ZYL Limited (ASX:ZYL) – South African Anthracite
Over the past year ZYL Ltd (pronounced “zed why el”) has steadily declined in price from above $0.20 per share to the current $0.018 per share. Much of the decline has been due to a very high cash burn (due in part to project acquisition costs), delays in project development, announcements by the company concerning the Mbila project and delays to the proposed York transaction. Nonetheless, there could be very substantial share price upside for ZYL, but not without commensurate risk.
In July 2010 ZYL Ltd entered in an agreement to acquire the Kangwane Central Project in South Africa. The company currently holds 42.83% of this project, has an agreement requiring the purchase of a further 7.27% (to 50.1%), and an opportunity to increase its holding to 70%. The project is anthracite, a valuable form of coal (read here, here, hereand here for more information on anthracite).
The results of a BFS (“Bankable Feasibility Study”) on this project were released on 30 November 2012, read it here. It returned a project NPV (“Net Present Value”) of AUD$155M, valuing ZYL’s share at $66M, or $0.13 per share. A BFS should “de-risk” a project, which then should become “bankable”, or able to be financed. Further, it is a widely accepted measure of project value. ZYL’s current market cap is around $8.8 million at $0.018 per share.
ZYL has varying interests in, or options to acquire, four other anthracite projects in South Africa, in addition to Kangwane Central. The projects are:
- Kangwane Central – 42.83% interest now, may acquire up to 70%
- Kangwane South – 70% interest
- Mbila – 44% interest but somewhat irrelevant, see below for more information
- Kangwane North – 0% interest now, may acquire up to 70%
- Marble – 0% now, may acquire up to 60%
These projects (excluding Mbila) are as good, or better than, Kangwane Central, giving ZYL the possibility of defining anywhere from 0.5 to 1.0 billion tonnes of high quality coal. So, why is it seemingly undervalued, with a market capitalisation of around $11 million? My intention is to answer this question.
I have identified 7 issues that appear to contribute to ZYL’s underperforming share price. Here they are, along with my explanations for why this negativity is overdone:
The value of anthracite is not well understood. For example, a well-known brokerage, in a review of ZYL, recently used an anthracite price of USD88.40 for Kangwane Central in 2015. The BFS uses an independently validated price of USD136 for 2014. That is a significant difference, read more about anthracite prices here. Kangwane anthracite is very low in sulphur and thus will attract premium pricing.
- Problems at Mbila
In a rather bland release on the Mbila BFS in November, ZYL reported a “…lower than expected conversion from Resources to Reserves…”. This halved the share price on the day of the release. My take is this:
The deal to acquire the Mbila project required a small initial payment to earn 5%, but a much more substantial payment to acquire up to a 44% interest, subject to BFS completion. The BFS has effectively reported that the project is not what ZYL thought it was buying.
In December 2012 ZYL stated that, for the above reason, they did not believe the company was bound by the agreement. In January 2013 the company further announced that a condition precedent had not been met by the vendor and therefore the agreement had lapsed and all monies paid must be refunded.
Thus, it appears that the Mbila deal will be subject to renegotiation, termination, and perhaps ultimately litigation. Should ZYL be unsuccessful in any renegotiation or legal action, the company may not have the financial wherewithal to meet its remaining obligations under the agreement. However without pre-empting the outcome of any legal action, ZYL’s position does appear to be strong, based upon recent announcements.
- Investor Communications
ZYL’s communication with the investment community has been rather minimal and often opaque. This view is supported by a request from ASX for further details relating to all releases since November 2012.
Key directors and management are located in South Africa, but the company is listed in Australia. This is one of the worst time-zone differences for corporate management, which does not help when communicating with Australian investors.
ZYL needs to improve communication with the investment community, perhaps by engaging a third party to more fully explain releases. This could avoid any potential legal or other corporate constraints.
I bought shares in ZYL a few months back and, like many others, am underwater. So I have reviewed the Company’s history since the start of 2010 and I doubt I have ever seen a more complex set of transactions. Everything looks OK, but unnecessarily complex. One suspects that the various parties involved have never heard of one of the fundamental principles in life: “KISS” (Keep It Simple Stupid). This leads to the next point.
- The Board
It has been a revolving door, with numerous board changes since 2010. However, while it is not a good look, I think it is justified. This is a company that has gone from being in administration in 2010 (ZYL was born from the ashes of tech wreck Zylotech Limited, in early 2010) to, only three years later, holding some of the best anthracite projects in the world. The board transition has, effectively, been from corporate specialists to deal makers to operational professionals.
The current board, particularly in South Africa, is very sound, with one exception: the lack of geological expertise at board level. Investors in the resource sector are well aware that expert geological advice is a must. Geological input at board level could perhaps have helped in a much earlier resolution to the Mbila issue.
- The York Transaction
I refer above to the fact that ZYL may increase its interest in existing projects, and also acquire two new projects, all with anthracite resources or highly prospective for the discovery of new anthracite resources. These interests are all to be acquired from York Energy Limited.
York’s objective was, in 2011, to secure the anthracite assets for ZYL, at a time when ZYL was unable to finance the acquisition itself. Some ZYL directors were directors of York. As best as I can determine from my research, there has been no profit derived by ZYL directors from their holdings in York. Looks honourable to me and great deal for ZYL.
This transaction is expected to be finalised in early 2013, however the state of play with Mbila has resulted in delays and the need to adjust terms to account for removal of Mbila from the transaction.
In September, ZYL made a rather opaque announcement regarding an AUD18 million convertible note to finance the possible Mbila acquisition, and to provide working capital. Now, I am not a fan of convertible notes that seem so common in this market. But this note was somewhat different.
This note was issued by Sin-Tang Developments Pte Ltd (“Sin-Tang”). Sin-Tang is an entity that was formed to acquire or invest in international resource projects of interest and value to China. It is also, by a country mile, ZYL’s largest shareholder.
Sin-Tang is backed by two massive and influential Chinese companies: China Railway and Construction and China Construction Bank. Sounds rather good, don’t you think?
On a more cautionary note, we do need clarity regarding ZYL’s current financial position and longer term financial plans. There is uncertainty as to whether the converting note funding can be transferred from Mbila to the Kangwane projects. This needs to be clarified and, if it cannot be transferred, what are the alternatives.
There is also considerable concern amongst investors that a highly diluting equity raising is being contemplated. It would be very positive if the company could clarify these financing issues.
A major issue I see with ZYL is that the company’s ASX releases often tend to obscure rather than clarify. No doubt this is in part due to legal and corporate matters, but even so, more information would help in understanding risk.
- High value anthracite
- Excellent project at Kangwane Central
- Opportunity to acquire additional anthracite assets
- The board, particularly in South Africa
- Superb backing from China
- The York transaction
- Mbila (but negativity overdone in my opinion)
- Complex and opaque deals
- Uncertainty regarding financing going forward
The upside could be very attractive from current prices, but caveat emptor (let the buyer beware). A stock well worth watching for a resolution to the various issues mentioned above.
Disclosure: Market Capital holds securities in ZYL Ltd as at the date of publication of this article.