Can you ever trust this company again?

published 15 February 2011

Shareholders in Atlantic Coal (LON:ATC) should stand by for action. Yesterday, the company announced that it is looking to raise £12m by placing 1.6 billion new shares. And there is every chance that an acquisition will follow in short order.

Atlantic's shares have soared this year on the back of fears of a supply shortage in coal - the result of the floods in Australia. And they continued to rise as Atlantic reported successful efforts to boost production last year. With this new placing, Atlantic could also radically expand production, probably through acquiring another mine.

But something disturbs me about this deal. I think Atlantic is pulling a bit of a stunt here. And it brings up a very important issue for penny share investors - does the company have your best interests at heart?

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How Atlantic could exploit the 'world's most valuable mineral deposit'

How will Atlantic spend the new cash? In 2009 Atlantic Coal had merger discussions with Strategic Natural Resources(LON:SNRP), which has a huge coal deposit in South Africa. But today its avowed strategy is to act as a consolidator in its local market. So the betting in the City is that it will strike a deal close to its existing operations in Pennsylvania.

Here, Atlantic runs the Stockton colliery, a union-free open-cast mine producing 250,000 tons of washed anthracite annually. Although it principally serves local markets, an agreement with XCoal gives it access to the booming export markets of India and China, and it is looking to double the production of the mine, which has an anticipated life of ten years.

Pennsylvania has a proud tradition of coal production. The Pittsburgh coal seam has been called the "world's most valuable single mineral deposit" and miners started to exploit it way back in 1761. It was in war time, though, that the Pennsylvania coal industry really proved its worth. In 1918, 330,000 miners produced a staggering 277 million tons of coal. After virtually grinding to a halt during the Great Depression, production was ramped up again in WWII, peaking at 209 million tons.

Coal production was in the range of 60m-90m tons from 1960 to 1990, but recently it has been on the increase again. 46% of US electricity is still generated by coal fired power stations, but the coal that Atlantic produces is high carbon 'clean' anthracite that is used for heating and industrial processes such as filtration and glass making. All of America's anthracite comes from Pennsylvania, demand has been outstripping supply, and Atlantic Coal predicts that its price will rise from $130 per ton today to $200.

Why investors should be miffed at Atlantic

If this prediction proves to be correct, then the Stockton mine, which has a resource of 2.1 million tonnes of anthracite, should prove very profitable. It's a pity then that the board has stiffed smaller investors in the company with the new issue of shares.

Existing shareholders have not been given an automatic right to buy the new shares. They are feeling aggrieved. Prior to this announcement Atlantic had 2.268 billion shares in issue, so the placing adds a hefty 71%. The 0.75p price of the new shares is substantially below the 1.1p at which the existing shares were trading last Friday, and the effect has been to knock the latter down to 0.84p.

Atlantic explains: "There is an opportunity to raise funds from a small number of institutional and other investors at the present time, including the company's principal investor, the Blackrock Smaller Companies Fund. The directors have therefore decided to effect the fundraising by way of the placing rather than by offering all shareholders the opportunity to acquire further shares. The directors believe that the additional cost and delay incurred in connection with any such offer would not have been in the best interests of the company".

Maybe not. But an offer to all shareholders would have been in their best interests - and since it is the shareholders who own the company, they have every right to feel that their interests should be properly respected.

Now Atlantic is certainly not the first company to pull this stunt, but still, the scale of the issue marks it out as an extreme example of the cavalier treatment of small shareholders. And what leaves a particularly sour taste in the mouth is the knowledge that Atlantic's directors have helped themselves to the discounted shares denied to others.

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Why I need to meet the managers first

All eyes in the City now will be on the expected acquisition. Chief executive Steve Best, a cheerful Geordie, has spent ten years developing the Stockton mine, an experience he describes as a "roller-coaster". But in that time he has seen plenty of interesting coal-mining opportunities in the vicinity and reckons that some family-owned mines might be ready to sell up.

I shall be surprised if a deal is not announced within the next few days, and it could be rewarding for all shareholders - but especially for those lucky enough to have been handed shares at 0.75p. "Coal is like character," said the geologist David White, "the deeper you get the more interesting it becomes".

Whatever the arguments in its defence, the character of a discounted placing that benefits some shareholders but not others is, to my mind, quite unattractive.

That's why I spend so much time travelling the length and breadth of the country when I'm looking for recommendations for my Red Hot Penny Shares letter. Because if you can meet the management before you invest, you will learn a lot about a company. It immediately puts you at a serious advantage to most investors.

Red Hot Penny Shares is a regulated product issued by MoneyWeek Ltd. Forecasts are not a reliable indicator of future results. Your capital is at risk when you invest in shares, never risk more than you can afford to lose. Penny shares can be volatile, relatively illiquid and hard to trade. There can be a large bid/offer spread so if you need to sell soon after you've bought, you might get less back than you paid. This can make them riskier than other investments. Please seek advice if necessary. 0207 633 3780

This article was first published in Tom Bulford's twice-weekly small-cap investment email The Penny Sleuth.

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Tom worked as a fund manager in the City of London and in Hong Kong for over 20 years. As a director with Schroder Investment Management International he was responsible for £2 billion of foreign clients' money, and launched what became Argentina's largest mutual fund. Now working from his home in Oxfordshire, Tom Bulford helps private investors with his premium tipping newsletter, Red Hot Biotech Alert.