Tag: FIU

First Uranium – valuation

I don’t know why I find the trading of First Uranium (TSX: FIU) to be this exciting, but it is fairly obvious the market is pricing in a turnaround in its operations. Considering that it couldn’t have been managed worse in the year 2009, this is not entirely surprising. FIU shares are up about 60% over the past month. A share price of $1.25 gives it a capitalization of $220 million. The shares will start to face resistance as it cuts into the overhang caused by the secured note issue (which is a $150M issue with a $1.30/share conversion price). Conversion of the notes will result in about 115M shares issued, or about 40% of the company.

Valuing the notes, subordinated debentures and equity is not a trivial process.

The notes currently are not the most liquid product on the planet, with a closing bid/ask of 105/124 cents on the dollar. These notes are also secured by assets and in the event of a default would likely have some sort of recovery. Using the flawed Black-Scholes model, and using a 50% implied volatility (which is an incorrect estimate) gives a 36.5 cent per share value per call option at $1.30, expiring in March 2013. At 105, ignoring the conversion feature of the note, represents a 6.7% current yield and a -2.0% capital loss for the remainder of the 2.4 year term. The actual return realized by noteholders will depend on FIU’s trading price.

Using the 50% implied volatility figure, the option embedded within the notes have a “delta” of about 65%, which means that for every 1% that the equity changes, the underlying value in the conversion feature will change 0.65%. If FIU trades significantly above $1.30/share, the equity portion will dominate the value of the note, while if FIU trades under $1.30, other considerations such as ability to liquidate the assets become more of a consideration. There is no “clean” way of valuing these notes, as you have to separately calculate the fixed income and equity components, despite the fact that both of them are linked!

The unsecured debentures, maturing on June 30, 2012 are trading bid/ask 75/77, and using the midpoint as a reference, the yield to maturity is a whopping 23.0%; or the current yield is 5.6% and capital gain on maturity at par is 18.7%, for a joint yield of about 24.3%. It is likely that if FIU is trading significantly above $1.30 around the maturity date of the debentures that they will be able to refinance them. If FIU is trading under this, then it becomes increasingly likely that the debentures will receiving significantly less – the people holding the debentures can force a bankruptcy, but given their low seniority they will likely not be in much of a position to doing so.

The equity has traded historically as high as $8/share in May of 2009, and the company was very smart to pull off an equity offering near this price (before the shares tanked). Indeed, if this valuation was at all correct, even when you factor in the subsequent dilution, there is the potential to see the operation go for $3-$4/share if everything goes to “plan”. Of course, it has not in the past, and will likely have issues in the future!

FIU’s capital structure is a very strange one to analyze, especially with respect to the profitability of its operations. As I stated before, this is a classic high risk, high reward situation. In no way would anybody be sane to “bet the farm” on it, but a small allocation is in order – which is what I have at present in both the notes and debentures but not the equity. The notes already have enough equity value in them that can take direct advantage of a price rise in equity.

The First Uranium Whiplash

Although I don’t have a stake in the equity of First Uranium (TSX: FIU), I note with some mild amusement how a company can go up and down so rapidly in a short period of time – makes you wonder whether it is the same participants buying and selling, or what the motivations of the market are at the time:

From a high of $1.36 intraday to 93 cents a share at the close is a 32% drop. Wonder who those people were that bought at $1.36, and what they are thinking now.

The debentures and notes were relatively stable – a trade went off at 110 cents on the notes (closing with a bid-ask of 95-100), and the debentures have creeped up to 74 cents, but nothing near the volatility seen in the equity.

Figuring out First Uranium’s trading

Over the past five days, First Uranium equity has gone up approximately 50%:

Nothing public has happened to the company in the past five days, and the last major piece of news coming out was on October 20th when they announced their Q2 production results (which one can extrapolate into a quarterly report). The only explanation here is that either there is some insider news that is leaking into the marketplace, or there is a technical factor, such as very short term covering of short positions, or institutional demand on the stock.

The stock trades an average of $500k-$1M/day in volume, while not Microsoft-style liquidity, it is sufficient for most investment funds that wish to accumulate a position.

Something interesting is the effect on the debentures – if the equity trades higher, then it is more likely the debentures will mature at par because the company can recapitalize the debt by doing an equity swap. The subordinated debentures have not moved too much – up from roughly 70 cents to about 73-75 cents, while the notes (where I was a little more fortunate on my timing) have moved up from about 90 cents to par value.

There is an embedded call option in the notes to buy equity at $1.30/share, expiring at maturity (March 31, 2013) that has to be priced into the valuation of the notes – obviously if the equity is trading above $1.30/share, then the notes will be trading above par.

With an equity value of $1.07/share at present, the notes at 90 cents are a very compelling value. This price is now gone.

Readers should be cautioned that I do own the notes and subordinated debentures of First Uranium, but not the equity.

Trading credit principal for quality – TFSA update

As readers here may remember, my TFSA investment (which I am trying to compound as quickly as possible) was in First Uranium debentures (TSX: FIU.DB), unsecured senior debt, coupon 4.25%, maturing June 2012.

This has been one of my lesser performing investments, due to a horrible entry point (the company announced some adverse news shortly after my investment), which I had an opportunity to see the writing on the wall and liquidate (which I could have received a very acceptable price), but unfortunately my worst decision in the year was to not.

Anyhow, my TFSA is currently sitting about $600 below the end of December 2009 mark (netting out the $5,000 deposit), which is not too good since my other (fixed income) investment candidates at the time would have resulted in an actual increase on investment, which is the whole point of the TFSA. If I was planning on losing money, I would have prefered to do it in the RRSP or in the non-registered account so I could deduct the loss. C’est la vie – that’s how things work sometimes. The question is now, how to get back on track?

The first thing to look at is whether the underlying securities are still worth keeping based on new information that has been received in the interim. First Uranium went through a recapitalization which saw common shareholders be diluted in the form of a convertible notes offering (senior, secured by all assets minus what Gold Wheaton is entitled to, maturing March 31, 2013, convertible at $1.30/share, 7% coupon, TSX:FIU.NT) and a 14 million share settlement to Gold Wheaton (TSX: GLW) since FIU did not finish constructing a mine module in time. The company itself remains active in the gold mining industry (despite the company’s name, Uranium is a small part of the business), having two mines operating – Mine Waste Solutions (which is operating well and is profitable) and Ezulwini (which has been a basket case operationally and has been losing money). After firing most of the board and management, it appears there are hints that the company is coming back to financial life again, especially with gold prices at the high prices they are at today.

The company’s financials, once they stop spending big cash on capital expenditures, should be cash generating and healthily profitable even if you believe they will moderately underperform the economic projections in the technical reports. So it becomes a matter of whether the market believes the management can deliver operationally, and whether the management is credible. Given the history of the company, they are not and the common stock and debentures trade as if this is the case.

Thus, this is a high risk, high reward scenario. I have only gone superficially into one of the risks in this post, but there are other risks that I have mentally dissected.

While I do not think this investment is a slam dunk, when you adjust it for risk/return, there is a compelling investment thesis on the debt of First Uranium, and possibly the equity, which appears to be somewhat undervalued. There is a huge amount of default risk for the equity holders, and some risk for the unsecured debenture holders, and limited risk for the secured note holders.

The TFSA transaction that I recently performed was to sell half the debentures ($12k face) at 70 cents on the dollar, and then use the proceeds to purchase $10k face of notes, which I subsequently purchased at 88.5 cents on the dollar.

Why would I trade lower priced unsecured notes, maturing earlier (and a better annual compounded yield at existing trading prices) for more expensive, secure notes with a later maturity and less yield? The quick answer is that I am trading yield for quality.

The longer answer is that I am reasonably confident that the secured note holders would be able to receive the full principal amount in a bankruptcy liquidation of First Uranium. There is $150M outstanding and the company is likely to fetch more than this from Mine Waste Solutions alone. The upside for the noteholders (beyond a payout at maturity) is the $1.30 strike price, 2.5 year call option embedded in the notes, which provides a mild amount of equity participation without actually having to own the equity. The equity is currently about 67% out of the money as of this writing.

If FIU does get its act together, it is likely that the equity will increase higher than 67%. However, the equity is far too risky in the TFSA – it is better suited to a non-registered account where you can at least book capital losses if it tanks.

Finally, there is the scenario of what happens to the unsecured debenture holders when their maturity hits (June 2012) – the company will either likely make an offer to extend the maturity or give the debenture holders a sweeter deal (higher coupon and lower conversion rate) while the company tries to make its mining operations profitable. I do not think the unsecured debenture holders will force the company into bankruptcy simply because of their rank – they have relatively less negotiating power.

I will emphasize that equity in First Uranium is a highly risky investment, and the debentures are a risky investment, but the notes appear to be less risky, and are priced to represent the lower risk.

The notes are also better positioned in the TFSA (since you will likely see your money back), while debentures are better positioned in the RRSP (income is tax-deferred, but you can still benefit if you have a loss of prinicpal), and equity is positioned in the non-registered account.

First Uranium reports FY2010 annual report

First Uranium, which is a completely mis-named company in light of the fact that most of its revenues are derived from gold sales, reported its fiscal year-end report on a Friday evening. Note their calendar quarter ends on March, so FY2010 is April 1, 2009 to March 31, 2010.

While the company has been, kindly put, a basket case over the past year, the report does give glimpses that recovery is on the way. It has two primary operations – Mine Waste Solutions, which reprocesses previous tailings for gold (and uranium in 2012 and beyond), and this part of the business is quite profitable – about $22.8 million in profit from this operation and likely to increase in the future. However, the other project, the Ezulwini Mine, has suffered through massive setbacks and managerial incompetence and has lost about $63 million for the year.

First Uranium spent most of the first calendar quarter of the year getting rid of its management and restructuring its board of directors with people that seem to have extensive credentials in the mining business.

Most of the solvency concerns were alleviated with the March 2013 secured debenture issue, which will be listed on the TSX sometime in August.

First Uranium at this point becomes an interesting case on whether they can turn around the Ezulwini mine operation or not. From the MD&A:

The Ezulwini Mine has yet to build up sufficient production to generate positive operating cash flow. The production build-up to date has progressed much slower than originally anticipated due to a number of factors including:
– The estimation of gold available compared to the gold accounted for was significantly below expectations, a relationship better known as the mine call factor. The planned mine call factor for the year was 87% whereas the mine achieved a factor of lower than 70% during the first nine months of the year.
– The face length creation proceeded as planned but the start-up and conversion from development to stoping was slower than anticipated. Significant improvements are expected in FY 2011.
– The face length utilization was relatively low during the year due to the newly appointed mining teams as well as inadequate face equipping. Special attention is being paid to the training of crews and equipping of panels, thus mining readiness is expected to improve in the forthcoming year.
– During the fiscal year, some seismic activity occurred in the shaft pillar which caused delays but more importantly required special attention to resolve it in a safe manner. The extra precautions and diligence paid to rock engineering issues resulted in slower than anticipated performance in FY 2010. The majority of the engineering issues are now resolved, thus improved mining performance is expected.

The new management appears to know what’s going on, and they are performing a detailed bottom-up production plan which is apparently going to be ready by the end of June 2010.

On the equity side, FIU closed Friday at $1.25/share, and has 180.8 million shares outstanding. Factoring in the senior secured debentures converting at $1.30/share, this brings shares outstanding to 315.3 million shares.

I am not sure how much cash flow they can get out of Ezulwini even if they turn around the operation. The interest “bite” is not too severe – the unsecured debentures have $155M at 4.25%, while the seniors are approximately CAD$150 at 7%. It is likely if the common shares are trading higher than $1.30 by the time June 2012 comes rolling around that it will simply be a debt-for-equity swap which will make the unsecured debenture holders whole.

The unsecured debentures have turned very illiquid and have recently traded around 66-70 cents on the dollar. Assuming a purchase of 70 cents at the ask, you are looking at a 6.1% current yield and 19.5% annualized capital gain assuming a maturity payout at par. I do own these debentures, and think they represent a fairly priced risk. I still cannot recommend the common, although it could double or triple in value if the Ezulwini project does indeed turn around from the financially disastrous fiscal 2010.

If they managed to pull off a steady-state operation of about 250,000 ounces a year (note: far above 30,000 in the last year, geologist report has 5.2 million ounces over 18 years), at current gold prices that would suggest First Uranium would clear operational profits of roughly $80-100 million. Flow this and the Mine Waste Solutions project into the bottom line and you get a justification for a much higher stock price than present, even with all the potential future dilution – my paper napkin valuation model suggests around a $4-5 share price with a conservative valuation multiple. There are a lot of “ifs” and given the track history of the company, it’s no wonder that First Uranium equity is currently in the toilet – it indeed represents a large risk.