Noront (CVE:NOT) update

Noront is in the process of getting a loan from its largest shareholder (RCF, a hedge fund with many mining professionals on its staff).  Overall, this looks a lot like a convertible junk bond.  The effective interest rate is really high once you sort out the financial engineering.  This makes sense as Noront has negative cash flow and is not safe to lend to.  The lender needs to be compensated for the risks on its loan.

Setting aside the trickiness of the loan for a second, I think that it is somewhat of a good sign that RCF decided to lend money to Noront.  It shows faith in Noront.  If it turns out that the nickel and chromite projects are not economic (and this could well happen), then RCF could lose a lot of money on its loan and be left with assets that aren’t worth that much.

The financial engineering

RCF gets paid a 2% fee in Noront shares for issuing the loan.

From now until Feb 2014, the interest rate is 10%.  This is payable in cash or shares, at RCF’s option.  A simple way of looking at it is that RCF has an effective interest rate of 12% in the first year.

From Feb 2014 to Dec 2015, the interest rate is 8%.  However, RCF can convert the loan into Noront shares at a price of $0.45/share.  They essentially gain a large number of warrants at $0.45/share.  These warrants are worth something.  The effective interest rate is higher than 8%.

RCF’s option of getting paid in shares or cash is smart.  When the stock is undervalued, they can choose to get paid in stock.  A backdoor method of buying this illiquid stock is smart.  It is however disadvantageous to other Noront shareholders (such as Baosteel and retail shareholders).

Financing alternatives

A rights offering would have been easier to evaluate and fair to all shareholders.  However, I guess the CEO and RCF knows how the game is played.  If you do a right offering, the brokerage community will shun the stock.  They will not have their analysts try to talk up Noront’s share price.  This will affect Noront’s chances of raising financing.  They will need several hundred million to actually build a mine.  They will need even more if they need to finance a road to the deposit.  I guess Canadian markets are extremely stacked against fair, simple, and cheap methods of raising capital.

RCF could have done a private placement and bought Noront shares at a discount to the market price and when the shares are at half the price they bought them for earlier.  The private placement nonsense happens a lot in the junior world unfortunately.  (Though I am guessing that a really large private placement deal would require shareholder approval.)  Thankfully, this did not happen as the dilution would be really bad for Noront shareholders.

Overall, this loan looks fair to me.

Bigger picture

Noront raised (at least) $10M cash from Windfall Lake and $15M from the RCF convertible loan.  That’s $25M.  This should allow Noront to continue to advance its deposit towards a production decision.  It will still need to raise more money in the future.

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