The Durban-ator Lives
Adam Hamilton January 19, 2001 4111 Words
Like the merciless cyborg assassin masterfully played by Arnold Schwarzenegger in James Cameron’s famous 1984 movie “The Terminator”, South African goldmine Durban Roodepoort Deep, “The Durban-ator”, continues to be unstoppable. Following some high-profile disasters last year, the worst gold price environment in decades, and a continual phalanx of assaults by naysayers, many were aggressively claiming that the venerable century old gold mining operation was on the ropes, ready to go down. Schwarzenegger’s dark character in the movie, “The Terminator”, was shot, run over, burned, exploded, and generally had the stuffing beat out of him. But he just relentlessly kept on coming, overcoming all obstacles, just like Durban. Of course, in the movie the Terminator was the bad guy and he had to lose, and that is where this sloppy analogy ends.
Far from being the villain, Durban is something of a hometown hero amongst incorrigible gold bulls. Durban Roodepoort Deep has long been THE favorite highly-leveraged gold speculation on the planet amongst diehard fans of the ancient metal of kings. On January 18, 2001, the little mine that could released its calendar Q4 2000 operating results, and they were very impressive. This essay discusses those results, both the good and not so good aspects. This analysis is based entirely off of those quarterly results, which are posted on Durban’s websites at www.durbans.com and www.drd.co.za.
Before we began, the usual disclaimer is in order.
On Wall Street, analysts constantly tout stocks and conflicts of interest abound due to lack of disclosure. For instance, a prominent analyst may tout a tech stock while at the same time her company is trying to win a lucrative investment banking or consulting contract with the very company being touted. Or even worse, the virtues of the tech stock are enthusiastically extolled by the front office while the traders in the backroom are selling it with both hands like it is plagued with Ebola Zaire. These practices are absolutely loathsome and utterly indefensible. One never knows the true motivations of an analyst if relevant information is not fully disclosed up front. I offer the following in the spirit of complete and full disclosure.
While I am an independent analyst, beholden to no one, I am a shareholder of Durban Roodepoort Deep. Like every speculator, I am interested in making piles of money in the markets, and I DO have a vested interest in seeing Durban thrive. I am not impartial and I am not disinterested. If it bothers you that I own and hold Durban, please stop reading here and spare yourself the stress! Finally, I have no ties or relationships with Durban management.
Like all my fellow shareholders, I have watched large unrealized losses grow in Durban throughout the year. It is CRITICAL to remember that speculating is RISKY. Stocks go up AND down, and Durban’s recent performance is a great testament to this ancient market truism. Do NOT throw money at the markets unless it is risk capital that you can afford to lose without shedding a tear. Do not speculate with your nest egg, college or retirement fund, or lunch money. It is dangerous. Most of all, do not make a buying or selling decision solely on what some chump on the Internet (like me) happens to be saying… Do your own due diligence! Consult a personal financial professional such as your financial planner, attorney, or accountant before making any important investing decisions. Chasing legendary returns involves bearing considerable risk. If you want the ultimate safe investment, buy physical gold coins and keep them in your possession. Durban is a speculative play on the price of gold, not a risk-free certificate of deposit…
Overall, Durban’s calendar Q4 2000 operating results were outstanding! We are very excited based on the fundamentally fantastic quarter Durban delivered up on a golden platter to its shareholders. The cash profit from operations had a massive jump, leaping 121% to $4.2m. After interest payments and other cash costs, cash generated on the quarter came out in the black at $1.1m, compared to a loss of $1.5m last quarter. It was a great sight to behold after marching through the barren Durban desert in 2000!
In our continuing surreal gold price environment, in which legal cases against the elite central bankers involved in suppressing the gold price are sprouting up all over the planet like mushroom clouds in the Terminator movies, one particularly dazzling number off Durban’s results is its cash operating costs. The average cash cost per ounce of gold in the current quarter was an incredible US$224 per ounce, a 9% reduction from the September quarter’s $245! This is simply an awesome achievement, and management deserves tremendous credit and kudos for aggressively controlling costs. Management had set the expectation among shareholders last quarter that operating costs would continue to drop, and they delivered brilliantly on that expectation. This is a huge coup and an extremely positive omen for Durban!
At the beginning of the quarter in October, gold was trading around $275 per ounce. At the end of the quarter in December, gold was STILL trading around $275 per ounce. With gold locked in its hobbled artificial trading range by unnatural forces terrified of a gold rally, cost control and reduction are the necessary strategies to maximize operating cashflow. The fact that our managers managed a remarkable increase in operating cashflow spun off in what was the worst quarterly gold environment in decades is fantastic news. The secret to making money is not so secret… sell your product for more than it costs you to produce it. Since Durban is cutting the corporate fat and getting lean and mean in a brutal gold environment, it is exciting to imagine its performance when the inevitable mega rally in gold bursts forth onto the global financial scene.
Durban’s legendary leverage to the price of gold is slightly dampened by its relatively small hedge positions, so the hedges are always of great interest to the shareholder community. We watch the hedgebook closely from quarter to quarter. In an essay published in early August 2000 on Durban operating results for calendar Q2 2000, “Roodepoort Rocket”, we explained why some hedges are good in a rising gold price environment and some hedges are bad. If the concept of good and bad hedges to deploy if a company is expecting a gold rally needs some refreshing, please review that prior essay.
The table below updates Durban’s hedge exposure, and it showed a nice improvement in the new quarter, especially considering the abysmal depths the price of gold plumbed…
The average net bad hedge exposure as of December 31, 2000 was 8.4%. This compares with 8.8% last quarter (September) and 8.5% two quarters ago (June). As dyed-in-the-wool gold bulls, we ultimately want to see ZERO hedges, but we are encouraged that hedge exposure is constant to dropping even with the central banks giving their gold away to tie a millstone around gold prices. Do these stubborn hedges hurt Durban’s legendary leverage to the price of gold? Not materially, as we will discuss further below with updated Durban leverage calculations.
On the Income Statement, there were no big surprises and pretty much everything looked fine, with the impressive operating results the golden crown on the statement. The only glaring concern was the number of common shares used to compute earnings per share. More on that below… The Balance Sheet was not bad either, once again with the exception of total issued capital which is discussed below.
On the current asset side of the Balance Sheet ledger, inventories were constant. One great thing about a gold mine is inventories never grow stale and there will ALWAYS be demand for gold. No spoilage here! Accounts receivable fell by 7%, which is good as it indicates other entities owe Durban less money. Cash had a very healthy quarterly 7.5% increase, which is always great to see.
On the liability side of the ledger, substantial improvements were also made by Durban in the December quarter. Long-term liabilities declined by 13.3% to $54m. All current liabilities also saw healthy declines. Accounts payable fell by 8%, which indicates Durban owes less money to suppliers and vendors. The current portion of the long-term debt was also paid down slightly, declining roughly 3%.
One concern we have heard articulated via e-mails regarding Durban since our last essay, “Durban Under Fire”, was published in November regards the current portion of long-term debt. Will Durban make enough cash to pay down the $28m in long-term debt due this year? After this current quarter, we believe the answer is clearly yes.
Assuming an average gold price of $275 per ounce for the next 12 months (this is conservative… it will likely be much higher than that), and cash operating costs of $225 per ounce, Durban makes an operating profit of $50 per ounce on gold produced. Assuming production in the coming 12 months of 1.2m oz, $50 per ounce x 1.2m oz = $60m. $60m in operating profits is more than enough to pay all cash expenses including interest and easily service the $28m of long-term debt due in the coming 12 months. Of course, if the average price of gold in the next 12 months is higher than $275, the operating cashflow spun off by Durban will increase dramatically, rendering the debt service question moot.
Unfortunately, Durban’s December US dollar Statement of Cashflows was not updated on the website or its South African mirror, and only the September quarter data was shown. Thankfully the Rand Statement of Cashflows WAS current. It showed a major issuance of new stock, worth R42.4m (say US$5.6m). All those new funds were used to pay down debt. This offers a great segway to the first not so good thing on the new quarterly financials, Durban management’s relentless dilution of existing shareholders.
All long-time shareholders will agree that one of the most frustrating aspects of owning Durban is the continual dilution of investor holdings through the seemingly perpetual issuance of new shares. In the December quarter, Durban reported 129,810,443 ordinary shares outstanding. Fully diluted (means the assumption is made that all options and other instruments that can be converted into common stock are hypothetically converted into shares), this number could be up to 143,748,050 shares outstanding. The shares outstanding data is meaningless when viewed alone, but over time an unwelcome trend is exposed that further damages shareholders who bought in earlier at higher prices.
At the end of March 2000, for instance, Durban had common shares outstanding of 106,825,779, and fully diluted shares of 120,763,386. In nine months, Durban management has diluted its longtime loyal shareholders by 21.5%! This rate of stock inflation rivals Greenspan’s M3 inflation in the US! In terms of fully diluted shares, the nine month dilution was 19%. Everything else being equal (which it is not, but bear with the assumption please), 21.5% of the drop in Durban’s share price since March is attributable to the dilution of existing owners through new capital issuances.
Dilution is a terrible thing, and it is hard to overstate how damaging it can be over a long timeframe. Every share of Durban, in effect now represents a 21.5% smaller share of the company than it did a mere nine months ago. From a shareholder perspective, dilution is very costly. We personally know many longtime shareholders who bought years ago when there were less than 50,000,000 shares outstanding, paying many dollars per share. The long-term trend for issued shares of Durban is definitely climbing steeply. Why issue undervalued shares to purchase assets when it just dilutes existing shareholders?
Management would no doubt argue that new shares are issued to fund acquisitions. Some shares are issued to settle debt, such as the settlement of Rothschild debt with shares in the December quarter. Management would likely claim that for every share that dilutes existing holdings, enough additional value is created to offset the dilution. Maybe in theoretical absolute terms this is true, but from a pure share price standpoint it sure has not been proven yet. As a matter of fact, on every Durban proxy sent out there is inevitably a resolution asking for shareholder approval to issue more shares. Just to be belligerent, we are sure to vote NO on every issue regarding further shareholder dilution. Obviously, we are in the minority, however, as more new shares are issued each quarter. Unfortunately, many shareholders do not understand the complex proxy statements and either do not vote or simply vote the way management advises.
We are strongly opposed to shareholder dilution, especially when Durban stock is so ridiculously cheap. When Durban is eventually OVERvalued, trading orders of magnitude higher than it is now (and that day IS coming!), then additional share issuance would be a different story. In these tough gold times, we would much prefer Durban management focusing on maximizing shareholder cashflow through existing properties, rather than issuing additional capital to take on new challenges. The time for corporate expansion and empire building will no doubt come, but with market sentiment surrounding Durban still stinging from last year’s litany of disasters, we believe it would be prudent to minimize dilution and focus on maximizing current cashflow.
Does the current dilution seriously affect each Durban share’s leverage to the price of gold? Not too badly. We recalculated Durban’s famous leverage to the price of gold and present the results below, and they are stellar! Nevertheless, we are strong advocates of management doing everything in its power to stop diluting existing shareholders while our holdings are underwater. Shareholder dilution… just say NO!
On Durban’s Frequently Asked Questions webpage (www.durbans.com/faq.html) there is a question regarding a potential stock buyback instead of paying dividends. The answer mentions a potential buyback of 5% to 10% of outstanding capital. When shares are purchased in the open market by a company, they are turned into “treasury stock” and taken out of circulation. A buyback would reduce the number of shares outstanding and offset some of the recent dilution.
It sounds good in theory, and it would raise the share price, but we question whether it is the most prudent use of surplus cash. From a long-term viability standpoint, we would be most happy if Durban would stop issuing new shares and use surplus cash to pay down its debts rather than buying back stock. When the company becomes debt-free and highly profitable, which would absolutely ensure that it would thrive until the neo-gold run commences in earnest, we believe only THEN may it be a prudent use of cash to buy back existing shares.
The second not so good thing that leapt out of the recent quarterly results was on the “Forthcoming Issues” slide of the Powerpoint presentation at (www.durbans.com/presentations/dec_quarterlies/presentation.htm). Bullet point numero uno reads, “Meet NASDAQ listing requirements – in February 2001”. Yikes!
We have to admit we find this one liner perplexing. Everyone knows about the NASDAQ listing requirements with the minimum bid rule, and they are located on the web at www.nasdaq.com/about/nnm1.stm. One of the requirements for continued listing is a “Minimum Bid Price of $1”. Durban is obviously trading below that magic number. These commonly known requirements, however, are for common and preferred shares traded on the NASDAQ.
Durban common shares, however, do not actually trade in the United States. DROOY is an American Depository Receipt (ADR), meaning it is a piece of paper representing one share of Durban held on deposit in a New York bank, but it is not a share of Durban itself. The rules for ADRs are different from the rules for normal common and preferred shares traded on the NASDAQ.
We have done some superficial research on the listing comment. NASDAQ Rule 4320 indicates that the continual listing requirements for non-Canadian foreign stocks and ADRs are quite different from common and preferred US NASDAQ shares, and do not include minimum bid requirements.
NASDAQ Rule 4320, available officially at www.nasdaqnews.com/about/rules/4320.html, outlines the requirements for continued listing for “Non-Canadian Foreign Securities and American Depository Receipts”. Once again, DROOY is an ADR, and NOT a share of Durban, so Rule 4320 would appear to apply. Rule 4320 lists the following requirements for maintaining a listing status on the NASDAQ for ADRs…
“(B) For continued inclusion, the issuer shall maintain:
(i) net tangible assets of U.S. $2 million;
(ii) market capitalization of U.S. $35 million; OR
(iii) net income of U.S. $500,000 in the most recently completed fiscal year or in two of the last three most recently completed fiscal years.”
Obviously the net tangible assets and market capitalization are not a problem, but since Durban has lost money in the last two fiscal years, the net income requirement was apparently not met. So, while the minimum bid requirement seems not to apply, this ADR net income requirement may be a problem. The million dollar question, in our minds, is what the big, fat “OR” means between lines ii and iii. That would seem to imply that all three of the 4320 requirements are not necessary, just some subset. Unfortunately, we are not securities attorneys and cannot emphatically state what exactly will transpire based on the NASDAQ rules.
Assuming rule 4320 IS a problem for Durban, NASDAQ Rule 4330 states that, “Nasdaq may make exceptions to the application of the criteria contained in Rule 4310 or Rule 4320 where it deems it appropriate.” If necessary, maybe Durban will simply make an appeal, “prove” it will be profitable this year, and NASDAQ will let it stay and play in the States until the current fiscal year ends on June 30, 2001. The company is over a hundred years old, trades in prestigious exchanges on four continents, has incredible staying power, and is not some fly-by-night dot com that has no hope of ever making money.
Some still believe the minimum bid requirement is the issue of importance for continued listing. If that set of rules really does apply, and not rule 4320, the solution is simple, a reverse split. For instance, Durban could do a 10 to 1 reverse split, indicating for every 10 shares of Durban worth $0.75 each a shareholder would receive a single new share worth $7.50, for instance. The net effect on shareholders would be nil, although markets typically frown on reverse splits as a sign of weakness and some reaction selling would likely ensue from such an action. Another possibility is a massive buyback that would raise Durban’s share price above $1.00, if the minimum bid requirement really does apply. This would burn a lot of cash that could otherwise be used to pay down corporate debt, however.
If, as we suspect, Rule 4320 is the heart of the “Meet NASDAQ listing requirements” line from the Durban presentation, the company MAY need to make an appeal to NASDAQ for continued inclusion. This is very important, as the lion’s share of Durban shares are held by Americans and traded in the States, and Durban needs to remain liquid and trade in a major US market in order to maintain this crucial American shareholder base. Durban management is well aware of this and we are confident they will rectify the situation.
The NASDAQ listing discussion is interesting, but we believe it will be resolved in the near future and Durban will continue to trade happily ever after in the States. Once this storm blows over, the horizon looks clear and the sailing ahead will be a lot smoother, thanks to management’s renewed vigor and success in pursuing positive cashflow tactical and strategic objectives.
The continuing dilution issue and the NASDAQ listing quest are the two major negative bits of information contained in the latest quarterly report. Other than those issues, which we believe will be resolved soon, the latest quarterly report from Durban was very impressive indeed!
Management delivered on the crucial expectations they set last year, including substantially lowering cash operating costs and substantially increasing cash operating profits even in the dismal gold environment. Ultimate valuation of a company is all about cashflow, and it is very encouraging to see major improvements in cashflow in the December quarter.
So, now that we have been through the good and the not so good, the ultimate question becomes… Is the Durban-ator still one of the ultimate leveraged gold mines in the world? Is the Roodepoort Rocket still on the launching pad and ready to roar to the heavens when gold is freed from its shackles? The answer, to both of these questions, is a resounding YES!
The following graph was originally presented in our Roodepoort Rocket essay published in August 2000. The numbers below are updated with December 2000 results. In order to determine what would happen over a whole year of operations, the December quarterly results were annualized as a proxy for a whole year. The cash operating profits shown are AFTER hedge costs, interest payments, and taxes. The left axis shows what kind of operating cashflow Durban would have generated over a year with results analogous to the December quarter under different gold prices, which are shown on the horizontal axis. The right axis shows the percentage gain, indicating the amazing leverage of Durban to the price of gold. Even a small percentage gain in gold yields a massive increase in operating cashflow spun off over a year by Durban Roodepoort Deep.
The following graph, also updated from the earlier Roodepoort Rocket version, outlines the annualized December 2000 quarterly results at various hypothetical gold prices. These are also after hedge costs, interest payments, and taxes. As in the previous graph, the horizontal axis shows various hypothetical gold prices. The left axis shows the projected Durban share price, using cashflow per share as a proxy for earnings and employing a standard 13.5x earnings multiple. The right axis shows the cash operating profits per share generated at these hypothetical gold prices…
As is obvious in these graphs, even after the dilution issue, Durban’s leverage to the price of gold is absolutely unparalleled! No additional superlatives are necessary to explain the above graphs.
In summary, Durban’s latest quarterly operating results were most excellent. We were extremely happy to see the major increase in operating cashflow generated and the major decrease in cash costs per ounce. Management has done a great deal in the last quarter to win back investors who had lost confidence during the tough previous fiscal year. Although the potential NASDAQ listing fracas is unsettling, we believe it will soon be resolved (if it is even a real issue) to the benefit of all involved. The NASDAQ does not kick companies out lightly, as evidenced by the numerable high-technology issues trading on the exchange that have yet to make a dime in their entire history. Heck, even NASDAQ darling Amazon.com has not made a single shiny copper penny in its entire existence! Durban, on the other hand, is a celebrated GOLDMINE that has been around for over a century, has made staggering returns for its owners in the past, and will again in the future.
NASDAQ loves the revenue stream from listing ADRs, and it advertises itself as the most ADR friendly exchange in the world. Durban is an old and prestigious gold mine, traded in many major exchanges all around the world. It is an asset for NASDAQ, not a liability, to trade South African companies like Durban and its mining compatriots. We fully expect this potential listing issue, like other challenges in Durban’s hundred plus year past, will pass as well and soon be forgotten.
Like the Terminator cyborg, the Durban-ator is becoming a lean, mean fighting machine. My colleagues and I enthusiastically maintain our holdings, as we are convinced that the price of gold will soon be liberated from its shackles. Between the famous GATA/Howe legal offensive, deteriorating equity market fundamentals, and the probability of a massive increase in metals investment demand, gold will not be held artificially underwater for long. When it smashes forth, and the market believes this new rally is “for real”, Durban Roodepoort Deep will become one of the most sought after companies on the planet. Everyone will be whipped into a frothy speculative gold mania, and they will be magnetically drawn to Durban’s extraordinary leverage to the price of gold.
Our day in the sun is coming, fellow Durban shareholders!
Adam Hamilton, CPA January 19, 2001 Subscribe at www.zealllc.com/subscribe.htm