Investing

Strathmore Minerals has agreed to sell Pine Tree-Reno Creek, Wyoming properties (Sale Properties) to Bayswater for $30M USD.

$30M USD is 43c CAD per share of STM. On August 18th STM closed at 43c CAD.

The sale properties are about 10% of Strathmore’s uranium or slightly less if you adjust for the reliability of the estimates. . It’s probably reasonable to assume that this deal values STM at about $4.5 CAD in the even of an orderly liquidation. I valued Strathmore in a prior post based on the Rio Kintyre sale at about $7.50 - $12 CAD based on an orderly liquidation.  A lot has happened since July 2008 but $4 - $7 is still supported by this deal with Bayswater.

My original valuation of Strathmore as a going concern is in the teens. Again nothing has changed dramatically but that’s unlikely to be realized until they have some properties producing.

This is a sound deal for Strathmore. They are probably giving up a couple of dollars per share in the very long term for cash now. Not doing this deal could risk everything. There are some conditions that need to be met including Bayswater raising $36M. They have 4 months to close the deal. There is a small break fee of $250k which STM would have to pay if they accept a better offer or Bayswater will need to pay if they fail to close.

The problem is that Bayswater’s market cap is currently $17M CAD. It is unclear how they think they will be able to raise $36M. STM have a bit of a history of entering deals with companies that simply can’t pay. The same has happened with Great Bear & the Chord property.

The recent concerns about STM have been whether or not they have the cash to see through production.

“They continue to be able to sell equity in properties that they acquired for cash. Real properties with Real Uranium deposits, even if they can't raise equity or debt financing. “

Strathmore went through a dramatic decline from 2001 to 2003, reaching 6c. In 2005 it reached $5.18. In Strathmore Groundhog Day I outlined that STM would survive this crisis just like the last one.  In the end when you have real assets you can always generate cash.

If this goes ahead it will be great for STM. If it doesn’t, then STM will need to find another source of cash which they are very likely to do successfully.

posted by Neil  # 11:30 PM 0 comments

Anyone who has bid in an auction on ebay has learned that there are only a few winning strategies that participants use:

1. Bid low and early, in the hope that no one else will participate. You win the auction at the reserve price.

2. Bid very high immediately not in small increments. This frightens off competing bidders, especially if your bid is at or above a fair price for the item.

3. Snipe, which is waiting until the last second and making the smallest incremental bid to win the auction before the other party has time to counter.

These is a fourth strategy which generally doesn’t win:

4.  Participate in the auction. That is bidding a little bit more than the last person at any time during the auction.

It’s pretty clear that Yanzhou is using strategy 1 (bid low and early) in their bid for Felix. Given the recent financial crisis it is unlikely that any competing bidder is going to have the stomach for strategy 2 (bid very high). That leaves an incompetent bidder using strategy 4 (participate) or a smart bidder using the one remaining strategy which is to try and snipe Felix.

Why does this matter? Because anyone expecting a counter offer should not expect it soon. Based on the published timeline, a counter offer can wait until November. There is additional benefit in waiting as the counter offer will be able to consider problems that the Foreign Investment Review Board (FIRB) has with the Yanzhou offer. Anyone looking to arbitrage a Felix buyout should wait for the excitement to die down. There is a good chance that you’ll be able to buy Felix at a lower price once the market believes that a counter offer isn’t coming. In fact, readers of this blog will know that a counter offer may yet arrive from a smart bidder.

I still expect a counter offer (>50% chance). The capital position of potential bidders is not great on the whole but this is counter balanced by the high ROI available from a counter bid. I don’t expect a counter offer in the next 4-8 weeks.

posted by Neil  # 9:57 PM 0 comments

Mesa Royalty Trust was formed in 1979 by Boone Pickens. In 1985 he reacquired 88.6% of the trust leaving the small 1.86M shares remaining.

About 75% of their royalties come from US Natural gas, the remainder from Natural Gas liquids and Oil.

A simple model based on Natural Gas prices shows that MTR should be worth closer to $37 from today’s price of $24.85. Instead the trust is being priced off short term cash flow, which will be around $1.90 this year for a yield of around 8% .

Simple valuation model based on NG

It is quite hard to develop a full financial model for MTR because they don’t have detailed financials on the wells that pay the royalties. Therefore both the NG only and the crude models are based on correlations to historic distributions. The correlation is quite good for just Natural Gas but as you would expect it’s slightly better once Crude is included.

Valuation model based on NG and Crude

The $6.50 NG & $75 crude cases closely reflect current long term strip prices. It’s therefore quite easy to make the case that MTR has 50%-60% price appreciation potential. If you believe that Natural Gas is going to move closer to it’s longer term average. My target Crude price is $112 per bbl based on my long term crude forecast and updated long term crude forecast. I have not developed a long term natural gas forecast. McDep is now using $8, $1.50 above the strip. Using $6.50 gas and $112 crude values MTR at $48 for appreciation of 95%.

There have been some problems with Mesa’s calculation of reserve life. They have previously based their calculations on the calculations by the operators that pay royalties. I don’t see a problem with this. However before their 2007 annual report they sought out an independent review of their reserve life. To quote from the 2007 10k

“The December 31, 2007 reserve estimates for the San Juan Basin properties were prepared by a third party reservoir engineering firm, whereas the December 31, 2006 and 2005 reserve estimates were prepared by the Working Interest Owner. Revisions to previous estimate in 2007 are primarily due to professional differences in judgment regarding estimate of San Juan Basin reserves.”

The difference is not small! They cut their natural gas reserves in half and their liquids by more than half. On that basis the trust has reserves until about 2020 which is my baseline case. However, if the professional differences are in fact in favour of the operators then there could be substantially more reserves and a higher value for MTR.

Valuation Sensitivity to reserve life

MTR is a trust and as such has no management (and no management expenses) only a trustee. SEC filings are sparse and currently quite late (due to the reserve issue mentioned above).

The value of MTR increases in direct proportion to the price of natural gas. A 10% rise in long term natural gas prices causes a 10% rise in Mesa’s value. Therefore you get to participate on a long call on Natural Gas prices while you are paid 8% to wait. Compared to UNG (MTR has a correlation of about 80% to UNG) where you have a cost of carry and management costs MTR is a fantastic deal.

I have no idea when natural gas will recover. The beauty of an idea like this is you get paid to wait and then you get paid once the waiting is over. The main risk is these sorts of ideas is truncation risk and that isn’t going to happen when there is no debt.

Mesa Royalty Trust has no debt and no management risk. There is 60% price appreciation to very conservative energy price assumptions. There is substantial leverage to additional reserves and higher long term energy prices with little risk and actual reward while you wait.

posted by Neil  # 5:12 AM 0 comments

I have received a few emails and comments on Felix and the chances of a counter offer. In summary, a counter is likely.

There are three criteria that determine the chances of a counter:

• Return on Investment of the deal based on the current price propose
• Contract flexibility based on the contract signed with the initial party
• Capability of alternate bidders to finance

Based on Yanzhou’s $18 offer they should see a 60% plus return in 2-3 years. This clearly support a counter offer. Furthermore there are parties that could create synergies from buying Felix, thereby creating an even greater return. At $24 there would still be a 20% return before synergies. If Xstrata were to bid then they could achieve substantially more than 20% because their Ulan mine is next door to Felix’s Moolarben mine. Examples of synergies would include shared transport infrastructure or marketing.

Next we consider the contract signed between Felix and Yanzhou. I was surprised by the small break fee of A$33M . While Felix directors are prevented from actively seeking another offer. They are allowed to negotiate and assist a potential acquirer once a superior offer is made. The contract appears quite supportive of an auction developing. 

Finally the ability of other bidders to finance a bid comes into question. This is probably the biggest impediment to an alternate deal. It isn’t easy to get substantial debt or equity finance right now (unless you’re borrowing from the Chinese government). Xstrata recently did a large rights offering to reduce debt as did Rio Tinto, it therefore seems unlikely that they would bid. BHP, Vale, China Shenhua, Noble and Peabody have been identified as potential bidders. There have also been rumours that Canadian Teck Resources were looking for an Australian mine to diversify their coal sources.

By looking at Felix as a percentage of the acquiring companies capital, looking at debt to market value of equity and analysing synergies it’s easy to establish who the most likely counter bids will come from.

• BHP: Felix would be a minor addition to their portfolio. They could offer shares as well as cash which might be attractive for those with large capital gains. BHP has a tiny amount of debt (though they could do a deal for Felix using available cash without additional debt) and could capture synergies with it’s current businesses. BHP seems like the most capable and obvious choice.
• Vale: Vale is not far behind BHP. Vale own AMCI who in turn on 19.9% of Felix! Felix would be a small but valuable addition to Vale’s portfolio. Vale is not highly levered and could easily afford to buy Felix with available cash or additional debt. Given that Vale already own nearly 20% of Felix they seem like a high likely candidate for a counter offer. (When I originally wrote this I incorrectly stated that AMCI was owned by Vale. Vale own AMCI Australia based in Brisbane not the AMCI that owns Felix. Vale still has the cash or debt capacity to buy Felix and Vale still has Australian operations that would provide synergies. However Vale is not as likely as when I thought the owned AMCI. Vale is still in the top 3. While you might expect Vale to be more interested in Metallurgical coal, in fact they already own Thermal coal operations in Australia, which is supportive of a bid.)
• China Shenhua are nearly 6 times larger than Yanzhou. They are very conservatively levered and Felix would end up as a small part of their portfolio. Shenhua have a very low amount of debt and could very easily buy Felix through debt. Given that Yanzhou are already bidding it seems unlikely that Shenhua would become involved. Even if the bid was substantially higher, Yanzhou has the debt capacity. Shenhua are prospecting for coal in Australia but do not have any mining operations here.
• Yanzhou is only the fourth most obvious candidate. At the offer price, Felix is 20% of their total capital so this is a substantial, company changing, acquisition for Yanzhou. They have effectively no debt so they can easily go to 20% debt to market value of equity. Even if Felix sells for more, Yanzhou have the debt capacity while remaining at a conservative debt to equity ratio.
• Rio and Xstrata are not likely acquirers. They both conducted substantial rights offerings to lower their debt and are unlikely to lever up so quickly. Felix would be a neat addition to either portfolio but the finance doesn’t make sense.
• Peabody is similar to Yanzhou in that Felix would become around 20% of the company. Peabody, however, already has debt at 33% of total capital. They would have some synergies but it seems unlikely that Peabody would be able to finance an offer.
• Teck Resources is rumoured to be looking for an Australian mine to diversify their operations and to offer their customers a wider variety of loading locations. Felix would be 10% of capital for Teck so it would be a nice addition. Teck’s debt is already 75% of capital and they are unlikely to be able to make such a substantial purchase.
• Noble is the smallest of the potential acquirers. Felix would be 45% of current capital. Noble has recently purchased Gloucester coal and it’s unlikely that Noble could manage to integrate two acquisition in such a short time. Given Noble’s current debt and size it’s also unlikely that they could finance a bid.

In closing, BHP and Vale are the obvious bidders if an auction develops. China Shenhua is not going to compete directly with Yanzhou. BHP and Vale could acquire a neat addition to their respective portfolios and achieve a high return on investment even at a substantially higher offer; both because of the attractiveness of Felix’s assets and because they would realize synergies with their existing businesses. Vale already owns 20% of Felix so they won’t need to do substantial due diligence to put together an offer.

A counter offer is reasonably likely from a non-Chinese company with the capacity to finance. It’s unlikely that Yanzhou has made their final offer. Given the synergies on offer, the ability to pay with shares and the break fee it seems likely that a counter will cause another Australian mineral company to spurn their Chinese fiancé or at least make her increase the dowry.

posted by Neil  # 9:01 AM 5 comments

• Felix Resources - The case for coal
• Valuing Felix Resource (FLX)
• Revising Felix Resources (FLX) fair value down

Felix was trading at $1.91 at the time of my first post in December 2005. At the time I valued Felix at around $10. Felix grew and the global energy market changed. My later valuations were around $24-$25.

Felix, today, announced the terms of a takeover proposal from Yanzhou Coal for about $18 (all amounts in AUD). Made up of $16.95 cash from Yanzhou, 5c worth of shares in a spinoff of their South Australian tenements and $1 worth of dividends.

There is a $33.3M break fee payable by Felix if any Felix director does not support the proposal, a competing proposal is accepted or there is a material breach. Yanzhou has to pay if it can’t secure financing or in the event of a material breach. This break up fee is pretty low and does not materially block another bid.

Felix directors are prevented from soliciting or encouraging other proposals, negotiating or discussing a proposal with 3rd parties and is not allowed to provide due diligence information to 3rd parties. However, if another proposal appears to be superior based on the statutory definition then directors can negotiate and share due diligence information.

The proposal has to be agreed by Felix shareholders and by 2/3rds of Yanzhou shareholders in addition to 14 other conditions including Yanzhou securing finance.

Yanzhou shareholders will be asked to approve the deal by mid-October, Felix will pay the first 50c dividend in late October. FLX shareholders will vote in early December and final consideration will be paid in late December.

Overall this is a barely adequate offer. Yanzhou are paying a small premium based on FLX recent closing price and are securing a good 75% plus upside over the next few years. Felix major shareholders are getting the opportunity to sell out together preventing the kind of debacle that happened with Macarthur Coal (where one shareholder sells a blocking stake).

Importantly the door is wide open for a serious better offer. There is plenty of time for one to materialize which gives FLX shareholders something of a floor. An offer nearer $24, would leave a reasonable 25% upside to the acquirer while paying a more reasonable price to current FLX holders.

posted by Neil  # 3:25 AM 1 comments

I wrote about Nickel, Mincor and Panoramic resources here , here and here. I sold out of PAN a few months ago and have now closed out my Mincor position. In this post I estimated a long term price for Nickel (all in USD) of $7.75, Nickel was $5.18 at the time. Today Nickel traded as high as $8.53. To briefly reiterate the basis for the $7.75 estimate it is a blend of the 2000 – 2008 average and the marginal cost of production. Nickel can be replaced in Steel manufacturing by pig iron for prices of Nickel over $8.

My fair value estimate for Mincor is $2.27. Today it traded as high as $2.30 and I sold out. I placed the limit sell order ahead of time so I wouldn’t have to go through the difficult psychological process of selling a very successful position.

After such a big shock to the world economy it doesn’t make sense that Nickel would already have exceeded its 10 year average (the long term average is even lower at $5.60). While I can believe (as outlined here) that China and India have shifted the  demand curve and that the supply curve has shifted; this ought to be captured in the 10 year average.

Nickel may double in the next month on its way to all time highs but it’s no longer a value investment, neither is Mincor.

posted by Neil  # 9:17 AM 2 comments

Cape Lambert Iron Ore (CFE CFE.AX AU:CFE) owns a number of natural resource related projects either outright or through ownership of shares in other listed or unlisted companies. CFE are not miners but instead trade natural resource projects. They often develop a project to the point where it could be mined and then sell it. They buy or take a share in individual projects or small companies, develop the projects and then sell them on to larger companies.

Cape Lambert has quite a history;

• In 2003 the precursor company to Cape Lambert (CFE), International Goldfields (IGL) merged with Hamill Resources. At that time they were focused on gold projects and were having some reasonable success with their enormous Mt Ida tenements and the Evanston project which came from Hamill.
• In 2004 Mt Ida mining continued. The Baldock load is mentioned and should have be producing by 2005.
• In 2005 exploration continued on Mt Ida, Evanstone and a copper-gold opportunity called Sacu in Romania. Mt Ida mining was put on care and maintenance to rework the mine plan in light of new resource discoveries including the Baldock load. IGL partnered with Cogema Group (a French mining company), they had the opportunity to earn in 51% of the project by spending 7.5M over the next 5 years. Evanstone exploration continued. The Sacu project continued exploration and IGL bought approximately 16% of NFX Gold in Canada.
• In 2006 the company acquired the Cape Lambert Iron Ore mine through the purchase of Mt Ankatell with the expectation of a 12-18 month feasibility study. IGL issued about $33M in shares to fund the acquisition and for other exploration. The Cape Lambert Acquisition cost $20M. The company changed its name to Cape Lambert Iron Ore (CFE). CFE announced that the gold assets would be spun off into International Goldfields (IGC) and was IPO'd for proceeds of around $5M. CFE spun out the remaining shares but retains a royalty interest in IGC's assets. CFE also sold its interests in NFX and listed itself on the London AIM.
• In 2007 extensive drilling of the Cape Lambert mine lead the company to expect a bankable feasibility study by Q3 2008. They produced interim mineral estimates for the mine indicating a 10-15Mtpa magnetite concentrate mine over 20 years. Some Chinese interest was explored but failed and CFE continued to pursue the prospects on their own. CFE also acquired additional acreage adjacent to the Cape Lambert tenement. The company agreed to sell 70% of the Cape Lambert project to a Mr Ding for US192M. Shareholders agreed and the deal was awaiting foreign investment board approval.
• In 2008 the sale to Mr Ding did not proceed. However the project was sold for $400M (with 80M yet to be received based on receipt of licenses) to China Metallurgical Group (MCC). CFE kept their interests in the southern extension of the project. CFE then returned 100M to shareholders and acquired 30% of the Marampa Iron Ore project in Sierra Leone from African Minerals for about US45M. . CFE spun out various interests in other iron ore projects to CFE shareholders via Global Iron Ore.

Apparently there was some board reluctance to sell Cape Lambert at the time. The board wanted to spend another 10-15M to improve the resource. Apparently Tony Sage pushed hard to get the sale through as he believed they had reached the optimum cost benefit for further drilling. With hindsight it was a brilliant decision.

Since the 2008 annual report the company;

• Cancelled their listing on AIM
• Explored their Cape Lambert South tenement
• Provided convertible loans to some small ASX exploration companies
• Worked with MCC to secure licenses and in turn their $80M payment.
• Acquired all the assets of CopperCo as the result of a liquidation of CopperCo due to default.

CopperCo was acquired by total payments of 129.7M made up of:

• The secured debt for 72.7M (with 15M of that deferred until July 2009) from Macquarie Bank and LinQ Capital.
• A $30M working capital facility during the administration.
• $27M on completion of the sale.

Fortunately I was never a shareholder of CopperCo because their assets were sold at the absolute market bottom for a small fraction of their fair value based on normalized (not peak) commodity prices. The managers of CopperCo did the owners a great disservice by taking on a level of debt that put immense value at refinancing risk. All this is great news for holders of CFE (which incidentally doesn’t have any debt).

The material assets of CFE are shown in the table below. There are multiple sources for the value of the CopperCo assets. These valuations are generally not peak valuations and have been adjusted for my long term commodity price assumptions. I have validated some of these valuations where underlying data was available. For example CopperCo published cashflow expectations for the Lady Annie Project and if anything they support a higher value than other sources.

CFE recently did a road show around Australia and released a presentation on the ASX. They disclosed that they are reviewing a potential trade sale of Lady Annie for around $150M . Hopefully they won’t proceed with such a sale. They revealed in their quarterly report that they have commenced a 2 year exploration program to expand the resource. CFE have a good (yet short) track record of adding value prior to sales and of selling once an appropriate (but not exhaustive) amount of value has been added. There is no reason that they can’t secure $200M for Lady Annie. My “Estimate” case assumes $150M for Lady Annie.

An article in Australia’s Paydirt has Tony Sage, the Executive Chairman stating that the company is going to try to sell their interest in Marampa for $400M US. I have no basis to value Marampa so I’ve assigned it the carrying value of $25M in my “Estimate” case (I’ve assigned $150M per the road show slides in the High case).

As mentioned above, there is 80M yet to be received from the sale of their name sake mine to MCC. I have assumed they will not meet the criteria to receive that payment in my “Estimate” case. The High case assumes they will receive the payment.

Finally there are some small equity investments that based on the road show disclosures I've valued at $7M.

Tony Sage, the Executive Director, has quite a storied history. Western Australian Police investigated Sage in relation to a vehicle that was later used in a crime, no charges were ever filed. He was supposed to have attended a soccer game with a criminal figure, though the newspaper that published the report later retracted it. Sage owns a Perth Soccer Club, night clubs and Fashion magazine Kurv. Sage has dealt extensively with Frank Timis, who hired Sage to work on Gabriel Resources many years ago. Timis is a controversial Romanian-Australian businessman who was arrested for Heroin dealing in his younger days. Sage is of the view that Frank needed to support his family. They have been friends for over 16 years. Ultimately Timis has made money for Sage and in turn for Sage’s shareholders. Timis was the seller of Marampa, through African Minerals. Sage has been criticized for the deal but time will tell how it works out. Most of Sage’s wealth is his equity in CFE so his interests appear to be well aligned with other share holders. Sage has developed a reasonable track record for proving the pundits wrong.

I don’t like the Marampa deal because the political risk in Sierra Leone (and in turn the increased discount rate for investment there) adds a factor that I don’t think CFE have sufficient experience dealing with. There have already been legal issues with the Marampa project. They may well get lucky and sell the deal to another company that will need to deal with the political risk; Chinese companies seem quite comfortable in Africa and Sage has been able to sell his projects on to Chinese companies. There were so many opportuities in natural resources earlier in the year that I am disappointed they didn’t forgo Africa and focus on more politically secure areas of the world. However, maybe that is what is causing such a dramatic under valuation in CFE shares.

Based on the sum of the parts valuation CFE is worth around 94c. Remeber this estimate assumes no residual from the MCC deal and no value to Marampa. Worst case it seems extremely unlikely that CFE is worth less than 39c. An article in the Mining Journal has Sage assert that CFE is worth at least 150% of its current market value of $150M. I would agree.

My average cost is about 32c. I am trying to buy more but I haven’t been willing to pay up after the recent rise. The combination of the recently completed road show, the resurgent broad market and a better appreciation of the Copper Co assets appear to be causing a revaluation of Cape Lambert. CFE most recently closed at 35.5c on the ASX for appreciation of nearly 175%. With no debt it is easy to make the case that Cape Lambert Iron Ore should hold a large sized position in your portfolio.

posted by Neil  # 4:30 AM 0 comments