Lonmin Plc – Annual report – 30 September 2018
Principal Risks and Viability (extract)
Principal risks facing the Group
The Board monitors the Group’s risk management and internal control systems on an ongoing basis, and carries out a robust assessment of the principal strategic risks, their potential impact and the mitigating strategies in place as described on pages 22 to 27. The principal risks include those that would threaten the Group’s strategic business model, future performance, liquidity and solvency.
For the purposes of assessing the Group’s viability, the Directors considered in detail all of the principal risks in three groups. Some of these, for example changes in government policy, are not sensibly analysed numerically but could have serious repercussions (for example resource nationalisation and other threats to our licences). However, other elements such as PGM prices and exchange rates can be modelled to show the limits of our financing arrangements. The management presented to the Board an array of scenarios and stress tests to illustrate this. The Directors considered also the correlations between these parameters, which provide some natural offsets in some cases. The Directors further considered those elements that are essentially within our control, such as costs, safety and productivity drivers of our business. These matters are kept under constant review and are specifically considered as part of the Board Strategy Review.
Sufficiently adverse movements in these parameters, if not able to be countered by timeous management action, and if persisting for a lengthy period, can threaten the viability of the organisation, as can some of the non-measurable risks. The management has established regular cash flow forecasting tools, and the Board considers these matters as part of the budgeting and results oversight process to ensure that any such trends receive urgent attention.
How we assess the Group’s prospects
The Directors have had detailed and ongoing discussions as a Board regarding the longer term viability of the Group. In 2017 the Board of Lonmin concluded that the acquisition of Lonmin by Sibanye-Stillwater represents a comprehensive and more certain solution to the challenges facing Lonmin than Lonmin could achieve by any alternative route. The Board of Lonmin believes that a combination of Sibanye-Stillwater and Lonmin creates a larger and more resilient company, with greater geographical and commodity diversification, that is better able to withstand short-term commodity price and foreign exchange volatility. By combining Sibanye-Stillwater’s existing, and contiguous, South African PGM assets with Lonmin’s operations, including Lonmin’s processing facilities, Sibanye-Stillwater is expected to be able to unlock operational synergies and become a fully integrated PGM producer in South Africa, thereby creating value for all stakeholders. Sibanye-Stillwater has developed a conservative Lonmin operating plan, which is not contingent on the development of new major capital projects and therefore limits downside risk while providing upside optionality in a higher South African Rand PGM price environment. Lonmin’s processing facilities will allow Sibanye-Stillwater in due course to smelt and refine ore from its existing Rustenburg Operations, enhancing and improving the economics of those operations, while simultaneously ensuring a sustainable source of material for these facilities, therefore maximising return on assets.
At 30 September 2018 covenant waivers were in place for the tangible net worth (TNW) covenants contingent on the completion of the acquisition of Lonmin by Sibanye-Stillwater. There was significant risk that Group could be in breach of its debt facilities in the event that the acquisition did not complete. To mitigate this risk, Lonmin entered into a $200 million metal sale agreement in October 2018 which amortizes over a period of three years (the Facility). Lonmin settled its pre-existing term loan of $150 million and cancelled all its other pre-existing undrawn facilities (together, the Existing Debt Facilities) with both its South African Rand and US Dollar lender groups (the Existing Lenders). The Facility will provide Lonmin with improved liquidity and removes certain restrictive current lender conditions notably the TNW covenants contained in the Existing Debt Facilities which were waived by the Existing Lenders subject to the anticipated successful completion of Sibanye-Stillwater’s all share offer for Lonmin.
Executive Management annually prepares a Life of Business Plan (LoBP) which covers a period in excess of 40 years detailing operational plans to utilise the Group’s long-life mineral resources. Focus has been given to the short to medium term with key consideration given to the ability of individual assets to generate cash and levers which can be pulled to ensure that those assets continue. The LoBP forecasts total mining production volumes and costs based on geological modelling and capital expenditure budgets. Capital allocation is determined based on portfolio optimisation models with the aim of ensuring that capital expenditure is invested only in the most valuable ore reserve development and expansion projects that are available to the Group.
Mining production and cost forecasts are then aggregated with concentrating, processing and overhead costs. Key financial assumptions including PGM prices, Rand / Dollar exchange rates and cost escalations are reviewed and incorporated into the LoBP. The LoBP output is incorporated into a Working Capital Model (WCM) which produces short and medium term financial forecasts. A detailed annual budget covering the following year is prepared and reviewed by the Board on an annual basis.
The key base case assumptions applied in the LoBP and WCM are disclosed in note 30 to the financial statements under impairment of non-financial assets. The Directors have interrogated the key assumptions and have satisfied themselves that they are appropriate. The financial forecasts from the WCM are then subjected to stress testing using the key downside risks of adverse PGM prices and exchange rates and lower than planned production.
The period over which we assess longer term viability
Mining is a long term business and time scales can run into decades. The capital investment required to fund the mine plan is dependent on the funding available and cash flows generated by the business which are underpinned by the key financial assumptions. Given the inherent uncertainty involved in setting key financial assumptions, specifically PGM prices and Rand / Dollar exchange rate, the period over which the Directors consider it possible to form a reasonable expectation as to the Group’s longer term viability, based on the planning and the stress testing described above, is the three year period to November 2021.
In 2017 the period over which we assessed viability was the period to 28 February 2019 in-line with the long stop date of the Sibanye-Stillwater acquisition and the covenant waiver period. The debt refinancing has enabled an extension to the 2017 viability period due to the increased liquidity and removal of the restrictive TNW covenant.
Assessment of viability
Lonmin has experienced financial constraints for a number of years caused by a range of external factors such as a persistently low PGM pricing environment and the inflationary cost pressures of operating in the South African PGM mining industry, which have been further exacerbated by internal factors including operational, social and labour issues. As part of a larger entity, Lonmin’s operations will be less constrained by significant fixed overhead costs which have in the past driven the need to fill processing capacity. The Board of Lonmin believes that a combination of Sibanye-Stillwater and Lonmin creates a larger and more resilient company, with greater geographical and commodity diversification, that is better able to withstand commodity price and foreign exchange volatility.
On completion of the acquisition of Lonmin by Sibanye-Stillwater the Facility requires a partial repayment of $60 to $80 million. Based on cash flow projections using assumptions that were duly considered by the Board, the partial repayment of the facilities at the closing of the deal is considered a reasonable expectation.
The refinancing and increased Rand basket price has improved the Group’s liquidity. Whilst we believe that it is likely that the Transaction will complete, some level of uncertainty exists over its completion given that the statutory time period of 20 business days to file an appeal or apply for a review and that approval by both Lonmin and Sibanye-Stillwater shareholders is still outstanding. This combined with the need for an alternative solution to the adverse longer term challenges faced by the Lonmin Group if the deal does not complete represent a material uncertainty that may cast significant doubt on the Group’s and parent Company’s ability to continue as a going concern and viability such that they may be unable to realise their assets and meet their liabilities in the normal course of business.
Nevertheless based on the Group’s expectations that the acquisition will be completed as expected and based on a robust assessment of the principal risks facing the Group, a well-developed strategic management Board process and stress testing of various drivers described above, the Directors have a reasonable expectation that the Group will be able to continue in operation and meet its liabilities as they fall due over the three year period to November 2021.
Notes to the Accounts (extract)
Basis of preparation (extract)
In determining the appropriate basis of preparation of the financial statements, the Directors are required to consider whether the Group can continue in operational existence for the foreseeable future.
At 30 September 2018 the term loan of $150 million was fully drawn and the Group had gross cash of $264 million. The term loan included several covenants the Group was required to comply with. A waiver was in place, subject to the timeous completion of the Sibanye-Stillwater transaction, over the two covenants related to the Group’s tangible net worth (TNW). At 30 September 2018 the Group’s TNW was lower than the waived covenant threshold.
After year end, in October 2018 Lonmin completed a $200 million forward metal sale agreement, settled the term loan of $150 million and cancelled all its other pre-existing undrawn, draw-stopped facilities with its South African Rand and US Dollar lender groups. As part of this agreement $200 million in cash was received, which will be repaid in Platinum and Palladium over a three year period. The new facility provides Lonmin with improved liquidity; tenure of financing; and removed the TNW covenants. Further details are provided in note 17. This refinancing therefore removes the risk of a material loan repayment if the transaction with Sibanye-Stillwater does not complete timeously or at all.
On 14 December 2017 the Board of Lonmin Plc unanimously recommended Sibanye Gold Limited’s (trading as Sibanye-Stillwater’s) offer until 28 February 2019 to buy the Group (“the Offer”). The Board of Lonmin believes that the Offer is in the best interests of Lonmin shareholders and all other stakeholders of Lonmin and provides Lonmin with a comprehensive and sustainable solution to the adverse longer term challenges it faces. The combination of Sibanye-Stillwater and Lonmin creates a larger and more resilient company, with greater geographical and commodity diversification, that is better able to withstand short-term commodity price and foreign exchange volatility.
Since December 2017 progress has been made on the key conditions precedent to the Offer including, most recently, South African tribunal competition approval on 21 November 2018. The statutory time period to file an appeal or apply for a review of the tribunal ruling is 20 business days. The key remaining conditions precedent which are expected to take place in early 2019 are approvals by the shareholders of Lonmin and Sibanye-Stillwater and sanction of the Transaction by the courts of England and Wales. The completion of the Offer requires consideration alongside the Company’s prospects on a stand-alone basis in assessing the appropriateness of the going concern basis of preparation and as such has also been considered by the Directors in reaching a conclusion.
If the Offer completes, a portion of the $200 million metal purchase agreement (between $60 to $80 million) would be required to be repaid on completion of acquisition. If the deal does not complete, the facility will be repaid in Platinum and Palladium over a three year period in monthly minimum instalments of $6.993 million.
The financial performance of the Group is highly dependent on the wider economic environment in which the Group operates. Factors exist which are outside the control of management which can have a significant impact on the business, specifically, volatility in PGM commodity prices and the Rand / US Dollar exchange rate, material adverse movements in which are unlikely to be offset by controllable management actions.
Going concern assessment
In assessing the Group’s ability to continue as a going concern, the Directors have first of all prepared cash flow forecasts for a period in excess of 12 months considering the finance facilities available to the Group as noted above and disclosed in note 17. The base case assumptions used in the model are disclosed in note 30.
Various scenarios, up to a 10% downside impact on revenue, have been considered to test the Group’s resilience against known risks including:
• adverse movements in PGM commodity prices from current spot prices and combinations of the latest price outlooks of various brokers and experts and Rand / US Dollar exchange rate or a combination thereof;
• failure to meet forecast production targets having regard to current and historical performance; and
• failure to achieve cost projections having regard to historical performance.
As the Offer is still subject to conditions, principally shareholder approval, the outcome of which is not controlled by the Group, the finance facilities have been stress tested for adverse movements in the above variables both in the event of the acquisition completing successfully and failing to complete.
i. The Offer completes
In the event the acquisition does complete, the Group has modelled the impact of repaying, between $60 to 80 million of the metal sale agreement on completion of the acquisition as well as transaction related success fees.
Secondly, the Directors have considered any conditions, including any restrictions on redundancies, of the acquisition agreed between Sibanye-Stillwater and the Competition Commission of South Africa in relation to Sibanye-Stillwater’s plans for Lonmin for a period in excess of 12 months.
Thirdly, before announcing the Transaction in 2017, the Directors had performed a due diligence over the Sibanye-Stillwater business to consider whether, if required, it could financially support Lonmin. The due diligence performed included inquiry with Sibanye-Stillwater management, review of private and public financial information and consideration of longer term trends as well as the financing facilities available to Sibanye-Stillwater. For purposes of the preparation of these accounts, the due diligence outcomes were updated with the latest available public information including press releases, analyst reports and the company’s latest interim report for the year ended 30 June 2018. The absolute quantum of Sibanye-Stillwater’s debt facilities as reported in their interim results to 30 June 2018 and the headroom in debt covenants have been stress tested. There has been continuous engagement between senior management of Lonmin and Sibanye-Stillwater regarding progress of the Transaction and operational business updates.
The Directors have concluded that the combined group will have adequate resources to meet obligations as they fall due and comply with its financial covenants whilst complying with acquisition conditions.
ii. The Offer fails to complete
If the Offer fails to complete the Group would continue to repay the $200 million metal repayment in Platinum and Palladium over a three year period. The Directors have considered various cash flow forecast scenarios for a period in excess of 12 months as explained above and believe that the Group and Company have adequate resources to meet such obligations if they fell due and comply with its financial covenants. While the metal sale agreement is not a long term solution to the challenges faced by Lonmin whereby the Group would be financially constrained and unable to fund the significant investment required to sustain the business, it removes the risk of a material loan repayment if the Offer does not complete and it therefore improves the Group’s status as going concern. While there are certain downside cash-flow scenarios under which the Group runs out of cash after approximately three years, in many of the scenarios the Group is able to continue operating and meeting its obligations as they fall due.
Whilst the Directors believe that it is likely that the Transaction will complete, there remains continuing uncertainty over its completion given the statutory time period of 20 business days to file an appeal or apply for a review and that approval by both Lonmin and Sibanye-Stillwater shareholders is still outstanding. This combined with the need for an alternative solution to the adverse longer term challenges faced by the Lonmin Group if the deal does not complete represent a material uncertainty that may cast significant doubt on the Group’s and parent Company’s ability to continue as a going concern such that the Group and parent Company may be unable to realise their assets and discharge their liabilities in the normal course of business.
Nevertheless, based on the Group’s expectation of the acquisition completing in early 2019, the Directors believe that the Group will continue to have adequate financial resources to meet obligations as they fall due. Accordingly, the Directors have formed a judgement that it is appropriate to prepare the financial statements on a going concern basis. Therefore, these financial statements do not include any adjustments that would result if the going concern basis of preparation were inappropriate.