Cline slumps on production delays, dilutive financing

Investors disappointed with Cline Mining‘s (CMK-T, CLNMF-Q) early morning announcement on May 16 that coal production in 2011 is going to be lower than expected at its recently reopened New Elk coal mine in Colorado were hit with more potentially unwelcome news that same afternoon. The company has also agreed to issue 27.28 million shares in a $75-million bought-deal financing at $2.75 a share, representing an 18% discount to the stock’s closing price on the previous business day.

Shares of the company that morning fell 39¢ to $2.95 on heavy trading volume of 3.22 million shares before being halted around noon prior to the second announcement. They retreated another 20¢ to $2.75 the next day and now sit near a 6-month low. 

“We have been slower in getting into production than we expected, mostly because we are ruled by waiting for the normal regulatory approvals,” Cline president and CEO Ken Bates explained in a telephone interview from the company’s head office in Toronto. “If they’re delayed, then we’re delayed.”

Cline now estimates it will produce around 350,000 tons of metallurgical-grade coal this year, down from the 1.2 million tons it had forecast for 2011 last year. The company also lowered its 2012 prediction slightly from 3 million tons to 2.75 million tons. 

“Sometimes we’re going to be right with our projections, and sometimes we’re going to be under. Maybe sometimes we’re going to be over. We don’t know,” Bates said. “But it’s not fundamental.” He noted that, despite the delays, the company had also increased coal resources at the New Elk project and updated its preliminary economic assessment.

 “The fundamental [question] is, ‘What is the project worth?’ I’m saying it is valued at US$1.4 billion and a year ago it was valued at US$1 billion. I think that’s fundamental. What is not fundamental is, ‘Did you hit your targets last quarter?'” 

Cline bought the past-producing mine in 2008 for $19 million and brought it to production in December 2010, using one continuous mining machine in the Apache coal seam. It is still using just the one machine (essentially a large rotating steel drum equipped with steel teeth to cut into coal seams) but hopes to bring in nine more throughout the year. The company has to complete further development in the Apache seam first, however, as well as a portal and slope to the Blue seam. 

The updated preliminary economic assessment (PEA) for New Elk is based on a 20-year mine plan. The report established additional coal resources of 73.5 million tons, bringing the total resource to 388.5 million tons of high-volatile, bituminous coal (191.2 million tons measured, 197.3 million tons indicated). 

The project boasts a pre-tax net present value of US$1.4 billion at a 10% discount rate per year, a payback period of 1.7 years and an internal rate of return greater than 100%.

According to Bates, investors might be thinking too much about the short term and not enough about the big picture. “I’ve had people call me and say, ‘What a stupendous, what a terrific news release,’ and to tell you the truth, it is. There is nothing negative, it’s all positive and it’s the best projection results we [have ever] got.”

As for investors unhappy with the timing of the financing, Bates had this to say: “We have been working on this for some time and it was to be struck at the market price when we signed the deal, and it happened to be Monday…when the stock was at a bit of a low.” He said Cline agreed with the underwriters and leading institutions behind the bought-deal financing to issue a news release about the updated PEA fundamentals before closing the deal at a 20¢ discount to the market price. 

“Anyone going out into the financial markets for this kind of money, and even worse if you’re going out for exploration – there’s no money at the moment. It’s dried up. That’s a reality. We’re fortunate actually…we got the opportunity, and we took it.”  

Bates said the company needs the money to pay for the 10 continuous mining machines it has already ordered, which cost roughly $11 million each. It also needs the money to complete the rail line and load-out facility, which will cost about $25 million, as well as for general corporate purposes.

Still, shareholders unhappy with the timing of the financing are unlikely to be comforted by the pattern of insider selling reported this past year by Cline’s officers and directors. According to their publicly filed trading reports, all seven company insiders have recently sold shares near the top of Cline’s market. 

Bates sold 900,000 shares between December 2010 and March 2011 at prices ranging from $3.02 to $3.67 for gross proceeds of roughly $3 million. Most of them were acquired by exercising
options to buy 600,000 shares at 51¢, 82¢ and $1.11 for a combined cost of $428,000, and he has 1.8 million shares remaining. At the end of March, Bates was granted options to buy 500,000 more shares at $3.49.

Vice-president and chief financial officer Ernest Cleave similarly sold 900,000 shares at prices ranging from $3.12 to $4.10 in December and February for gross proceeds of around $3.6 million. Almost all of the shares he sold came from options exercised at 42¢, $1.11 and $1.59. He is now left with just 4,800 shares and options granted to him at the end of March to buy 500,000 shares at $3.49.

Director Dale Hendrick exercised options to buy 1 million shares at 35¢, 51¢, $1.11 and $1.59 between February and April. He then sold 925,000 of the shares at prices ranging from $3.22 to $3.74 for gross proceeds of $3.33 million between February and early May. He is left with just 75,000 shares and the same option to buy 500,000 shares at $3.49.

Chairman Bill McKnight, a former Canadian Member of Parliament and former federal cabinet minister of six different ministries, got some of the best prices for his shares. After exercising options to buy 300,000 shares at 51¢, he sold all 300,000 at prices ranging up to $4.60. He has 350,000 shares
remaining, however.

Director Peter Elzinga (once chief of staff for Ralph Klein, the former Premier of Alberta) exercised options to buy 600,000 shares at similar prices and sold them all, leaving him with no more shares; director and Canadian senator David Tkachuk exercised options to buy 300,000 shares and sold all but 30,000; and finally, Dennis Mraz, Cline’s chief operating officer and executive VP, exercised options to buy 300,000 shares and sold 191,000 of them.

When asked about the recent trading activities of Cline insiders, Bates replied they were restricted from selling any shares almost the whole of last year because the company completed three financings, which each required three-month blackout periods on trading. And despite the last financing closing in mid-November 2010, Bates said the underwriters approved them selling a “certain amount” of shares “…because they were appreciative of the job we were doing.” 

“I’m a large shareholder myself, but I’m not blowing the shares out. Forget options – you can exercise options and then you can sell them, particularly now, honestly that’s what they’re there for. If [management] can bring the company up, that’s an incentive for them. Without incentives, people don’t work too well.”