Farmer's battle to save Lonmin

Gareth Tredway | Tue, 28 Jul 2009 06:30
[miningmx.com] -- ONE phone call. The simple picking up of a handset by Xstrata CEO, Mick Davis in August last year. That’s all it took to rock Lonmin’s world and set the ball rolling for massive change within the group, most notably the resignation of the phone call’s recipient, Brad Mills.

Davis informed Lonmin’s CEO that Xstrata – with previously stated intentions to develop a platinum division – had settled on Lonmin as its next major step into the sector.

It wasn’t a stunning surprise: Lonmin had already tested the waters through its Mototolo joint venture with Anglo Platinum, a deal with junior explorer Nkwe Platinum and the extraordinary $1bn cash acquisition of Eland Platinum in 2007.

A couple of months later – and with Lonmin having rebuffed Xstrata’s offer as beneath its own valuation – Xstrata just as suddenly stepped away. Uncertain financial markets and unsuitable debt terms had made the deal unfavourable, it said.

However, it didn’t leave the scene empty-handed, having spent almost Ł1bn buying 24.9% of Lonmin’s shares on the market.

For Mills the outlook was bleak. Not only was the bid a present danger to his own position as CEO of Lonmin, but its rationale also appeared to formally put his management achievements under the microscope, particularly Lonmin’s operational shortcomings of several years. Meanwhile, Lonmin’s share price is currently languishing at half the offer price of Ł34/share.

The board didn’t look far for a successor, offering the top job to 46-year-old Ian Farmer, former strategic officer and a 22-year veteran at the company. “I think clearly it was beneficial to the company to have somebody at the helm who knows the company and could hit the ground running, making some of the changes that were necessary,” says Farmer after almost eights months into the job.

“Clearly, I’m a known person to the board and so they weren’t taking the risk of an outside appointment. I guess it was the logical thing to do at the time.”

Since then the company has shelved $650m worth of growth projects, acquired several years earlier, slashed the size of its London office by a third, halted its aggressive mechanisation strategy and shrunk its production profile to the lowest levels since 2000.

I’m a known person to the board and so they weren’t taking the risk

If there were any doubt as to why such cost surgery was required look no further than its recent results. In May it announced its first interim loss ever, passed the dividend and has joined the wall of global corporates tapping the market for fresh funds, raising in June $457m via a rights offer.

“The rights issue effectively puts us in a cash neutral position on a pro-forma basis,” says Farmer. “The cash flow in the second half of our year is still trending negatively but at a lower run rate than the first half. So we’ll end this financial year to end-September with a small, moderate amount of net debt again.” Farmer describes the restructuring moves as a “series of self-help tests” to try and “restore some stability and focus in the company”.

Ouch

Lonmin reported a $112m loss in the six months to end-March 2009, which included $44m of restructuring costs, expected to derive around $90m of annualised savings.

In a “sell” note titled “Ouch!”, Evolution analyst Charles Kernot wasn’t impressed with the small costs savings that will be achieved from the restructuring costs mentioned. “We believe the group will need to take more radical action and that, with a difficult outlook for platinum group metals prices, group profitability will remain under pressure,” Kernot wrote.

Yet Farmer says he’s hopeful its 2009 half year loss was a bottoming point in the numbers. “We’ve taken various steps to put the company in a much better position in the second half by reducing our cost base and taking the high cost ounces from our portfolio.

"So the next six months should be positive from an earnings before interest, tax, depreciation and amortisation perspective but may still be negative from a cash flow perspective, because of the capital programme we’re working on.”

After selling more than 900,000 oz/year for three years to 2006, platinum ounces sold then trended lower and 2009 platinum production is expected at 700,000 oz.

Its flagship Marikana operation does have potential to again get group production to 900,000 oz, says Farmer. However, that isn’t planned any time soon. “Quite when we’d get there – and how much money it would take to get there – is something that’s still under debate.”

Farmer's three-pronged plan

Farmer’s three criteria for growth are: balance sheet capacity, now bolstered by the rights issue; the complete reworking of the company’s long-term plan, expected at the November results announcement; and a clear indication the market can absorb the additional metal.

The existing Marikana business has three new shafts sunk, equipped and currently being developed. Farmer says the largest – K4 – isn’t producing at all, the Saffy shaft is producing at 25% of capacity, while the smallest of the three is producing at 50% capacity.

“They are brand new shafts,” says Farmer. “There’s an increase in the amount of capital required to activate that, but it’s not huge in the context of platinum industry benchmarks as the shafts are sunk and they’re already equipped. It’s just a matter of accelerating development.”

The company’s failure to produce results from its aggressive mechanisation strategy has seen its rollout drastically reduced. Under Mills, Lonmin had a goal that half its production would be sourced from mechanised operations by 2010. That would have been achieved by fully mechanising the new shafts mentioned above.

The number going forward now looks more like 8% to 10% – a level Farmer says he’s happy to let continue until the concept is proved. “The failure of the mechanisation initiative was that it was clearly too ambitious a project,” says Farmer, referring to its scope and timescale.

Other growth opportunities include Lonmin’s Limpopo and Akanani projects, bought in 2005 and 2006 respectively. While they remain core to Lonmin both have a long way to go before producing metal. The Limpopo mine was mothballed last year and restarting it would only take place on an expanded basis. Meanwhile, Akanani hasn’t yet got a pre-feasibility completed.

Kernot’s note explains the lack of growth coming out of Lonmin over the medium term does effect is valuation. “The company’s earnings outlook is therefore likely to remain focused on a relatively stable production profile for some time. Valuation, therefore, will be related to the group’s existing free cash generation rather than any growth-related premium,” he wrote.

Of course, Farmer may not get to live his growth strategy if Xstrata makes another grab at Lonmin. Interestingly, however, relations between the two management parties appear to be open since the pre-offer was dropped. Farmer says there have been a handful of meetings over the past six months, where the results have been shared and “roadshow opportunities” have been offered. Even newly appointed Lonmin chairman Roger Phillimore was introduced to Davis.

I’m actually quite grateful for Xstrata’s support

“Quite frankly, it [Xstrata] hasn’t asked for any greater involvement in the company – nor have we offered it,” says Farmer. “I’m actually quite grateful for Xstrata’s support. It’s made supportive comments generally about the actions we’ve taken and the direction we’re heading and it’s supported the rights issue, which is a vote of confidence.”

As Farmer jokes that less things keep him awake at night than six months ago, his hasty entry into the CEO seat – and the 50:50 split in time spent at the London and South African offices – have “kept him flat out”.

With wage negotiations expected around September, and the large shareholder Xstrata in another corner, the new CEO’s job will continue to be both eventful and unpredictable.