Ben Axler is Managing Partner and co‐founder of Spruce Point Capital Management, a New York‐based hedge fund that specializes in cash‐rich, value equities and special situations. Prior to founding Spruce Point, Ben spent eight years as an investment banker advising, structuring and executing financing, risk management and M&A transactions for leading Fortune 500 companies. Ben started his career with Credit Suisse in 2000, and from 2006 to 2008 was an associate director at Barclays Capital in the Diversified Industrials Group.
We had the opportunity to ask Ben about his highest conviction holding in his fund, and he chose a smallcap, Australia-based resources firm.
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What is your highest conviction stock position in your fund - long or short?
Our highest conviction long position for 2010 and beyond is Legend International Holdings (LGDI.OB).
Legend International primarily focuses on the development of its phosphate rock interests in the Georgina Basin in Queensland, Australia. The Company also has interests in diamond and base metal projects in Australia and Canada. We like Legend International because of multiple converging growth themes: agriculture and fertilizer demand, China and India.
The Company’s phosphate rock interests include Paradise, Lady Jane, D-Tree, Thorntonia, Lily Creek, Quita Creek, Sherrin Creek and Highland Plains, which have combined historical deposits of more than 1 billion tons.
India does not have enough phosphate rock in the long-term to supply its vast domestic agricultural needs, so IFFCO, the largest Indian agricultural cooperative, partnered with Legend to develop and purchase large quantities of the rock through an off-take agreement. Likewise, China, as a large producer of fertilizer products to the world market, needs long-term sources of phosphate rock for its growth. As a result, in November 2009 Legend formed a strategic alliance with the Wengfu Group, one of China’s largest fertilizer producers.
Can you talk a bit about the industry/sector? How much is this an "industry pick" as opposed to a pure bottom-up pick?
At Spruce Point we look for value from both angles, and gain conviction from our selections when both the top-down and bottom-up stories are aligned. In this case, we have found a situation where we believe there is a dearth of a commodity for the long-run, and an emerging, underfollowed company with catalysts in place to prosper from it.
Can you describe the company's competitive environment? How is this Company positioned vis-a-vis its competitors?
We think the Company is well positioned from a geographic and timing perspective to serve its end customers in China and India, where demand is greatest in the long-term. Most world phosphate rock production occurs in China, the U.S., and Morocco, with most consumption also taking place domestically. Some new capacity is slated to come online in the near-term (notably Vale’s (VALE) mine in Peru, which could produce 4m tons per annum), and in West Africa.
There are also two other Australian phosphate rock ventures, Phosphate Australia [ASX: POZ] and Minemakers Ltd [ASX: MAK], both of which are smaller, lacking adequate cash resources and strategic alliances such as Legend’s partnerships with IFFCO and Wengfu. As a result, they will likely not beat Legend to market in commercializing their assets.
What is the current sentiment on the stock? How does your view differ from the consensus?
The current sentiment on the stock is positive. The stock is slowly coming onto the radar screen of major institutions, which are recognizing the value and opportunity facing the Company. The stock had a large run above $4/share in the commodity boom of 2008, but languished as a penny stock for most of 2009 despite the Company’s strong balance sheet of A$79m (US$70m) and no debt. Improving prospects in the fertilizer sector and strengthening rock prices would make Legend break-even to profitable for initial sales later in 2010.
Also, the lone analyst covering Legend at BMO Capital Markets recently raised his rating of the Company from Market Perform to Outperform. The analyst presented base case scenarios at $125/ton of rock where Legend’s shares could be worth $2.50/share or 85% higher from its current price of $1.35/share. The estimate is highly leveraged to changes in rock price assumptions with even a $25/ton increase adding over $1.30/share to the target price.
Does the company's management play a role in your position?
Yes, the Company’s management plays a strong factor in our predisposition to own the shares. The Company is run by a successful, entrepreneurial mining family and headed by its patriarch, Joe Gutnick. The family owns over 20% of the Company, is the largest shareholder, and gives us some comfort that its interests are aligned with other shareholders. IFFCO also holds a seat on the Board of Directors.
What catalysts do you see that could move the stock?
There are numerous near term catalysts that can move the stock higher, aside from improving phosphate rock prices. First, the Company is looking to get listed on a major exchange from the bulletin board where it currently trades. We believe that Legend will seek to get listed on the Toronto and/or Australian exchanges in 2010. The Company is also waiting for JORC (Joint Ore Reserves Committee)-compliant drill results, both direct shipping ore and full resource, from the Paradise North and Paradise South assets. This report would help substantiate the quality and amount of Legend’s phosphate rock assets. This report is expected in the first quarter of 2010. Furthermore, Legend is looking to make initial sales of ore to its customer IFFCO later in 2010, and begin to start generating cash flow.
Longer term, Legend has discussed the construction of a beneficiation plant. Beneficiation is a variety of processes whereby extracted ore from mining is reduced to particles that can be separated into mineral and waste, the former suitable for further processing or direct use. After completion of a positive feasibility study for the mining and beneficiation, Wengfu will become an equity partner with Legend to strengthen the alliance and share in the benefits of successful development of all stages of the project including the production of specialty phosphate chemical products. Clearly, should this occur, Wengfu would purchase shares of Legend, with the only alternative to be in the open market, since Legend has no stated plans to issue new equity.
What could go wrong with this stock pick?
Legend is subject to numerous risks particular to the agriculture and mining industries. Some of the greater concerns include the Company’s available rail and port capacity to ship its product. However, in December the Queensland government announced it would spend~A$100 million upgrading the Mount Isa–Townsville rail line. Longer-term, there will need to be more investment in rail infrastructure to support Legend’s goal of shipping 5 million tons per annum of its product. Also, Legend does not have a firm agreement with IFFCO to purchase the phosphate rock in the event IFFCO can purchase it cheaper from other sources.
There are also sizeable shareholders of Legend that could seek to exit their positions, although we see this as a low possibility in the near term. George Soros, who owns over 10% of the Company, actually doubled his position last year when the share price collapsed from over $4/share to around $0.40 cents. Soros’ investment style tends to be long-term oriented, so we see little risk of him selling anytime soon. Additionally, hedge fund Atticus Capital owns 13% and partner IFFCO owns over 15% of Legend. IFFCO is unlikely to sell given that it just purchased its stake in late 2009 and is a partner in the project. Atticus’ shares are held by its European fund which was not liquidated. Given Atticus Capital’s historical fundamental and value-orientation, it is also not likely a near term seller.
Thank you very much, Ben.
Disclosure: Spruce Point Capital Management is long LGDI.OB