Comparison Companies for Southern Arc Minerals Inc.
July 29, 2007
Friends,
While we're waiting for some cheerful tidbits to come our way… here’s what I was thinking about over the weekend.
My topic today is comparison companies for Southern Arc. This is by no means a light task, as the selection of a comparison company depends on a number of assumptions in entirely unrelated areas.
My pursuit was prompted by a re-read of Omar Boulden’s Case Study on Due Diligence (using SA as the illustrative example). I was reminded of something that troubled me the first time I had read the article. Here’s the passage that raised my eyebrows at the time:
“Now we have to determine what percentage of this value the market assigns on average for in-situ metal. There is a very useful and interesting website that compiles and calculates the types of numbers we are looking for. You can find it at the link here.
If one looks at the column called EVPU (Enterprise Value Per Unit), we can see how the market is valuing one (equivalent) gold ounce in the ground for various exploration companies. The range is quite large, from $251/ounce to $1.7/ounce.”
What concerned me then, and does even now, was the huge spread in valuation by the market, across these companies.
I poured the table from this linked site into Excel, added a couple of columns and did a little number crunching over the weekend. To start with, I considered only those 58 companies with stock listings in either Canada or the U.S. Secondly, I calculated as a percentage the market capitalization as a percentage of the in situ value. Both figures were included in the table, so this was no great feat. Placed in descending rank order, Meridian (MNG.TO) was at the top of the list, showing a ratio of 40.3%. What this means is that the market values (share price x number of outstanding shares) the in ground resource at just over 40 cents on the dollar. Certainly an important piece of information to have as you consider where to put your investment dollars. The bottom of the list was held by Northern Dynasty (NDM.V), at just 0.3%. In other words, the market values this stock at less than one-third of one per cent of its in situ value. Maybe this is why Peter Grandich is so hot on NDM.V
The average ratio (MC/IS) for these 58 companies is exactly 10%. So far so good. Here’s where it gets a little tricky. The standard deviation for this distribution is a massive 8.4%. If this is a normal distribution, that makes using this data almost untenable as a predictor of any value. In lay terms, this means that, if the distribution of these ratios fits into the shape of a ‘bell curve’ (it’s called a ‘normal’ distribution), then approximately 68% of these figures are bounded by 10%, plus or minus 8.4%. In other words, it stinks as a predictor. To include just over two-thirds of the figures, you need to span from 1.6% all the way to 18.4%. Hmmmm. So, where do you take the search for a good predictor next?
The table on the linked site categorizes these companies into four different types, each at a different level. They are Exploration 1, Exploration 2, Junior Producer, and Mid-tier Producer. Maybe this differentiation will account for much of the variability in this MC/IS ratio. I sub-divided the 58 companies into the four groups, and found their average ratios and standard deviations to be as follows:
Exploration 1 – MC/IS = 6.8%; SD = 6.5%
Exploration 2 – MC/IS = 7.2%; SD = 5.8%
Junior Producer – MC/IS = 11.6%; SD = 8.4%
Mid-tier Producer – MC/IS = 20.0%; SD = 9.7%
While this has some very small differentiating value, it certainly doesn’t take us where we need to be in an effort to compare SA to any other company(ies) with any level of confidence. The variability is just too great.
I tried a few other configurations to see if anything helped to narrow the dispersion in the data. For example, I looked only at those companies with more than $4 Billion in estimated in situ value. Didn’t help. More than $10 Billion. Didn’t help. Gold estimates at greater than 3 million ounces. Didn’t help. Threw out the top five and bottom five in the ranking. Didn’t help. The estimates of market capitalization as a proportion of in situ value, under these constraints, offered no level of predictability.
Alternative variables to consider would include (but not be restricted to): depth of mineralization; grade of metal; costs to mine; and political risk.
I have not yet done enough homework to say much on any of these key factors as may help to assign value to SA. This said, I think we’re all of one mind that the proximity of our mineralization to the surface (for Selodong, at least) is an attractive point in our favour. Political risk is still pretty much an unknown, but shows good signs of improvement. Fingers crossed, let’s hope that, as Wayne Gretzky might say, ‘go not to where the puck is, but where the puck is going’ is a winning strategy for SA. We’ve certainly set up our office ‘behind the net’, as it were.
On the costs to mine, I found quite a range of mining costs for gold, as high as $500 per ounce. Of interest, the lowest cost I found (in an admittedly brief search) was for Newmont’s Batu Hijau mine, at under $200 per ounce.
I’m led to consider Batu Hijau as perhaps the best comparison ‘company’ available for us, as we try to guestimate what Selodong might be worth. Let’s not even touch on any SA assets beyond Selodong. It’s far too early to come up with any meaningful numbers. Some would say this is still true for Selodong, but let’s follow Bob Moriarty’s lead on this. From one of his articles:
“Batu Hijau is a gold-rich porphyry copper system. That's the ideal today; they are giant systems, rich in gold and copper and can be mined cheaply.
I think Southern Arc is sitting on one at Selodong, the numbers already show a giant system. Consider that one property Batu Hijau Junior.”
Some very interesting figures come up in researching Batu Hijau, a few that boggle the mind, and others that caution exuberance somewhat, although perhaps only somewhat.
I’ve read that Batu Hijau accounted for 80% of Newmont’s 2005 profit. Considering that Newmont (worldwide) currently shows a market capitalization of some $18 Billion (down from $30 Billion in the past two years), and that the valuation of a company is driven first by the expectation of profit, one might be tempted (in a moment of fancy-free imagination and logic) that Batu Hijau comprises $14.4 Billion of that market valuation. One might next be tempted to proportionally transplant such a valuation to Bob Moriarty’s ‘Batu Hijau Junior’. Now that, in and of itself, is an exciting prospect, liable to keep you awake at night, conjuring up images of Scrooge McDuck, counting coins in his vault.
But, ‘no’, you say – ‘we couldn’t run a mine alone, we’ll need to dilute the value of Selodong by bringing in a JV partner’. True, but let’s take another look at Batu Hijau. Newmont only owns 45% of that project. One of the other major partners is Japan’s Sumitomo.
While we’re on the subject, let’s see what Sumitomo has to say about Batu Hijau. From their website:
“The Batu Hijau Mine , located in the southwestern part of Sumbawa, Indonesia, has estimated reserves of about 1.0 billion tons, making it one of the world’s most important large-scale mines.”
“The mine has an advantage in terms of profitability, as well, as not only copper but also gold is contained in the ore.”
“The Batu Hijau Project is the mainstay of Sumitomo Corporation’s copper resources development business.”
By the way, from this partnership, we can see why it just doesn’t work to apportion 80% of the Newmont market capitalization to Batu Hijau. To do so, as suggested earlier, would mean a valuation of $14.4 Billion for Batu Hijau. If my in situ value of $31.1 Billion for Batu Hijau is close to accurate, then Newmont’s 45% share would be just $14.0 Billion, a figure less than the apportioned market cap. No way that the market cap is going to exceed the in situ value, before costs and taxes. Nice try, though.
Let’s look at some of the numbers for Batu Hijau, and see how they compare to what we know, so far, about Selodong.
Best estimates I can find for current in ground resource for Batu Hijau are 7.6 million troy ounces of gold and 7.2 billion pounds of copper. (As with all of my figures, these remain open to improvement. Please feel free to correct me.)
So, there are almost 1,000 times as many pounds of copper as there are ounces of gold. What does this mean in terms of value? By my calculations, the in situ value of Batu Hijau, using these numbers and current prices for the two metals, is approximately $31.1 Billion. Of this, $25.9 Billion is for the copper. Hmmmmm… Let’s carry this one step further. The estimated cash costs for mining gold at Batu Hijau (for fiscal 2007) are approximately $215/ounce, or a little less than 32% of the current price. At the same time, the estimated cash costs for mining copper at Batu Hijau are $1.10-$1.20, or between 30.5% and 33% of the current price. So… there’s no greater profitability on a cost percentage basis for either metal over the other, using current prices.
Here’s where you might want to slow the horses down on the way to Scrooge McDuck’s vault. Let’s look at the Batu Hijau metal numbers, in comparison to what we’ve so far learned about Selodong. Their grade of gold is pretty much in line with ours, at .42 gpt. So far, so good. Their grade of copper, however, is about .55%. Ours is, so far, around .30%. This is a material distinction. Where it manifests itself is in the volume of metal at the end of the calculation. Whereas the Batu Hijau proportions are approximately 7.6 (million ounces of gold) to 7.2 (billion pounds of copper), ours (using our best of the first three holes – MB001) would be 2.9 (Au) to 1.3 (Cu). Let me be perfectly clear. I’m not comparing the gross totals here, as it’s far to early to estimate what Selodong may have to offer (my personal hope is for more than 10 million ounces of gold and 4.5 billion pounds of copper, applying the proportions for holes drilled so far). At today’s prices, that would yield an in situ value of approximately $23.1 Billion. The purpose of this comparison, rather, is to highlight both the importance of copper in the profit calculation, as well as the comparative proportions of copper-to-gold, looking at Batu Hijau and Selodong (at its early stage of exploration).
This does not greatly concern me, though, as it’s clear that Selodong (and other SA prospects) contain more than just gold and copper. Molybdenum and Silver, to name two popular metals, show great promise for profitability.
Remember that my purpose, in this part of the investigation, is to find useful comparisons for Selodong. Not finished the search yet, but given the location (political risk), the matching type of deposit (gold-rich copper porphyry), and the lower costs of mining (near surface, and labour), Batu Hijau is the one that calls. By the way, given (as I understand it) that Newmont draws on Lombok island (home of Selodong) for labour, ferrying to Sumbawa on a daily basis (read this as both infrastructure and variable costs), it’s not reaching too far to say that we’ll have a ready workforce (keen to stay on their home island), and labour costs no higher than those of Batu Hijau.
That’s about it for now. The search continues. Just wondering out loud.
Your critical review, as always, is most welcome.
Regards,
Kevin