Getting to the bottom of the Western Potash and CNOOC deal
Zimtu Capital Corp. (TSX.V: ZC) has appreciated over 30% in the last couple of days and certainly one of the drivers for this rebound has been the recent success one of Zimtu’s major holdings Western Potash Corp. (TSX: WPX), which announced a strategic investment from Chinese parties buying 19.9% of the company for $31.9 million. The deal is set to close on June 14th.
In fact, the correlation between ZC and WPX is remarkable as Zimtu holds over 2.75 million shares and 2.7 million warrants. To this day there remains a close relationship between the two companies as ZC was a founding partner of WPX. It’s worth pointing out, for every 1000 shares of ZC investors have a total exposure to 477 shares of Western Potash including warrants. So, from ZC’s perspective there are strong reasons to have a closer look at this deal.
Let’s start with a bold statement: The Milestone Potash mine in Saskatchewan will be built! And here is an even bolder one: The mine will be built by WPX – today a junior company! The market may not fully comprehend this yet, but with the latest news of the entry of significant Chinese partners into WPX, the Company has embarked on a different route that may surprise everyone. The aim of the WPX deal – positioning oneself with a strategic partner – when successful, could become a model for future foreign investments into the Canadian natural resources sector.
Here is what WPX is trying to achieve and what this deal is really about: The Company wants to put a major asset – a 2.8 million tonnes per annum potash mine – into production while keeping WPX shareholders in the picture. How is this possible? How could a company with just over $150 million market capitalization be able to pull off a financing in the order of $3.3 billion? Let’s start by taking a closer look at the participants that have just bought into WPX :
CNOOC, the parent company of China Blue, is the largest off-shore oil and gas producer in China. China Blue, the subsidiary itself, is a Hong Kong listed Fertilizer Company with expected sales of $12 billion for the current year. Looking at China Blue’s product portfolio indicates a strategic need. Their executive summary states that China Blue is strong in urea and phosphor, but KCL (the third essential element in a complete fertilizer) is missing. So from China Blue’s point of view, the deal with WPX makes perfect sense. Milestone has the size and longevity to supply up to half of China’s current potash imports (no growth supposed) for decades.
The other group participating and 40% owner of the newly formed JV vehicle, CBC Holding Corp (CBCHC), is Benewood Holdings Corp., a wholly-owned subsidiary of GUOXIN International Investment Corp Ltd. GUOXIN is a large financial investment institution listed in Hong Kong, who keeps a low-profile but is growing in significance. Chinese investment banks can structure finance agreements with a 3:1 debt to equity ratio. This could mean that WPX would only need $750 million USD to fully finance the mine construction. On a side note, this deal sends a message to Western based investment banks. The WPX deal structure offers a new way to finance large scale resource development projects.
I recommend everyone Google “CNOOC and Saskatchewan”. Not only will you find information on the recent acquisition of Nexen Inc. by CNOOC for $15.1 billion, but more importantly, you will find the comments by the Saskatchewan Premier Brad Wall. Mr. Wall has publicly stated that Saskatchewan wants to protect itself against the take-over of its natural resource assets by large multi-nationals and state sponsored entities. The prolonged political scrutiny by the Canadian Monopoly Commission regarding CNOOC’s purchase of Nexen conveyed apprehension in relinquishing control of Canada’s natural resources at the federal level.
It is fully apparent that the Chinese government and the large companies they sponsor are focused on the projected long-term needs of their country. Canada is rich in natural resources, and the size and grade of the commodities Saskatchewan boasts, is clearly attractive to countries like China. However, there appears to be a shift in the willingness of Canadians to allow sizable domestic natural resources to be acquired by foreign entities. As well, the dismissal of BHP’s bid for Potash Corp. (TSX: POT) by the Federal Government, influenced by the Government of Saskatchewan, has sent a strong message that the Province will not be pillaged. The Chinese appear to understand all of this, and that if they want to gain access to assets in Saskatchewan a different approach is required; the current deal with WPX is such a different approach. In this case, the Chinese have understood that owning a part of a Canadian company that creates employment opportunities for Canadians, and that will pay Canadian taxes is the way to get access to these assets for their interests.
It is important to point out the WPX deal is different from other off-take agreements that the junior potash industry has seen in the past. Not only has WPX closed (or is about to close) a deal with a producer, but there is also a bank involved. This is a very powerful combination. No other recent deal is close to negotiating a successful financing structure. The market understands that deals with weak off-take partners are dead in the water and the likelihood of these projects being built is small. The access to capital is crucial.
The WPX deal has a lot more to it: It is a non-exclusive, off-take deal for one million tonnes per annum or 30% of the production under one million tonnes over 20 years. The important fact is that other participants are welcome to join. This deal is an invitation to other groups. It’s as if WPX was planning a major shopping mall and had just found the first major tenant. The second tenant (off-taker) will have an easier decision and runs a smaller risk. Most likely, this new incoming party will be agreeing to actively participate in the project. Therefore, direct investments against off-take agreements and/or equity stakes in the project could be a viable route to secure the collateral for a debt financing.
Certainly the Milestone Project is not for the short-term speculator. Structuring a final deal, potentially tying in more off-take agreements and overcoming other challenges will consume time. The truth is that with this deal WPX will slowly become a story for real investors. Patience is required, but there is great potential.
Therefore, I would suggest that WPX should be of interest to potential investors. Technical reports completed by amec, available on the Western Potash website, indicate a significant net asset value for the Milestone Project. This deal is an important step in realizing the potential value which has been locked away in WPX shares. However, investors interested in diversity should also take a look at the unique opportunity ZC shares provide. Through project generation and equity investments, ZC has built significant exposure to many different mineral exploration companies. Therefore, ZC shares offer both diversity of mineral projects and the commodity being actively explored, while providing significant exposure to WPX.
The author Sven Olsson is a director of Zimtu Capital Corp. The views expressed in this article are personal and do not represent an instigation to buy stock.