Sirius Minerals buys its way into Brazil

Sirius Minerals, which is trying to build a deep fertiliser mine in North Yorkshire, has had to take a stake in a Brazilian distributor to gain access to the world's most important and fastest growing fertiliser market.

The UK listed miner announced a share swap Monday, handing over £27m of stock for a 30 per cent stake in Cibra, Brazil's sixth largest distributor and a subsidiary of the privately held Omimex Group, a Texan oil and gas company.

Sirius is hoping to persuade the world's farmers to sprinkle its rock, known as polyhalite or Poly4, on their fields, and needs big long-term supply contracts to show lenders a market for the product exists, as the company attempts to arrange $3bn in financing, much of it guaranteed by the UK government.

The latest deal takes the peak volumes Sirius has agreed to sell to 8.2m tonnes, with Cibra agreeing to take 2.5m tonnes of Poly4 by the seventh year of production, in about 2028 on the current schedule.

However, there is no word on how much Cibra has agreed to take in the preceding years, and there looks to be some flexibility in volumes and pricing, which at the very least suggests the customer/partner has driven a hard bargain. From the press release:

The Supply Agreement contains provisions which allow Cibra to roll forward and roll back a small proportion of take-or-pay volumes between contract years. 

Pricing terms include a minimum commitment price that is linked to relevant product benchmarks, as well as a unique downstream price participation mechanic which enables Sirius to benefit from higher realized POLY4 prices for the duration of the contract. Pricing to be received by Sirius under the Supply Agreement is expected to be broadly in-line with other offtake agreements in the early years of supply, with the potential to realise higher pricing sooner than the Company's existing supply agreements. 

When we took a hard look at the challenges Sirius faces as it attempts to finance and build a mine on budget, while simultaneously creating a new fertiliser market, we noted that Brazil was a significant omission from a customer list which was heavy on Chinese start-ups.

Slide 5 of Monday's presentation on the deal had a chart which shows what Cibra and Sirius are up against, and just how hard it is going to be to crack Brazil:

Well over half the market is controlled by four larger suppliers which are either owned or influenced by major producers. (And remember, in pure tonnage terms Sirius wants to more than double the existing specialty fertiliser market.)

Omimex, run by Naresh Vashisht since he started the company in 1987, does have some form in fertiliser. in 2014 the group sold its Colombian fertiliser operations to Yara, the Norwegian group, for $425m (including assumed debt).

Starting with the purchase of Texaco's assets in Colombia in 1994, Vashisht also has long experience of investing in South America. Asked what motivated him to invest there, in the 2017 Omimex summer newsletter, he said:

My philosophy in life has been that when everybody is running away from something, you run towards it.

Cibra has grown rapidly in the four years since it was acquired by Omimex. Here for instance is how the company described itself in an press release announcing a $40m loan from the International Finance Corporation last year:

Between 2012 and 2016, Cibra grew at an average of 55 per cent per year, becoming one of the largest fertiliser companies in Brazil. In that period, it increased sales volume from 200,000 to more than 1.3 million tons of fertiliser per year, with revenues reaching $366m in 2016.

Yet, as with other partners announced by Sirius, the agreement implies a transformation of the existing business. At $145 per tonne, what Sirius has said other customers have agreed to pay, 2.5m tonnes would cost Cibra $363m in 2028. Or graphically, from the Sirius presentation:

The point is that doing so will be possible, but far from easy in a highly competitive market.

Sirius hopes that the UK government will underwrite as much as $1.5bn of the debt it plans to raise. Cost estimates for the mine, have already risen, with the company this month announcing the £0.5bn increase means it will have to issue additional subordinated debt or equity.

As with a deal with Archer Daniels Midland, a blue-chip agribusiness, the customer gets something out of the agreement — ADM will supply Sirius with a “starch binder” for its fertiliser granules. Cibra will be able to sell its 95m shares, worth £27m at pixel, in a year.

Sirius pointed to a lot of corporate activity in Brazil in the last five years, with fertiliser producers in particular acting to secure the route to market through the large distributors.

“It is very clear, that the industry, our competitors have a heavy incentive not to help us in the market”, said Chris Fraser, Sirius chief executive.

“It became clear that Cibra provided us with a really good option in that market and they weren’t just interested in just being a distributor, they wanted a proper partnership,” he said, “Out of that dialogue, became an idea for a share swap as a way of going beyond a straight supply agreement.”

He also said the investment, which will see him join Cibra's board, means the companies' interests are aligned.

We asked Fraser how the price for the Cibra stake was arrived at, given the company is privately held. In such situations a company might seek a so-called “fairness opinion”, where a third party investment bank or analyst prepares a valuation report which can be used to reassure stakeholders on all sides that the price is appropriate.

He said:

We looked at the other transactions that happened in the market for similar assets. So we looked at values for capacity, earnings and we looked at net assets and equity. Out of that came a negotiated value that we feel is fair for both parties.

The company also provided us with a selection of relevant transactions:

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