Investment Analysis of The Mopani Share Offer: Deal Or No Deal – Let’s Do The Math

By: Munyumba Mutwale

‘If you buy things you don’t need. You may find yourself selling things that you do need’
Warren Buffet

Two weeks ago following the ongoing battle of whether Mopani should go on care and maintenance or whether it should be forced to continue operations, News hit the market that Glencore will likely sell its entire 73.1% stake in Zambia’s Mopani Copper Mines to the government’s mining investment arm ZCCM-IH. So, the debate has now circled the question, Is this a good move?

Having seen how this matter has been debated and potentially weaponized in the public square, I am going to attempt to do something different here with Mopani, I am going to remove politics from this and handle this purely as an investment analysis and just assess the viability of the business case of Mopani Copper Mine. This article will focus on answering the question, ‘Is Mopani Copper Mines worth buying?’

The tendency for all investment bankers and financial advisors is that all deals are good deals because they are just generally there for the transaction fees and to get their commission. However, I am going to look at this after the transaction, a sort of life after the wedding analysis.

THE FINANCIAL ANALYSIS OF MOPANI

Let’s start by assessing the finances and operations of Mopani from 2014 to date.

	2014	2015	2016	2017	2018
LME 12-Mo Copper Price ($)	6,771	5,549	4,937	6,314	6,482
Total Copper [metric tonnes]	185	184	110	99	120
Own Copper [metric tonnes]	110	92	41	42	57
Revenue [$ million]	1,337	1,121	584	353	842
Profit / Loss [$ million]	(23)	(285)	(177)	(290)	(722)

Financial information derives from Mopani Copper Mines Excerpts 2014 – 2018

FINANCIAL AND OPERATIONAL HIGHLIGHTS

• Output has been a major problem of Mopani from 2014 to 2019. Total output has declined from 185 thousand metric tonnes, in 2014, to 120 thousand metric tonnes in 2018. Worse off, preliminary reports of 2019 show that only 51 Thousand metric tonnes of output were produced, this is inclusive of purchases of copper from third parties, which would have an approximate market value of $310 million.
• The mine has been plagued with a series of shutdowns due to maintenance problems with the smelter. Partial suspension of operations and reduced capacity of the smelter occurred in September 2015, and in 2017 there was another 45-day shutdown of the Mine, again due to the smelter.
• Due to a combination of lower production and downward trending copper prices revenue has been declining from $1.337 Billion, in 2014 to $842 million in 2018.
• With debt levels rising due to shareholder loans, now sitting at $3.2 Billion in 2018, putting the total net liabilities at $2.562 billion above assets, and thus financing costs have risen. Added to this total costs have risen from $1.36 Billion in 2014 to 1.56 Billion in 2018. In terms of average costs, the average cost of a Metric tonne has almost effectively doubled, moving from 7,351, in 2014, to 13,000, in 2018. With the exclusion of 2016, which was still a loss-making year of $177 million, Mopani has been registering growing losses moving net losses from $23 million in 2014, to a record loss of $722 million in 2018.
• The approximately $1.1 Billion of capital expenditure, between 2014 and 2019, aimed at the 1280 meter Synclinorium Shaft at Nkana Project, as well as the Mindola Deeps and Mufulira Deeps seem to have not borne fruit. These projects were not only conducted to extend the life span of the mining operations by another 20 to 25 years, which they probably did but were mainly supposed to reduce the operational costs of the mine. However, this capital expenditure has led to such high financing costs that the operational cost reductions and even a rising copper price has been wiped out and losses have increased faster. Added to this the projects still require more financing to get them to an optimal level.
• All this has left the Mine with a 5 year low of $65 million in working capital.

Unfortunately, nothing about these financial statements says the company is in a healthy, let alone redeemable state. Even with Glencore writing down the value of Mopani to $700 million from its original valuation of $1.4 Billion, Mopani still does not seem a good investment because it doesn’t seem that any investment in the firm is recoverable. Even in 2014, with 180 Metric Tonnes of copper output and a copper price of $6,770 per metric tonne, the company was still loss-making, and through the analysis showed that Mopani needed a copper price of $7,350 to just break even. So optimally in 2014 Mopani needed a combination of a minimum copper price of $7,500 and the same 185,000 metric tonnes of output from the mine, to have sustainable profitability.

However, with the significantly higher levels of debt on the books, the same combination of a copper price of $7,500 and 185,000 metric tonnes of output would have the mine operating at a loss of $172 million. Even at optimal pricing and optimal production, the investor and new owner would need to have $172 million to finance the net losses even after acquiring Glencore’s 71% for $500 million. The mine needs a price of $8,500 just to break even while making sure the smelter is fully functional and output remains above 185,000 metric tonnes. Both of these occurrences are not only highly unlikely to occur simultaneously, but even on the off chance they do occur, it’s highly unlikely to sustain such a unicorn set of conditions.

Now, added to this, Assuming 50% of all profits are distributed as dividends and the copper price of $9,000 stays constant indefinitely, it would take the investor at least 13 years to recover the nominal sum of $500 million. This is only possible if the copper price stays above $9,000 the whole time, and any time it drops below $8,500, it will require loss financing which will undo any funds recovered, creating a one step forward 2 steps back situation.

THE COPPER PRICE OUTLOOK

Now let us turn our attention to the outlook for the copper price over the next 10 to 20 years. What are the factors that led to the last copper price rally and can they be sustained for the period of 10 to 20 years this time?

The key drivers of the copper price currently are trends in building and construction, infrastructure (especially in China), electrical materials, consumer electronics, electrical devices, electrical equipment and transportation equipment. The main things that led to a copper price rally in the years 1999 to 2012 were the following;

• US HOUSING MARKET BOOM: Between the years of 1994 and 2008, mainly driven by mortgage industry deregulation, there was a surge in homeownership levels in America that moved homeownership levels from 63% to 69%, effectively creating 20 million net new homeowners and creating a big housing construction boom. Good news for Zambia is that since 2017, another even bigger housing market surge in the United States is currently underway and is setting up to be the biggest of all time.
• CHINESE CONSTRUCTION BOOM: The 1990s to 2000s were a strong session of Chinese construction which also led to growth in the construction sector in China. Though there was disruption with the financial crisis of 2008, the Chinese Government stimulus came and pushed Chinese construction through the final stages of the Boom. Fixed Asset Investment also picked up during this period. Right now due to PBOC Stimulus, construction and infrastructure spending and activity is at another peak and thus triggering a rise in Copper demand.
• CHINESE INFRASTRUCTURE SPENDING: From 2008 – 2011 the Chinese government was in the middle of conducting a major infrastructure stimulus plan of $500 billion. This time Beijing has triggered a $1 trillion stimulus plan which has been the key driver behind the copper price rally of H2 2020.
• MOBILE PHONE MARKET BOOM: Bearing in mind that copper plays a pivotal part in mobile phone circuitry and the wiring of mobile technology, what is probably the single most underappreciated part of the 1999 to 2012 copper price rally, was the impact of the revolutionary rise of the mobile phone and its supporting technology. Between 2000 and 2010, driven mainly by Asia, mobile phone coverage moved from 12% to 76% of the world’s population. Going back further in 1990 only 0.2% of the world’s population had mobile phones. This means that by 2010, the mobile phone industry had expanded 500% since the year 2000, and 37000% since the year 1990. The decade of 2000 to 2010 posted the single largest growth in Mobile phone users as it translated into 4.5 billion new mobile subscriptions thus leading to a booming consumer electronics industry and therefore rising copper demand. Since 2010 the mobile phone market has slowed down as mobile subscriptions grew by 2 billion in the decade of 2010 to 2020, which is only 50% of the previous decade which saw 4.5 billion new mobile subscriptions added. Now in 2020, having reached a point of market saturation in the mobile phone and consumer mobile technology markets, we are not likely to see mobile phone sales growth that will contribute to a rise in copper demand like it did in the 2000 to 2010 period. This can be seen in the fact that mobile sales growth has slowed down for companies like Apple and Samsung.
• SHARP RISE IN ELECTRIFICATION: Led mainly by Indian Electrification with support from Latin America and China, the period of 2000 to 2010 saw a steep rise of 10% Global Access to electricity and thus improved demand for copper wiring for electrification. However, the closer the world moves to total electrification and with only Africa remaining below the 50% electrification mark, there is not much room for growth and thus the copper demand outlook from this sector is not great. There is one trend rising in renewable and green electricity wiring driven by the Global Decarbonisation movement which is being financed by the Responsible Investment movement.

With those major trends showing that copper demand will mainly be driven by housing and construction, in general, rather than a combination of electrification, consumer electronics and Housing and Construction, this means that the copper rally this time will probably be a bit more tempered, and struggle to pass and hold the $9000 per metric tonne mark as it did last time, though it stands a chance to momentarily show parallels. In the Long Run, namely over the next 10 years, the World Bank and IMF do not see the copper price going above the $7,000 threshold. However, this analysis did not take into consideration, the Coronavirus impact on London Metals Exchange Warehouse Supply levels, which have been severely drained, and the Beijing Infrastructure stimulus plan of $1 Trillion. There is potential for the Copper price to breach the $8,500 mark, but this can only hold for a period of 3 to 5 years at best before returning to the present $7,000 peak price.

The only factor that may help with the copper price is the TRUMP FACTOR. President Trump has stated his intentions to use the current low-interest lending regime to conduct a $2.3 trillion mega infrastructure revitalisation plan. However, looking at the political environment and the ambitions of the Democrat party to rather enact the Green New Deal and Green Infrastructure [which ironically also would increase copper demand], there has been no success on such talks and persistent deadlock has been the outcome. Therefore, with a Trump presidential re-election most likely, it appears the only chances of that happening would be a Republican victory of the house of representatives and the senate to push through such a bill. That level of stimulus could indeed take the copper price around the $9,000 per metric tonne sustainability level for at least 10 years. However, the likelihood of a Republican Clean sweep is rather uncertain..

MY INITIAL ASSESSMENT

Given the state of the financial health of the company and the high unlikelihood that the copper price could reach and sustain a price of $9,000 per tonne for 10 to 20 years, acquiring Mopani would be a highly risky move because there is very little upside and major downside to this venture. Even if Mopani was done through a leveraged buyout, this still would be highly unlikely to be successful given the leveraged position of the company and its impact on the unit cost of production. Additionally, we have been running on the assumption that Mopani would be able to get back to the 185,000 metric tonne total output level which itself is highly unlikely, given the persistent smelter faults.

The Major problem is that the investor will find itself needing to constantly inject at least $60 million to $200 million annually in relief financing just to keep Mopani afloat, even after paying $500 million to purchase the asset. Some may argue that Mopani is an important source of Forex for Zambia, which historically has been true, but with $3.5 Billion, in shareholder loans (liabilities owed to a foreign entity), sitting on its books, any Forex that comes in will be channelled out to repaying that loan, thus nullifying the forex value debate.

With all of that in mind, not only would I recommend not investing in Mopani, I would even go as far as saying we should consider divesting from the entity altogether and starting the process of liquidating the mine and selling it for parts to liquidate all debts and payables. In this regard, all owning parties should just accept their losses, and move on before the mine calls on and drains more resources. This is the investment analysis conclusion, however, my recommendations are a little bit different and cover a different perspective.

MY RECOMMENDATION

In the spirit of being open-minded, and also just never giving up an opportunity to quote Morpheus from the matrix, I am going to give Zambia 2 recommendations for 2 different scenarios. For this exercise, we shall call them the Red Pill and the Blue Pill recommendations.

Now if Zambia chooses the Blue pill, we can simply go with the vanilla recommendation which is the investment recommendation given above of divesting and liquidating. If we intend to take over Mopani to continue business as usual, my suggestion is that we go with the above-mentioned investment recommendation of liquidation and divestment. Mopani should be stripped and sold for its parts to liquidate debt positions. However As a nation, we should be concerned for the 5,000 to 10,000 employees at Mopani, and thus we should consider guaranteeing their income, for a period of up to 2 years, to ensure we do not see the collapse of towns like Mufulira. In a rudimentary estimation, it would cost the nation approximately $100 million to conduct such an undertaking, drastically less than purchasing the mine and still incurring annual expenses of operating it at a loss.

Now, should Zambia be willing to dream, and muster up the courage to take advantage of an ailing mine and grab a hold of a once in a lifetime opportunity to Transform the nation, then take the Red Pill, and let me take you down the rabbit hole and show you what a new futuristic Zambia can look like. This is a total transformation of the business model that seeks to turn Mufulira into something I would like to call THE COPPER ELECTRIC CITY.

Now Close your eyes, and Imagine with me, a business to business COPPER BASED ELECTRIC INNOVATION HUB, made up of small locally owned innovation-based businesses, who produce all futuristic needs of copper-derivative products based on the trends of where copper demand will be in 10 to 20 years from now, and taking advantage of a 25-year extension from the Synclinorium Shaft Investment. Imagine, if we took all the combined skills of every engineer, physicist, roadside phone repairman and tradesman, and put them in a city where they manipulate and create with copper meeting the copper-based needs of 2030. That city can be Mufulira if we want it to be. This Idea would be based on looking into the future of the world and taking advantage of some major emerging trends. It would require that Zambia dispenses with the idea of trying to catch up with the world today and focuses itself on trying to position itself now, to catch the trends of tomorrow, because catching up always keeps you behind, while catching tomorrows trends puts you ahead, and growth, is reserved for those willing to get ahead. This is similar to how China positioned Shenzhen to take advantage of the mobile phone industrial revolution in the 90s, and become the centre for phone parts needed around the world. Now because of that foresight in Chinese Leadership, Shenzhen today is known as the city of the Future. Now, Imagine having the foresight to do that with Mufulira.

We need to start by asking the question, as we are in 2020, what trends will drive the Copper Markets in 2030 and prepare ourselves to not only be ready but to be a leader in that before it comes. Here are some emerging trends we need to look out for

1. THE RISE OF THE ELECTRIC VEHICLE: According to Bloomberg predictions, electric car sales will probably make up 50% of the 70 million new automobiles sold annually around the world by 2030 and possibly even 85% by 2040. However, right now, the 2 biggest problems are the low-cost manufacturing of the Copper-based Electric Power Train (the engine of an electric car that consists of a lot of copper) and the Electric Car Battery System. All of the world’s electric Vehicle manufacturers are struggling to solve this problem as they try to mainstream affordable electric cars, and Zambia could be ground zero for creating a town of designers and innovators who create Copper-based solutions for these problems and win contracts with said Electric vehicle Manufacturers. Instead of just watching Munali Nickel mine go into liquidation it too can play a role, as Electric Vehicle Batteries have strong components of Nickel along with 3 times more copper wiring than their gasoline car predecessors. Using the Mopani mines in an open-source fashion and keeping its output strictly as a feeder into the Copper Electric City, we can finally start to look at value-adding our copper to meet the coming needs of the world tomorrow, especially with the low-cost and highly unemployed willing labour that Zambia has available and ready to work.
2. GREEN ELECTRICITY AND THE RISE OF ENVIRONMENTAL-SOCIAL-GOVERNANCE EXCHANGE TRADED FUNDS (ESG ETFs): There has been an astronomical rise, led by Europe, of investment in funds that support responsible investing and green initiatives. During 2020, while the world of Exchange Traded Funds (ETFs) were losing $345 billion, in the form of outflows, ESG ETFs have taken in $45 billion, in fund inflows, thus showing that moral and socially driven investing has become a strong trend that is economically resilient. Black Rock predicts that by 2030 there will be $1.2 trillion, in assets under management, in ESG ETFs globally. Zambia must position itself with THE COPPER ELECTRIC CITY OF Mufulira to convert copper into parts for Solar Panels and Wind Farm Equipment. On a side note, the rise of solar panel production in Zambia would give full justification to the revival of Kapiri Glass. This idea would give Zambia Access to the rise in ESG Funds and a strong FDI wave along with a new higher income set of exports. ESG Funds are growing fast and actively seeking global initiatives that position themselves to be part of a Global Supply chain or provide initiatives and innovations in green technology. This is in support of the Decarbonization movement that I mentioned earlier but with much more favourable, or simply put cheaper investment terms.

Just these two trends and the Vision of turning Mufulira into THE COPPER ELECTRIC CITY would give Zambia a new diverse export channel for its copper with higher value, and at the same time would attract FDI from ESG Funds that are growing at the rate of knots in comparison to any other kind of funds. ESG Funds are less interested in above-average returns more than they are in investing for making a positive and morally correct impact on the future. Then, if you are working on a Green Tech city like Mufulira, it also gives Zambia an investment case with Global ESG Funds for the refinancing of our Sovereign debt, at lower and more sustainable interest rates.

Now, This isn’t philanthropy, we still need to get a good deal from Glencore because the state Mopani is in, is still a bit of a death trap. Both sides must accept a compromise, Glencore needs a way to stop haemorrhaging money and we need a source of copper to feed the copper electric city vision. So here is a deal I would propose. The first step should be to get the equity stake through a 10-year leveraged buyout, similar to how a lot of our mines were bought in the 90s, simply turning the tables, because they too have a toxic asset on their hands. Step 2 should be to trade in the $3.5 billion in shareholder loans, in exchange for an agreed 25-year mineral royalty (the extended life that the Glencore investments have given to the mine) on the mine output during the period. This is a clean exit for them with a path to getting some money out and gets rid of that $3.5 billion in shareholder loans that have added unmanageable financing costs to the operations of Mopani. After this, ZCCM-IH would have to go through Mopani’s costs structure with a fine-tooth comb and clear out any operational excesses, such as having expatriates or international services where local labour and service providers would do, to cut the cost structure down to the bare minimum.

This would finally be a solution that would make Zambia a part of the future rather than being part of the herd, always lagging, trying to catch up with it, and always seeming like every step of progress feels like it’s late to the party. This would be an opportunity to make Zambia the empowered authors of our future rather than the dependent recipients of crumbs from a predesigned global system.

This is now a case of Zambia catching futuristic trends instead of trying to catch up with today, which will always be the past by the time you get there.

So to paraphrase Morpheus from the matrix, this is our last chance. After this, there is no turning back. We can take the blue pill, dissolve and divest and the story ends there. we continue in our comfortable reality of poverty waiting for the next rising star in the global economy to take pity on us and throw us a few bucks on their way up. which should hold us as we wait for a little bit as the next cycle comes. Or we can take the red pill and enter a world of imagination and innovation, and see where this journey can take us as we look at taking something ailing and dying and seeing if we can use it to create the COPPER ELECTRIC CITY of the Future. Remember, all I’m saying is that this is a chance to try something new, to actually look forward and live forward instead of living stuck in the mud with our heads down doing nothing but perpetually auditing our past, looking for mistakes whos discovery will yield nothing for our future and the for future generations to come.

The choice is ours and only ours to make.

The Authour is a Financial Economist with over ten years of experience in the Zambian Financial and Capital Markets in and with companies and institutions such as the Lusaka Securities Exchange, Securities and Exchange Commission, Aon Zambia and many other participants. He is also a freelance economic journalist from Lusaka who writes about currency, commodities, macroeconomic policy and markets from the Global and Domestic Perspectives. He can be found on Twitter at @MutwaleM.