18/10/2011 - 09:15

How to make $500 million without really trying

18/10/2011 - 09:15


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UNDERVALUED: Two recent deals suggest Kerry Stokes' Iron Ore Holdings stock is trading at a hefty discount.

Kerry Stokes probably doesn’t need an extra $500 million, but if anybody else wants to triple their money it might be time to join him on the share register of Iron Ore Holdings (IOH).

Stokes, a billionaire best known as the major shareholder in the Channel Seven television network and Westrac industrial equipment business, is also the 50.5% shareholder in IOH, one of many small iron ore explorers active in the Pilbara region of Western Australia.

For some time, management at IOH has been saying that investors are substantially undervaluing the stock, a claim which has fallen on deaf ears because that’s what managers at small exploration companies always say.

But, two recent deals demonstrate that IOH really is worth a lot more than its current price of $1.36 a share. A more realistic value is closer to $6, and perhaps more.

Before demonstrating how IOH is trading at a hefty discount a warning. What you’re about to read cannot be taken as investment advice. See your licensed adviser for that, but when you do, ask him why he hasn’t been recommending IOH.

Listed on the Australian stock market just six years ago IOH pegged a series of exploration tenements in the central Pilbara, with its best assets located roughly equidistant from the major mining operations of the Pilbara’s big three miners; BHP Billiton at Mt Newman, Rio Tinto at Tom Price, and Fortescue Metals at Cloudbreak.

Being at the centre of activity, and close to all-important railway and road transport corridors IOH could, in theory, develop its own mines. In practice, that is almost impossible for a small miner because of the problem of winning access to the infrastructure of the big miners.

So, rather than waste time and money fighting to gain access to the railway systems of a rival miner IOH has been selling its discoveries for a handsome profit – and it has much more to sell.

On October 7, IOH finalised the sale of its Koodaideri South tenements to Rio Tinto subsidiary, Hamersley Iron for $32 million, plus a future 2% royalty on ore mined. Last Thursday it sold a package of three more tenements to Mineral Resources for $42 million.

For a company valued on the stock market at about $150 million when news of the asset sales broke (September 27) the $74 million raised in two asset transactions is a significant event. More important however than the cash was the value placed on each tonne of IOH’s ore.

In the case of the Hamersley deal the $32 million bought 106 million tonnes of ore assaying 58.6% iron. On a unit basis the price is equivalent to $3.32 per tonne of ore. In the second sale to Mineral Resources the $42 million bought 54.8 million tonnes of 56.7% ore, $1.30 a tonne.

Valuing iron ore is never easy because all deposits differ, and a valuation must take into account factors such as the iron content in the ore, the location of the orebody, and then apply a discount for impurities such as phosphorous, silica and alumina.

But, as a rule of thumb, IOH has demonstrated (twice) that it can sell seemingly stranded orebodies for a handsome price with the $74 million raised lifting the company’s cash balance to around $116 million (it had $42 million in the bank on June 30) – which means that 51% of the current $226 million value of the company (166 million shares at $1.36 each) is covered by cash.

What comes next could be even more significant because IOH’s flagship project, the 259 million tonne Iron Valley project, would fetch a handsome price thanks to its grade and location which sees it surrounded by all three major miners – Rio Tinto to the east, BHP Billiton to the north-west, and FMG to the north-east.

IOH claims it is moving towards a decision to mine Iron Valley with a pre-feasibility study scheduled for completion in the middle of next year, potentially leading to a mine producing up to 15 million tonnes of ore for between 12 and 15 years.

Or, IOH could do what it does best and take the cash which, using the Rio Tinto deal as a template ($3.32 per tonne) means Iron Valley is worth $859 million – 3.8 times the current $226 million market capitalisation of IOH on the stock market.

In effect, IOH has worked itself into a win-win situation. It either continues to take the cash from asset sales, or forges ahead with its own mine plan.

More money will be made mining, but over time, and if a transport solution can be found.

Continued assets sales, a reasonable alternative given the weakening outlook for iron ore prices, could see IOH amass a pot of cash approaching $1 billion which, given the current issued capital of 166 million shares implies a value per share of around $6, more than four-times the current price of $1.36.

If IOH ever gets to that theoretical $6 share price the value of Stokes’ 83.8 million shares slides comfortable over the $500 million mark which, given that his major interests are in media and industrial equipment might be considered petty cash.


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