April 22, 2008

  

Phosphate company in the limelight amid agricultural boom

 

 

With fertilizer companies looking pricey, hedge funds hoping to ride the agricultural commodities boom are getting into small and obscure trades in the sector to profit from the cycle they believe is just beginning.

 

More crops mean more fertilizer use, and fertilizer producers need basic ingredients such as phosphate, which explains the rationale for betting on Legend International Holdings Inc. (LGDI), a company with the rights to explore phosphate rock in northwestern Australia.

 

Atticus Capital certainly saw the appeal in the trade, which is paying off handsomely. Last December, the New York-based multibillion-dollar hedge fund firm bought 18.75 million shares of Legend through a private placement at 80 cents a share, or US$15 million. Four months later, the value of that stake has grown threefold thanks to rising phosphate prices and the likelihood that Legend will get a supplier contract in the coming months, even if production is at least two years away.

 

Behind the price boost was Legend's release last week of a study detailing the scope of its deposits in the Georgina Basin in Queensland, Australia. The study, by British Sulphur, a consulting division of CRU Group, forecast annual gross earnings at US$702 million, based on a best-case scenario with global phosphate rock prices at US$200 per tonne and annual production of 5 million tonnes. Phosphate rock concentrate exported by Morocco, the world's second-largest producer after the US, traded at US$350/tonne to US$400/tonne in March, according to the study, so earnings could potentially be much higher if prices remain around that level.

 

Even if Legend's earnings are only theoretical right now, the bet is for the long run, and investors believe recent commodity price gains are going to continue a while.

 

Atticus, a key early-stage investor, seems to share the faith in the venture and is strengthening its position in the trade.

 

The firm, run by Tim Barakett and a regular investor in the mining sector, increased its position in Legend during the first quarter to nearly 13 percent of the outstanding shares and, as of March 31, had 28.8 million shares of the phosphate rock prospector in its portfolio, according to regulatory filings. On Thursday, that stake was worth US$70.5 million, compared with US$55 million a week earlier.

 

Legend trades on the over-the-counter and highly illiquid Bulletin Board market, and thus it's below the radar screen of the vast majority of investors. Atticus got into the name after its analyst Duncan Maclean saw a presentation by the company and recommended it to the portfolio manager, according to Legend's executives.

 

Legend's market capitalization jumped 85 percent this year to over US$410 million last week after the scoping study was released. The company aims to list on the American Stock Exchange as soon as the stock meets the criteria of trading above US$2 for a month. It crossed that threshold for the first time on Wednesday. The company does not have any revenue.

 

The next hurdle for Legend is getting an agreement to supply a major manufacturer, known in the industry as an offtake agreement. Such a deal would enable the company to finance the development of a beneficiation plant to boost the quality of the rock, the construction of a 300 kilometer slurry pipeline to carry the product to the port of Karumba, as well as of a drying facility and berthing area at the port. The cost of these capital expenditures is pegged at over US$800 million by the study, which can be covered in about one year of production if phosphate rock prices trade at about half their current level.

 

"The main thing is the offtake agreement, and that will bring us financing," said Joseph Gutnick, Legend's chief executive officer, whose family controls 47 percent of the company.

 

Given the current tightness of supply, Gutnick said in an interview with Hedge Fund Trades, he expects a contract should be reached in coming months.

 

Gutnick said there is huge demand for the rock and there are fertilizer plants in India running at 30 percent capacity due to lack of supply. These plants produce the widely used fertilizer mixes monoammonium phosphate and diammonium phosphate, known as MAP and DAP, said Gutnick.

 

Legend expects to ship its phosphate rock to Asia, primarily to India, China and Indonesia.

 

The company's deposits in Queensland were first identified in the 1970s, when a feasibility study put them at 1.46 billion tonnes, but low market prices at the time did not make for a profitable venture so exploration and production never happened.

 

High grain prices are an incentive for farmers to use more fertilizers, and analysts predict phosphate rock will never trade at its low again. In a quarterly newsletter released last November, analysts at Mosaic Co. said that the phosphate price cycle has shifted higher because of structural changes to the market, which will push consumption of the nutrient higher at an annual growth rate of nearly 4 percent in the next five years. Plymouth, Minn.-based Mosaic (MOS) is one of the largest fertilizer producers in the world.