- Strategic investor bids $145mn to buy 65% of OMEX, implying valuation of $223 million. OMEX’s market cap prior to announcement was $45 million. Liquidity fears abate for one year minimum.
- “Strategic” is word of the day. MINOSA, the mining arm of Mexican industrial conglomerate, AHMSA, is second largest mining firm in Mexico. Investor’s clout and expertise offers OMEX significant benefits.
- OMEX now has a financially strong, politically connected, credible Mexican partner on its side of the table when it comes to negotiating a deal to develop Oceanica and other assets.
- Further catalysts: MIA approval, MINOSA equity investment, strategic fertilizer partnership , Victory re-approval, Victory recovery updates, Russell reconstitution, Central America title ruling, announcements regarding new mineral and/or shipwreck projects.
- Despite ownership dilution, valuation analysis indicates near-term target of $2, and 12 month upside of $4 to $6 (pre-split).
Odyssey Marine (NASDAQ:OMEX), a company that recently traded at a market capitalization of just $45 million, has received an offer from a subsidiary of Mexican mining firm, MINOSA (Minera del Norte S.A. - a subsidiary of Altos Hornos de Mexico (AHMSA))(we will use MINOSA and AHMSA interchangeably in this note), to purchase 65 percent of the firm for $145 million. The deal is subject to various terms and conditions, but if executed as planned, would value OMEX at approximately $223 million.
The proposal points to a deep disconnect between the private market value of Odyssey's assets (principally Oceanica) and the public market price of its equity. It is clear from the circumstances surrounding the transaction, as well as some of the deal terms, that AHMSA's purchase is being driven by the firm's interest in Odyssey's seabed mining assets (again, principally Oceanica). If we were to ascribe 75 to 100 percent of AHMSA's purchase price to Oceanica, it would value the asset at approximately $310 - $410 million, roughly in-line with the value of the Mako options strike price.
The fact that this disconnect is being brought to light thanks to the in-depth due diligence efforts of a multi-billion dollar Mexican mining firm, possessing privileged access to sensitive information related to Oceanica, gives it greater significance. Further, given OMEX's compromised position vis-à-vis its lack of liquidity, it is likely that the premium paid in this transaction understates the value of OMEX's assets considerably. More of that value will be unveiled in coming months, as this offer triggers a series of events and transactions which will highlight fairer valuations.
Much of the AHMSA investment won't come until after a shareholder vote, and shareholders will have to elect to stomach significant dilution in accepting this deal. Regardless, it is clear that AHMSA has made a significant commitment to OMEX. That commitment is evidenced not only in the convertible note financing, but just as importantly in the man-hours, legal fees, and the relationships which would have been formed to achieve an offer such as this one. We shouldn't underestimate the ties already established between these organizations.
The AHMSA offer marks a transformation for Odyssey, but not just for the obvious reasons. In fact, some of the less obvious reasons may be far more important than the $145 million in liquidity the company will likely add to its balance sheet. The strategic nature of this investment marks the beginning of Odyssey's emergence as a mining company with a multi-billion dollar portfolio, and an end to the company's pell-mell investing and financing history. This is a watershed moment for OMEX investors.
At a high level, if approved and executed, this transaction does a number of things for OMEX:
Provides ample liquidity, allowing the market an opportunity to credit the company for its large assets which were previously undervalued or disregarded due to liquidity risk.
Implies further substantial unrecognized value in these assets and lends credibility to large monetizations ahead, validating OMEX's strategy.
Puts OMEX on the road to becoming a subsea mining firm, and attracts a new group of mining-focused investors.
Brings the discipline and oversight of a successful, large mining partner, with board seats and a controlling equity interest.
Provides a cash cushion to transition OMEX into a self-sustaining, positive cashflow, business.
More detailed conclusions are summarized below:
Oceanica Call Option - Unlikely to be exercised due to restrictions outlined in documents.
The Buyer - Second largest mining company, and largest steel producer in Mexico. Operator of eighteen mines in country. Has made successful Mexican fertilizer investments in recent past.
Environmental Application (MIA) -Large and influential Mexican miner would not make a loan or equity offer without thoroughly vetting MIA. The Investor would have been impressed with the thoroughness and scientific backing behind MIA to make these commitments.
More value to come -Transaction sets in motion a series of events that will unlock value in seabed mining concessions. Strategic importance of Oceanica asset to Mexico, and the Americas more broadly, means that it will attract a large investment from an integrated fertilizer company. Additional seabed mining developments may be announced soon. Victory salvage project also likely to add value.
Short Story - Principal negative arguments eliminated upon execution of investments. Shorts face less appealing risk/reward outlook with additional catalysts of high significance on horizon and liquidity concerns removed for at least one year.
Vote of Confidence - Buyer's main interest is mining assets, but investment in parent company, rather than directly in Oceanica, implies confidence in OMEX's other mining and shipwreck assets, and in the firm's expertise.
Oceanica - MINOSA/AHMSA's due diligence confirms Oceanica is a highly valuable and strategic asset.
Valuation & Liquidity - Buyer with superior information willing to pay $1/share for the largest portion of equity investment. Implies that the investor believes the company is worth significantly more. ~$15mn in note proceeds plus SS CA monetization proceeds would allow company to survive twelve months on a restricted diet while beginning Victory recovery if deal is not consummated.
The Oceanica Call
This transaction has raised a number of questions due to its complex nature and the paucity of information provided by the parties involved. Not only is the small amount of information provided insufficient to understand certain parts of the transaction, but some of the documents appear to have been partially redacted. Further, we may not have seen all of the deal documents if some were deemed non-material. More important, what information we do have may not accurately describe the intent of the two parties. The documents and conference call describe the legal bounds of the transaction but leave plenty of room for different outcomes depending on the intent of those involved.
The Oceanica Call is a perfect example where the legal documents provide more questions than answers about the true nature of the deal. This analysis will attempt to describe why the Call option is there, and under what circumstances it might be exercised. Our conclusion is that the Call is unlikely to be exercised.
On the face of it, the Call doesn't make much sense. AHMSA is offering $145mn in exchange for 65% of OMEX. AHMSA's interest lies almost exclusively in OMEX's mining business - which is primarily Oceanica. If we ascribe 75-100 percent of the transaction price to Oceanica, this would imply an overall valuation of approximately $310 to $410 million for the asset. Why would OMEX write AHMSA a call on Oceanica at a valuation of approximately $74 million, when AHMSA has made a substantially superior offer for that asset?
The situation is nonsensical unless we describe the two transactions as mutually exclusive. In other words, the Call won't survive if the Stock Purchase Agreement (NYSE:SPA) is closed, and the SPA won't close if the call is executed. It doesn't make much sense for AHMSA to buy Oceanica twice, and the alternate way of thinking (buying OMEX ex-Oceanica) requires some heroic valuations regarding Odyssey's other assets (mainly mining assets because that is where AHMSA's interests lie) to justify the price tag.
From a financial perspective (ignoring strategic considerations), it would make sense for the Investor to wait for MIA approval, then execute the Call and terminate the SPA. AHMSA would walk away with 54 percent of Oceanica for $40 million (plus their pro rata share of the payable owed to OMEX) and forget about buying OMEX stock.
Let's ignore the fact that were this the buyer's plan, there would have been no need for the SPA and the legal bills, wrangling over board seats, due diligence on OMEX, etc.. The more definitive reason why this course of action is unlikely comes from the documents.
FROM THE CALL OPTION AGREEMENT:
Section 6.1. Termination of Agreement. This Agreement may be terminated and the transactions contemplated hereby may be abandoned prior to the Closing as follows:
(NYSE:A) at any time, by mutual written consent of Holder and Purchaser;
(NYSE:B) by Holder, upon written notice to Purchaser, in the event that Purchaser elects to terminate the Purchase Agreement pursuant to Section 8.1(NYSE:D)(NASDAQ:III) thereof; or
(NYSE:C) at the Expiration Date, if an Exercise Note has not been delivered prior to the Expiration Date.
FROM THE PURCHASE AGREEMENT:
Section 8.1. Termination of Agreement. This Agreement may be terminated and the transactions contemplated hereby may be abandoned prior to the Initial Closing as follows:
by Investor, by written notice to the Company, if:
SECTION 8.1 : at any time, if the Investor, in its Sole Discretion, determines that the conditions to closing in Section 6.2(NYSE:H), Section 6.2(NYSE:I), Section 7.2(NYSE:G) or Section 7.2, have not been satisfied;
Section 6.2. Investor Conditions. The obligation of Investor to consummate the Initial Closing is subject to the satisfaction (or waiver by Investor in its sole discretion) of the following conditions:
Investor Consents. Investor shall have received the consent of certain of its parent entity's creditors, and such consents shall be satisfactory to the Investor in its Sole Discretion.
Don Diego Consent. The Investor shall, in its Sole Discretion, be satisfied with the viability of the Don Diego Project (including, but not limited to, the status of the application for and the terms of all necessary Permits related to the Don Diego Project).
Section 7.2. Investor Conditions. The obligation of Investor to consummate each Subsequent Closing is subject to the satisfaction (or waiver by Investor in its sole discretion) of the following conditions:
Investor Consents. Investor shall have received the consent of certain of its parent entity's creditors, and such consents shall be satisfactory to the Investor in its Sole Discretion.
Don Diego Consent. The Investor shall, in its Sole Discretion, be satisfied with the viability of the Don Diego Project (including, but not limited to, the status of the application for and the terms of all necessary Permits related to the Don Diego Project).
To simplify - OMEX has the ability to terminate the Call if the Investor terminates the SPA using either one of its two discretionary conditions. The other conditions by which the SPA may be terminated are basically out of the Investor's control and/or discretion. So, unless AHMSA wants to buy Oceanica twice, these terms would seem to substantially impinge upon the Investor's ability to Call Oceanica for $40 million.
Alternatively, if AHMSA were to execute the Call, wait a period of time, and then attempt to terminate the SPA, OMEX couldn't terminate the Call if it had already been executed. The company would be powerless to stop AHMSA from walking away with Oceanica at a dirt cheap price, and opting out of the equity investment.
The issue in this scenario is that AHMSA would look like a bad actor, and would open itself to class action investor lawsuits which could tie up Don Diego in courts for years. It would be difficult to invoke either the "Investor Consents" or "Don Diego Consent" conditions to terminate the SPA after having executed the Call option. The creditors and AHMSA somehow were concerned enough about OMEX (essentially Don Diego) to terminate the SPA, but not concerned enough to pass up the Call option? It would be tough for the lawyers to make that argument while keeping a straight face. It would also be difficult to argue that AHMSA's actions were consistent with the intent of the deal structure.
The allure of buying more than half of Oceanica for $40 million would be high, but the risks would likely be higher. The asset could be lost entirely, the project would almost certainly be delayed significantly, minority shareholders in the asset would be upset and could make AHMSA's life difficult, and the company would be thrust into the spotlight in a very negative light.
Why have the Call option at all if AHMSA can't use it while terminating the SPA? What if it's not AHMSA terminating the SPA, but OMEX instead? If OMEX's shareholders were to vote down the proposed transaction, the Call option might make some sense. If another buyer emerged with a superior offer for OMEX, the SPA could also be terminated by OMEX and the Call option executed. The Call would offer the Investor protection to make sure that AHMSA got a return for all the work put into the deal, and work put into the asset itself, after the initial deal was signed. A shareholder rejection or White Knight bidder are both fairly unlikely outcomes, which is why the Call is not likely to be exercised. Nonetheless, each is a possibility. This seems to be the best explanation as to why the Call exists.
The explanation fits with the background of the deal as well. The Investor has a strategic interest in seabed mining and sees OMEX as an inexpensive vehicle to gain access to the business. The Investor's interest is not limited to Oceanica. Even though the Call option would certainly be an attractive financial option for the Investor, the documents were constructed such that this was a protective mechanism for the buyer, not the preferred outcome. This would reflect the Investor's strategic interest per management commentary.
More Than Meets The Eye
Anyone who has read the deal documents will attest to the fact that this is a complex transaction. The most important information, however, is not written in the documents. This information comes from reading between the lines.
OMEX was clearly in a compromised state as it negotiated this deal. The company had been running on fumes for at least a month prior to the closing. I'm sure they were able to slow pay some vendors and perhaps sell some assets to ameliorate the situation, but OMEX was not in good shape regardless.
None of this would have been lost on AHMSA, a sophisticated multi-billion dollar mining company with a fiduciary duty to extract the best deal for its shareholders. AHMSA would have also realized that as a strategic investor, it could not be easily replaced - a financial investor could not offer many of the advantages AHMSA brings to the table.
The fact that a sophisticated strategic buyer holding asymmetric bargaining strength would offer a 23 to 77 percent premium for OMEX stock, after thoroughly vetting the company, and accessing data that you and I cannot, makes a forceful statement about the strength of Odyssey's assets.
Why would AHMSA/MINOSA pay a premium for equity in a company that was on the brink of insolvency, and that had no prospect of near-term cashflow? No rational investor would risk their capital in that manner unless they saw significant upside, and manageable risk, in so doing. Investors in OMEX are left wondering what price AHMSA would have paid had the deal been struck months ago when the company was in better financial health.
The relative strength of the company's position may also be understood by reflecting on what the transaction isn't rather than what it is. If short sellers were correct, and Oceanica and the rest of OMEX's assets, had little or no value, then there would have been no deal at any price. On the other hand, if there was high potential value in its assets, but the risks were seen as severe, then the deal would have come at a steep discount to market prices.
The transaction could have taken the form of an expensive project-finance-style investment - after all, this has been a structure OMEX has relied upon in the past. It could have also been a death spiral convertible bond, as some investors have speculated. It could have taken the form of a direct interest in a particular asset. It could have required operational or performance hurdles, for future investments.
The fact that none of these alternatives were undertaken speaks directly to the strength of the company's assets. AHMSA wasn't able to take advantage of OMEX in a more costly deal despite the company's weakened state. AHMSA certainly held the upper hand, and did their homework to understand OMEX's prospects, yet the company offered a significant premium to buy stock.
Though this investment was in the parent company, it was largely driven by interest in subsea mining (Oceanica being the most developed subsea asset). This can be seen in the deal terms. The buyer, a large Mexican mining and steel manufacturing firm, may have been approached by OMEX to buy a part of Oceanica due to the buyer's Mexican mining industry expertise. That buyer would have realized that instead of paying for Oceanica at a valuation of around $400 million, it would make more sense to buy approximately half of OMEX, giving the group 27 percent of Oceanica (since OMEX owns 54% of Oceanica) for $100mn+, implying roughly the same $400 million valuation for Oceanica. Buying OMEX equity gives AHMSA upside from Victory, Neptune, all future Oceanicas, and the rest of the shipwreck salvage program at no cost, despite the fact that these assets and businesses have value.
On the face of it, OMEX investors would have been far better off having sold AHMSA a direct interest in Oceanica, rather than parting with OMEX equity at such a cheap price. Had the deal followed this format, however, OMEX shareholders would not have benefited from a corporate-level strategic partnership with AHMSA. In essence, OMEX shareholders are giving up half to two-thirds of the upside in all of Odyssey's assets in return for $100-$145mn, plus the influence of a large, strategic partner. If AHMSA's involvement has the potential to double or triple the value of the rest of Odyssey's assets, and win OMEX new business, then the dilution is worthwhile, and we've made a good deal.
AHMSA offered to pay $1.00 for $100 million worth of OMEX shares for the same reason you or I buy shares in a company - because it believes they are worth more than they are paying for them. Because of the size of AHMSA's investment, its involvement in the business and the Board, and the restricted stock that it took, this is obviously a long-term investment for the firm. AHMSA would only offer such a long-term commitment if the firm saw very strong upside in OMEX with manageable risk.
This deal involves plenty of dilution in ownership. Generally speaking, however, dilution of ownership is neither good nor bad. What matters to shareholders is the change in per share value that results from dilution. If our ownership is represented by a piece of pie, we should be somewhat indifferent to changes in the size of the pie as long as the size of our piece stays the same. In this deal, because AHMSA would pay a premium, the size of our slice is actually increasing while the pie is getting much larger.
As with any investment, the hope is that over time the size of our slice of pie grows larger. The idea behind attracting a strategic investor is that such an investor can help grow the pie at a more sustainable and faster pace than the pie would have grown otherwise. Sometimes having a bigger pie makes growing the pie easier. If this is accomplished, dilution is a net positive.
Yet, judging whether or not this is a "good" deal for shareholders will always be a subjective exercise. This is because we can only theorize about how we would have fared under the path not chosen. All the same, if the deal with AHMSA leads to Oceanica's development, an investment from a fertilizer company, future Oceanica-like developments and approvals, more effective management and asset utilization, greater and more predictable revenue/cashflow streams, then it is likely that shareholders will agree that this dilution represented equity well-spent.
Shareholders with whom I've spoken have mixed feelings about this deal. No matter how well we justify dilution, we all instinctively react negatively to it. While we can argue this deal is a good one for shareholders, we can also see that had it been struck sooner, it may have been less dilutive. It's also true that had the company not faced widely disseminated reports that it had violated SEMARNAT rules, was insolvent, and was publishing manipulated technical data in its 43-101 compliant technical reports, it would have likely been successful raising money this summer. That cash could have made this a less dilutive deal for shareholders.
A Transformative Deal
While the word "transformative" is overused in the world of corporate finance, in this case it is appropriate. The offer from MINOSA has the potential to dramatically change OMEX on several different fronts.
OMEX, a shipwreck salvage company that has a tradition of living on the knife's edge of liquidity, could rapidly become a cash-rich subsea mining exploration and production company, with a multi-billion dollar project on the cusp of development, and a rich portfolio of others behind it. With newfound credibility behind its seafloor mining portfolio, OMEX would have the prospect of further mining monetizations, both in the near and distant future, and the potential for services income. The company also has a shipwreck salvage business that could produce more than a half billion dollars in pre-tax profit over the next 9-18 months.
A massive injection of cash is obviously transformative for OMEX. Liquidity risk has dominated the story since inception. OMEX has traditionally lived from deal to deal, using project finance or equity to see it through to the next monetization. Assuming this investment is approved and executed, OMEX not only will have plenty of cash to deploy, it will have the potential for increasingly steady cash flows in the future, and many opportunities to deploy cash into potentially high return mining projects as well as the HMS Victory recovery. With a full plate of potential investments, OMEX would finally be in position to self-finance those opportunities, promising greater returns to shareholders. Management would no longer be consumed by the prospect of finding the next deal, instead they could focus more time and energy on running the business, and investing capital where it will generate cashflow to shareholders.
The most significant transformational story, however, is that this deal promises to make OMEX a viable subsea mining company. Not only is Odyssey a large owner in Oceanica, which is likely to become a mining operation capable of producing over $100 million in cashflow per year, but OMEX has a portfolio of other seabed mineral rights. A wealthy and experienced mining partner may help finance and develop these concessions, bring new investors to the table in future transactions, and create consistent mining services work for OMEX.
With the potential for substantial cash on its balance sheet, and the prospect of more to come in the form of steady revenues and future asset monetizations, Odyssey could finally afford to pursue existing and new seabed mining opportunities going forward. The speed at which Odyssey developed Oceanica from nothing two years ago, to what may be a multi-billion dollar asset after the MIA approval, is impressive. How many more multi-billion-dollar-potential assets are in the current portfolio? How many more will be added in the near future? The market will need to discount these possibilities going forward.
Minera del Norte (MINOSA) is the mining subsidiary of Altos Hornos de Mexico (AHMSA). MINOSA supplies iron and coal to AHMSA's steel plants and to the Federal electric utility. The unit also mines silver, gold, and copper.
AHMSA is a multi-billion dollar Mexican industrial conglomerate. It is the second largest mining company in Mexico, operating at least eighteen mines in the country (and a couple outside the country). AHMSA is the largest steel producerin Mexico, has 23,000 employees, at least nine subsidiaries, and plans on becoming a producer of natural gas through its coal exposure in northern Mexico.
(click to enlarge)
Picture of Alonso Ancira (right) and Mexican President, Enrique Pena Nieto
AHMSA and its Chairman, Alonso Ancira, appear to be well-connected within Mexican political circles. The picture above shows Ancira with Mexican President, Enrique Pena Neito, last year as AHMSA was opening its new $2.3 billion steel plant dubbed "Phoenix." As each of these articles suggest, Ancira is considered to be a friend of Nieto, and of Mexico's PRI party more generally.
When the PRI party is not in power, AHMSA has had difficulties. The company has battled allegations of corporate abuse and tax evasion. When Vincente Fox of the PAN party became President, AHMSA was charged with evading $2 million in corporate taxes and Ancira fled Mexico to live in Israel. The charges were dropped two years later when Fox left office. AHMSA has also had difficulties with the Mexican environmental agency, PROFEPA, when the PAN party was in power. PROFEPA now counts AHMSA as one of the top ten businesses in Mexico for its environmental leadership (pg 26).
AHMSA recently emerged from a fifteen year bankruptcy. The company filed for protection under Mexican bankruptcy law in 1999, during an awful period for steel companies in North America. Around that time, forty-four US steel companies were forced to declare bankruptcy.
With a number of attractive growth initiatives open to it at this point, AHMSA chose to settle with creditors so that it could open up new sources of growth capital. Under the agreement, AHMSA will repay creditors much of what they are owed, while some debt will be converted to equity. This may pave the way to a public issuance of equity.
Pictured: AHMSA Chairman, Alonso Ancira (right) with Dan Chapman of Black River, signing debt reorganization papers.
Prominent US-based investment management firm, Black River Asset Management, appears to be AHMSA's principal debt-holder (and soon-to-be equity investor). Black River is the $10bn-plus private equity/hedge fund arm of Cargill. Cargill helped create Mosaic (NYSE:MOS), and is one of the leading agriculture products company in the world. Black River's expertise in the fertilizer business, and their connections within the industry, could be seen as highly strategic to the development of Oceanica. One would imagine that as the principal creditor, and soon-to-be major equity holder, Black River would have taken an active role in performing due-diligence on OMEX and its subsea mining concessions. Creditor interest in the OMEX transaction is clearly evident in the deal documents.
AHMSA is a fairly healthy company by industry standards. In the first nine months of 2014, the company generated cash flow from operations ofapproximately $300 million. While AHMSA is losing money on an accounting basis (as is much of the industry), this is largely due to the significant interest expense the firm carries. The debt restructuring, which will involve a partial retirement of debt and a conversion to equity, would make AHMSA profitable on an accounting basis, all else equal.
One of AHMSA's top growth priorities is tapping the natural gas associated with the coal seams it mines in northern Mexico. With the liberalization of the Mexican energy markets last year, AHMSA is in position to become a significant producer of natural gas. Its land holdings in northern Mexico are part of the Eagle Ford shale oil and gas basin that extends south from Texas. AHMSA holdsover 7.4 million (pg 3) acres of mining rights in the Eagle Ford within Mexico. Since AHMSA is already mining coal in the area, and venting the associated methane into the atmosphere (since it had been illegal to sell if before last year's deregulation of the oil and gas industry), building infrastructure to capture and distribute that gas could be a high-return endeavor.
AHMSA is positioning itself to be an important player in Mexico's fertilizer market, aiming to deliver a meaningful boost to President Nieto's National Crusade Against Hunger. AHMSA's moves to produce natural gas may be part of that strategy. Natural gas is in short supply in Mexico, with the country relying on imports, sometimes expensive LNG (Liquified Natural Gas), to meet approximately one-third of its needs. While Pemex controlled the energy industry, natural gas never gained traction in Mexico, as the state-owned energy giant focused on large oil projects. Natural gas is crucial to developing an integrated fertilizer industry, as it acts as a feedstock for the production of ammonia which is used to produce nitrogen-based fertilizers. Ultimately these nitrogen products combine with phosphate (in the form of phosphoric acid) to produce popular fertilizers such as MAP and DAP.
Early in 2014, MINOSA sold a rehabilitated urea plant in Veracruz to Pemex for a total investment of $475 million. That urea plant's economic viability is premised on the idea that more domestic natural gas production will lead to lower input prices for natural gas. AHMSA's plans to produce natural gas, its acquisition and sale of the urea plant, and the investment in OMEX should serve as a signal to investors that AHMSA is serious about participating in the development of a domestic fertilizer industry in Mexico. It would also point to Oceanica's importance to Mexico on a national scale. It would not be surprising to see the mining & steel giant move to build an integrated downstream processing infrastructure around Oceanica, probably with the help of a partner or two.
AHMSA and Black River are powerful institutions which will likely wish to increase the value of their investment in OMEX using a number of different levers. As a miner, AHMSA not only understands environmental science and how to build a successful and thorough MIA application, but the firm knows how to run a mine and process and sell ore. In particular, the firm's expertise in processing may be helpful to Oceanica, which aims to be one of the lowest cost producers of rock phosphate in the world. AHMSA and Black River would also be excellent deal-making partners to have on our side of the table when Oceanica is sold or partnered in the next strategic deal. AHMSA's business connections in Mexico could facilitate future investments in new tenements, new shipwreck salvage business, and other marine services work.
Seabed Mining Opportunity
In a period of two years, Odyssey has created more value from mineral exploration than they created in twenty years of shipwreck salvage. If Oceanica's MIA is approved, OMEX is sitting on what is likely to be a multi-billion dollar asset. Based on the $20-30mn or so that was required of OMEX to fund Oceanica, the returns from this operation appear to be exceptional.
As impressive as OMEX's success in developing Oceanica appears to be, what is especially appealing to shareholders is the fact that OMEX has the potential to repeat this feat any number of times in the future, compounding our gains.
As we speak, we're focused on trying to produce the next Oceanica-type opportunity for Odyssey shareholders - Mark Gordon, 3rd Quarter Conference Call, Nov 10th, 2014
As the market will now appreciate, Mark Gordon's comments carry significance. OMEX has an experienced staff of marine geologists, and the know-how and exploratory tools to grow the portfolio and acquire more attractive concessions. We don't know if the next project will be more successful than Oceanica, but we do know that OMEX will be in better position to retain a larger slice of the next project's economics. With a strong balance sheet, a large, experienced, and connected mining partner, and a record of successful development, OMEX may also be able to streamline future development timelines.
Seabed mining is just beginning to hit the radar screens of institutional mining analysts with big-name buy-side funds. Analysts are coming to realize that seabed opportunities offer the potential for much higher returns than land-based mines, and that becoming involved early will yield the greatest upside. Though the commodity cycle is not favorable right now, and there are still plenty of challenges ahead for this sector (as witnessed with the Chatham Rock refusal), there is little doubt that fundamental economic forces will turn this into an industry over time. Many institutional investors can afford to take the long-term view, and will see OMEX as an inexpensive play on this trend.
The early success of Nautilus Minerals (NUS.to) with its large mining backers, Teck Resources, Anglo American, and Metalloinvest, is paving the way toward the institutionalization of the subsea mining segment. Nautilus has already gained environmental consent for its large-scale (at least for subsea) Solwara1 seabed project, and was recently funded with a $120mn investment from the government of Papau New Guinea, in exchange for a fifteen percent equity stake in Solwara1. Nautilus's success will help to open institutional purse strings for the rest of the sector, and OMEX will benefit. Again, these are still early days for subsea mining, and a long-term investment horizon is required, but the progress is promising.
Environmental Application (MIA)
With a substantial portion of Oceanica likely in the control of a powerful Mexican mining company, the project may be more easily accepted by Mexico. Of course, AHMSA is more than just another Mexican investor. As the second largest mining company in Mexico, and one of the country's largest industrial conglomerates, AHMSA must have as much or more experience as anyone preparing MIAs for approval.
AHMSA didn't become Mexico's leading steel producer by making poor investments. The company knows what it is doing when it comes to mining operations, environmental filings, and industrial chemical/fertilizer plants. Management at AHMSA would have likely done extensive due diligence on Oceanica and Don Diego's MIA before consummating this deal.
Marine dredging projects are not new to SEMARNAT. As the Mexico Dredging Today website indicates, there is a vibrant dredging industry operating in the country. Dragamex (Boskalis's Mexican subsidiary) claims to have conducted over 200 projects in Mexico. This document notes a Dragamex project which will dredge an environmentally sensitive, protected lagoon in Cuyutlan to create a harbor that will host an LNG (Liquified Natural Gas) terminal. Oceanica, operating in an area known as the "mud pits" for its lack of biodiversity, should compare favorably with other dredging projects, especially given the massive benefits the project offers to the Mexican population.
SEMARNAT's decision should come by late June or early July. SEMARNAT has elected to extend the evaluation period an additional 60 working days, after receiving a lengthy response from Oceanica regarding its questions.
For those who are new to this story, Oceanica (also known as Don Diego) is a large, seabed phosphate tenement, located 40 kilometers off the coast of Baja California Sur, Mexico. You'll find more information about Don Diego on the corporate website and in this report published this past summer.
According to the most recent NI 43-101 compliant technical study, the deposit has measured, indicated, and inferred rock phosphate of almost 500 million tons, at a concentration of approximately 18.5%. The size of the defined resource is likely to grow in the future because the company has yet to incorporate data from two adjacent concessions they recently secured. They may also take core samples to a greater depth. Ultimately, the size of the resource could range between 700 million to a billion tons, making Oceanica one of the largest stand-alone phosphate ore bodies in the world.
While we won't get into detail in this note, Don Diego is a resource of significant global scale and strategic importance. In 2010 the US Geological Survey estimated that only 16 billion tons of phosphate reserves were economically viable (out of a total of approximately 71 billion tons of global resource). World production of rock phosphate in 2013 was approximately 230 million tons, so we are depleting a scarce resource at a rapid clip.
The 16 billion ton figure is subject to debate, and the number may be larger. Regardless of the correct global number, however, the supply situation is especially troubling in the Western Hemisphere. The US is the only country in the region with substantial reserves (only 1.1 billion tons) and many of those reserves lie underneath environmentally sensitive areas. Despite these reserves, the US is a net importer of phosphate. Phosphate is expensive to ship from Africa (where most of the world's non-captive reserves are located), so Oceanica is seen as a very strategic, and much needed resource for Mexico and the rest of the Western Hemisphere.
The largest producer of finished phosphates in the world, Mosaic, held itsquarterly call a couple weeks ago. On the call, the company was emphatic in its positive outlook for the phosphate market, while also highlighting Mosaic's desire to grow production in the Western Hemisphere. This commentary, of course, speaks directly to the strategic appeal of Oceanica.
James T. Prokopanko - Chief Executive Officer, President and Director (Mosaic) - Jeff, I encourage you and your colleagues all to just pay closer attention to this phosphate market. It's a story we've been -- the drum we've been beating for a couple of years now. This is a market that's not fully understood, and by that, not fully appreciated. This is a good -- the phosphate is a good market. It's really transformed over the last 5, 6 years. We've seen the structure change. We've seen the alternative suppliers find higher costs. Demand has just been outstanding. We're going to be over -- well over, I think it's 65 million, 66 million tonnes of phosphate production, and it just is one that keeps on going and just hasn't had the spotlight. Well, I think phosphate's day has come, and investors have to be mindful of that and be mindful of who the largest producer of finished phosphates in the world is. And that's Mosaic, if you didn't know.
Michael Rahm (Mosaic, Strategic Planning) - Thanks, Jim, and Jeff, I think the story on phosphate, on one hand, it's a good demand storyeven absent one of the most important buyers, for all intents and purposes, namely India. And I think going forward, we would fully expect that India is going to be back in the market in a much bigger way this year and in the -- really, for the rest of this decade. But I think the other fact that's not fully appreciated is what's happened on the supply side. If you go down the list of major suppliers and take a look at some of the adjustments that have taken place over the last year or 2, there were some pretty dramatic changes. You can probably calculate 2.5 million to 3 million tonnes of supply that is no longer producing.
James T. Prokopanko - Chief Executive Officer: … I'll take your question about the phosphate and the degree to which we're satisfied with our current footprint. This is a market that we continue to be positive about. We're -- the market, as I said earlier, has changed. The structure of the industry has changed for the better and the barriers to entry are huge. We -- and so we feel very good about the market. If that's signaling that we're interested in growing in the phosphate market, you absolutely heard right. We'd like to be -- have a bigger footprint in the market. That's, in part, the reason we invested in the Ma'aden joint venture. Some years out, there could be a Ma'aden Phase 3, but we are going to continue to look for opportunities to be a bigger player in the -- in phosphate production. And ideally, to broaden our geographic presence, Latin America is an excellent -- is one of the fastest-growing agricultural regions in the world. If there was some way to get into the phosphate business in Latin America, we'd be interested in doing that.
One would have to imagine that Jim Prokopanko, CEO of Mosaic, knows quite a bit about every prospective phosphate mine of significance in the world. Mr. Prokopanko knows that there is a way to get into the Latin American phosphate business, in a big way, and he appears to be prepping investors for just such a move. The timing of his comments is interesting in light of Black River's involvement in Oceanica.
The fact that Mosaic is operating a rock producing JV in Peru, and has operations for blending and distributing phosphate products elsewhere in South America, tells us that the company is already in the phosphate business in the region. It sounds like what Mr. Prokopanko is saying is that he sees the opportunity for a major investment in the region. Making an investment to build downstream processing and produce phosphoric acid, MAP, and DAP, would only be justified if Mosaic had access to a large and secure source of rock phosphate, and the potential for sourcing cheap natural gas.
Oceanica's appeal to MOS and other integrated fertilizer companies is not limited to the concession's enormous size or its strategic location. There are several technical characteristics of the rock which make the resource attractive, and then there are the costs of extraction. OMEX management has been unequivocal in their messaging regarding the costs to extract this resource:
We believe that given these factors, this project could be among one of the lowest production cost phosphate extraction operations in the world." Mark Gordon, 1st Quarter Call, May 13, 2014
The CEO of Odyssey knows the costs of his project better than just about anyone else, but we can confirm his conclusion using other sources. This research note outlined many of the relative cost advantages of subsea vs. terrestrial extraction. We also know that marine dredging for aggregates, a process that is almost identical to phosphate dredging, has been operating profitably in Europe for over thirty years. Aggregates are sold at prices around $10/ton (pg 2), indicating a cost to extract that is well below $10/ton after taking into account costs to crush, screen, and rinse the material. So the idea of selling phosphate at well over $100/ton (Mexico pays ~$140/ton for Moroccan rock) using the same marine dredging process (plus floatation which adds up to $20/ton in cost) is likely to be highly economic. Based on Mosaic's recent commentary, I believe that they've also come to this conclusion.
The Future of Don Diego
The Mexican government and Pemex (Mexico's state owned oil & gas company) have already made it clear that the build-out of a fertilizer industry is a strategic imperative for the country. Don Diego is just a piece of that puzzle, but it's an important piece because it's a large source of a crucial feedstock. The fact that Oceanica is important on a national (as well as international) scale, means that the concession is likely to become part of a multi-billion dollar, high value-added, vertically-integrated industry, which will create and sell a number of fertilizer products at home and abroad.
As we argued in a previous paper, Oceanica's value could ultimately exceed $2bn. This, however, would require a large investment in the project. That investment might come from an integrated fertilizer producer who could build-out new processing infrastructure in Mexico, or use existing infrastructure elsewhere. The format of that investment could be similar to that used by Vale in their phosphate mine in Bayovar, Peru. In that transaction, Mosaic agreed to buy a large portion of the mine's production, and Mosaic and Mitsui invested $660mn for a 60% stake, valuing the concession at $1.1bn. Oceanica is more than double the size of Bayovar, has higher run-of-mine phosphate concentration, and is said to be more cost competitive, so its value is likely to exceed that of Bayovar. In fact, given Oceanica's size, strategic nature, and potential for government involvement, the transaction might look more like Mosaic's $1bn investment in the Ma'aden project in Saudi Arabia, which valued that project at $4bn.
As in the case of Ma'aden and Bayovar, Oceanica could be capitalized by one of the integrated fertilizer companies who might buy a large stake, take all or part of Oceanica's production, and contribute $1bn+ toward capex. This would mean that OMEX would not have to put another penny into the project, but could see large cashflows from it once production begins (assuming it does not sell its stake). With the equity provided by AHMSA, Odyssey can afford to wait several years while that mine and supporting infrastructure are built. That wait may be made easier if OMEX is engaged to do exploratory and management work around the concession, providing OMEX with a source of steady income prior to the production start date.
AHMSA's investment can be seen as a bridge that will get OMEX to that large, strategic deal. It validates the concession, involves an important domestic owner, provides OMEX the prospect of services income, and gives OMEX the funds necessary to survive until Oceanica starts to spin out cash.
The Future of OMEX
The investment from AHMSA has the potential to change OMEX from a cash burning machine to a consistent cash generator. This change won't happen overnight, but AHMSA's capital, and the opportunities afforded by the AHMSA relationship, can provide a path to Odyssey's self-sustainability.
Neither AHMSA nor any other OMEX investor wants Odyssey to burn through the new equity capital and find itself in need of cash again four or five years from now. In fact, one would imagine that AHMSA would demand certain assurances and controls (through its board presence) to insure that steps will be taken so that this does not happen.
What can change Odyssey into a consistent generator of cash? The mineral exploration side of OMEX's business will never generate consistent cashflows - exploration businesses never do. Yet, with a balance sheet full of cash, a large mining partner, and a successful and proven exploration program, Odyssey may be able to accelerate the development of future concessions and replenish its balance sheet more rapidly from monetizations in the future.
Even so, OMEX needs a source of income to reduce or eliminate its cash burn until Oceanica begins producing (or it monetizes its stake). There are a couple of near-term sources that may help. First, OMEX is due Central America proceeds within the next six months. We estimate those proceeds at approximately $9 mn net of the Fifth Third credit line. Second, the company could realize $10mn-$13mn+ in a receivable due from Oceanica if the concession is monetized in a strategic transaction. Also, the HMS Victory salvage should get underway later this year, and could generate hundreds of million in proceeds over time. We're guessing that Odyssey wouldn't realize cash from Victory for at least eighteen months, but we would be able to get a handle on potential cash realization over the next six to nine months. A successful Victory salvage would be a game-changer.
Yet, neither AHMSA nor the rest of OMEX's investors want to rely entirely on these potential one-off sources of cash. We would expect AHMSA to help Odyssey secure services-type work to reduce or eliminate its cash burn over time. Odyssey could be paid to finish the exploratory work on Oceanica. This might include drilling in the north and south extensions, and drilling to greater depths in the original concession. Oceanica would need to be capitalized to pay for this work, so we would assume this work would happen after a strategic deal.
There is also the potential for AHMSA (or others) to inject equity into one or more of Neptune's projects. This would allow for Odyssey to earn income for completing exploratory work for Neptune. Alternatively, Odyssey could begin developing the next Oceanica, AHMSA could help capitalize the project, and OMEX could earn cash income for helping prove and develop the claim.
AHMSA is well-connected in the business community in Mexico. There is potential that this investor could help OMEX win new business in Mexico, doing exploratory or other marine service work for other companies in that country.
Finally, with a balance sheet full of cash, Odyssey could move to pursue some of its commodity wreck salvage jobs currently in backlog. These are wrecks where Odyssey has secured agreements on the cargo, and has a good idea of what is likely to be recovered. Odyssey has a number of projects in backlog but has not pursued them due to balance sheet constraints. With a balance sheet full of cash, we could see the firm reengage this program concurrent with the Victoryrescue.
We can't know ahead of time exactly how all of this will play out. Assuming that the equity investment is made, means that experienced and professional investors such as AHMSA and Black River will take an active interest in operations. This should give all investors some comfort that OMEX will not compromise itself with respect to liquidity in the future.
Valuation and Liquidity
Following this transaction, we can value OMEX as a portfolio of assets, and a couple of businesses. Below is a chart that assigns values to the assets and businesses to give us a rough idea of what OMEX may be worth in a number of different scenarios.
In the first case the MIA is refused. OMEX is left with AHMSA's note and the SS CA cash to operate for the next year. The Victory project becomes the focus and cash is conserved. The "shareholders reject" scenario shows what we're left with if shareholders vote against the deal and AHMSA buys Oceanica for $40 million (less the $10 million Monaco loan). We assume in this scenario that none of OMEX's other assets have value with the exception of Victory, because of a still-constrained balance sheet. The base case is my best estimate of a current snapshot of value assuming the deal is consummated (all scenarios anticipate Victory re-approval per MHF guidance). The optimistic scenario indicates what might happen in the next 12-18 months assuming that OMEX has success in a number of its projects.
Since some of OMEX's long-term assets can produce a wide range of values, and will take years to monetize, this model takes a conservative view with respect to these assets in the base case. Also, it does not account for taxes (the firm has around $200 million in NOLs but we are unsure how much will be retained after a change of control), nor have we applied any kind of liquidity discount to any of these assets. The model assumes $20mn in cash outflow for the first year and that working capital remains unchanged. If the firm wins some services work around Oceanica, this may be too pessimistic. There is substantial upside to some of these estimates, even in the optimistic scenario, but this may take years to prove.
All Figures in Millions (except per share)
MIA Shareholders Today One Year
Refused Reject Base Optimistic
Cash (Increase by $43.4 for option) 14.75 14.75 101 101
Oceanica Stake 0 30 200 800
Victory Recovery 150 150 150 570
Neptune Minerals 0 0 12 24
Central America 9 9 9 9
Oceanica Receivable 0 13 13 13
Undisclosed Seabed concessions 0 0 0 50
Marine Services Business 0 0 0 10
Commodity Shipwreck Salvage 0 0 50 100
One Year Cash Outflow -15 -20 -20 -20
Total 159 197 515 1,657
Est. Shares Outstanding (million) 90 90 190 190
Shares Outstanding (million) With AHMSA at 65 Percent 277 277
Value Per Share (pre-tax) $ 1.76 $ 2.19 $ 2.71 $ 8.72
Value Per Share (pre-tax) AHMSA at 65% $ 2.02 $ 6.14
Base case assumes current valuation of approximately $400mn. This is based upon ascribing AHMSA's $100mn offer for half of OMEX (assuming no option) all to owning 25-27 percent of Oceanica. The optimistic case assumes that the MIA is approved, and that Oceanica is developed into an integrated, multi-billion-dollar fertilizer operation. In this scenario, I have assumed the value of the asset is $2.4 bn, but that OMEX is diluted to one-third ownership. The valuation could exceed what I have implied, as my cost assumptions may be too high.
OMEX does not seem very concerned about the fact that the MOD withdrew its Victory approval to address issues related to a Judicial Review. In a letter sent to shareholders the company wrote:
This does not immediately affect Odyssey's plans for Victory as the Maritime Heritage Foundation has indicated that they believe the issues will be dealt with promptly and permission will be reinstated.
We remain confident that once the issue is dealt with, the Maritime Heritage Foundation and Odyssey once again be given approval to proceed with this important project.
It is true that the MOD's reconsideration has injected a new measure of uncertainty into the equation. If MHF is correct, however, and the project is reinstated with an approval that has addressed the issues brought forth in a Judicial Review, then the recovery will proceed in the next couple months.
Our conservative estimate is that OMEX would net $150 million from the Victory rescue. A best case scenario (with very conservative assumptions regarding coin value and wholesale spreads) would yield OMEX $570 million.
Neptune Minerals (30%+ owned by OMEX)
Neptune holds seafloor tenements in the Western Pacific totaling approximately 175,000 sq km. The closest comparable to Neptune is Nautilus Minerals (NUS.to), which holds more than 185,000 sq km of tenements plus another 215,000 sq km under application. Nautilus is much further along in developing its operations, and has the backing of some very large mining partners, and the government of Papua New Guinea. Nautilus's market cap currently stands at approximately $240 million.
With Nautilus's Solwara1 project moving forward toward production, having already gained environmental consent, the environment for funding and developing select tenements in Neptune's portfolio has improved. Assigning a value to these early-stage mining projects is difficult. They may ultimately be worth billions, but that value won't come until the industry is proven.
For now we take a conservative stance and assume a value of 15 percent of Nautilus's market cap in the base case, and 30 percent in the optimistic case. Again, depending on how financing and operations progress, these figures could prove very conservative.
Reflects approximate proceeds net of Fifth Third loan.
The receivable is likely to be repaid in a strategic Oceanica transaction.
Future Mining Developments
This estimate accounts for future Oceanica-like tenements the company has indicated they will develop. We don't know anything about these potential concessions, however, with a solid balance sheet and a strong partner, OMEX may be able to provide more details regarding another promising deposit or two within the next twelve months.
Marine Services Business
There is potential for OMEX to have a full plate of services work around Oceanica, new OMEX tenements, and other projects, that could generate several million in operating cashflow per year. This business can reduce cash burn substantially, even if it will not generate large returns.
Commodity Shipwreck Salvage
With a new balance sheet, Odyssey will be free to pursue commodity wrecks (ships less than 100 years old) it hasn't been able to salvage in the past due to liquidity limitations. These wrecks are relatively low risk because the cargo for salvage has been contracted, and the cargo is well documented. OMEX has 25 wrecks targeted in this program with an aggregate value of $800 million. The company might attempt to salvage some of the higher value, bullion wrecks first. The Odyssey Explorer could be used for this work, keeping costs low, as it wouldn't require the larger ships and specialized equipment that could be needed for the lower value/bulkier commodities.
The Gairsoppa commodity salvage captured $84 million in silver, with net proceeds after costs to Odyssey of approximately $35 million. The Gairsoppa salvage was expensive because it required contracting a large vessel, and because the recovery was encumbered by a GALT project finance deal. If we assume that the Explorer is used for the bullion wrecks, and that there is no project finance attached to these projects, the economics could be substantially more attractive.
Over the last three years, OMEX has recovered ~$40 million in value each summer from wreck salvage work. If the company can continue this pattern of recovery, with the better net economics mentioned above, it's not unreasonable to assume they could net $10 - 20 million per year from this work. Assigning a 5x multiple on that stream gets us to the base and optimistic scenarios. A strong balance sheet may allow OMEX to accelerate this program, and my numbers may prove low.
In a scenario where the MIA is not approved and the AHMSA deal is not consummated, OMEX will need to conserve its cash while moving forward with the Victory recovery. The $15 million provided by AHMSA plus proceeds from the SS CA recovery (net of the fifth third loan) would give OMEX runway for at least a year if the company throttled back its expenses.
There is little doubt that the Fifth Third loan, which is collateralized by the SS CA recovery items, will be extended until the legal mess is cleared up. OMEX has a long history with the bank, and Fifth Third understands that its position is secure. Based on management's commentary, the legal mess should be resolved in the next couple of months, allowing monetization to proceed.
The liquidity provided by AHMSA and the SS CA might also allow the company to use the Odyssey Explorer on a couple small bullion wrecks. Proceeds from the bullion wrecks and/or Victory would be used to refinance the AHMSA note.
This almost goes without saying, but the AHMSA investment invalidates all of the negative (and many times ridiculous) claims made about Oceanica by short-sellers. Obviously this buyer has more expertise and better access to the asset, the experts, and the data connected to the asset, than any OMEX short-seller (or investor). AHMSA would know the Oceanica business plan backward and forward, including its operating costs and margin structure. This Investor would also have infinitely better connections within Mexico to form a viewpoint as to how this project will be accepted in the country. The fact that AHMSA has come to this valuation, leads us to believe that the ultimate value of Oceanica will be much higher. There is no longer much doubt that the asset is real, highly strategic, and commercially attractive.
We will hear more from short-sellers who will tell us that this deal is not going to make a difference to Odyssey. They will tell us that there is no significant commitment from AHMSA, and that everything is on the come. They have a point, based purely on a reading of the filed documents. It is, nonetheless, an uncomfortable position for short-sellers to maintain. AHMSA has undoubtedly committed more value in man hours, legal fees, and reputational exposure to this deal than it has dollars (thus far). It would never have loaned the company a dime had it not felt strongly about Odyssey's prospects.
There is much more to AHMSA's position than this, however, and a short-seller would be oblivious to this point. It is in AHMSA's self-interest to do this deal and the firm will do everything within its power to make sure that this deal moves forward. AHMSA did its homework, and saw not only the wealth it could create with Oceanica, but also the potential for the development of the rest of OMEX's seabed mining portfolio. AHMSA intends to leverage OMEX's expertise and knowledge to build what could become a very large and successful seafloor mining firm - a leader in the field. AHMSA realizes that it is getting an exceptionally good deal because of OMEX's liquidity situation, and that it may have far more to lose if this deal doesn't happen than OMEX shareholders.
Even though we can tear the deal documents apart and find plenty of "outs" for both parties, it is unlikely that these "outs" will ever be used. The intent on both sides is to do the deal because both sides are made better off by getting the deal done. Even though OMEX shareholders face substantial dilution in ownership if the deal goes through, I believe that most shareholders will acknowledge that AHMSA is a highly strategic owner, and we will all benefit from the firm's involvement. Though the deal comes at a steep cost, it is probably worth it.
Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.
Additional disclosure: DISCLOSURE: This note is solely a reflection of my opinion based on my knowledge of the circumstances. I consulted with experienced professionals in making my assessments, and we are in broad agreement on these issues. All the same, these are my words, not those of the experts. The Author has obtained all information herein from sources he believes to be accurate and reliable. However, such information is presented "as is," without warranty of any kind - whether express or implied. The Author makes no representation, express or implied, as to the accuracy, timeliness, or completeness of any such information or with regard to the results obtained from its use. All expressions of opinion are subject to change without notice, and the Author does not undertake to update or supplement this report or any information contained herein. This is not a recommendation to buy or sell any investment. We may transact in the securities of OMEX at any time subsequent to publication. Green River is a holder of OMEX shares.