Description

$80 mil market cap / $60 mil cash / no debt / major catalyst this summer / market is verifiably not paying attention / going from negative -$5 mil EBITDA to $20+ mil positive EBITDA /  

MFC Bancorp has been written up on VIC before in several different iterations. It’s been called MFC Industrial, Terra Nova and other names. It is a merchant bank with a number of more or less problematic assets and a core business amidst a turnaround. Most of the assets were opportunistically acquired by CEO Michael Smith. What I know about him is solely thanks to earlier VIC writeups describing his style of management as one relying on opportunistic deep value investing, financial engineering and tax optimization. Here I really want to thank both xds68 and salvo880 for their write-ups and refer you to their pieces for better insight in both the legacy Compton assets as well as the merchant banking turnaround. I also thank Francisco432 for the Terranova write-up that was very helpful. 

One of the ways Michael Smith unlocks value in opportunistically acquired assets is by spinning them off later and consequently there isn’t an easily visible track record of success. Via Salvo’s work I came across a detailed account of Smith’s track record. From looking at the assets they have been purchasing, the prices paid and the attention paid to tax optimization, I’d be surprised it his historical track record wasn’t good.

The MFC Bancorp vehicle seems to have been consistently undervalued, loaded with cash or undervalued assets and with varying degrees of optimism surrounding its acquired assets. This write-up follows that tradition by perceiving safety in liquid assets on the balance sheet while seeing the potential for tremendous upside through a royalty on the - soon reopening - Wabush (Scully) iron ore mine.

The operating side of the business (which is being restructuring) is a “merchant bank that provides financial services and facilitates structured trade for corporations and institutions. This includes marketing activities, captive supply assets, structured solutions and financial services. Because MFCB is restructuring, it is losing a lot of low margin revenue. Meanwhile hiring people to build up higher margin new activities utilizing the recently acquired European banking license. MFCB paid $160 million which equals book value of assets minus liabilities and nothing for any goodwill for this bank back in 16’.  The license allows them to provide regulated banking services like bank guarantees, letters of credit, factoring and other financing transactions. MFCB isn’t currently profitable yet but it has made a lot of progress. The previous Xds86 write-up focused on the merchant banking turnaround as a catalyst. To keep this very simple I’m going to take management’s comment they are now cash break-even at face value and assume his business stops losing money going forward. But I won’t attribute any profits to it. It is likely I'm being too conservative.

First; if this is such an attractive position why didn’t anyone notice?

I think the following reasons contribute:

1. Over the last 5 and 10 years the stock mostly went down

2. At least 3 years of restructuring “just completed”

3. Incorporated in Cayman Islands (no taxes)

4. HQ based in Ireland (another tax friendly jurisdiction)

5. Their latest acquisition is a Cypriote bank with a European banking license (this only excites VIC members)

6. The company is a collection of deep value assets

7. Acquired deep value assets are often commodity related (value investors who could be attracted to the “value” nature tend to dislike commodity plays)

8. Acquired deep value assets are often foreign based

9. Including Uganda

10. Eastern Europe

11. And China

12. When they have an asset in Canada; its shut down

13. It’s a microcap

14. Lots of name-changing

15. No coverage

16. Business descriptions are awful and lack key information

17. Asset descriptions are awful and lack key information

But at the same time; not everyone is overlooking it.

Nantahala Capital Management, LLC acquired 6.8% of the shares outstanding. They were buying in February. I think they have a good track record and have over $1.6 billion in AUM.

Peter Kellogg Group owns 33% of the shares (this ownership isn’t welcomed by CEO Smith and there is an adversarial )

Lloyd Miller estate owns 16.3% of the shares (well known micro cap value investor)

It has been written up countless times on VIC though I suspect many have been smoked out in between. 

Downside protection

There is uncertainty surrounding the upside for MFC Bancorp. It is also a classic case of lots of uncertainty but not a lot of “real risk”.

MFC Bancorp has almost $4 in cash, short term investments and per share. There is no debt. There are other relatively straightforward assets like real estate worth another $3.11 per share. There is some working capital and this all adds up to ~$8 and mitigates the downside.

There is also $3.3 total on the liabilities side but that includes over $1 in reclamation liabilities and over $1 in deferred income tax liabilities. I don’t think these are the worst kind.

Current share price is around $7. You could argue there is 32% downside risk if you assume full liabilities and disregard all assets besides the cash and real estate. That seems overly conservative given the long list of assets and the type of liabilities.

There is tremendous potential for upside embedded in the company assets. I’ll show the market is ignoring this value further down in this write-up.

other risks

One risk that I should probably mention is the potential opportunity cost of time. I’ve gathered quite a bit of information outside of the company’s filings. The disclosure of the company aren’t very clear. Even though I spent quite a lot of time I feel like I’m only scratching the surface of what there is to know about this company. One example being I have no idea what the real estate is that’s on the company’s balance sheet or how it got there.

This is a typical situation where experience and years of following the company probably give you an advantage. I may have gotten things wrong and I think an investment here could suck up a lot of valuable time relative to what could amount to only a small position. If you want to turn this inside out it is going to take a lot of time. On the flipside this is probably one of the reasons the value is overlooked.

How much can we make?

Michael Smith gathered a lot of deep value assets over the years and the value of these is not easily discernible from a cursory glance at the financial statements. Currently the most important asset and the focus of this write-up is the Scully or Tacora Wabush Iron Ore Mine. But I’ll go briefly touch on other assets as well.

Tacore Wabush mine (key to the upside)

The key to this idea is a royalty interest on a closed-mine. This mine has been taken over by a new operator who then renegotiated the royalty rate with MFC Bancorp. The royalty interest now equals a 7.0% net revenues royalty interest on iron ore produced from the mine and 4.2% net revenues royalty interest on iron ore produced from tailings and other disposed materials. Under the terms of the sub-lease there is a minimum royalty payments of $3.25 million per year

It appears the operator (unfortunately a private company) is on track to commence mining mid 19'. Its plans look fairly solid judging by this presentation. Slide with timeline:

Why would Tacora succeed where Cliff Natural Resources failed previously?

Cliff considered this mine to be very high on the cost curve. Even though it is connected to a port by rail and the iron ore product can be marketed on a global basis they closed down operations in an all Canada shut down.

I can’t be sure Tacora is going to succeed long term but they did a few things right and because of these steps I’m optimistic they will succeed in running this mine (at least for a while):

-renegotiated royalty with MFC Bancorp

-renegotiated collective bargaining agreement with steelworkers union before even acquiring the asset

-Lined up Cargill to take off production until 2033

-Lined up financing

-Tacora had a town Hall meeting , you can watch the entire thing here https://lnkd.in/dqrUeMe

-Company is hiring actively since November and should really ramp up hiring this month as is evidenced by the many job openings:

• Operator 1 – Entry level non-trade Employees including HTD

• Operator 2 – Trained and certified on multiple equipment within the mine and mill including entry level shovel Operators and boiler Operators

• Operator 3 – Employees trained and certified on all equipment in mine and incremental multi-disciplined mill Employee above Operator 2

• Maintainer/Operator Mechanical 1 – Certified Millwrights and/or Diesel Mechanics

• Maintainer/Operator Mechanical 2 – Mechanical 1 plus certification in at least one additional certification.  Ex. Millwright plus certified Welder.

• Maintainer/Operator Electrical 1 – Certified Electrician

• Maintainer/Operator Electrical 2 – Electrical 1 plus certification in at least one additional certification.  Ex. Electrician plus Welder.

• Human Resource Associates

• HSE Technicians

• Administrative Assistants

• Accountant

• Warehouse Manager

• I.T. Coordinator

• Warehouse Coordinator

• Purchaser

• Mine Operations Superintendent

• Mine Operations Supervisors

• Mine Maintenance Superintendent

• Dispatcher

• Geologist

• Mine Planning Engineer

• Drill & Blast Engineer

• Projects Engineer

• Mine Technicians

• Mine Maintenance Supervisor

• Mine Maintenance Planner

• Concentrator Operations Superintendent

• Concentrator Maintenance Superintendent

• Concentrator Operations Supervisors

• Concentrator Process Coordinator

• Process Control Coordinator

• Maintenance Planner

• Maintenance Supervisor

• Project Manager

• Mechanical Engineer

• Electrical Engineer

• Process Engineer

• Lab Supervisors

• Mine Manager

• Chief Mine Engineer

• ERP System Controller

-Tacora will install a manganese reduction circuit which opens up additional areas of the mine (previously off limits) and will extend the life of mine. Cliff also considered this but I think they didn’t do it because they were in a JV.  

-This enables Tacora to start with a downhill haul from an easily accessible part of the mine. This increases the odds the reopening will start of well for MFCB.

-Mining district matured; firms providing services you preferably want to outsource are located in the vicinity and capable. This decreases the need for lots of on-staff specialized personnel.

-Between 20-50 year minelife (note the royalty only runs until 2055)

Production rate

Production rate helps estimate the cash flow derived from the royalty.

Target figures have not been disclosed by Tacora Resources directly. Premier Dwight Ball luckily talked about 260 jobs and six million tons here. Which is quite helpful.

Historical figures can also function as a baseline. In 2012 Cliffs produced 3.2 million tons and in the Terranova write-up a 10 year average annual production rate of 4.6 million tons is mentioned.  

Expecting a ramp up to a 4 million tons run-rate seems reasonable.

The mine produces a high quality ore but let’s be conservative and assume it sells at spot which is currently $85. You can also argue current iron ore prices don’t reflect future prices well but going with the benchmark price mitigates that concern.

Revenue

4 million tons of production should translate into revenue of $340 million annually. The 7% royalty translates to $23 million in gross revenue flowing towards MFCB. Taxed at the 20% Canadian royalty rate we are left with $19 million in revenue. Importantly that gross revenue falls straight to the bottom line for MFCB.

Given MFCB’s $87 million market cap this is a game changing development. If Premier Dwight Ball is right about the six million tons there is a lot of additional upside to this asset alone.

Other assets on the balance sheet (not critical to the write-up but I want you to be aware of these)

Energy assets

The company also owns certain hydrocarbon interests located in west central Alberta, Canada.

61 producing and 96 non-producing natural gas wells

3 producing and 18 non-producing oil wells

76.2% working interest in approximately 86,500 gross acres of land

These are the legacy Compton Petroleum assets purchased in 2012 for $33 million. Interestingly the company was written up on VIC in 2011 at an Enterprise Value of $254 million. Its market cap at the time $111 million. The write-up asserted:

Compton Petroleum Corp (TSX: CMT), is an E&P company that produces natural gas and oil in Western Canada that is extremely undervalued on an asset value basis.  We believe there is the opportunity to make over a 3x return from today by the company trading back in-line with its cheapest peers.

Compton got killed by too much leverage but there is at least a case for these assets to be worth more under the right circumstances. If we go by the VIC valuation target it would be worth 15x compared to what it is on the balance sheet for. Probably it is not worth much in the current natural gas environment but this goes to show how fortunes can turn.

The company currently seems to receive about $8 million in revenue from these operations - it is hard to figure out what to attribute revenue to - and it is unclear to me whether that means they are currently being operated profitably. The answer is probably no.

There is a backlog of natural gas in Western Canada because of export pipeline constraints. Natural gas prices are even lower than in the U.S. They are at the absolute low end of the range they have been since 2000.

Because this is hardly producing revenue and with prices exceedingly low I’m assigning this no value except for any current contribution it is making through the income statements.

Zinc alloy processing facility

The company owns a zinc alloy processing facility, located in Slovakia, whose customers include steel companies and other related industry suppliers in Europe;

It sounds bad but this is an operating asset now called Brock Metals and it has been previously owned by Rio Tinto. Its operations should be reflected in the company’s financials.

Natural gas power plant located in Alberta, Canada

MFCB owns a 16.5 megawatt natural gas power plant in Alberta, Canada, which is currently idled and I suspect it serves the Tacora mine. Tacora doesn’t plan on using it because they can get power in a cheaper way. I’m not ascribing any value to this for now.

Hydro-electric power plant located in Africa

The company owns a 9.9 megawatt hydroelectric power plant in Uganda. It produces a trickle of revenue. I believe this served Cobalt operations that the company also acquired “Kabese Cobalt Company Limited but this is either a finished or near finished liquidation.  

Non-ferrous rolling mill in Germany

A non-ferrous rolling mill in Germany whose customers include companies in automotive, engineering and other industries; and

Natural gas processing plant in Alberta, Canada.

From the earlier write-ups I gathered the Compton assets also included a processing facility that Smith valued at $50 to $60 million on a conference call.  I’m assigning this no value except for any current contribution it is making through the income statements.

Pea Ridge Mine

MFC Industrial owns a stake in the Pea Ridge Mine but it isn’t in operation. Maybe it never will be because there’s Thorium at the site which is radioactive and makes mining more difficult. However, this recent paper seems to suggest there is a remote chance it will one day be operated:

Currently, the Pea Ridge Mine is closed. The Canadian commodities supply chain corporation, MFC Industrial Ltd., co-owns the mine with Saint Louis based Alberici Constructors. The previous owner, Wings Enterprises, still owns 70% of the mine’s REE reserves and is attempting to convince the new owners of the mine to reopen it (Scher Zagier, 2013).

Back in 2012 MFCB had an independent NI 43-101 compliant technical report on the Mine (the "Technical Report").  This estimated the following in situ (originally present) iron resources in all categories of mineralized material:  

Chinese assets

The company used to own a flourishing business eye care business in China. However, this has now mostly been shut down. Because of costs and capital expenditures required ,MFCB let its eye care lease expire. The remaining China operations are now exclusively focused on healthcare, merchant banking and related markets and I believe they barely bring in any revenue. I’m valuing the operations here at zero.

Iron ore mine India

MFCB acquired an iron ore mine in India for $50 million but shortly afterwards mining became prohibited in the entire GOA province. The mining ban won’t necessarily last forever(source):

With the winter session of parliament nearly over and no sign of the promised amendment to help restart iron ore mining in Goa, things are increasingly bleak for the industry that was hoping to be up and running before this year’s Lok Sabha elections.

Shut since March 15, after the Supreme Court ruled that the ‘renewals’ of 88 mining leases by the state government in 2015 were illegal, the industry has pinned its hopes on an amendment to either the Mines and Minerals (Development and Regulation) (MMDR) Act or the Goa Daman and Diu (Abolition of Concession and Declaration as Mining Leases) Act, 1987 in order that it can avoid the process of auction as is now mandated by the MMDR Act.

This asset isn’t included in my valuation. 

Why I believe the market is completely missing the possibility of the Tacora restart?

January 25 2019 a tailing dam at Vale’s Córrego do Feijão mine collapsed. At least 186 people have died in this tragic event. This event reverberated across the entire iron ore (if not mining) industry. The mine itself wasn’t that large but other Vale properties with similar dams were shut down as well and this is taking a lot of high-quality iron ore supply out of the market. Because supply was taken out, prices jumped upwards and this has been reflected in the share prices of competing iron ore miners. The graph below clearly shows this dynamic:

Data by YCharts

MFCB underperformed the S&P 500 over this period by 2%+.

Data by YCharts

This clearly shows the market is not aware of the implications for MFCB if Tacora Wabush restarts.

To summarize:

I think there is obviously a real possibility the royalty stream from the Tacora Wabush mine starts flowing again in H2 19’. The mine is of such substantial size this flow may start small but should ramp up to $19 million per annum vs a current enterprise value of $35 million. This new cash flow will be extremely high margin. The market is not pricing in this possibility as the security does not respond to changes in the iron ore market. The company is effectively trading at 1.8x forward EV/EBITDA. Meanwhile we are blatantly disregarding the possibility the core operations become EBITDA positive and ascribe no value to any and all of Smith’s collection of deep value bargains that are currently not (fully) reflected in the income statement outside of the Tacora Wabush mine.

Catalyst

Restart of the Tacora Wabush mine