Reclam’s bonds ride Zimbabwean diamond adventure as concession fight continues

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Since breaking out in 2006, the battle over Zimbabwe’s massive Marange diamond field has drawn the attention of numerous regional power brokers and the scrutiny of NGOs ranging from the Kimberley Process to Human Rights Watch. A very different constituency is tracking the conflict on trading desks of the City and other European financial capitals – the owners of high yield bonds issued by New Reclamation Group (Reclam).

Nominally a South African scrap metals recycler, Reclam switched gears dramatically last year when it partnered up with a government entity to exploit the Marange mines despite an ongoing legal dispute. The core of that court fight – Zimbabwe’s forceful appropriation of the fields – is unlikely to be resolved anytime soon.

Several holders of Reclam’s EUR 153m 8.125% 2013s said they expect the company’s alliance with Zimbabwe’s authoritarian regime to trump any adverse court rulings. It’s far less certain whether revenue from Marange diamond sales would actually upstream to the parent company backing the 8.125% notes, and bond holders will probe management on the matter during a 1Q10 earnings call scheduled for Tuesday (25 May).

Reclam sold EUR 245m of the bonds in 2006 via Citigroup to a cross-section of institutional investors. Many of those accounts sold out in 2008 as the spot price of ferrous metals plummeted, or in early 2009 when Moody’s Investors Service cut its rating of the bonds to Caa1 from B3 citing adverse commodity pricing, according to former holders interviewed by Debtwire.

That trading left the outstanding debt in the hands of distressed debt and risk-hungry hedge funds, some of whom bought in as low as 30, buysiders said. The notes rebounded in line with the rest of the high yield market, hitting 87 in early November 2009. Shortly thereafter news of the company’s off-piste venture into diamond mining into politically unstable and notoriously corrupt Zimbabwe caused the bonds to slide back to the low 60s.

The notes have since rallied to the low 70s on the back of perceptions that the deal could pay off for Reclam and ease its liquidity crisis, one buysider noted. While 4Q10 earnings rebounded on a year-on-year basis from the troughs of the downturn, they dipped sequentially compared to the previous quarter.

EBITDA for the quarter ending 31 December 2009 was ZAR 49.8m (EUR 5.8m), an 81% rise on the same quarter in 2008 but barely half the ZAR 91.7m generated in the previous quarter.

Hit by a ZAR 150m part prepayment to settle a currency hedge that was ZAR 564m out of the money at its 1 February 2010 expiry date, and the ZAR 196.7m of cash plowed into Mbada Diamonds, Reclam’s cash position dwindled to ZAR 28.5m by the end of 2009, compared to ZAR 307.3m the previous quarter and ZAR 1.356bn the year before.

But it remains unclear when or whether revenues from Marange diamond sales will flow through to Reclam’s coffers. The scrap seller invested in the mines by making an inter-company loan to Grandwell Holdings, an unrestricted subsidiary, which in turn invested in the diamond operation.

“There are a lot of corporate governance issues here, this deal is pretty shady,” a third bond holder commented. “The investment seems to have been made outside of the restricted group, so there are no assurances that any cash flows will come back into the business.”

Blood diamonds in the rust

In August 2009, Grandwell made a ZAR 200m (EUR 20m) investment in a 50/50 joint venture, Mbada Diamonds, together with Marange Resources, a fully owned subsidiary of Zimbabwean state-owned mining company ZMDC. The JV was created to mine the northern area of Marange under a concession held by the ZMDC.

But London-listed mining company African Consolidated Resources (ACR), which had obtained the license to the Marange field in 2006, challenged the creation of the company in court and won a favorable judgment only to be de-facto stymied by the government of President Robert Mugabe.

“ACR had a claim, but it looks like the Ministry of Mining found a way technically to nullify it, which shows that the government looks onside with Reclam,” a bondholder said.

After claiming that the Marange field is in a reservation area requiring a special grant, the ministry cancelled ACR’s license and awarded it to the ZMDC. ACR challenged that action in the Zimbabwean High Court, which ruled that the new concession was illegal and upheld ACR’s claims in September 2009.

The ministry responded by lodging an appeal against the judgment with the Zimbabwean Supreme Court, which ordered the roughly 4m carats of diamonds (worth some USD 200m) mined by Mbada to be held by the Zimbabwean Reserve Bank and all mining activity to cease until the appeal has been heard.

ACR launched an urgent application with the High Courts in March to set aside the ministry’s unlawful cancellation of its license, which Reclam claims was unsuccessful and dismissed with costs, according to its website. That sparked a roughly ten-point rally in Reclam’s outstanding EUR 153m 8.125% 2013s, from around 60 to 70/71 in April, a second buysider noted.

But Reclam’s statement is untrue, said Andrew Cranswick, the CEO of African Consolidated Resources. The judge ruled that the matter was not urgent, but has not heard the case itself, he said. Reclam declined to comment.

What that means is that Mbada remains in control of the bulk of the diamonds, and continues to mine the field. ACR launched a second urgent application to the High Courts in May to uphold the Supreme Court ruling and ban further mining activity and diamond sales but the High Court judge again passed the buck, dismissing the urgency of the case on the basis that ACR could claim compensation at a later stage.

“Any judge would have treated this hot potato with understandable trepidation,” Cranswick said. “No one is enforcing the Supreme Court order, but the appeal is still pending and any violation of that order by any party makes that party guilty of contempt of court – an imprisonable criminal offence in Zimbabwe.”

Mbada may boost Reclam’s bottom line but some collateral damage is inevitable given widespread opprobrium over the government’s part in a massacre of roughly 200 diggers at the mine in 2008. South African insurer Old Mutual Life Insurance is debating whether to sell its 5.2% stake in Reclam due to the company’s foray into Marange, according to press reports.


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