Ambre’s Shaky Finances: Rebutting the Response

Gard Communications, the public relations firm that speaks for Ambre Energy, released a response to our report on Ambre’s finances on Wednesday. Or should I say “pre-sponse.” You see, according to the information (the “metadata“) in the computer file that Gard distributed, their “pre-buttal” was last edited on Wednesday at 9:33 a.m.—but we didn’t publish the report on our website until 10:24 that morning. Which either means that Gard got hold of a leaked copy of our report in advance (unlikely!), or else they were writing blind, complaining about “bias” in something they hadn’t actually read.

Regardless, Gard made six specific, substantive points about Ambre, designed to present its client as a stable and financially secure business. Had they read the report, they would have seen that five of the six claims were discussed in the report; the sixth was discussed at our press conference. And when considered in detail, none of the points that Gard raised put Ambre in a particularly favorable light.

So I’m actually happy that Gard has given us reason to address, in greater detail, each point they raised about their client, Ambre Energy.

1. [Ambre] has 10-year contracts to supply up to 5 million tons of coal per year to two Korean power generating companies, Korea South-East Power and Korea Southern Power.

As discussed in our report, Ambre’s FY 2012 financial report states that they have secured “10-year coal supply agreements” with the two Korean power companies. Let’s sidestep the question, for a moment, of whether using publicly-owned coal to turn the US into a resource colony for Korea is a sound long-term economic development strategy. Instead, let’s focus on the meat of those agreements with the Korean utilities.

Ambre’s annual report characterizes those agreements as “worth over [Australian]$3.5 billion at market prices at the date of signing.” But note the reference to “market prices”—which signals that Ambre may not have a firm-price sales contract, but simply an agreement to buy coal at prevailing market prices at the time of sale. If so, it’s not a guarantee of stable prices, but just an indication that there’s at least one willing buyer. I believe Ambre perceives this as an important agreement, since its coal is of a type that few power generators can use straight up: its ash has a high sodium content, which can foul coal boilers. So Ambre may be happy to have found any overseas customer willing to buy its high-sodium coal.

But as I discuss in the report, the real substance of the agreements with KOSPO and KOSEP is that the two utilities loaned Ambre some money. And those are loans that now carry the exorbitant interest rate of 10 percent per year. Remember, junk bonds—the riskiest of rated securities—currently yield less than 6 percent. So the interest rates that KOSPO and KOSEP demanded for their loan signal that the credit markets generally consider the company to be an incredibly high-risk venture—junkier than junk, if you will. In this case, Ambre’s alleged show of strength highlights the risky, speculative nature of the company’s business plan.

2. [Ambre] has operated two US coal mines since 2011 in conjunction with joint venture partners Anadarko Petroleum and Cloud Peak Energy.

Let’s be clear about Ambre’s “partnership” with Cloud Peak: just a few months after they became “partners,” Cloud Peak sued the bejeezus out of Ambre. Ambre then counter-sued, and the two companies ultimately settled their differences in cases out of court—but on terms strikingly unfavorable to Ambre.

How unfavorable? Ambre bought the first half of the Decker mine, plus half of the better-performing Black Butte mine, plus two currently idle coal deposits, from a company called Level 3 Communications for just over $4 million in cash. But in the Cloud Peak settlement, Ambre agreed to buy the second half of Decker alone for $57 million, if it can find the funding by this March. If Ambre delays, it will have to pay Cloud Peak $64 million at a later date. Ambre also agreed to replace Cloud Peak’s reclamation bond—which, as the settlement press release suggests, represents an additional investment of $70 million that Ambre won’t be able to do anything with until it fully cleans up the Decker mine.

Perhaps the Cloud Peak execs had themselves a good chuckle about how they concluded their mining “partnership” with Ambre.

But the controversies surrounding Ambre’s coal mining “partnerships” sidestep the real point: Ambre is losing millions of dollars on its coal mining business. The company owned a 50 percent stake in two coal mines, for only 8 months out of the 2012 fiscal year. And yet it still managed to lose $10 million in the mining business. The Decker mine—the one that Cloud Peak maneuvered Ambre into buying—has hemorrhaged money so quickly that the mine recently announced that it was laying off nearly half of its work force.

Another point about these partnerships: neither Anadarko nor Cloud Peak had any choice in “partnering” with Ambre in the first place. Ambre bought into the partnerships by purchasing the failing coal assets of another company—Level 3 Communications—that was sensibly trying to get out of the coal business. Ambre simply bought those “partnerships;” it didn’t forge them.

In a way, though, Gard has raised an important fact about its client: Ambre’s only concrete experience in the global coal industry is a little over a year running an unsuccessful, money-losing mining business—a year that was scarred by a costly lawsuit that was settled on what can only be described as unfavorable terms to Ambre, and that was punctuated by an announcement of mass layoffs among the company’s mineworkers.

3. [Ambre] has over 350 employees across the USA and Australia.

For now, at least. If reporters care, they should ask Ambre or Gard if this figure counts the 75 layoffs at Decker. I don’t happen to know myself.

4. [Ambre] has strong private equity support from Resource Capital Funds in Denver.

We discuss Resource Capital Funds extensively in the report. Resource Capital Funds (RCF), the Denver-based, minerals-focused venture capital fund, has been the only thing standing between Ambre and outright bankruptcy. Ambre’s financial reports show that it has made extensive concessions to RCF:

• Ambre has granted RCF anti-dilution rights for future stock issuance—which is good for RCF, but could discourage new investors from putting capital into Ambre.
• Ambre is paying interest rates of 12 percent per year for money that RCF has loaned to the firm. Remember, junk bonds yield less than 6 percent.
• Ambre’s 12 percent per year loan is actually a “balloon loan”—Ambre doesn’t pay interest on the loan, it just adds the interest to the principal each month.
• At the end of the loan term, Ambre has agreed to a $110 million “makewhole payment” to RCF, regardless of the amount of principle and interest left on the loan.
• If Ambre’s executives decide that the company is unable or unwilling to pay back the loan, it will have to cede a significant ownership stake to RCF.

In short, Ambre pays usurious rates for RCF’s capital, suggesting that it can’t find any other major funders who are willing to give Ambre money on more favorable terms. If Ambre actually is able to make a go of it in the global coal export game—a big if—RCF will be sitting pretty. But in the short term, the terms that RCF has dictated to Ambre suggest that the capital and credit markets (correctly) perceive Ambre as a tremendous risk.

And while RCF’s terms strongly favor RCF, they make Ambre a worse deal for anyone else who wants to add capital to the venture. At this point, any other company or venture capitalist doing due diligence on Ambre would have to ask itself: why inject more capital into Ambre, if my first contributions are just going to be used to make sure that RCF recoups its earlier investment?

RCF’s involvement with Ambre underscores the risky nature of Ambre’s business model in another way as well. As a venture firm, RCF maintains several portfolios of high-risk minerals companies. Some of these firms struggle; a few do well enough to make the fund profitable as a whole. So when RCF invests in a company, it doesn’t mean that the company is likely to succeed. Perhaps the opposite is true: hedge funds exist to fund high-risk ventures, many of which fail. (Paging Pets.com…)

A good example of RCF’s business model can be found in the story of a company called Molycorp, a rare-earth minerals mining firm. RCF made early investments that helped propel Molycorp towards its initial public offering. Soon after the company went public, prices of rare-earth minerals spiked, and Molycorp and RCF were the darlings of Wall Street. Shares of the firm rose from $13 in August 2010 to more than $77 in May 2011. But when rare-earth prices came back down to earth, Molycorp’s stock tumbled. Its business plan looked weaker and weaker, and ultimately the company came under SEC scrutiny for improper disclosures. As of yesterday, Molycorp closed at $7.49—less than a tenth of its peak, and far lower than its IPO price.

But RCF still made a bundle on Molycorp: according to the SEC’s insider transactions data, RCF sold large shares of its stock at prices of $50 or more. In this case, RCF’s genius wasn’t in fostering a stable, long-term business, but in taking advantage of a temporary stock price blip in an over-hyped industry. One would be forgiven for thinking that RCF is trying for the same result with Ambre.

5. [Ambre] is developing two of only three coal terminal projects in the US northwest which have advanced to a stage where permit applications have been submitted.

Sure. But “we’ve applied for a permit” doesn’t mean “we’re starting a business.” There are lots of steps left in the process. The Longview site faces a lengthy environmental review. Oregon’s Department of State Lands recently delayed a decision on Ambre’s Morrow project, and the Corps of Engineers could still require a costly Environmental Impact Statement for Morrow. The company faces other regulatory hurdles as well.

6. [Ambre] has strong joint venture support from US coal major Arch Coal, Inc. at its Millennium Bulk Terminals project.

OK, but frankly, Arch Coal isn’t doing so well itself. Its stock has tanked, and the company lost $295 million in the fourth quarter of 2012 resulting from sharp declines in coal sales volumes and revenues. More tellingly, in its most recent investor conference call Arch copped to the fact that it has been selling its Powder River Basin coal at below the cost of production—a striking admission that piqued a lot of interest among the analysts participating in the call. And the fact that so many of the key players in the coal export controversy have such shaky finances simply underscores that coal exports aren’t actually a safe, sober, and stable business platform. They’re the sort of high-risk gamble that you’d expect from a desperate industry (i.e., the US coal sector, with Arch as a prime example) or from a high-risk startup (like Ambre).

That concludes my rebuttal to Gard’s response to my report. I’m happy to continue the online conversation with Ambre Energy and its P.R. firm, Gard communications—and I’m looking forward to their next response.

Gard Communications’ response to Sightline Institute’s report, Caveat Investor (PDF)