Karnalyte Resources Inc. announces agreement in principle for $700m US financing for potash mine

One of Karnalyte's summer drilling projects. — Photo courtesy Karnalyte Resources

CALGARY, March 14, 2016 /CNW/ - Karnalyte Resources Inc. ("Karnalyte" or the "Company") (TSX: KRN) is pleased to announce that Karnalyte has entered into an agreement in principle (the "Agreement in Principle") with Gujarat State Fertilizers and Chemicals Limited ("GSFC") to finance construction of the first phase of Karnalyte's 625,000 tonnes per year (tpy) potash mine at Wynyard, Saskatchewan ("Phase 1"), and an agreement in principle to spin-out Karnalyte's secondary mineral assets and unexplored lands into one or more separate entities.

Robin L. Phinney, Karnalyte's founder and President, stated:

"I am proud to announce that Karnalyte is about to achieve its most significant milestone yet: a fully financed structure to build our potash mine in Saskatchewan. We are extremely pleased to have entered into the Agreement in Principle with GSFC which is expected to enable Karnalyte to develop its significant potash resource. The Agreement in Principle provides for a comprehensive financing package to fully fund Karnalyte's 625,000 tpy potash mine while enabling shareholders to maximize their investment in Karnalyte's secondary minerals and unexplored lands. I would like to thank GSFC who has been supportive of Karnalyte's project since GSFC's initial investment in 2013, and Karnalyte's management team and employees for their hard work in securing such a compelling transaction in otherwise difficult markets. I look forward to presenting the full details of the transaction for shareholder approval once we have concluded final documentation."

Mr. Vishvesh Nanavaty, GSFC's Senior Vice President and CFO, stated:

"This ground-breaking deal structure demonstrates GSFC's long term commitment and desire to secure supplies of key natural resources through investment structures that are aligned with the values of Canadian shareholders. I believe this financing will serve as a template for future investment by Indian companies in Canada and will strengthen relations between our two countries for years to come."

In 2011 Karnalyte received a positive feasibility study prepared by Foster Wheeler Canada and Ercosplan for Karnalyte's plans to construct a solution mining facility at Wynyard, Saskatchewan to produce a high-grade (97% purity) granular potash product. Karnalyte intends to construct the facility in three phases, with Phase 1 expected to produce approximately 625,000 tpy, increasing by 750,000 tpy with Phase 2, and totaling 2.125 million tpy with the addition of Phase 3.

In 2013, GSFC, one of India's largest fertilizer and industrial chemicals manufacturing companies, made a strategic investment in Karnalyte of approximately $44.7 million, resulting in GSFC holding a 19.98% ownership stake in Karnalyte (the "Private Placement").

In connection with the Private Placement, Karnalyte and GSFC executed an off-take agreement (the "Offtake Agreement) for GSFC's purchase of approximately 350,000 tpy from Phase 1. The offtake commences with commercial production from Phase 1 with the result that Karnalyte has secured sales for approximately 56% of its potash production from Phase 1 for approximately 20 years.

The Offtake Agreement also provides GSFC with the option to increase its off-take by 250,000 tpy to 600,000 tpy from the date of commencement of Phase 2 commercial production. The Offtake Agreement provides GSFC the potential to increase its offtake by up to 400,000 tpy from Phase 3 such that the total annual quantity of potash to be sold pursuant to the Offtake Agreement shall be up to 1,000,000 tpy.

The strategic partnership between Karnalyte and GSFC provides Karnalyte with a significant competitive advantage in the marketplace, and is anticipated to provide GSFC with a secure supply of potash for many years to come.

Overview

The Agreement in Principle contemplates a transaction that includes senior secured debt, subordinated unsecured debt, and an equity infusion to be backstopped by GSFC (the "Transaction"). This innovative structure allows for a 3:1 debt to equity ratio for the project financing. The equity component of the project financing is anticipated to be fulfilled 50% by way of the issuance of common shares by the Company ("Common Shares"), and 50% by way of the issuance of unsecured subordinated debt, which is anticipated to limit the dilution to shareholders of the Company. Key attributes of the Transaction include:

• Senior secured debt in excess of $500 million USD over a 20 year term;
• A total equity requirement equal to one-third of the amount of the senior secured debt, with up to 50% to be raised through subordinated unsecured debt and the remainder to be raised through the issuance of Common Shares;
• Backstop guarantees by GSFC for any shortfalls of equity in the event that Karnalyte is unable to raise sufficient amounts through the issuance of Common Shares; and
• Backstop guarantees by GSFC in the event of project cost overruns.

Senior Secured Debt

The senior secured debt is comprised of a two part structure whereby a subsidiary of GSFC will secure a non-fund based facility in the form of a standby letter of credit ("SBLC") to be provided by a syndicate of banks and financial institutions with SBI Capital Markets Ltd. acting as lead arranger. The SBLC, which is similar to a bank guarantee and will be unconditional and irrevocable, will be used to secure a foreign currency loan made to Karnalyte by a syndicate of Indian banks and financial institutions. To secure the SBLC, GSFC has undertaken to arrange any shortfall in funds for the equity required upon closing and to fund cost overruns for Phase 1, if any, in the form of additional equity, at a price to be agreed between GSFC and Karnalyte prior to closing of the Transaction.

Mezzanine Debenture

Up to 50% of the total equity requirement may be satisfied by the issuance of subordinated unsecured debt which will be considered equity by the project lenders for the purposes of the debt-equity ratio calculation. If for any reason Karnalyte is unable to raise sufficient subordinated unsecured debt, GSFC shall use its reasonable commercial efforts to arrange the same or may purchase Common Shares at a price agreed between GSFC and Karnalyte prior to closing of the Transaction, subject to applicable regulatory and legal approvals.

Upon maturity of the subordinated unsecured debt, which is anticipated to be seven years, Karnalyte shall raise the funds required to payout the subordinated unsecured debt by way of an equity financing. To the extent that Karnalyte is unable to do so on satisfactory terms, GSFC or any affiliate thereof shall purchase from Karnalyte such number of Common Shares at an issue price per share be determined prior to closing of the Transaction to the extent necessary to satisfy these obligations, subject to applicable regulatory and legal approvals.

Equity Issuance

Karnalyte shall issue Common Shares to the extent necessary to satisfy the senior and subordinated debt covenants relating to the required debt to equity ratio. If Karnalyte is unable to raise the required equity on satisfactory terms, subject to applicable regulatory and legal approvals, GSFC or any affiliate thereof shall purchase from Karnalyte such number of Common Shares at an issue price per share equal to the lesser of: (a) the issue price of the equity financing; and (b) an agreed upon floor price based on the then fair value of such Common Shares, prior to closing of the Transaction.

Special Voting Share

As a condition to obtaining the project financing, GSFC is required to have and maintain at least a 51% voting interest in Karnalyte while the senior secured debt is outstanding. A special voting share ("SVS") will be issued to a subsidiary of GSFC to satisfy this condition. The SVS will carry a 51% voting right in Karnalyte, and no issuance of Common Shares by Karnalyte will affect such 51% voting right. The SVS will carry no economic interest in Karnalyte. Upon repayment of the SBLC, the SVS will be retracted. The issuance of the SVS will not result in any economic dilution to the shareholders of Karnalyte.

The Agreement in Principle and associated documentation contemplates one or more newly created corporations to be initially held by current Karnalyte shareholders in proportion to their shareholdings as at the closing date of the spin-out transactions, provided that such transactions have no material adverse legal, regulatory, commercial or tax implications to Karnalyte and/or its Wynyard potash project.

Secondary Mineral Co.

In 2012 Karnalyte announced that it had received a positive preliminary feasibility study ("PFS") for magnesium co-products, portions of which were included in a National Instrument 43-101 compliant technical report defining reserves and resources of its Wynyard Carnallite Project. The PFS was prepared by Lyntek Incorporated and provides for a magnesium production facility with an annual capacity of 100,000 tpy of magnesium chloride ("MgCl2") brine and 104,000 tpy of hydromagnesite, a form of basic magnesium carbonate, at 99% purity.

The Agreement in Principle and associated documentation contemplates that Karnalyte's secondary minerals, including magnesium, will be developed in a separate entity to allow current Karnalyte shareholders to benefit from these currently untapped assets.

Unexplored Land Co.

Karnalyte owns a 100% interest in Subsurface Permit KP 360A and Subsurface Mineral Lease KLSA-010, which are located near Wynyard, Saskatchewan, and comprise a total of 85,126 acres, or approximately 344.5 km2 of land (the "Total Lands") located in the heart of the 'potash belt' in Wynyard, Saskatchewan. The lands which have been explored and which the Company intends to mine in connection with which Phases 1, 2 and 3 comprise approximately 106 km2 and represent approximately 30% of Karnalyte's Total Lands.

Karnalyte's unexplored lands include approximately 241 km2, or approximately 70% of the Company's Total Lands (the "Unexplored Lands"). The Agreement in Principle and associated documentation contemplates an assignment of the Unexplored Lands to a separate entity which will have the benefit of a license for associated intellectual property to allow such entity to further explore and develop these currently untapped assets and allow current Karnalyte shareholders to benefit from such development.

In order to facilitate the completion of the transactions, Karnalyte, GSFC and Robin L. Phinney have entered into an agreement (the "Framework Agreement"), effective February 24, 2016, which contains, among other things, an agreement with respect to the composition of the board of directors of Karnalyte ("Board of Directors"), voting support and solicitation.

The parties to the Framework Agreement have agreed that:

• they will use commercially reasonable efforts to provide that the Board of Directors will continue unchanged until the transactions contemplated in the Agreement in Principle have been completed;
• Robin Phinney, Henry Kerkhoven and Sokuen Sue Ng are director nominees of Mr. Phinney and in the event that any such nominee ceases to be a director of Karnalyte, Mr. Phinney has the right to nominate a replacement director;
• Vishvesh D. Nanavaty, Sanjeev V. Varma and Mukund Purohit are director nominees of GSFC and in the event any such nominee ceases to be a director of Karnalyte, GSFC has the right to nominate a replacement director;
• a permanent Chief Executive Officer or Chief Financial Officer will not be appointed during the term of the Framework Agreement;
• each party will vote all Common Shares owned or controlled by them in favour of the current Board of Directors and the spin-out transactions;
• during the term of the Framework Agreement, Robin Phinney will not dispose of 1,671,750 Common Shares owned by him; and
• during the term of the Framework Agreement, GSFC will not dispose of 5,490,000 Common Shares owned by it.

The Framework Agreement will terminate on the earlier of the date that the transactions contemplated in the Agreement in Principle are entered into and September 30, 2016. If the Framework Agreement terminates without the consummation of the transactions contemplated in the Agreement in Principle, the parties have agreed that:

• GSFC will cause one of its nominee directors to resign from the Board of Directors;
• Karnalyte and GSFC will use commercially reasonable efforts to cause the Board of Directors to consist of not more than seven members;
• GSFC will be entitled to require that Karnalyte nominate at any annual or special meeting of the shareholders of Karnalyte held for the purpose of electing the directors of the Company (i) three duly qualified nominees of GSFC for election to the Board of Directors if there are seven members of the Board of Directors; (ii) two duly qualified nominees of GSFC for election to the Board of Directors if there are five or six members of the Board of Directors; and (iii) one duly qualified nominee of GSFC for election to the Board of Directors if there are fewer than five members of the Board of Directors;
• Karnalyte will use commercially reasonable efforts to cause GSFC's nominees to be elected by the shareholders of Karnalyte at any annual or special meeting of the shareholders of Karnalyte held for the purpose of electing the directors of the Company; provided that if at any such meeting none of the individuals nominated by GSFC are elected by the shareholders of Karnalyte, the nomination rights of GSFC set forth under the Framework Agreement will terminate and GSFC and Karnalyte will then be subject to the terms and conditions set forth in the Subscription Agreement that had been previously entered into by such parties, which (i) based on GSFC's current ownership interest entitles GSFC to designate one nominee for election or appointment to the Board of Directors as long as GSFC holds 10% or more of the outstanding Common Shares; and (ii) entitles GSFC the right to nominate an observer to attend all meetings and committee meetings of the Board of Directors if GSFC owns less than 10% of the outstanding Common Shares.

The Board of Directors has determined that the comprehensive financing package and associated transactions as set forth in the Agreement in Principle are in the Company's best interests as it will allow Karnalyte to fully finance the construction of Phase 1 and will also allow current Karnalyte shareholders to realize the value in the Company's non-potash assets. This determination was based on a number of factors, including but not limited to, the unanimous recommendation of a special committee of independent directors formed to consider the Company's financing alternatives after consultation with the Company's financial and legal advisors.

Over the coming months Karnalyte expects to negotiate the definitive terms of the Transaction, which, if approved by shareholders, could be transformative for the Company. Completion of the proposed Transaction is subject to finalization of definitive documentation, approval by the boards of directors of Karnalyte and GSFC, approval by Karnalyte's shareholders, and receipt of all necessary regulatory approvals, including the approval of the Toronto Stock Exchange ("TSX"), as well as other customary closing conditions. The Company cautions that there is no assurance that the Transaction will be agreed upon or that the terms set forth herein will be the final terms agreed to in the definitive documents for the Transaction. Any announcements regarding the proposed Transaction will be disclosed in accordance with all applicable legal and regulatory requirements.

Karnalyte and GSFC have jointly engaged SBI Capital Markets Ltd. to act as lead arranger for arranging the project financing in respect of the Transaction.

Karnalyte was further advised on financial matters by Dundee Securities Ltd. and by Norton Rose Fulbright Canada LLP on legal matters.

GSFC was further advised on financial matters by SBI Capital Markets Ltd., and by Cyril Amarchand Mangaldas Advocates & Solicitors and Torys LLP on legal matters.

Karnalyte's corporate relationship advisors include Mr. Mukund Purohit (India) and Mr. Julius Brinkman (Canada).

Karnalyte is engaged in the business of exploration and development of high quality potash and magnesium products. Karnalyte intends to develop and extract a carnallite - sylvite mineral deposit through a known solution mining process at competitive costs and with minimal environmental impact. Using a staged approached to construction, the Company plans to operate a solution mining facility that will initially produce 625,000 tpy, increasing to 2.125 million tpy. Karnalyte owns a 100% interest in Subsurface Permit KP 360A and Subsurface Mineral Lease KLSA-010 located near Wynyard, Saskatchewan, comprising a total of 85,126 acres.

Karnalyte's Common Shares are traded on the TSX under the symbol KRN.

Gujarat State Fertilizers & Chemicals Limited (BSE:500690, NSE:GSFC, CSE:GSFC), founded in 1962, is a publicly traded agribusiness company focusing on the production and sale of fertilizers and industrial products in India. In addition to marketing fertilizers and agri-inputs throughout India, GSFC also operates a research and development centre, multi-disciplinary University, and develops new fertilizer products, a variety of other chemicals and materials, as well as applications for its various industrial products.

Source: Karnalyte Resources Inc.