Terra Nova: A 'Blue Light' Special

| About: MFC Bancorp (MFCB)
Terra Nova (NYSEARCA:TTT) announced its share rights offering this past week. Since the last review, when TTT was trading at $10.38, the company has distributed a stock dividend of $1.27 worth of (OTCPK:KHDHF) stock and now trades at around $8.60. As typical of a Michael Smith company, determining TTT’s value, and hence a fair market price, becomes an intriguing exercise.
Terra Nova is an iron ore royalty company that derives its income through indirect ownership in the Wabash Mine in Labrador, Canada. Its income is dependent on the price of iron ore and the amount of ore mined. In addition, TTT is a large holder of shares in its former parent company, German-based cement manufacturing equipment specialists KHD Humboldt Wedag International AG (KHDHF.PK), also known as KID. TTT is in the process of distributing the majority of its KID holdings to shareholders, and has completed two of three KID stock dividend distributions, with the third due this month.
Management is still in the process of transforming TTT from a virtually insignificant asset to a viable investor and financier in iron ore projects. Jettisoning KID allows management (Michael Smith) to focus on generating increasing income from additional ore investments. The rights offering will generate $50 million in additional cash. Added to the cash and securities reported as of 3/31, Smith should have upwards of $160 million to expand TTT’s investments.
Investing in iron ore royalties and mine development is an interesting approach to commodity exposure. Usually considered more conservative than mining stocks due to large distributions, their fate is still determined by the strength or weakness of the global steel and commodity iron ore markets.
The rights offering entitles shareholders of record as of Aug 6th the opportunity to buy 1 share of TTT for every 4 shares owned at a price of $6.60. The rights expire Sept 2, and will trade for a short time on the NYSE using the symbol TTT RT. Upon exercising the rights, there will be 7.6 million new shares issued for a 25% dilution to current shareholders and share count will increase to 38 million.
As a royalty income company, TTT will trade as a function of either book value or yield. While the company is still in the process of generating capital and locating suitable investments, calculating a realistic book value is difficult - the vast majority of book value will be in cash. TTT was separated from its parent, KID, as of 3/31 and does not have but a few months of operating history as a standalone firm.
A dividend policy and amount has yet to be determined, but clarity should come over the next few quarters of financials. As a large percentage of TTT’s book value is in cash, the full potential of management’s ability to generate income returns for shareholders is unknown. The dividend in the short-term will be based on current income from the Wabash mine, with increasing distributions over time coming from the deployment of the company’s large cash position.
Book value calculations become intriguing at this juncture. There are still several parts and pieces in transition. For example, management plans on increasing the book value of the Wabash royalty contract from $27 million to $200 million, or about $4 per share pre-dilution, to reflect a more realistic value. Currently, Terra Nova’s assets include the following:
  • Based on the recent SEC 10-F filing for the rights offering, TTT owns 52% of outstanding shares of KID, or about 17 million shares, and 9.3 million shares, or 29%, is scheduled to be distributed before the rights offering expires. TTT anticipates retaining 24% interest in KID (increased from 19% per PR of 3/31) to be distributed to shareholders sometime in the future.
  • Cash and securities of $108 million as of 3/31
  • Royalty contract and long-term income cash flow.
Management pegged book value of the retained portion of KID, cash and royalty assets at $5.42 per share as of 3/31. Of that, $3.56 was in cash, making the value of KID and Wabash royalty assets, less liabilities, $1.86.
The table below outlines potential changes to book value over the next few quarters:

Pre-Rights Post-Rights
Shares Outstanding 30.3 mil 38.0 mil
Cash and Securities - $108 and $158, respectively $3.56 $4.15
Value of KID and Royalty Assets, less liabilities $1.86 $1.47
$5.42 $5.62
Value of KID shrs to be distributed Aug 2010 $1.74
Pending upgrade to Wabash royalty value $4.00 $3.00
Book Value $11.16 $8.62
Click to enlarge

The current share price reflects the company’s book value after a 25% dilution, the anticipated stock dividend in Aug, and the upgrade of the Wabash royalty asset. The rights offering at $6.60 should be a good deal for investors as it reflects a 22% to 25% discount to anticipated future book value.
As the record date for the rights offering, including settlement, is Aug 6, new investors past Aug 3 may not acquire the rights. As the record date for the Aug KID stock dividend has not been announced, new investors up to 3 days prior to the announced record date (for settlement) should be eligible for this distribution.
Terra Nova is still an investment in management’s ability to invest capital for the benefit of shareholders. Due to being in its start-up phase, shareholders are waiting for a series of quarterly financials to determine accurately expenses and distributions.
This lack of clarity is keeping share prices down, and investors who buy TTT (receiving both the KID stock distribution and the rights offering) before the settlement/record date of the offering should be well rewarded.
As Smith’s business plan unfolds, Terra Nova should provide adequate returns for investors for both income and capital gains, with or without KID distributions and rights offerings.
As always, investors should conduct their own due diligence, should develop their own understanding of these potential opportunities, and should determine how it may fit their current financial situation.

Disclosure: Long TTT and have been a shareholder since 2008, Long KHDHF.PK and have been a shareholder since 2010