worse than Bosnia. It is still on the list of places you would send the mother in law to on holiday but it is not a total lawless hell hole like Somalia or Coventry.

The Jajce ferrosilicon plant had a long history as a part of Elektrobosna, was a industrial powerhouse, employing 3000 and accounting for 14% of the total export sales of the former Yugoslavian Republic of Bosnia-Herzegovina”. It was even the subject of an old CIA report 

After the civil war Elektrobosna was privatised and one facility has been continuously operated by Metalleghe of Italy. The larger one operated under local ownership for several years to 2005 but was plagued by ownership disputes. Steelmin got control in late 2011. The plant has competitive advantages in nearby quality quartz, cheap electricity from hydropower (electricity is 40% of costs), low labour costs, and favourable tax regime. Nearby Metalleghe ferrosilicon plant evidences the business model, as does LOIs and expressions of interest that Steelmin has from groups as ThyssenKrupp.

Steelmin is owned and has been funded by western investors and they have lots of experience in this jurisdiction. The CEO represents the investors and is an internationally experienced investor (based in london). The operating local team comprises the key members (head hunted by the CEO) of the old management team from Elektrobosna have been brought in and the plant refurbished with Furnace V completely overhauled, work that is finishing this year as yoiu can see HERE  

Red Rock has actually structured a smart deal as it has positioned itself above all the other (including western) investors as the senior lender. This means it has real control and can squeeze the other equity investors if required. It has an accelerated schedule to get their money back and it still ends up with an equity investment for no cost - somewhere between 16% and 30%. it has structured its free equity stake to encourage Steelmin to refinance them out as soon as possible to reduce the equity it gives up. Most AIM companies would just buy the equity. Red Rock has been way smarter.

A consortium of investor (including YA, Cuart and some family offices) have lent the money to Red Rock to fund the deal. What's clever here is that the all of the cost of funding is passed on to Steelmin so the ultimate cost to Red Rock is low. Red Rock is expecting to get proceeds from the Jupiter sale soon. A minority proportion of these proceeds will be used to pay off the loan. So only a fraction of the Jupiter cash is being used to do this deal and then when the loan is repaid by Steelmin, the full Jupiter cash will be restored to Red Rock.

The loan to Red Rock is a pure cash to cash loan with NO conversion rights for the investor (other than standard default terms if the company does not comply with its obligations) and only a small amount of warrants being issued.
This is not a death spiral. If you actually look at what my friend Comrade Bell has arranged with Yorkville it makes sense. I am not saying Red Rock shares are a buy ( they may be or may note be) but suggestions that this is a death spiral, dilutive, hocking the family silver and that Bell eats babies for breakfast are all wide of the mark.

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