Tom Konrad CFA
Holders of Ram Power Corp. (TSX:RPG, OTC:RAMPF) on November 26 (the “record date”) will be receiving valuable coupons as the result of the company’s rights offering, announced November 18th. Just in time for the holidays, these coupons, or “rights” can be used to buy additional shares of Ram Power for 8¢ Canadian per share any time before 5pm on December 23rd. (Disclosure: I am long Ram Power stock.)
Holiday shoppers looking for more traditional gifts will be able to raise a little cash by selling the rights on the Toronto Stock Exchange, where they are listed as RPG.RT. Since they began trading on November 25th, they’ve traded between ½¢ and 1¢. Shareholders will have received one right for every share of Ram they owned; each 4.5 rights allows the purchase of one share of Ram at 8¢.
Why The Bargain
The reason for the extreme couponing at Ram Power is the company needs cash. While its main project, San Jacinto-Tizate in Nicaragua, is currently operating at reduced capacity while its contractors are working on a remediation project expected to bring its production up to somewhere between 59MW and 63MW of net electricity output. The remediation is expected to be complete in mid December, with results from testing in mid January, after which Ram will be eligible to receive distributions from the project.
The low 59MW production estimate will easily be enough to keep Ram from having to default on its project loans (they need at least 55MW,) but as long as the net output is below 65MW, $2.95 million of Ram’s Project equity must remain in a maintenance reserve account, and maintenance contributions will be increased by $0.2 million per quarter for every MW of capacity below 65 MW (net.) Ram will be eligible to receive distributions if there are available funds from power sales after the reserve increases and the original Project distribution requirements are met.
Without any other operating projects, Ram did not have the cash to meet an upcoming corporate debt payment at the end of December. Unfortunately the offering was delayed until a few days after Ram’s third quarter earnings announcement. When a company needs money quickly, they usually have to raise it on very unfavorable terms to existing shareholders, and that prospect led the stock to sell off between the quarterly earnings report and the rights announcement.
As it was, a rights offering of this sort is about as shareholder-friendly a way as possible to raise needed cash. Instead of outside investors buying the stock at a discount and immediately dumping it on the market, existing shareholders are given the opportunity. As I mentioned before, if they are not willing or able to come up with the additional cash, they can still monetize the opportunity by selling their rights in Toronto.
A Guaranteed Successful Offering
Two provisions of the rights offering ensure that the company will be able to raise the full C$5.3 million targeted by the deal First, holders of rights will be able to exercise an “additional subscription” privilege on a pro-rata basis to buy shares which would have been available under any rights which are not exercised. Ram has also arranged for standby purchase agreements with Dundee Securities, Newberry Holdings International Ltd. and Exploration Capital Partners to purchase any shares which are available but not issued subject to the rights offering. The fact that these large, sophisticated investors, including Ram’s investment bank and an affiliate of one of its largest investors are willing to backstop the deal is one more piece of evidence that it’s a good deal for investors to participate.
Company for Sale
Because it looks unlikely that the remediation program at San Jacinto-Tizate will increase capacity enough to allow Ram to resume distributions and fund its ongoing overhead and corporate debt payments going forward, Ram has is also “Exploring strategic options,” which is management speak for “the company is for sale, all or in part.” In addition to making the December interest payment, the funds from the offering should be sufficient for Ram to complete its remediation project and find a bidder for the whole company, or just San Jacinto-Tizate and its other projects.
With about C$50 million of Earnings before interest, tax, and depreciation (EBITDA) increasing with inflation, Ram would be worth about C$600 million if trading at the same (12x) multiple as mature power power producers on the TSX. That number includes no value to its development projects. Ram will of course not receive a 12x multiple, but a 7x to 9x multiple, such as discussed in the recent earnings call does not seem out of line. Adjusted for liabilities and the dilution from the rights offering, a 7x multiple would result in a value for Ram at 24¢ a share. The 9x multiple would result in a value of 51¢ a share. Note that Ram’s high debt makes this number very sensitive to the selling price, and a sale at 6x EBITDA would leave only 10¢ per share for equity holders.
A buyer would probably be able to achieve some cost savings by no longer running Ram as a stand-alone business. Reducing management and listing costs could amount to as much as $3.5 million annually, or another penny a share at the 7x EBITDA multiple.
Because it looks unlikely that the remediation program at San Jacinto-Tizate will increase capacity enough to allow Ram to resume distributions and fund its ongoing overhead and corporate debt payments going forward, Ram has is also “Exploring strategic options,” which is management speak for “the company is for sale, all or in part.” In addition to making the December interest payment, the funds from the offering should be sufficient for Ram to complete its remediation project and find a bidder for the whole company, or just San Jacinto-Tizate and its other projects.
With about C$50 million of Earnings before interest, tax, and depreciation (EBITDA) increasing with inflation, Ram would be worth about C$600 million if trading at the same (12x) multiple as mature power power producers on the TSX. That number includes no value to its development projects. Ram will of course not receive a 12x multiple, but a 7x to 9x multiple, such as discussed in the recent earnings call does not seem out of line. Adjusted for liabilities and the dilution from the rights offering, a 7x multiple would result in a value for Ram at 24¢ a share. The 9x multiple would result in a value of 51¢ a share. Note that Ram’s high debt makes this number very sensitive to the selling price, and a sale at 6x EBITDA would leave only 10¢ per share for equity holders.
A buyer would probably be able to achieve some cost savings by no longer running Ram as a stand-alone business. Reducing management and listing costs could amount to as much as $3.5 million annually, or another penny a share at the 7x EBITDA multiple.
In addition to the advantage of simply buying the shares at 8¢, there are also significant benefits from the optionality inherent in the rights. For example, a Canadian shareholder not planning to participate in the offering can still take advantage of this opportunity to maintain his or her position.
Rather than selling the rights, he or she could sell 1/4.5 (or 2/9) of his or her shares (as long as they sell for more than 8¢), and then buy them back by participating in the offering in three weeks. This reduces the risk of loss in the event the stock declines, while maintaining the full benefit of any increase in the share price.
Conclusion
The Ram Power rights offering is the most shareholder-friendly way possible for this company to raise needed cash. Since Ram has also put itself up for sale, and is worth between 25¢ and 50¢ per share, investors who are able should participate in the rights offering and the additional subscription privilege, unless the stock falls below 8¢ before December 23rd. If it does fall that far, they should buy the stock instead.
This article was first published on Forbes.com on November 30th.
Disclosure: Long RPG.
Lead Image: Ram Power’s San Jacinto-Tizate plant
DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results. This article contains the current opinions of the author and such opinions are subject to change without notice. This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.
