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Risky business

Jan 29 2013 07:26 *Jarred Myers

(Picture: Shutterstock)

Company Data

GOLD FIELDS LIMITED [JSE:GFI]

Last traded 40.39
Change -0.66
% Change -0.02
Cumulative volume 1082107
Market cap 31.31bn

Last Updated: 22/10/2014 at 04:23. Prices are delayed by 15 minutes. Source: McGregor BFA

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FEW tasks are as unemotional as asking the investment public for money.

Institutional investors shun publicity and act on behalf of their clients making cold calculated decisions based on facts and figures conforming to their contractual obligations, mandates and guidelines.

That is not to say that they are always right or safe from the manias which grip investors, but it does mean that they are not swayed by well-meaning empty promises from politicians in the face of contradictory facts on the ground.

Why this is important is that South Africa is getting a no holds barred health check-up from international investors - and the results are potentially alarming.

This week Sibanye Gold, the spin-off which is to be created by Gold Fields [JSE:GFI] as part of its unbundling, went on a road show to the United States.

A road show, as the name implies, is an effort by senior execs to pre-sell much of the offerings soon to be available as investment opportunities.

In extreme cases like that of the semi ill-fated Facebook listing, investors clamour for shares and need the right connections to actually secure any at all.

Suffice it to say that this was not what Sibanye experienced.

Or in the words of Sibanye Gold CEO Neal Froneman, “If you want to get around this issue of depth and perceived political risk, you can’t do it in North America and Europe; you have to look at the East and the Asian stock exchanges.”

So what exactly was Sibanye telling investors that spooked them so?

Froneman and his team are in an awkward position. They need to sell their goods, but they can’t sugar coat too much for fear of losing credibility – much like an estate agent selling a"handyman’s dream".

The frame of reference need be positive, albeit with a healthy dollop of realism.

So let’s take a look at what Sibanye’s sugar-free pre-listing statement highlighted, and assess for ourselves the real and perceived risks in SA.

The risks were divided into three broad categories (this article will discuss the first two):
  • Risks related to South Africa
  • Risks related to mining in South Africa
  • Risks related to the Sibanye-specific unbundling
Risks related to South Africa:
  • Mining taxes or royalties
  • Economic, political or social instability
  • Power cost increases
  • South African exchange control regulations
  • Regulation of greenhouse gas emissions and climate change
  • HIV/Aids, tuberculosis and other contagious diseases
  • South African environmental and health and safety regulations
  • Water use licences
Risks related to mining in South Africa:   
  • Changes in the market price for gold
  • Mineral resources and mineral reserves are estimates based on a number of assumptions   
  • Strikes, union activity and new and existing labour laws
  • The nature of mining and the type of gold mines it operates, material risk of liability, delays, mine stoppages and increased production costs from environmental and industrial accidents and pollution
  • Ageing infrastructure may cause breakdowns and unplanned stoppages
  • Concentrated in a few locations, disruptions in these locations could have a material adverse impact on its business operations
  • High fixed costs which may impact its profitability
  • Loss of senior management or is unable to hire and retain sufficient technically skilled employees
  • Sales are in US dollars, while virtually all production costs are in rand
  • Actual and potential supply chain shortages and increases in the prices of production
  • Power stoppages, fluctuations and usage constraints may force halt or curtail operations.
  • Theft of gold and production inputs, and illegal mining
  • Experience problems in executing acquisitions or managing and integrating the acquisitions with its existing operations.
  • Expanding its current mining operations, it may experience problems associated with mineral exploration or developing mining projects
  • Information technology and communications systems, the failure of which could significantly impact its operations and business
I have intentionally colour coded these risks to indicate which risks are under the control of government (red) and which are general industry risks (green).

After further aggregating these risks, what emerges is quite startling indeed. As detailed below, every non-operational risk is directly attributed to economic, political or social instability - in other words, the government failing to do its job:
  • Economic, political or social instability
  • Strikes, union activity and new and existing labour laws
  • Concentrated in a few locations, disruptions in these locations could have a material adverse impact on its business operations.
  • Water use licences
  • South African exchange control regulations.
  • Mining taxes or royalties
  • Regulation of greenhouse gas emissions and climate change
  • Theft of gold and production inputs, and illegal mining
  • Losses of senior management or is unable to hire and retain sufficient technically skilled employees
  • South African environmental and health and safety regulations
  • The nature of mining and the type of gold mines it operates, material risk of liability, delays, mine stoppages and increased production costs from environmental and industrial accidents and pollution.
  • HIV/Aids, tuberculosis and other contagious diseases
  • Power stoppages, fluctuations and usage constraints may force halt or curtail operations
  • Power cost increases
  • High fixed costs which may impact its profitability.
  • Actual and potential supply chain shortages and increases in the prices of production
  • Changes in the market price for gold
  • Mineral resources and mineral reserves are estimates based on a number of assumptions
  • Ageing infrastructure may cause breakdowns and unplanned stoppages
  • Sales are in US dollars, while virtually all of production costs are in rand
  • Experience problems in executing acquisitions or managing and integrating the acquisitions with its existing operations
  • Expand its current mining operations; it may experience problems associated with mineral exploration or developing mining projects
  • Information technology and communications systems, the failure of which could significantly impact its operations and business
If you are reading this and are struck by the obviousness that SA's risks are all related to government incompetence, you are most likely not a member of the ruling class.

As such, your efforts are required in the evangelical pursuit of spreading the word - the government needs to up its game.

Unfortunately SA's political leaders would respond that your critique is unwarranted, that they are doing a great job and that your efforts are merely a front for your racist, colonial, mutinous, undemocratic, apartheid era beliefs - and that they as protectors of the people have little appetite for such diatribes.

Anyone familiar with squabbling children in the back seat of a car is familiar with the "he started, no she started" phenomenon. Likewise, any astute parent knows that in all likelihood both are to blame with a disproportionate share falling on one of the offenders.

In this case, with no clear evidence over which squabbler is truthful, both usually shoulder the consequences.

The backseat metaphor extends to the bickering experienced in SA between private and public leadership, with industry leaders timidly complaining that government isn’t doing its job and government retorting with abusive, fact-starved rants.

Fortunately in this case there is clear evidence of culpability provided by an impartial referee – new foreign investors. These investors unilaterally express their views, simply by investing or not.

It is tempting to believe that these investors don’t have the requisite risk appetite, but risk and reward are part of the investor's DNA, so risk per se does not detract investment.

In reality managers have portfolios and complex mechanism to mitigate risk; these allocations are in fact what describes their day jobs. But what skilled investors can't stomach is not the risk, but the inability to manage that risk.

With this in mind, let us re-categorise the above mentioned risks based on the criteria of manageable and unmanageable.

What emerges from this exercise is that the un/manageable list is a perfect duplicate of the public/private list above, with both green and red risks split along the exact same lines

The implications of this are stark: green risks can be managed with tools such as hedging, diversification, adjusting the cash flow assumptions or doing more homework.

In contrast, none of the risk-mitigating tools available to investors are effective in mitigating the red risks.

The inference from the data is unambiguous: government is screwing up the business environment.

The converse is also clear: government is the only party which can unscrew the business environment.

It is not the way of fund managers to whip out their soap boxes and begin accusing leaders of arrogance, theft, duplicity and the like, as we have grown accustomed to hearing from SA’s governing twits and tweets.

Investors are skittish by nature and have a strong herd mentality. Perception of confidence is painstaking to win and easy to lose.

The good news is that government can fix its mess; the bad news is that it will take competence and hard work. Both are rare earth commodities in Pretoria.

 - Fin24

*Jarred Myers is a resources strategist and can be followed on Twitter on @JarredMyers. Opinions expressed are his own.

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jarred myers  |  mining
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