Southport mineral

Southport Minerals

Case Analysis



http://es.scribd.com/doc/51021089/Southport-Solution

 
N. Saikumaar Southport Mineral Case StudySection A, 2010PGP200
Submitted for Fin - II

Background

Southport Minerals Inc. is the US’ largest sulphur producer, and is facing an upward swing in its business cycle in 1967. After a few years without any successful projects, Southportis nowexamining a mining prospect in the FirstburgMountain in Indonesia. Though discovered years earlier, the rising prices of Copper worldwide have now made extraction of copper from Firstburg economically viable.

Soutport’s initial experiences in Cuba, where it had to write off $19 million due to expropriation, was wary of committing to large investments in developing nations. Fortunately forSouthport, countries like Indonesia offered attractive credit guarantee schemes to stimulate investments. Encouraged by this scenario, for mining copper in Firstburg, Southport Indonesia, a wholly-owned subsidiary of Southport Minerals was established. Initial experiments established that Firstburg mine contained 33 million tons of copper ore with an average copper content of 2.5%.

Bechtel conducted thecost and feasibility studies and informed that the total development cost would be $120mil and could be operationalized by end of 1972 (including$4.5 mil working capital). The ore body is expected to last for 13 years and the production costs are expected to be among the lowest in the world. SM is concerned with the expropriation risk and output risk as these are the major risks that are yet tobe mitigated. Though world copper prices rose from 28.7 cents (in 1961) to 66.3 (in 1969), the project does not provide the minimum required return of 20% on equity (NPV is -$17 million). Corporate financing the project can reduce the WACC thereby making the NPV to be positive. In 1969 (at the time of deciding this project), SM had $231 million in net worth and hardly any debt apart from very goodliquidity and profitability. Though SM can take the leverage on its balance sheet to fund the entire $120 million, namely corporate-financing the project, it is still wary of the risk of nationalization of its mining assets.


Southport’s financing plan

SI began to contract the output of the mine to Japanese and German smelters. 2/3s of the mine output would be contracted to the Japanesesmelters, and 1/3 to the German smelter.

The Japanese deal would allow a consortium of smelters to invest $20 million in subordinated debt to SI at an interest rate of 7%. The principal would be amortized over 6 years and payable in chunks of 3.3 million. This debt was junior debt meaning they were last in line to receiver payments before senior debt obligations are claimed. Having severalsmelters contribute to the loan will lower the risk of the Japanese invested capital. This loan would be guaranteed by the Export-Import Bank of Japan.

The German smelter had induced a German bank to lend SI $22 million of senior debt at7% interest. This loan would be repayable between 1974 and 1982 in escalating installments and was guaranteed by the Federal Republic of Germany. Thus the totalforeign investment is$42 million.

A group of U.S. banks had agreed to give SI $18 million repayable between 1974 and1976 with an interest rate a ½% over the prime rate. This was a senior loan and was guaranteed by the Export-Import bank of the U.S. They made this guarantee because SI agreed to purchase$18 million of U.S. manufactured equipment, a you scratch my back Ill scratch yours kind ofdeal.

Offering the biggest investment was a group of U.S. insurance companies which agreed to lend $40 million repayable between 1975 and 1982 at 9.25% interest. A guarantee was supplied by the Overseas Private Investment Corp., an agency of the U.S. Government, this guarantee would cost 1.75% per year, which would raise the interest rate of the loan to 11% all together. This guarantee was a...