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Unloved and undervalued

Unloved and undervalued
December 18, 2014
Unloved and undervalued

Those figures were announced yesterday and the company has sensibly taken a close look at all its commodity investments and taken a realistic view of their current worth. Inevitably this has led to write-downs, the largest of which has been on Polo’s Nimini Komahun gold project in Sierra Leone. Following the outbreak of ebola in the country, and the declaration of a state of emergency, Nimini has moved to a care and maintenance footing until the crisis is over.

To recap, the Mine Development Agreement which will establish the fiscal regime for the development was signed in February by the minister of mineral resources to Sierra Leone’s government. Subsequently, Nimini was advised that certain terms needed to be renegotiated ahead of ratification by parliament. However, the outbreak of the ebola virus has led to a postponement of those negotiations. Polo has written down the investment by $31m to $20m, or £12.7m, which equates to 4.5p of its net asset value of 27.2p a share. The last Mineral Resource Estimate showed a resource of 890,000 ounces of gold at the project.

Sensible accounting

The company has also marked to market value all its listed investments. These include holdings in Aim-traded Banglasdesh coal project developer GCM Resources (GCM: 15.75p); Australian listed Celamin Holdings NL (CNL:ASX), a company holding phosphate interests in Tunisia; Western Australian gold explorer Blackham Resources (BLK:ASX); and Aim-traded Namibian copper explorer Weatherley International (WTI: 2.5p). Combined these four investments are worth 2.3p per Polo share. Polo has made investments in the last three companies in the past six months to try to take advantage of the sharp fall in commodity prices and the favourable environment for making investments in this area. It reviewed no fewer than 40 potential investment opportunities as part of this process.

Time will tell whether any of these pay off, but frankly they don’t have to because at the current price all of Polo’s investments are in the price for free. That’s because as of 12 December 2014, Polo had cash, receivables and short-term deposits of $35.6m (£22.6m) on its balance sheet, or the equivalent of 8.3p per Polo share. This means that 1.3p of cash on the balance sheet and all of Polo’s unlisted investments worth 16.6p per Polo share are in the price for free too.

So even if you ignore the 4.5p per Polo share represented in the company’s net asset value of 27.2p by the Nimini investment, and ignore the value of all the aforementioned listed investments worth 2.3p a share, then there is still value to be had in Polo’s unlisted holdings, worth 11p a share.

Valuable investments

As I have noted before, the key value creation for Polo shareholders still lies in its 42 per cent stake in Signet Petroleum. Following Signet’s farm-out deal with Shell in Namibia in February this year - which led to a $22.8m cash payment to Polo, worth 5.1p per Polo share – Signet has invested $10m of its retained sale proceeds in Regalis Petroleum, a company that has been developing oil concessions in both Chad and Namibia and owns a 70 per cent interest in Block 2813B in the Orange Basin, nearby the Kudu discovery and the former Signet Petroleum block. This gives Signet a 9 per cent shareholding in Regalis. Polo already has a 7 per cent direct interest in Regalis so in effect now has a 10.78 per cent combined interest, worth $12m in total, or the equivalent of 2.8p per Polo share, through its 42 per cent stake in Signet.

Importantly, the investment in Regalis by Signet was pitched at the same price - $2.25 a share – as all of Regalis’ other fundraisings (totalling $30m since mid-2012). Regalis is still working to a farm-out agreement on Block 2813B and is in the late stages of finalising a joint venture for a 72 per cent working interest in three prospective exploration blocks in Chad. The $10m raised from Signet’s investment will be used for a drilling campaign to starts early next year.

And Signet’s $10m investment in Regalis aside, there is still substantial value to be untapped from the investment in Signet’s other assets too. These include an 80 per cent operated interest in the Mnazi Bay North licence offshore Tanzania where 2D and 3D seismic data indicates an up dip extension of the neighbouring BG/Ophir Chaza gas discovery; a 90 per cent operated interest in Block 03 offshore Benin; and a 87.5 per cent operated interest in Block C in Lake Tanganyika Burundi.

Signet and Regalis hold the key

In terms of likely value creation for Polo’s shareholders, which is what counts most, the investments in Signet and Regalis – accounting for around a third of Polo’s net asset value of 27.2p – are key as far as I am concerned. True, it’s disappointing that Polo hasn’t used some of its cash to initiate a share buy-back programme of its own as this would be significantly value enhancing given the company’s share price is a massive 75 per cent below book value. I believe that chairman Michael Tang, who acquired 11.77 per cent of his company’s share capital at 40p a share in May 2013 through his investment vehicle, Mettiz Capital, has missed a trick here as it would have given a major confidence boost to investors. Admittedly, the results release provided far more detail than previous ones so it would appear that the board have at least been listening to requests for greater transparency. Shares in the company bounced more than 10 per cent post yeaterday’s results release.

It’s well needed too as appetite for small cap resource investment companies in the current climate is depressed to say the least. But as analysts at Liberum Capital rightly point out: “Polo remains well capitalised to weather the current market difficulties and take advantage of investment opportunities with 30 per cent of its net asset value in cash and its operating cost base declining.” And with net cash and receivables of £22.6m now exceeding Polo’s own market capitalisation of £19.3m, then the potential for any positive news on the drilling front, or potential farm-outs, or asset sales, is in the price for free.

Polo shares are unloved, and well under water, but they are still worth holding onto at 7p.

Fortune favours the brave

I am not the only one who has seen the obvious value in Fortune Oil (FTO: 9.4p), a supplier of crude oil, transportation fuels and natural gas. A consortium owning almost 57 per cent of the issued share capital do too and have launched a cash bid this morning valuing each Fortune share at 10p, valuing the equity at £259m. Shareholders are also being given a contingent value right worth 5p a share, or £129m, and one which means they will benefit from a material share in any value realised from Fortune’s valuable 11.3 per cent shareholding in Hong Kong-listed China Gas Holdings (HK:384), an energy giant with a market value of £5bn. Shares in Fortune rose 50 per cent to 9.4p on the news and are now slightly above the recommended buy-in price in my 2014 Bargain shares portfolio.

It seems a fair assumption to make that Fortune Oil's shareholders will get the other 5p a share as the stake in China Gas Holdings is currently worth £565m, or 21.8p per Fortune share, so is way above the level of the 15p a share offer. The 15p a share offer represents a small premium to Fortune Oil’s last reported net asset value of 13.8p, but this only valued the China Gas stake at £400m in the accounts, or 6.3p per Fortune Oil share less than the current market value.

I feel that this is probably the best way to extract value for Fortune shareholders and with 57 per cent support the offer is likely to succeed. For now though I would await documents for the full details of the takeover bid.

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