Taking Stock

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Taking Stock 14 October 2021

IT may have escaped the attention of our media and most investors but last week New Zealand received some great news.

Our country has discovered a major resource, probably worth billions of dollars, and within months may be able to announce a world-class resource that in subsequent years should make a significant contribution to the country.

If the resource grows in line with statistical probability, the great outcome would be: -

- 350 permanent, new, well-paying jobs, in Central Otago, none dependent on tourism.

- An annual revenue base for the Crown of tens of millions.

- An increase in exports to Australia of more than a billion each year.

The project to which I refer is at Bendigo-Ophir, less than an hour north of Cromwell.

The area has a tiny population- a few grapevines, and a few farms – and currently is on land some distance from any sealed road, accessible via Crown land, but probably needing a new road to make entry easy.

The resource is gold.

Last week, the news release advised investors that an independent agency in Australia had assessed recent diamond drilling test results and calculated that the area drilled was likely to contain 640,000 ounces. The area drilled was a tiny fraction of the land that will be drilled.

Drilling continues. It would be a statistical oddity if within months that number of inferred resource was less than a million ounces.

A million ounce gold mine meets most definitions of a world-class mine.

To put this into perspective, when the discovery was made that led to Macraes Mine, in a similar geographic area, the estimates of resource had reached a million ounces.

More drilling at Macraes led to mine extension. Some thirty years later, Macraes, now owned by OceanaGold, has smelted more than five million ounces of gold, and believes it has some further millions of ounces to extract in coming years. The land has released gold worth more than ten billion dollars.

The land at Bendigo-Ophir was identified years ago by veteran geologists, Kim Bunting and Warren Batt, as being similar to the land where Macraes started.

Batt had been the principal geologist in the discovery of the Macraes find. Bunting believed Bendigo has similar characteristics.

He has made Bendigo a personal project and currently wears the smile of someone whose instincts and training have been rewarded by independent confirmation that Bendigo-Ophir might soon be classified as world-class mine, as Macraes certainly is.

Getting to this point has been an adventure.

Raising the millions needed to access and begin drilling is no simple feat in New Zealand.

Bunting and Batt achieved that, and then scaled up their drilling after agreeing to merge with a small Australian mineral explorer, Santana Minerals, listed on the ASX.

With the help of Australian broker Bell Potter, new money was raised enabling Bunting and Batt to have certainty about funding a three-year drilling programme, in the hope of proving that a world-class mine could be planned. Last week's announcement suggests the programme is on track.

Every diamond drilled hole costs around NZ $100,000, the work performed by a Southland company with expertise and the access to the drilling gear.

Last week's news provided the breakthrough, albeit being the first major step of what should be a long-term project.

As well as confirming a resource that grows as the drilling continues, the independent analysis confirmed that the gold-bearing rock has been oxidated in the last 800 years and thus should release its gold with a process known as heap leaching.

This process reduces the energy required by eliminating the need to ''grind'' the rock, a method commonly used that is expensive, and energy intensive.

Furthermore, the new analysis revealed higher grades of gold than anyone had anticipated, implying that the attraction of the find will not just be the savings caused by heap leaching.

Bunting and Batt will be expecting the size of the resource to be recalculated in coming months, perhaps allowing Santana to raise further capital with placements or rights issues, enabling the mine to enter its next stage.

While all this is futuristic, some things are undeniable:

1. 640,000 ounces, recoverable at, say, 90%, equates to a resource worth $1.4 billion at today's gold price.

2. The government receives royalties on all gold that is smelted. Three percent of $1.4 billion would be $42 million.

3. Gold sold at a margin over cost of $500, would produce profits per year of $50m. Tax at 28% would accrue at $14m per year. (Figure calculated on 100,000 ounces of production per year.)

4. Dividend income would ultimately be attractive.

Without room for argument one can conclude that the news release (to the ASX) by Santana Minerals should have been welcomed by the government, investors, the media, and the many businesses in the area that would benefit from a major, long-term (10 years plus) project generating wealth and well-paid employment.

Of course, there are caveats.

The gold price could sink. (It could also rise.)

The tiny area drilled might not be representative of the many hectares yet to be drilled.

And let us not talk about the consenting process. Even when the land itself is not Crown-owned, there will always be those who prefer to leave gold in the ground. For the Crown to take this view would be odd, given that it authorised the exploration of the land.

Currently those who have read the Santana ASX release clearly understand that there are caveats. The Santana share price doubled, from 10 cents to 20 cents, when the news was digested.

If the news had been that the quantum of gold had been confirmed, that consent was certain, and that the gold price would be stable, the Santana shares should be worth a high multiple of its current level. There are uncertainties, the consent process being the most obvious.

Yet, we should be celebrating.

A large mine, producing hundreds of millions of revenue each year, indefinitely employing hundreds of well-paid staff, generating annually tens of millions for the Crown, ought to be an item of good news welcomed by a cash-depleted government, having to cope daily with gloomy news and rising debt, requiring servicing with what looks like rising interest rate cost.

Meanwhile, investors should keep an eye on the next ASX release.

Another major increase in the inferred resource would surely brighten everyone's day!

Disclosure: Our family trust holds shares in Santana, as does a group of our clients.

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WE all know the law can be an ass, especially when it is created off the hoof by people with neither an understanding of the principle of unintended consequences, nor the practicalities of executing a plan.

Law is for many a boring subject, especially commercial law, but investors might be wise to follow an imminent case in the highest courts, relating to the innocent subject of holiday pay.

Currently, the Holiday Pay law is designed to protect vulnerable workers, and it ensures workers are fairly compensated for any unused leave when they retire from a job.

This aspect of the law was hardly drafted to protect the privileged or the highly paid. Yet in recent times a well-paid executive resigned from a public company, was paid out for his unused leave, but was unhappy about the formula for calculating his entitlement for his unused holiday entitlement.

The executive had regularly qualified for a discretionary bonus, paid on top of his salary. He is now taking the company to court, claiming his unused holiday pay should have included his (potential) bonus, as a component of his actual salary, despite the bonus being payable only at the discretion of the company.

(As an aside, one anomaly in unused holiday payouts is that the payments are based on the final year's salary, so if an executive begins work on $50,000 a year, never uses his leave, and retires after twenty years on a salary of $500,000 p.a., he might claim his unused leave (80 weeks) and expect to be paid out at the rate of $500,000p.a.)

The new court case tests the claim that the potential, discretionary bonuses are an entitlement.

If the court finds the claim has merit his holiday pay-out would need to adjust somehow, to some assumed entitlement to a discretionary bonus.

As it is now big companies accrue the expense of unpaid leave, display the number in the accounts but never include undeclared, discretionary bonuses.

A large company may have tens of millions of accruals to meet the claim, but no company has ever imagined that the final payout for unused leave must include undeclared, or unawarded, discretionary bonuses.

A sanguine employer might well reason that a departing employee does not require incentivizing with a bonus.

The biggest losers if the law found against the company would be the trading banks, which habitually allow senior staff to accrue leave, assessing the urgency of their daily work to outweigh the need for holidays. It is not uncommon for banks to ''owe'' staff tens of weeks, for the leave never used.

The banks will be up for at least tens of millions, and possibly hundreds of millions in Australasia, if the law rules in favour of the claim.

For that reason, I assume that the banks are funding the public company's defence against this claim. ANZ is certain to be funding the defence. The banks will see this cost as money spent to clarify an issue without any public focus on the banks.

Without such funding the public company itself might have just settled confidentially, assuming that the cost, say $50,000, was cheaper than paying the legal bill of a case.

A more cynical view might stem from the counter argument, that should the claim fail, the cost to the claimant might be catastrophic. A large organisation, at least potentially, might simply invite the discontented, departing employee to back off, given the cost of a court case, should the claim fail.

Whatever, this case will be in focus for all public companies, indeed all companies that offer discretionary bonuses.

Might this be the case that puts an end to the practice of discretionary bonuses, or leads to a redefinition of entitlement? Might such bonuses be deferred and dependent on future years of employment, perhaps recoverable if an employee leaves before an escrow period is reached?

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THE law society has welcomed the concept of litigation funding, arguing the merits of access to justice outweigh the risk of frivolous claims. I applaud that response.

In focus will be the current planned case against A2 Milk, where existing investors in ATM will be pondering the extent of potential payout to those ATM investors who bought shares last year, at a time when ATM had not signalled the extent of its falling revenue.

Investors would want to know who would foot the bill if the litigation funder succeeds.

I bought some of my holding during that period. If I were compensated, the money might effectively be paid to me by those who had owned the shares prior to the alleged ATM disclosure failure. I have owned ATM for many years. Effectively I would be paying myself, if ATM itself simply paid me, from its company funds.

Yet, if there were a real error by the ATM directors, might the directors be the target of the claim, their professional insurance providing the pool from which I might be compensated?

This question must surely be considered.

Litigation funding has already served one great purpose.

It has brought to attention lazy, incompetent directors, forcing them to retire or adopt new levels of thoroughness, and to accept that their behaviour affects other people's money.

When the court defines how much Mainzeal's inept directors must pay (personally), investors will have proof that incompetence has a cost.

One extrapolates from this mindset the future arguments of those who will ponder why fund managers, KiwiSaver managers, as an example, charge fees for expertise, even claim massive bonuses in good years, yet are seldom asked, for example, why they mis-used other people's money by buying canines (such as TV3 many years ago, as an obvious example).

The case against fund managers is not far away. Out of court settlements will be a device used to avoid publicity.

Litigation funders are bringing change to behaviour. They are levelling the playing fields, but there will be unintended consequences.

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Johnny Lee writes:

THE takeover of Z Energy, by Australian fuel retailer Ampol, has cleared its first major hurdle – board support.

The board of Z Energy has thrown its weight behind the takeover, negotiating what is effectively an extra 5 cents to bring the total offer price to $3.83. The eventual price paid will likely be lower, reflecting dividends extracted from the company during the takeover process.

There are several more hurdles to overcome.

Commerce Commission approval is one such hurdle. Ampol currently has a presence in our market due to its ownership of Z Energy rival Gull. Combining the two assets would likely fail the ''substantial lessening of competition'' test. To get ahead of this issue, Ampol has committed to eventually selling Gull – either to another owner, or into public ownership via a share market listing – if the takeover proceeds. This solution seems likely to satisfy competition concerns, as this ultimately results in a scenario where there is no change in market power – simply a change in ownership.

A public listing of Gull would certainly be intriguing to investors, particularly current Z Energy shareholders, who have grown accustomed to the risks and rewards associated with fuel retailing over the past 18 months.

Ampol has also indicated that it intends to dual list its own stock on our exchange following the takeover. Overseas-based dual listings tend to suffer from extremely low liquidity on our exchange, and the trend has in fact been for Australian companies to delist from our board, rather than join it. Nevertheless, the NZX will no doubt be more than happy to see more companies list on our exchange.

If Z Energy’s departure heralds the arrival of both Gull and Ampol onto our exchange, investors may even find themselves better positioned long-term.

Overseas Investment Office approval must also occur. The scheme of arrangement makes the preliminary case that Ampol's significant infrastructure – including trading and shipping operations – will see benefits down the line to Z Energy beyond just scale.

The shareholder vote will be another key milestone in the process.

Previous discussion regarding this takeover generated a strong response from some shareholders that viewed the price on offer ($3.78 at that time) as being unacceptably low. The offer is well below the price many long-term shareholders paid for their shares, and the 5 cents per share increase is unlikely to make a material difference to those shareholders. The previously indicated dividends attracted many to buy the stock in the first place, and the prospect of a payout at these levels will feel opportunistic to some of these shareholders.

The board of Z Energy will be aware of this. Ultimately, the offer does not require 100% support, and the company will already have an idea from its major shareholders as to whether the offer can get across the line.

The independent valuation from Calibre Partners (formerly KordaMentha NZ) will be crucial. These reports have, in the past, been shown to carry some influence in swaying shareholder support, and nudging bidders higher to fall within a valuation range.

The first step is complete – the board, elected by its shareholders, has put forward its recommendation. It believes the offer is fair and should be accepted by shareholders. Shareholders will soon be presented with an independent view and asked to vote for or against the proposal.

This is expected to occur early next year, assuming no rival bid emerges.

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TWO IPO's were placed on hold last week, as telecommunication companies 2 Degrees and Orcon (formerly Vocus) consider whether a merger of the two companies is feasible and could produce a better outcome than either company individually competing.

2 Degrees operates predominantly within the mobile sector, with approximately 20% market share. Orcon instead has a focus on the broadband market, where it has a market share of around 13%, almost twice that of 2 Degrees' 7% broadband share. In both markets, Vodafone and Spark remain the main competitors.

These numbers are important. Mergers within the telecommunications sector are notoriously tricky, due to a Commerce Commission that seems very reluctant to allow scenarios which could reduce consumer choice.

2 Degrees and Orcon will undoubtedly argue that ''joining forces'' is necessary to create an entity able to aggressively compete with Spark and Vodafone. The rollout of 5G, deemed necessary to compete in the mobile sector, is a burden that 2 Degrees majority owner Trilogy International Partners would much rather share than carry alone.

In turn, Orcon will know that bundling mobile and broadband – like Spark and Vodafone - is a much more appetising offer for consumers than either one alone. There is a logic for both sides to pursue this path.

Conversely, both owners will be cognisant that such a process may take far longer to resolve than the proposed floats – which were originally mooted for completion this calendar year. In the case of the failed transaction between Vodafone and Sky TV, it took almost a full 12 months for that matter to reach its conclusion. I imagine both Trilogy and Orcon-owner Macquarie Asset Management (joint owners with Aware Super) will be reluctant to waste too much time on merger discussions unless there is a genuine chance of a successful transaction.

The merger discussions are a very late twist in the tale and are by no means guaranteed to result in an actual transaction. Indeed, there are many impediments that could make such a merger unlikely. For now, investors can wait, as a raft of other opportunities begin to appear on the horizon for consideration.

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Johnny intends to be in Tauranga on October 21.

Any client wishing to arrange a meeting is welcome to contact the office.

Chris Lee & Partners Ltd

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