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The murky battle for Katanga Add to ...

It is not the kind of present shareholders wish for. On Christmas Eve, Katanga Mining Ltd. gave investors the gift of dilution.

Katanga quietly announced plans on Dec. 24 to issue an avalanche of new shares that could give control of the company to commodities trader Glencore International AG. If the financing deal goes through, Glencore will gain ownership of a former market darling with the potential to be Africa's largest copper producer. Katanga's assets include 240 million tonnes of high-grade copper and cobalt at properties in the Democratic Republic of the Congo.

The massively dilutive financing would also bring the messy Katanga soap opera to a definitive end for all but a few brave Canadian investors who choose to hang on to their shares. The company's short history has been marred by backstabbing, political power plays and corporate subterfuge carried out by an intriguing cast of international characters.

Katanga doesn't need shareholder approval for the deal, which will issue nearly one billion shares to the secretive Swiss trading firm and balloon Katanga's share count by 462 per cent. It is relying on a "financial hardship exemption" under Toronto Stock Exchange rules that allow distressed companies to increase their float by more than 25 per cent without a vote.

Created from cast off assets by former executives of Toronto's Kinross Gold Corp., Katanga was once a more widely held mining firm poised to lead the revival of valuable mineral extraction in the war-torn Congo. The company and its founding management, chief executive officer Art Ditto and chairman Bob Buchan, tapped millions of dollars from Canadian investors who bet that Katanga and its team had the fortitude and savvy to navigate the African country's intense political risks and mine its mineral riches.

What was once so promising a venture, however, has turned to heartbreak for most shareholders and some former management. The stock is down 97 per cent over the past year and an exhausted Mr. Ditto left the CEO job and the company in October. Mr. Buchan, meanwhile, had cashed out more than a year before. He stunned his long-time friend and colleague Mr. Ditto in June, 2007, by selling his entire Katanga holdings - more than 4.6 million shares - to a fund associated with an Israeli businessman and diamond magnate named Dan Gertler. The surprise stock sale dismantled the control that management had on the company. Katanga was facing a hostile takeover bid at the time and although the bid fell away, it was under pressure from the Congolese government to combine with another rival miner called Nikanor PLC. Katanga soon announced a $2-billion (U.S.) cash and stock takeover bid for Nikanor.

Mr. Gertler was the founding shareholder of Nikanor and ended up with a large stake in Katanga. Glencore was also a major Nikanor shareholder and it too gained a stake in Katanga from the Nikanor deal, a seat on the board, as well as the right to appoint Katanga's CEO. According to a report in the Financial Times, Glencore was instrumental in getting the takeover done.

Now Glencore, which is best known for its 34-per-cent stake in Xstrata PLC, is poised to gain control of Katanga and a stranglehold on the company's promising assets. With Mr. Ditto gone and a Glencore executive seconded to the Katanga CEO job, the company has agreed to a desperation financing deal with Glencore. In exchange for $265-million (U.S.) in financing, Katanga has awarded Glencore the right to purchase nearly a billion shares for 28 cents each that could give it up to 88 per cent of Katanga's stock.

The TSX rules prohibiting the excessive dilution without a shareholder vote won't apply in the case of Katanga, which says it is relying on the financial hardship exemption. It argues this will permit it to issue the 953 million shares to Glencore, even though the deal is a related-party transaction between Katanga and one of its major shareholders.

"This is outrageous," said Manny Drukier, an 80-year-old retiree in Toronto who owns roughly 18,000 Katanga shares. Last year, with the price of copper and cobalt soaring, Katanga's market value climbed to more than $2-billion. Besieged by financial woes and a crash in commodity prices, it has since plunged to less than $100-million.

Under the new financing plan, the number of Katanga shares outstanding will increase from approximately 206 million to a jaw-dropping 1.1 billion. The public float of the company, once headquartered in Toronto but now based in London, will shrink from an already thin 34 per cent of total shares to just 6 per cent.

Katanga is by no means the first or only struggling company to make use of the TSX's financial hardship exemption. Just this week, cash-poor NovaGold Resources Inc., which once rebuffed a $1.3-billion (U.S.) takeover offer from Barrick Gold Corp., gave a New York investment fund shares and warrants that could be exercised for control of 46 per cent of the company, in exchange for $60-million in sorely needed funds.

Amid a wave of dilutive desperation financings caused by the market meltdown, Katanga's Christmas Eve bomb has raised questions from analysts and common shareholders about the actions of company management, in part because its chief executive officer, Steven Isaacs, is a Glencore employee appointed by Glencore to the Katanga CEO job.

Just two months ago, Mr. Isaacs told investors on a conference call to discuss Katanga's third-quarter financial results that the company had a "strong relationship with a consortium of debt financiers" and management "remained very hopeful in this regard."

It's not clear how the new loan arrangement was negotiated with Glencore. Katanga corporate officials would not comment on the record. They said Mr. Isaacs was not involved in the negotiations and that the company's two independent directors, Robert Wardell and Terry Robinson, determined that the company was in enough financial distress to warrant the financial hardship exemption. Katanga director Aristotelis Mistakidis, an executive with Glencore since 1993, was recused from the discussions, the Katanga officials said, adding that the dismal credit markets left Katanga with no options other than the Glencore deal.

Most troubling to some is that Katanga has agreed to amend the terms of a previous $150-million convertible loan with Glencore, even though it was not scheduled to come due until Nov. 5, 2009.

"We believe that management's actions exacerbated the need for external financing and limited the timeline available to investigate alternative financing options," UBS Securities analysts Onno Rutten said in a recent note to clients.

Mr. Rutten said that despite a looming liquidity crisis, Katanga spent aggressively on certain projects in the Congo that were unlikely to begin production any time soon, including assets formerly owned by Nikanor. He also noted that Katanga has had unusually high expenses compared with its peers in the Congo.

Other investors have been invited to participate in the equity issue, but the company has said that "insider participation in the issue could be up to 100 per cent." If that happens, Glencore, African construction and mining magnate George Forrest, Mr. Gertler and a handful of other investors could end up controlling 94 per cent of the company. Mr. Ditto's holdings would be reduced to just 2 per cent.

Some minority shareholders are hopeful that another party will step up with an offer for a stake in Katanga and cash to help it fund its operations. But sources have said that potential buyers are hoping to strike a friendly deal with Glencore.

If that doesn't happen and if metal prices recover and the Congo finally completes its mining contract review, Glencore, which dominates the cobalt trading market, appears likely to end up controlling what could be the best base metal mine assets in Africa.



Follow on Twitter: @iamandyhoffman

 

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