1.

Why did Bulong default—was it the result of a bad strategy, poor execution, or
bad luck?”
Preston acquired Bulong from Resolute in July 1998 for A$319 million. Preston revenues in
1998 were A$ 231,000, consolidated assets of A$ 29 million. Preston funded the A$319
million by borrowing A$260.5 million from Barclays in the form of Bridge loan, issuing
A$39.9 million equity to Resolute, assuming A$11.1 million in liabilities, and paying A$7.5
million of cash on a deferred basis. At the time, the contracts had a negative net value on a
mark-to-market basis of A$33 million, a liability that Preston assumed from Resolute.
The projections made by Bulong assumed average nickel price of US$3.25, which was too
optimistic seeing the present conditions and London Metal Exchange’s spot and forward prices
of Nickel. Pricing of Nickel as per CRU assumptions were $2.03 and $2.07 for initial couple of
years which is about 62% less than what assumed by Preston. Also there was an exchange rate
risk.
Also Preston became a highly leveraged firm after the buyout. In 1998 Preston D/V value was
37.1% which soared to 83.3% in 1999. In 2000, Preston’s value of assets plunged by more than
200% from (in A$ 000) A$367,839 to A$ 115,100 creating a negative equity position for
Preston. Preston cash reserves were a mere A$2,233,000 in 1998. Bulong management had
assumed that commissioning would be completed in December 1998, but it started in March
1999 to be again stopped in August because certain valves were limiting throughput. The
semiannual interest payments of A$ 18.3 million on the project bond that Preston had issued in
December 1998, were to commence on June 15, 1999. The note issue had left BOP with cash
reserves of A$66 million, in June 1999. With this cash reserve Bulong could make both
required interest payment in 1999, but it failed to replenish the DSRA in Jan 2000, as between
July 1999 till May 2000, Bulong faced operation problem and was not able to produce. The
actual revenues in 2000 were 155% less than what was forecasted. The revenues generated
were not sufficient to make payments to employees and suppliers.
The forecasts that Preston used were that of Resolute. Resolute’s forecast was of processing
600,000 tons of ore annually to produce 8000 tons of nickel and 670 tons of cobalt. Preston
(Exhibit-10) in its forecast kept the ore processes to be 600,000 tons but increased Nickel-
output sold to 9000 tons and Cobalt-output sold to 750 tons. The Bulong deposit averaged only
1 per cent nickel, compared with grades of 3 per cent being mined at Kambalda at the time.
Also financial assumptions for (US$/lb) assumed by Preston were $3.30 for Nickel & $15-
$25/lb for Cobalt, whereas as per CRU Nickel prices were at $2.03/lb and $8.74-22.56/lb for
Cobalt. Thus we can say operating as well as financial forecasts done by Preston were very
optimistic.
Thus we can say that operating side of Bulong bleached into the financial side and since
the financial side was also not robust enough Bulong defaulted in Jan 2000. Bulong’s
default in Jan 2000 was due to the failure of interest payment and the DSRA account
replenishing.
Let’s try to understand this default from the Operations as well as financial side.
Financial Side analysis:
- Bridge loan of A$260.5mn was taken during acquisition of Bulong by Preston
- Preston raised a bond of A$185mn to clear off the bridge loan debt
- In Yr. 2000, the borrowings from bond issue and other were used to clear of the Bridge loan
debt
- The interest on the bond to be paid for the 1st year was A$42.78mn
Let’s look at the below tables which highlights the Sources and Uses of fund:
Sources Diff 99-98 % Sources Diff 00-99 %
Acc Payable $14,341 3% Acc Payable $40,293 5%
ST Borrowings $43,643 9% ST Borrowings $321,653 38%
Provisions $2,867 1% Other $123,992 15%
Other - 0% Share Capital $1,562 0%
Acc Payable $3,143 1% Cash $20,618 2%
LT Borrowings $279,964 57% Receivable $4,124 0%
Provision $69,514 14% Inventories $1,799 0%
Share Capital $73,750 15% Other $3,722 0%
Total $487,222 Receivables - 0%
Investments $268 0%
PPE $252,739 30%
Exploration $33,729 4%
Other $44,451 5%
Total $848,950
Uses Uses
Cash $19,209 4% Provisions $2,278 0%
Receivables $5,201 1% Acc Payable $1,045 0%
Inventories $10,741 2% LT Borrowings $279,964 33%
Other $6,608 1% Provisions $66,883 8%
Receivables - 0% Reserves $1,562 0%
Investments $159 0% Accumulated Losses $479,219 59%
PPE $367,582 75%
Exploration $7,095 1%
Other $46,805 10%
Reserves $525 0%
Accumulated Losses $23,295 5%
Total $487,220 Total $848,951

Yr Sr. Bond 1st 2nd Interest at 1st Interest at 2nd Total

No Issues half half half half interest
2000 1 291.85 277.26 262.67 17.33 16.42 33.75
2001 2 262.67 248.08 233.48 15.50 14.59 30.10
2002 3 233.48 218.89 204.30 13.68 12.77 26.45
2003 4 204.30 189.70 175.11 11.86 10.94 22.80
2004 5 175.11 160.52 145.93 10.03 9.12 19.15
2005 6 145.93 131.33 116.74 8.21 7.30 15.50
2006 7 116.74 102.15 87.56 6.38 5.47 11.86
2007 8 87.56 72.96 58.37 4.56 3.65 8.21
2008 9 58.37 42.78 29.19 2.74 1.82 4.56
2009 10 29.19 14.59 0.00 0.91 0.00 0.91
From the above table we can easily identify that the ST borrowings (i.e. Bond issued + other
borrowings) A$321.653mn were used to pay back the LT borrowing (i.e. Bridge loan) of
A$279.964mn (A$260.5 + interest accrued). So the majority of source of fund in Yr.2000 was
used to pay the borrowings.
Now consider the interest to be paid for the bond issued (US$185 mn); in below table –
The 1st year interest payment is of A$ 33.75mn
Considering the operations side now we try to find whether the revenue generated was enough
to facilitate the interest amount;
From the Exhibit 5 of the case, the Operating Revenue in year 2000 is A$ 62.259mn; which on
deduction of expenses becomes A$ - 33.51mn! (Ref: Exhibit 5). This clearly shows that the
Op. rev of A$ 62.59mn cannot clear the interest payment of A$ 33.75mn
To meet the interest payment of A$ 33.75mn, an operating revenue of at least A$ 129.52mn is
required – which as per the revenue projection (Exhibit 9) should be A$ 159.022mn. Also, if
we try to adjust the interest rates to meet the revenue generated; still as the Op. Exp. are so
huge that the interest payment would not be made.
Now let’s consider the Business side analysis
Business Side analysis: The main objective of Preston to acquire Bulong was to utilize
Bulong’s operation cash flow in developing Marlborough mine and also, to utilize the
expertise at Bulong for Marlborough.
But, without having detailed examination on profitability/break even of mine – they
directly considered it as a rare opportunity!
Let’s examine the Break even analysis, based on the Exhibit 5, 10 & 11; we can conclude that
the BEP production volume in 2000 were very high than the existing production! (Please refer
below table)

Op Exp 51427.7 A$ (000)

Co rev 7416.8 A$ (000)
Ni rev 44010.9 A$ (000)
BEP Ni prod 9602.2 ton
 Act Ni prod 4006.4 ton

From the above table; the BEP Ni production required is 9602.2ton against current production
of 4006.4ton! Almost 140% reduction!
Now suppose we consider that the above situation was for that particular year 2000 only. So
we try to find when it will achieve BEP considering average production and average prices.
Please find the below table showing average production required per month and its relative
expenses and revenue generated.

200 2001 200 Avg/ mnth

0 2
Ni ton/ mnth 364 529 544 479
Rev(A$)/ mnth 166 2279 245 2135
9 5
Co ton(A$)/ mnth 19 34 33 29
Rev(A$)/ mnth 674 1061 849 862
Op exp(A$)/ mnth 467 6832 673 6081
 5 5

Total Avg Ton Total Avg Rev Total Avg OpExp

Existing 508 2996 6081
Additional 523 3085 0
Required 1031 6081 6081

The above table tells us the whole story on the required production to meet BEP. Bulong will
have to mine on a n average of 1031ton of Ni+Co per month, i.e. around 12000ton per year!!
Which when compared with their projections too, it doesn’t match throughout the period. Now
suppose say, they will rise their commodity prices and recover the break even; but the markets
won’t allow this too! As the prices of Ni and Co is falling y-o-y.
Based on above analysis we can say that the strategy to go for Bulong itself was a flawed! And
they were bound to default with the flawed strategy backed by weak operations and a bleeding
financial side.

2. Cash flow adjustments (capital expenditures, selling & marketing, increases in

NWC)?

3. When Preston announced the Bulong acquisition, how much was it losing
money?
The Preston agreed to buy Bulong from Resolute in July 1998, with $319 million. The company had to
borrow A$260,5 million from the Barclays in the form of bridge loan, issuing A$39.9 million of new
equity to Resolute, assuming A$11.1 million in liabilities, and paying A$7.5 million of cash on deferred
basis. Additionally, the Preson was really optimistic about the opportunity to acquire a high-quality
project, but on the day of the announcement, the Preston’s stock price fell by 12%.
4. Should Bulong’s project use high leverage? Why?
Bulong's decision to use high leverage, as seen in the acquisition by Preston, increased financial
strain, making it challenging to meet interest payments and sustain operations during market
downturns. It appears to be a contributing factor to its default because the high leverage resulted in a
significant debt burden, leading to challenges in meeting interest payments and negatively impacting
the financial health of Bulong.
The mismatch between optimistic revenue projections and the actual financial performance, coupled
with unfavorable market conditions, suggests that relying on high leverage was not a prudent strategy
for Bulong.
Besides, there are some point to consider:
-Market Conditions:
- Bulong faced adverse market conditions, including lower-than-anticipated commodity prices. High
leverage can exacerbate the impact of market fluctuations, making it riskier for the project.

-Operational Challenges:
- Bulong encountered operational issues, leading to delays and lower production. High leverage can
amplify the negative effects of such challenges, making it difficult to meet debt obligations.

-Revenue Shortfalls:
- Optimistic revenue projections, coupled with the mismatch between forecasted and actual
revenues, suggest that Bulong's financial strategy may not have aligned with the project's operational
realities.

-Debt Servicing:
- The need to service high levels of debt, as seen in Bulong's financing structure, can strain cash
flow and financial stability. This is particularly problematic when revenues fall short of expectations.

-Risk Mitigation:
- In commodity-driven industries, such as mining, where prices are subject to market volatility,
excessive leverage without adequate risk mitigation strategies (such as hedging) can expose the
project to significant financial risks.

In light of these considerations and the challenges faced by Bulong, a more conservative approach
with lower leverage might have been advisable. Lower leverage could provide greater financial
flexibility, reduce the risk of default, and enhance the project's ability to weather unforeseen
challenges. It's crucial to align leverage levels with the project's risk profile and the inherent
uncertainties of the industry.

5. Do you think that extensive hedging facilities should be used in Bulong’s financial
strategy?Why?
Hedging strategies are used to reduce risk in a portfolio. They can be used to protect against a variety of
risks, including changes in interest rates, currency fluctuations, and changes in the price of commodities or
other assets.
Hedging strategies can be used by individuals, businesses, and governments. Individuals may use hedging
strategies to protect their retirement savings or their investments in stocks or bonds. Businesses may use
hedging strategies to protect their profits from changes in the price of their products or the cost of their
inputs. Governments may use hedging strategies to protect their economies from the effects of changes in
the global economy.
Considering the uncertainties in commodity prices, exchange rates, and market conditions,
incorporating extensive hedging facilities in Bulong's financial strategy could have been beneficial.
Hedging helps mitigate the risks associated with price fluctuations and currency exchange rate
movements. Given the significant impact of nickel prices and exchange rate risk on Bulong's financial
performance, effective hedging could have provided stability and reduced vulnerability to adverse
market conditions, contributing to a more robust financial strategy.

In this case, i suppose that the company should use extensive hedging, especially in the exchange rate. To
be more specific, by early 2002 Bulong’s workings from Barclays had increased to A$43.5 million and its
unrealized losses on the hedging facilities had increased to A$240 million, largely due to the foreign
currency contracts, as the Australian dollar had depreciated form US$0.63 in Noveber 1998 to US$0.51 in
December 2001. To protect against losses, they can use Future contract to hedge can help to protect
company from losses if the exchange rate of AUS/USD falls.
To improve risk-adjusted returns: Hedging can help to improve an investor's risk-adjusted returns. Risk-
adjusted returns measure an investment's return after taking into account the amount of risk involved.
Hedging can help to reduce risk, which can lead to higher risk-adjusted returns. Moreover, Bulong supplied
Nickel to different countries, and they entered into forward nickel contracts covering 100% of production
for 1999 and 2000. Then, the nickel contracts locked in a sales price of US$3.30 per pound while foreign
exchange contracts required Bulong to sell US Dollars and buy Australian dollars at average price
US$0.73=A$1.00. Company should also use the Forward contract to ensure that they can buy their goods at
specific price in the future.

6. Discuss Raising Additional Debt and Equity for Bulong’s project?

The Preston turned to Barclays for an A$5 million working capital loan in October 1999 - this loan
would later grow to A$30 million by the year - end 2000. Moreover, Preston considered issuing A$75
million of new equity in October 1999, with a final trading price of A$0.27/share, or considered a joint
venture with the Australia firm Anaconda Nickel Ltd. In the end, management did not complete either
option.
If we try to restructure by issuing more equity; say A$ 75mn, then the new structure would look as
below:

Year 2000 Restructure

d= $ 375,296 $ 300,296

plus $ 75 million e= 102,137 177,137

v= 477,433 477,433

d/v = 78.61% 62.9%

e/v = 21.4% 37.1%

Debt break up

Bond $ 291,853 $ 233,529

Borrowings 83,333 66,767

Total $ 375,296 $ 300,296

Even by restructuring with Equity of A$75million won’t help in meeting the interest payment! Now the
problem has been aggravated as your operating side is put under pressure due to it not meeting the
financial obligation. You are not in a position to raise more debt as it will further increase the burden
on interest payments.
The only way to look ahead is bring some confidence in operation side by easing the financial
obligation on the operation side! This is possible if we know that our operation side can be strong in
the near future and convince the lenders of this scenario; with this support we can put forth the
conditions to ease in covenants to attain more Flexibility in capital structure and confirm our Execution
of the debt.

Yr Number Bond 1st 2nd Interest in 1st Interest in 2nd Total

issue half half half half interest

200 1 18.56 17.64 16.71 1.10 1.04 2.15

0

200 2 16.71 15.78 14.85 0.99 0.93 1.91

1

200 3 14.85 13.92 12.99 0.87 0.81 1.68

2

200 4 12.99 12.07 11.14 0.75 0.70 1.45

3

200 5 11.14 10.21 9.28 0.64 0.58 1.22

4

200 6 9.28 8.35 7.43 0.52 0.46 0.99

5

200 7 7.43 6.50 5.57 0.41 0.35 0.75

6

200 8 5.57 4.64 3.71 0.29 0.23 0.52

7

200 9 3.71 2.78 1.86 0.17 0.12 0.29

8

200 10 1.86 0.93 0.00 0.06 0.00 0.06

9

The new bond issue would be of only A$18.56million incurring an interest payment of A$2.15million
which is very much feasible to cover from operations!
This structure will basically make the debtors to be the equity holders! There are chances of them
(i.e.note holders and Barclays’) to resist against this; as they would be facing the whole risk of Bulong
while Preston would be enjoying its Marlborough mines!
But looking at the scenario, this option looks the best. As once the assets start generating revenue,
the note holders and Barclays are in full position to sell off the assets and recover their funds. If the
restructuring fails then it will ultimately lead to the liquidation of the Company, which again has its
costs. Thus looking at the scenario the restructuring is best for both Preston as well as Barclays.