Stockwatch: A share to fascinate speculators

Between Christmas and New Year is prime time for unusual stock movements: with fund managers away from their desks, a tighter market can make a party as private traders chase any squeeze upwards. This is happening in the London-listed shares of Russia's second-largest gold producer Petropavlovsk which nearly tripled from about 6p close to 18p in three days' trading to New Year's Eve, currently about 15p.

While volumes have been keen the trade sizes imply individuals not institutions. Certainly this is a stock liable to fascinate speculators, having fallen from about 100p in 2014 (or £14 in 2010) and prone to sentiment swings.

Technical factors of a steeply-discounted rights issue, dictate trading

The company became caught with high debts as gold prices fell and needed to refinance convertible bonds maturing, the proposed solution being a fully-underwritten if highly dilutive 15-for-1 rights issue at 5p a share.

The jump in market price is likely explained by speculators recognising an opportunity if the shares can continue to trade above the 5p rights price. Even if buyers pay about 15p they gain the per share rights to 15 additional at 5p. Of course the bet assumes the ordinaries' market will settle usefully above 5p when the price goes "ex-rights" to reflect dilution. Shares can indeed do this in attractive recovery situations, but mind how the fundamentals affecting Petropavlovsk remain high-risk.

Some of the numbers and ratios in the table look bizarrely attractive, but reflect the very low share price due to the refinancing uncertainty.

Shareholders will have two main options

The details are yet to be published but rights issues' convention allow two main options: you either subscribe for additional shares or sell (part of) your rights. The "nil-paid" rights will likely trade in their own market with a value according to any premium the ordinaries trade above 5p; making them a geared play on an already volatile share, hence of interest to traders in a month or so. If you do nothing, then convention is for your rights to be automatically sold and any value returned. But this is best checked in due documentation, also whether your nominee broker would fulfil such. As yet there is no firm timetable, but a presentation on the company's website posits late January/early February for the rights offer period. Possibly the documentation will soon be published here also.

Mind the company will still face gold price uncertainties and high debt

Lest this sounds an invitation to "free money", mind how key factors why the company got into this situation will continue. Gold prices bump around $1200 (£770)/ounce, having trended volatile-sideways to down over 2014, and there is concern the metal will drop further if the US economy continues to strengthen and interest rates rise - i.e. reducing gold's appeal as an alternative investment. Management contends it can cope; indeed, there is "upside potential because the margin between the US dollar-related gold price that the group currently receives and its operating costs remains strong." The depreciation of the Russian Rouble should help.

To illustrate the debt context: the $235 million equivalent rights issue at 5p and a new $100 million convertible bond are being proposed in order to re-purchase $310.5 million outstanding bonds maturing. (Like most miners, Petropavlovsk reports in US dollars.) But even after shareholders are diluted by a factor of 15, the company's net debt will only be reduced to about $700 million, hardly the "transformation" being touted.

The end-June balance sheet had $655.8 million longer-term debt and $332 million short-term debt, relative to $1,009.5 million net assets (mainly $1,167.9 million property, plant and equipment). This $987.8 million combined debt made for a $35.7 million net interest charge against $44 million operating profit during the first six months of 2014. While just an accounting snapshot in time it shows major challenges weighing.

The thrust of the rights issue proposal is making Petropavlovsk "investable", although it still appears highly speculative, not investment grade. Straws of comfort are offered by recent exploration success implying 2014 production target of 625,000 ounces can rise to 680,000 to 700,000 ounces in 2015. "This increase is more important than it might seem, because it is net of the reduction that follows from the anticipated disposal of our low-margin alluvial production (historically 80,000 to 90,000 ounces a year)."

It is suggested this will help cash generation, but one is still left guessing. The website presentation takes the usual form of miners' fund-raisings, e.g. entertaining "new high grade prospects" but you are really looking for cash flow scenarios according to gold prices. Possibly Bank of America Merrill Lynch, the company’s broker, will make an attempt and the numbers get picked up on a message board.

Then there is Russian political risk. However, President Putin is riding high on nationalism and may avoid any pressures for regime change as the economy gets throttled by sanctions and low oil prices. The re-appointment of co-founder Pavel Maslovskiy to the board since last October (having retired from the Russian parliament) should also mitigate country risk - specifically asset grabs, the classic fear for investors.

Founders taking up their rights

Peter Hambro and Pavel Maslovskiy say they "have agreed to support an underwriting of $30 million rights and additionally are retaining our ability to invest further by taking up our rights". This sounds positive, but mind what they do actually commit and if underwriting fees (normally lucrative) accrue. A 6 November update stated Maslovskiy and his associates own 7,514,485 ordinary shares (3.8%) i.e. a potential commitment over £5.6 million equivalent. So one aspect arising might be the ability to part-invest by selling nil-paid rights, without too much fresh capital. The extent of commitment by the founders will be crucial for sentiment; whether they dig deep.

It's impossible to make a long-term call here, you can but assess events as they unfold. The stock did, however, become priced for failure so is enjoying some respite - or a stay of execution, according to your view of gold prices. If Petropavlovsk can manage through, then its stock will rise usefully from this re-basing near 5p, although dilution will limit recovery.

For more information see petropavlovsk.net.