2023-05-15 05:44:29 ET
Summary
- Polymetal has announced its intention to redomicile to the Astana International Financial Centre (AIFC) in Kazakhstan.
- This is the stepping stone on the path to restoring shareholder value, by unlocking dividend payments and further corporate actions.
- I believe the current valuation implies a meaningful margin of safety, with a 2-4x potential upside over the next few years.
Introduction
I have been beating the drum for Polymetal International (AUCOY), (POYYF) since last November . While significant uncertainties remain, I see considerable value embedded in the current valuation. More importantly, the company has delineated a clear path towards the restoration of shareholder value, the first step of which is the redomiciliation to a friendly jurisdiction.
On May 10, Polymetal announced, during its Analyst and Investor Briefing event, the intention to proceed with the change of domicile to the Astana International Financial Centre (AIFC) in Kazakhstan. This decision will need to be approved by shareholders during the General Meeting of May 30. Everything that was said during the conference call is in line with what management has repeatedly stated it would try to achieve since the beginning of the Russo-Ukrainian war. I believe that management is making the correct choices given the current set of circumstances, that it is communicating openly and transparently its strategy to shareholders, and that the strategy has a good chance of success.
Reasons for the redomiciliation
Some investors might have preferred to do nothing and wait out the end of the conflict. In the evaluation of the management, this option is not viable, as it would expose the company to unacceptably high political risk and potentially lead to catastrophic destruction of shareholder value.
For example, the company could be placed under temporary management, or have trouble renewing or acquiring licenses (gold is on the list of strategic minerals that require special approval to be exploited by foreign companies).
Because of its current domicile in an "unfriendly" jurisdiction (Jersey), the company is also subject to capital controls. It is prohibited to transfer money from its Russian accounts to other jurisdictions, as well as grant intra-group loans. It is prohibited to pay dividends from the Russian subsidiaries to the holding company (because of Western sanctions, it is also prohibited to pay dividends from the holding company to Russian shareholders still locked in NSD). Finally, it is prohibited to enter into any transaction regarding the shares in the Russian subsidiaries, including the planned spin-off of the Russian assets, which is crucial to free the share price from any Russian discount.
The change in domicile will remove all these restrictions. Compared to other alternatives, the AIFC offers the advantage that the company already has a significant presence in Kazakhstan, and that dividends would not be subject to any withholding tax.
Share price action
Despite the fact that the change in domicile to Kazakhstan was expected, the share price took a nosedive just after the announcement, with its main listing on the London Stock Exchange (POLY.L) declining intra-day by more than 50% to 125 pence per share, before bouncing back strongly and closing at around 215 pence. The stock has been drifting higher for the rest of the week and is currently around 12% below the price before the announcement.
Interestingly, the Russian listing on MOEX is trading at around 700 pence per share, more than three times the valuation on the LSE. Of course, no arbitrage opportunity actually exists (because it is impossible for foreign investors to sell on the MOEX, nor is it possible for Russian investors to buy on the LSE). However, I would argue that the valuation on the MOEX is the most realistic one. If anything, the Russian listing should trade at a discount, given that Russian investors holding Polymetal's shares via the NSD are unable to vote, or receive dividends, and this will remain true even after the redomiciliation to the AIFC (because of Western sanctions against the NSD).
Cheap valuation, with tailwinds
Polymetal is a company with a market capitalization of $1.4 billion that is likely to generate around half a billion in FCF in 2023. Two tailwinds are also gaining strength: the ruble is weakening and gold prices are rising.
After averting financial collapse last year by constricting the flow of funds out of the country via capital controls, Russia seems now inclined to let the ruble fall. A weakening ruble helps commodity exporters, but is also the result of declining energy prices and increased deficit spending. Since the majority of the company's costs are denominated in rubles, while revenues are in dollars, a weaker ruble implies higher free cash flow. In its 2023 guidance , Polymetal was assuming a RUB/USD exchange rate of 65, while today the exchange rate is around 76. A 1 RUB/USD movement in the exchange rate is approximately equivalent to a $25 million increase in FCF according to the company's disclosure .
Meanwhile, gold prices are up 7% year-to-date, at around $2000 per ounce. This is well above the $1764 per ounce the company realized last year. Since every $100 per ounce increase in realized prices is roughly equivalent to a $140 million increase in FCF, we should expect very robust FCF generation during 2023, also considering that Polymetal is on-track to achieve its guidance of 1.7 million ounces per year (in line with last year's production).
It should be noted that the company still has to unwind some of the accrued gold inventories from 2022. As of May 2023, based on remarks from Polymetal's CEO Vitaly Nesis during the recent Investor Briefing event, the company was still holding around 100 thousand ounces in bullion and around 120-130 gold-equivalent ounces in concentrates. This accumulated inventory is expected to be fully sold down during the year, and should also boost 2023 financial results.
Risks
While the company is certainly cheap, it is also obvious that the valuation suffers from a severe discount due to geopolitical factors. I cannot emphasize enough that, while the risk/reward is, in my opinion, attractive, there remain significant sources of risk.
First and foremost, there are the uncertainties related to the redomiciliation. While the company claims to have obtained all the necessary authorizations at the highest political levels and not to be violating any sanctions, it is not certain that the change of domicile will go through. It will need to be approved by shareholders, and also not be blocked by Russian authorities.
In theory, since April 25, Decree No. 302 authorizes the Russian federal agency for state property management to exercise external management over assets held by foreign companies from "unfriendly" jurisdictions. Since Polymetal is domiciled in Jersey, in principle, its Russian assets could be placed under temporary management. However, for the time being, Polymetal is not explicitly mentioned in the decree, which only lists a couple of Russian power generation companies that belong to Uniper and Fortum. While the probability is low in the estimation of the management team, the new decree provides one more reason to proceed with the redomiciliation as fast as possible.
Second, there is the issue of the trade suspension and subsequent cancellation of the primary listing on the LSE. Unfortunately, the company has not managed to find a willing provider to maintain the current listing through the use of depository interests and/or the listing of global depositary receipts. This is not a surprise, since the company had already warned of this eventuality. More precisely, during the conference call, it was mentioned that there would have been willing providers, but that the new listing would then have been suspended again at the time of the jurisdictional split off of the Russian business. The board has therefore chosen not to pursue a solution destined to stay in place only temporarily.
In the meantime, what will happen is that, if the redomiciliation goes through on July 17, trading on the LSE will be suspended, as the company's shares become foreign shares and cannot be traded and settled within CREST (at least, without the addition of some additional structure, such as a GDR, which will however not be in place for the reasons mentioned above). On that day, shares will become untradable, but the listing will continue to exist.
The intention of the company is then to request an orderly termination of the London listing. The timeline for this further step is a bit nebulous. Termination would require the publication of an FCA-approved circular and shareholder approval. Therefore, it depends on when the UK Financial Conduct Authority ((FCA)) will release the circular and is conditional on shareholder approval. In any case, it cannot happen before July 17, which means that investors have more than 2 months to take care of transferring their position, if need be.
The delisting from the LSE exposes investors to the risk of seeing their position liquidated by their brokers, if brokers are unable or unwilling to hold the Kazakh shares in their name. While this risk can be removed simply by either transferring the shares to any of a number of brokers that can hold the AIFC listing (such as Halyk Finance , Freedom Finance , or Wood&Co ; the latter one offers only custody), or converting them to certified shares, it is still an inconvenience. In addition, unless the broker has access to the AIFC, the position will be untradable.
It should be emphasized that this is a temporary solution. In fact, the intention after the redomiciliation is to split off the Russian business (POLY-R), while the Kazakh business (POLY-K) will be relisted on the LSE. POLY-K will have no association whatsoever with Russia. As a fully independent company domiciled in Kazakhstan, unless Kazakhstan also falls under Western sanctions in the future, POLY-K could easily re-list on the LSE (and potentially other stock exchanges).
The issue remains about POLY-R after the spin-off. Russian shareholders will be able to receive dividends, but Western shareholders will not under the current sanctions. POLY-R will be listed on MOEX, which means that Western shareholders will also not be able to sell. POLY-R may receive an alternative listing. For example, Rusal is listed in Hong Kong and is able to pay dividends even under the current sanctions, but it is unclear whether POLY-R will manage to be listed there. In other words, POLY-R is intended to concentrate in itself all the Russia-related risks, leaving POLY-K free to re-rate. Crucially, the current valuation already assigns no value to POLY-R at all and implies at least a 50% discount on POLY-K, so despite the uncertainties regarding the value of POLY-R to Western investors, the margin of safety remains meaningful.
Conclusion
In my opinion, Polymetal is not a trade. Other sell-offs are possible on low volume, especially if some positions get liquidated after the delisting. Polymetal is instead a buy-and-hold speculation for at least a couple of years. It is a bet that the management's strategy will work out, with optionality due to rising gold prices and a weakening ruble.
The recent sell-off is probably motivated by fear, uncertainty and doubt regarding the change of domicile and subsequent delisting from the LSE. Nonetheless, I believe the company has been very transparent in its communication. There is even a dedicated webpage and a dedicated address for inquiries ( redom@polymetalinternational.com ).
To summarize, if an investor desires to sell already (after all, the price has already almost tripled from the lows), he is advised to move his position to a broker integrated with the AIFC. If not, he should only make sure not to get liquidated, by engaging with his stockbroker and clarifying whether the stockbroker can continue to hold the Kazakh listing in his name. If not, he should transfer his shares to a broker who does, or convert them to paper certificates. In both cases, dividends can be paid.
Many investors may consider Polymetal too risky at the moment, or be unsure whether Western shareholders will be able to realize the value implied by the current valuation. My belief is that the current strategy has a high chance of going through, and that value will also be returned to Western shareholders, given the commitment to resume dividend payments as soon as possible.
For further details see:
Polymetal International: On The Path To Restoring Shareholder Value