Approximately two-and-a-half years ago, the Company’s former majority stockholder, MMC Norilsk Nickel (“Norilsk”) sold all of its stock in the Company. Since then, the Board has been free of the control of a majority stockholder and free to guide the Company as it saw fit. In our view, the results have not been pretty.
Since Norilsk’s exit, as we describe more fully below, Stillwater has engaged in two value-destructive acquisitions (in pursuit of what we believe is a questionable strategy), spent imprudently on marketing and other administrative matters, and executed an unnecessarily costly and dilutive financing transaction. Meanwhile, the Board has more than doubled the Chief Executive Officer’s annual pay and granted its own members hefty pay increases as well. We believe these unforced errors combined with increased compensation have eroded stockholder confidence in the judgment of the Board and left the Company with a muddled strategy, a motley collection of assets and an overpaid Chief Executive Officer.
In short, once the reins came off, so did the wheels.
As a result, the Company’s stockholders have been hurt. Since Norilsk’s exit, the Common Stock is down more than 37% (through March 25, 2013) even though the Company has added net cash to its balance sheet and the value of its proven and probable Platinum Group Metal (“PGM”) reserves have declined by just 7%.
We believe decisions made by the current Board caused the Common Stock to fall in value.
First, the Board and management team decided to diversify away from the Company’s historical roots, expanding into copper, gold, Canada and Argentina and away from PGMs and the United States – transforming the only US-based, pure-play PGM producer into a “diversified” mining company. We believe that in introducing “diversity”, the Board chased away investors whose primary reason for acquiring the Common Stock was to gain exposure to the attractive fundamentals of PGMs without any political risk. If the stockholders wanted diversity, they could have achieved it on their own by buying shares in any one of dozens of publicly traded mining companies. We believe the Company’s diversification strategy was, and continues to be, a mistake.
Worse, in pursuit of this questionable strategy, the Company made what we believe were two ill-conceived acquisitions. In 2011, the Company announced the purchase of Peregrine Metals Ltd. for more than $450 million, a 290% premium to Peregrine’s market value at the time. Peregrine owned certain mining rights to Altar, an undeveloped copper and gold deposit that requires billions (the Company does not have) to fully develop into a working mine, in an unstable country (Argentina) with a history of nationalizing natural resource assets. Peregrine had acquired most of its mining concessions just a few years earlier from Rio Tinto Mining and Exploration Ltd. for a total payment of $2.8 million plus small future royalties. Although Peregrine, and now the Company, have done some resource definition work at Altar, there remains “significant uncertainty … as to the economic viability of the Argentine resources.” The Common Stock declined 47% in the month following the announcement of the purchase, destroying $1.3 billion in stockholder value.
The Company has also admitted that its other acquisition in pursuit of diversity, of Marathon PGM Corporation for approximately $125 million, was completed after faulty due diligence, leaving management and stockholders with insufficient data to know whether the Marathon project in Canada will ever be economic. Because of the diligence mistake – which involved “palladium grades being overstated on a significant portion of the project area” – there is “uncertainty as to the ultimate extent, quality, final grade, [and] mineability” of Marathon. Perhaps we are old fashioned, but we believe that in spending the stockholders’ money, management and the Board should accurately assess the asset being purchased. Even now, years later, management cannot assure stockholders that the Marathon project contains resources that can be economically mined and it recently delayed the release of revised resource estimates. Stockholders are left to hope the Company gets lucky.
Together, we believe these acquisitions succeeded in distracting management, siphoning cash away from the Company’s core PGM business and destroying stockholder capital; all this in pursuit of a misguided strategy of “diversity”.
Second, the expense base of the Company has grown substantially and is draining cash flow away from stockholders. Without the presence of a majority stockholder such as Norilsk to check management, the Board has seemingly been unable to do so. During Norilsk’s ownership period (lasting 29 fiscal quarters through December 2010), the Company operated with average annual SG&A expenses of approximately $25 million, or half the annual SG&A expenditures of 2011 and 2012. Meanwhile, production of metal ounces from the Company’s mines has declined.
A good portion of this increase in SG&A expense is in the form of marketing. Once Norilsk sold its Common Stock, the Company increased its contributions to Palladium Alliance International (the “Alliance”), an opaque, for-profit business chaired by Stillwater’s Chief Executive Officer, supposedly to promote the wearing of palladium jewelry. No other palladium producer has joined the Alliance, leaving Stillwater to fund the entire budget even though Stillwater produces just 4% of the world’s palladium. This off balance sheet marketing program has increased from $2 million per year in each of 2009 and 2010 (during Norilsk’s reign) to $11 million per year in each of 2011 and 2012. We do not believe the Company’s annual spend on the Alliance – which in turn funds celebrity endorsements of palladium jewelry (and potentially other activities that are not known to Stillwater stockholders) – is a good investment and management has been unable to provide what we would view as a reasonable justification for it either. What we do know is that for the Company’s spending to produce a good return, the price of palladium must be at least $30 more per ounce than it would be without these marketing efforts.
Taken together with the Company’s spending in Argentina and Canada and other increased administrative costs, this marketing spend is indicative of a bloated expense base that is not tied to stockholder returns. The Board has been unable to restore the spending and capital allocation discipline that Norilsk imposed during its reign.
Third, in October 2012, the Company issued a dilutive and expensive convertible debt security in exchange for proceeds of nearly $400 million. We believe that the Company could as easily have issued high-yield, non-convertible bonds, with a significantly lower all-in cost of capital. The convertible debt was also priced inefficiently, causing the converts to be over-subscribed with enthusiastic purchasers by “mid-afternoon on the first day of marketing,” according to the Company’s Chief Financial Officer. The rich deal was a boon for the convertible bond investors who participated – those bonds traded up nearly 30% within four months of their issuance – and a concomitant value destroyer for those of us who own Common Stock.
We thus are not surprised that the market has afforded Stillwater – a company with successful mines in
Montana and a unique position in the PGM market –a valuation we consider low. We believe the mistaken strategic plan focused on “diversity”, the ill-conceived and poorly executed M&A activity, the bloated cost structure and the dilutive and expensive financing program have left investors without the confidence in management and the Board needed to support a fair Common Stock valuation.
We believe change is needed.