Solomon mine bondholders count losses not riches

By David Yong, Benjamin Purvis and David Stringer | Bloomberg
Locals walk through the Gold Ridge mine in 2003.
 Photographer: Torsten Blackwood/AFP via Getty Images
The unraveling of a two-year old gold-mining venture in Solomon Islands, a Pacific Ocean nation named for the biblical king known for his wisdom and wealth, is burning bondholders.

Australia’s St Barbara Ltd., which is seeking an exit from the Gold Ridge operation it acquired in 2012 in a $545 million takeover, has seen the value of its notes tumble to 79.75 cents on the dollar last week. More pain may loom: Standard & Poor’s pegs their value at just 30 cents to 50 cents on the dollar in the event of default.

The odds of that happening are rising after defaults by compatriot miners Mirabela Nickel Ltd. and Midwest Vanadium Pty. in the past year. Metal producers globally are in retreat from a decade-long $616 billion investment spree in mines as supply gluts and muted Chinese demand weigh on prices.

“We are in an environment where commodity prices are generally not supporting top-line growth,” Ric Ronge, a money manager in Melbourne at Pengana Capital Ltd., said by phone on Aug. 27. His firm oversees about A$1.2 billion ($1.1 billion) of assets. “Some companies that are very leveraged have likely been treading on solvency issues.”

Miners have cut staff, slashed budgets and shut operations as gold slumped 28 percent in 2013, the biggest annual decline in more than three decades. Producers including the biggest gold miner Barrick Gold Corp. and Newcrest Mining Ltd. recorded at least $26 billion in writedowns last year.

Returns Lag

Bonds sold by global mining and metal producers have returned 3.6 percent this year and offered 511 basis points over Treasuries as of Aug. 29, according to the Bank of America Merrill Lynch U.S. High Yield Metals & Mining Index. That’s less than the 6.9 percent return for global corporate bonds, which have a yield premium of 109 basis points.

Solomon Islands, which is three hours away by charter flight from Brisbane, is part of an archipelago named by Spanish navigator Alvaro de Mendana after the Israelite King Solomon, whose reign is described in the Bible as a period of great prosperity. The nation experienced unrest in the late 1990s and early 2000s prompting intervention by Australia, New Zealand and other neighboring countries to restore order.

Gold Ridge

Tropical Cyclone Ita flooded an access road to the Gold Ridge mine in April, halting production. When staff returned in June to assess damage, hundreds of illegal miners had set up encampments, forcing Melbourne-based St Barbara to evacuate workers from the site. The Australian producer is negotiating with the Solomon Islands government to transfer control after booking pretax impairments of about A$280 million against the mine in the past two years, according to filings.

“There’s a possibility, which is well advanced, of a win-win where the government can secure the future of the asset and we can leave with a clean exit with limited liabilities,” Chief Executive Officer Bob Vassie said in a phone interview Aug. 29. “That’s what we are shooting for.”

The company’s $250 million of 8.875 percent notes due April 2018 fell to 79.75 cents on the dollar last month from 99.49 cents when they were issued in March 2013, according to Bloomberg prices. The yield has risen to 16.52 percent, or 15.3 percentage points more than Treasuries.

Highest Risk

St Barbara is rated Caa1 by Moody’s Investors Service, a grade it reserves for borrowers deemed to be in “poor standing.” (SBM) It has the highest risk of default among Australia’s junk-rated miners based on measures of liquidity, analyst Saranga Ranasinghe said by phone on Aug. 28.

In a default, the bonds may have a recovery value of 30 to 50 percent, S&P estimated in March, and the company’s going-concern value may be as little as A$175 million to A$200 million. That hasn’t changed, analyst Brenda Wardlaw said by phone on Aug. 28.

St Barbara’s cash fell 32 percent to A$79 million as of June 30 from a year earlier, according to its financial statement released Aug. 27. Its debt includes a $75 million loan at 8.5 percent interest from RK Mine Finance, payable over 33 months from end-February 2015. The lender has priority to claims over bondholders, according to S&P.

The miner’s plight in the Pacific underscores the weak performance in Australia’s junk-rated miners. They returned 1.8 percent this year in the Bank of America’s Metals & Mining Index, while Canadian producers gained 9.9 percent.

Demand Drops

“A lot of that aggressive scramble for yield that took investors into junk-rated paper seems to have petered out a few months ago,” said Michael Bush, head of credit research at National Australia Bank Ltd. “Risk tolerance has narrowed and people are being a lot more discerning.”

St Barbara’s two mines in Western Australia produced profits in the year ended June 2014, accounting for 75 percent of revenue of A$533.8 million, according to a Aug. 27 statement. High costs at the company’s Pacific operations, which include Gold Ridge and the Simberi mine in Papua New Guinea, dragged the producer to a net loss of A$500.8 million in the period, it said.

“A lot of the acquisitions in the gold sector were made when prices were very high,” S&P’s Melbourne-based Wardlaw said. “It’s been difficult to get an adequate return now that prices have been lowered for a period of time.”

Cash Flow

The company is seeking to raise output at its Simberi mine to improve cash flow, Vassie said. “It’s on the right path to deliver cash and we have a very strong cash generating asset at Leonora” in Western Australia, he said by phone from Melbourne. “That gives us the confidence that we have stabilized the company, we haven’t defaulted on any payments and the big bond item is due only in 2018,” he said.

Building cash flow is “critical” before debt repayment kicks in, Rob Craigie, an analyst in Melbourne at Baillieu Holst, said by phone on Aug. 27. That hinges on the operating performance at its mines in Western Australia and Papua New Guinea, gold prices and capital expenditure, he said.

The Gold Ridge mine poured its first gold in August 1998 and was shuttered after two years. Then-owner Delta Gold Ltd. exited in June 2000, after which workshops and stores were vandalized. Allied Gold Ltd. bought the mine in 2009 before the company was taken over by St Barbara in September 2012.

Investors may see more defaults in the industry as the cost of capital remains high for miners with weak balance sheets, Pengana Capital’s Ronge said.

“We aren’t expecting a strong across-the-board rally in commodities over the next six to 12 months,” he said. “It really comes down to their ability to control costs and restructure their debt.”
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