Key points:
- Cloudbreak Discovery has drawn down £750,000 on the equity funding
- It’s given a put option or price guarantee to Crescita
- This is a significantly strange thing to be doing
- Cloudbreak Discovery Shares Down 40% From Peak – Why?
Cloudbreak Discovery (LON: CDL) has drawn down £750,000 on the equity line it has with Crescita. They’ve done this by issuing new Cloudbreak shares which then rank pari passu with those already in issue. There’s no problem with this at all. In fact, it’s a pretty sensible method of financing Cloudbreak’s activities. The thing that does slightly worry, though, is that at the same time they’ve issued what amounts to a put option – or given a price guarantee – to Crescita. Which really isn’t quite how equity is supposed to work now, is it?
The basic idea of the Equity Drawdown Agreement is entirely sensible given Cloudbreak’s basic business model. Which is, as we know, to be a “natural resources project generator”. This essentially means being a deal organiser in the junior mining arena. Not a million miles away from the old model of investment banking – before it all got replaced with paper trading – or the old mining houses. A centre of expertise that small miners can draw on when necessary. Equally, the ability to spot when projects can be designed to meet market needs and desires. The return from that activity comes from having a slice of the projects created in return for the work.
Why not? The sector is hugely fragmented after all, there is value that can be added in such a manner.
But this also requires the availability of capital. That’s part of what a stock market quote is about, of course, access to capital. But issue cost money, and given the size of Cloudbreak Discovery, coming to market with a rights offer each and every time a tranche is desired might not be cost-effective. So. set up the deal with Crescita, allowing up to £10 million to be drawn down. This can come in those small tranches as they’re needed. As has just been done with that £750,000.
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All of that’s fine but then comes this eyebrow-raising part:
The parties have agreed to vary the terms of the original agreement. If within six months of a relevant allotment of shares under the Equity Drawdown Agreement, Crescita completes the sale of any of the ordinary shares in Cloudbreak issued to them (or their nominee(s)) pursuant to an equity drawdown notice, the following provision shall apply: If the aggregate sale price is less than 110% of the aggregate subscription price paid by Crescita to the Company for such ordinary shares allotted and issued pursuant to the relevant equity drawdown notice (the “110% Price”), Cloudbreak shall make a one-time payment to Crescita for the shortfall from the 110% Price in ordinary shares or cash at the discretion of Cloudbreak.
That’s akin to a put option for those 6 months. The risk of the share price falling now moves from Crescita to all other Cloudbreak shareholders. For, if the share price does fall within 6 months of an equity drawdown, then it’s shareholder funds – via either cash or dilution – which have to make up the difference to Crescita.
This is, therefore, more like – for that first 6 months – a preference share issue than plain equity. More than that, there’s a risk here. Say the share price falls to 1 pence. Now, just an example, not a prediction, just an example of the logic – then significant new share issuance will have to take place. Which would push the share price down again – and so require more share issuance. It’s possible – again, not likely, but logically possible – that this leads to a spiral of ever more issuance to Crescita and dilution of everyone else.
Another way to put this is that by granting a price guarantee, that put option, to Crescita then Cloudbreak has increased the risk to all other shareholders. Higher risk should logically mean a lower valuation in and of itself.
It’s possible that this is not a positive for the Cloundbreak share price. As is also the talk of looking to raise more capital in the coming months. At a minimum, it’s possible that the desire for more capital will put a lid on any price run-ups – for any such increases might well be met by more share issuance to raise that new capital.