Arrium has become the first of the iron ore miners to raise equity in response to falling prices. The company announced it would tap shareholders for $750m to pay off debt, more than doubling its share count and devastating per share profits.
Shareholders will no doubt be cross and some may suggest it was unnecessary. Indeed, on first glance, Arrium doesn’t appear particularly distressed.
Net debt of just under $2bn is enormous next to a market capitalisation of under $900m but operating cash flow covers the interest bill more than 5 times and the company holds assets with a book value of over $8bn.
In its half yearly report, Arrium reported cash costs of about $50 a tonne so it would appear to generate comfortable margins even at current prices. After adding capital expenses, however, total costs climb closer to $90 a tonne.
Arrium is dangerously close to losing money from every tonne it mines. Although it is not distressed today, without prices rising, it surely would have been.
By surprising the market and raising money now, the company was able to access a large pile of cash on reasonable terms. Waiting for necessity would be too late. Markets would discount equity and debt would quickly become an obvious problem. Without action now, the entire business could be threatened.
This is a rare case of a business raising equity smartly. Existing shareholders will be hurting but at least they are still in the game. There are plenty of examples of companies holding out from raising equity until it was too late to do so. Boart Longyear and Billabong are two glaring examples.
Management will use the cash to lower debt and try to withstand a price bust that is getting more vicious.
Arrium does have a few options. An operator of a high cost and low cost mine, it could reduce output and lower average costs. The company also generates about $100m a year from a mining consumables business – all valuable cash.
I’m not tempted by iron ore miners but I don’t mind getting to know a few of them now. Everyone knows that iron ore prices are going to go lower. As one wag puts it, when everyone knows something, it means nobody knows anything.
