Restructuring Bulongs Project Debt

Subject : INFIN-II Guidance of Prof. Pramod Submitted by Abhishek Shah, Kumar Abhishek 4/1/2013

Q1. Why did Bulong default in Jan 2000? Was it a result of a flawed strategy, poor execution, or bad luck? Were any of the factors that caused them to default foreseeable? Preston acquired Bulong from Resolute in July 1998 for A$319 million. Preston revenues in 1998 were A$ 231,000, consolidated assets of A$ 29 million. Preston funded the A$319 million by borrowing A$260.5 million from Barclays in the form of Bridge loan, issuing A$39.9 million equity to Resolute, assuming A$11.1 million in liabilities, and paying A$7.5 million of cash on a deferred basis. At the time, the contracts had a negative net value on a mark-to-market basis of A$33 million, a liability that Preston assumed from Resolute. The projections made by Bulong assumed average nickel price of US$3.25, which was too optimistic seeing the present conditions and London Metal Exchanges spot and fo rward prices of Nickel. Pricing of Nickel as per CRU assumptions were $2.03 and $2.07 for initial couple of years which is about 62% less than what assumed by Preston. Also there was an exchange rate risk. Also Preston became a highly leveraged firm after the buyout. In 1998 Preston D/V value was 37.1% which soared to 83.3% in 1999. In 2000, Prestons value of assets plunged by more than 200% from (in A$ 000) A$367,839 to A$ 115,100 creating a negative equity position for Preston. Preston cash reserves were a mere A$2,233,000 in 1998. Bulong management had assumed that commissioning would be completed in December 1998, but it started in March 1999 to be again stopped in August because certain valves were limiting throughput. The semiannual interest payments of A$ 18.3 million on the project bond that Preston had issued in December 1998, were to commence on June15, 1999. The note issue had left BOP with cash reserves of A$66 million, in June 1999. With this cash reserve Bulong could make both required interest payment in 1999, but it failed to replenish the DSRA in Jan 2000, as between July 1999 till May 2000, Bulong faced operation problem and was not able to produce. The actual revenues in 2000 were 155% less than what was forecasted. The revenues generated were not sufficient to make payments to employees and suppliers. The forecasts that Preston used were that of Resolute. Resolutes forecast was of processing 600,000 tons of ore annually to produce 8000 tons of nickel and 670 tons of cobalt. Preston (Exhibit-10) in its forecast kept the ore processes to be 600,000 tons but increased Nickel-output sold to 9000 tons and Cobalt-output sold to 750 tons. The Bulong deposit averaged only 1 per cent nickel, compared with grades of 3 per cent being mined at Kambalda at the time. Also financial assumptions for (US$/lb) assumed by Preston were $3.30 for Nickel & $15-$25/lb for Cobalt, whereas as per CRU Nickel prices were at $2.03/lb and $8.74-22.56/lb for Cobalt. Thus we can say operating as well as financial forecasts done by Preston were very optimistic. Thus we can say that operating side of Bulong bleached into the financial side and since the financial side was also not robust enough Bulong defaulted in Jan 2000. Bulongs default in Jan 2000 was due to the failure of interest payment and the DSRA account replenishing. Lets try to understand this default from the Operations as well as financial side.

Financial Side analysis: - Bridge loan of A$260.5mn was taken during acquisition of Bulong by Preston - Preston raised a bond of A$185mn to clear off the bridge loan debt - In Yr. 2000, the borrowings from bond issue and other were used to clear of the Bridge loan debt - The interest on the bond to be paid for the 1st year was A$42.78mn Lets look at the below tables w hich highlights the Sources and Uses of fund:
Diff 99-98 Sources Acc Payable ST Borrowings Provisons Other Acc Payable LT Borrowings Provisons Share Capital $ $ $ $ $ $ $ $ 14,341 43,643 2,867 3,143 279,964 69,514 73,750 % 3% 9% 1% 0% 1% 57% 14% 15% Sources Acc Payable ST Borrowings Other Share Capital Cash Receivables Inventories Other Receivables Investments PPE Exploration Other Total Uses Provisons Acc Payable LT Borrowings Provisons Reserves Accumulated Losses $ $ $ $ $ $ $ $ $ $ $ $ $ Diff 00-99 40,293 321,653 123,992 1,562 20,618 4,124 1,799 3,722 268 252,739 33,729 44,451 % 5% 38% 15% 0% 2% 0% 0% 0% 0% 0% 30% 4% 5%

Total Uses Cash Receivables Inventories Other Receivables Investments PPE Exploration Other Reserves Accumulated Losses Total

$ 487,222

$ $ $ $ $ $ $ $ $ $ $

19,209 5,201 10,741 6,608 159 367,582 7,095 46,805 525 23,295

4% 1% 2% 1% 0% 0% 75% 1% 10% 0% 5%

$ 848,950 $ $ $ $ $ $ 2,278 1,045 279,964 66,883 1,562 497,219 0% 0% 33% 8% 0% 59%

$ 487,220

$ 848,951

From the above table we can easily identify that the ST borrowings (i.e. Bond issued + other borrowings) A$321.653mn were used to pay back the LT borrowing (i.e. Bridge loan) of A$279.964mn (A$260.5 + interest accrued). So the majority of source of fund in Yr.2000 was used to pay the borrowings.

Now consider the interest to be paid for the bond issued (US$185 mn); in below table
Yr Sr. No 2000 1 2001 2 2002 3 2003 4 2004 5 2005 6 2006 7 2007 8 2008 9 2009 10 A$ Bond Issue 291.85 262.67 233.48 204.30 175.11 145.93 116.74 87.56 58.37 29.19 A$ A$ A$ A$ A$ 1st half 2nd half Interest at 1st half Interest at 2nd half Total interest 277.26 262.67 17.33 16.42 33.75 248.08 233.48 15.50 14.59 30.10 218.89 204.30 13.68 12.77 26.45 189.70 175.11 11.86 10.94 22.80 160.52 145.93 10.03 9.12 19.15 131.33 116.74 8.21 7.30 15.50 102.15 87.56 6.38 5.47 11.86 72.96 58.37 4.56 3.65 8.21 43.78 29.19 2.74 1.82 4.56 14.59 0.00 0.91 0.00 0.91

The 1st year interest payment is of A$ 33.75mn Considering the operations side now we try to find whether the revenue generated was enough to facilitate the interest amount; From the Exhibit 5 of the case, the Operating Revenue in year 2000 is A$ 62.259mn; which on deduction of expenses becomes A$ - 33.51mn! (Ref: Exhibit 5). This clearly shows that the Op. rev of A$ 62.59mn cannot clear the interest payment of A$ 33.75mn To meet the interest payment of A$ 33.75mn, an operating revenue of at least A$ 129.52mn is required which as per the revenue projection (Exhibit 9) should be A$ 159.022mn. Also, if we try to adjust the interest rates to meet the revenue generated; still as the Op. Exp. are so huge that the interest payment would not be made. Now lets consider the Business side analysis Business Side analysis:
The main objective of Preston to acquire Bulong was to utilize Bulong s operation cash flow in developing Marlborough mine and also, to utilize the expertise at Bulong for Marlborough. But, without having detailed examination on profitability/break even of mine they directly considered it as a rare opportunity! Lets examine the Break even analysis, based on the Exhibit 5, 10 & 11; we can conclude that the BEP production volume in 2000 were very high than the existing production! (Please refer below table)

Op Exp Co rev Ni rev BEP Ni prod Act Ni prod

51427.7 7416.8 44010.9 9602.2 4006.4

A$ (000) A$ (000) A$ (000) ton ton

From the above table; the BEP Ni production required is 9602.2ton against current production of 4006.4ton! Almost 140% reduction!

Now suppose we consider that the above situation was for that particular year 2000 only. So we try to find when it will achieve BEP considering average production and average prices. Please find the below table showing average production required per month and its relative expenses and revenue generated.

Ni ton/mnth Rev(A$)/mnth Co ton/mnth Rev(A$)/mnth Op exp(A$)/mnth

2000 364 1669 19 674 4675

2001 529 2279 34 1061 6832

2002 Avg/mnth 544 479 2455 2135 33 29 849 862 6735 6081 Total Avg OpExp 6081 0 6081

The above table is summarized as below:

Existing Additional Required

Total Avg Ton 508 523 1031

Total Avg Rev 2996 3085 6081

The above table tells us the whole story on the required production to meet BEP. Bulong will have to mine on a n average of 1031ton of Ni+Co per month, i.e. around 12000ton per year!! Which when compared with their projections too, it doesnt match throughout the period. Now suppose say, they will rise their commodity prices and recover the break even; but the markets wont allow this too! As the prices of Ni and Co is falling y-o-y.

Based on above analysis we can say that the strategy to go for Bulong itself was a flawed! And they were bound to default with the flawed strategy backed by weak operations and a bleeding financial side. Q2. How did Preston try to resolve the default? Why has it been difficult to restructure the debt? Preston tried to resolve the default by taking working capital loan of A$30mn from Barclays Also, looked towards restructuring by issuing equity of A$75mn and considered a JV proposal with Australian firm Anaconda Nickel Ltd.

If we try to restructure by issuing more equity; say A$ 75mn, then the new structure would look as below:
d= plus A$75mn e= v= d/v= e/v= Debt break up Bond Borrowings Total Yr. 2000 $ 375,296 $ 102,137 $ 477,433 78.61% 21.4% $291,853 $83,443 $375,296 Restructure $ 300,296 $ 177,137 $ 477,433 62.9% 37.1% $ $ $ 233,529 66,767 300,296

The new interest payments for the bond issue of A$ 233.529 would be A$27mn
Yr Sr. No 2000 1 2001 2 2002 3 2003 4 2004 5 2005 6 2006 7 2007 8 2008 9 2009 10 A$ A$ A$ A$ A$ A$ Bond Issue 1st half 2nd half Interest at 1st half Interest at 2nd half Total interest 233.53 221.85 210.18 13.87 13.14 27.00 210.18 198.50 186.82 12.41 11.68 24.08 186.82 175.15 163.47 10.95 10.22 21.16 163.47 151.79 140.12 9.49 8.76 18.24 140.12 128.44 116.76 8.03 7.30 15.33 116.76 105.09 93.41 6.57 5.84 12.41 93.41 81.74 70.06 5.11 4.38 9.49 70.06 58.38 46.71 3.65 2.92 6.57 46.71 35.03 23.35 2.19 1.46 3.65 23.35 11.68 0.00 0.73 0.00 0.73

Even by restructuring with Equity of A$75mn wont help in meeting the interest payment! Now the problem has been aggravated as your operating side is put under pressure due to it not meeting the financial obligation. You are not in a position to raise more debt as it will further increase the burden on interest payments. The only way to look ahead is bring some confidence in operation side by easing the financial obligation on the operation side! This is possible if we know that our operation side can be strong in the near future and convince the lenders of this scenario; with this support we can put forth the conditions to ease in covenants to attain more Flexibility in capital structure and confirm our Execution of the debt. Q3. Will the second proposed restructuring plan work? Who will support/oppose the plan contained in the schemes of arrangement? What are the alternatives if the plan is not approved? How much is Bulong worth as going concern?
The 2nd proposal is a very interesting scenario! By giving up 95% of its equity to the note holders and Borrowers, Preston is basically making Bulong equity driven firm that too on Debtors fund! i.e. the equity issued is to the Debtors, which in turn are financing the firm and this transfer directly puts them in ownership structure! Thus, they fund 95% of debt as equity and also they fund 5% of debt! But from Prestons point of view; the equity infusion will definitely make the structure work. Lets look at the new structure and the interest payments thereafter:

d= issue 95% e= v= d/v= e/v= Debt break up Bond Borrowings Total

Yr. 2000 $ 375,296 $ 102,137 $ 477,433 78.61% 21.4% $291,853 $83,443 $375,296

Restructure $ 23,872 $ 453,561 $ 477,433 5.0% 95.0% $ $ $ 18,564 5,308 23,872

A$ A$ A$ A$ A$ A$ Yr Sr. No Bond Issue 1st half 2nd half Interest at 1st half Interest at 2nd half Total interest 2000 1 18.56 17.64 16.71 1.10 1.04 2.15 2001 2 16.71 15.78 14.85 0.99 0.93 1.91 2002 3 14.85 13.92 12.99 0.87 0.81 1.68 2003 4 12.99 12.07 11.14 0.75 0.70 1.45 2004 5 11.14 10.21 9.28 0.64 0.58 1.22 2005 6 9.28 8.35 7.43 0.52 0.46 0.99 2006 7 7.43 6.50 5.57 0.41 0.35 0.75 2007 8 5.57 4.64 3.71 0.29 0.23 0.52 2008 9 3.71 2.78 1.86 0.17 0.12 0.29 2009 10 1.86 0.93 0.00 0.06 0.00 0.06
The new bond issue would be of only A$18.56mn incurring an interest payment of A$2.15mn which is very much feasible to cover from operations! This structure will basically make the debtors to be the equity holders! There are chances of them (i.e. note holders and Barclays) to resist against this; as they would be facing the whole risk of Bulong while Preston would be enjoying its Marlborough mines! But looking at the scenario, this option looks the best. As once the assets start generating revenue, the note holders and Barclays are in full position to sell off the assets and recover their funds. If the restructuring fails then it will ultimately lead to the liquidation of the Company, which again has its costs. Thus looking at the scenario the restructuring is best for both Preston as well as Barclays.

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