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Introduction

The price of potash has been volatile during the past decade, rising from about $175 per ton in the beginning of 2007 to over $870 in early 2009 before stabilizing around its current $450. Potash is a nutrient-rich substance that is mined out of the ground and added to most fertilizers. The days of cheap potash are long gone, primarily due to limited supply, population growth, increased food consumption in developing countries, and the need for more efficient farming and crop yields. After the large rally in the price of this natural resource, many countries and agricultural companies are looking to secure future supply contracts. Major companies that have already boosted potash production this year include PotashCorp (NYSE:POT), Mosaic (NYSE:MOS), Agrium (NYSE:AGU), Rio Tinto (NYSE:RIO), BHP (NYSE:BHP) and Vale (NYSE:VALE).

Extra! Extra! Arizona Has $1 Trillion Of Potash!

Amid potash's 300% rally in 2008, the State of Arizona released a study that its Holbrook basin contains a significant amount of potash. According to the governmental study, the basin contains 682 million to 2.27 billion tons. At a price of $450 per ton, this implies a reserve that is worth between $300 billion to $1 trillion- and that is from just one of the state's basins.

Companies quickly took notice of the government's report. Soon thereafter, the basin's land was gobbled up by three companies: Passport Potash (OTCQX:PPRTF), Hunt NZ Potash (a private company formed from Hunt Oil and NZ Legacy) and Prospect Global Resources (NASDAQ:PGRX). Aside from minor federal, state and Native American royalty interests, these three companies won the bidding wars and are the only entities planning to mine potash in Arizona's Holbrook basin.

Currently, about 20% of the Holbrook basin's potash lies beneath the Petrified Forest National Park. An additional 30% will fall under the park boundaries following the implementation of the Petrified Forest Expansion Act of 2004. The remaining 50% of the land is owned by the federal and state governments, private owners, and Native Americans (largely by the Hopi people). Note that it is still possible for companies to mine potash on land that is part of the expanded Petrified Forest National Park and Native American lands, so long as they obtain permission. (The Hopi people have already announced their intent to do so with Passport.)

Racing for a Slice of the $1 Trillion Pie

How much does it cost to mine potash? It costs Intrepid Potash (NYSE:IPI), the only major producer of potash in the U.S. and operator of three mines in Utah and New Mexico, an average of $175-190 to produce one ton of potash. Canada's largest potash company, Potash Corporation, is producing at $112. So, with potash selling for $450 at a cost of $112-190, this means that mining companies can earn profit margins of 60-75%. Given these numbers, it is no wonder that companies rushed to stake their claims in the Holbrook basin.

As mentioned above, the three major companies exploring for potash in the Holbrook Basin are Passport, Hunt NZ, and Prospect Global.

  1. Passport's land package includes about 122,000 acres of land with easy access to the major railroad (Burlington Northern Santa Fe). It recently signed a letter of intent with the Hopi people, setting the foundation for a comprehensive mining development agreement. It also recently resolved a dispute with North American Potash Development, allowing Passport to take 100% interest in North American Potash Development land in the Holbrook Basin.
  2. Hunt NZ's land package includes about 75,000 acres of land. In general, only sparse information is available about Hunt NZ due to its private status. We do know that although it is a competitor, Hunt NZ is also cooperating with neighboring Passport; in August, Passport announced that it had signed a 50% joint venture to explore and develop 21 permitted zones for which Passport holds the drilling permits but Hunt NZ owns the land.
  3. Finally, Prospect Global's land package includes 90,000 acres of land. It does not have access to the major railroad and a large portion of its planned mine include future areas of the Petrified Forest National Park or holdings of its competitor, Passport. However, the company has already obtained a preliminary economic assessment and has signed a provisional contract to sell potash to a Chinese firm, Sichuan Chemical.

Inherent Risks of Small-Cap Investing

Valuing companies in their early stages is difficult and often proves imprecise. The Holbrook basin is a greenfield project, so there are no historical estimates upon which to base predictions. Nevertheless, investors can still use relative calculations to determine if a company is cheap or overvalued compared to its peers. Based on recent stock prices, we know that Passport is worth $36 million and Prospect Global is worth $130 million. The valuation gap is large, but both combined are still less than 1/10th the value of established producers like Intrepid Potash.

Despite the prestigious $100 million investment by Apollo Group and the billions in signed purchase agreements from China, there are nevertheless risks to the future of Passport and Prospect Global. Both companies will require over $1 billion in project expenses for ultimately building their mines. Although this is less than 1/2 the cost of developing a typical Canadian potash mine, the dollar amount is still large. Common shareholders are not normally diluted significantly during this funding process, as the majority of the money is raised through purchase contracts, debt financing, royalty agreements or JV partnerships with major producers.

Both companies will also face a risk of insufficient mineralization in their pre-feasibility and feasibility studies. Despite early indications of large potash deposits from Passport's 43-101 and Prospect Global's PEA, if the companies cannot prove that there is enough potash to justify their mine build-outs, there is risk that they will not be able to acquire sufficient financing.

In general, investing in early-stage mining companies is risky. The success of former pinksheet companies like Allied Nevada (NYSEMKT:ANV) is somewhat rare, and investors should consult with a financial advisor before taking a position in speculative companies that may fail. (Hunt NZ is not open for pubic investment, so only sophisticated investors will likely be able to discern the full range of risks for this private company.)

Current Standings in the Race

Technically, Prospect Global is ahead of Passport in its formal timeline, as Prospect Global has already prepared a preliminary economic assessment and signed a provisional contract for selling some of its potash in China. Passport, in contrast, expects to release its preliminary economic assessment by the first quarter of 2013. Both companies are forecasting production within a few months of one another: Passport by 2016 and Prospect Global by late 2015 or early 2016.

Despite their similarities, when compared on other metrics, Prospect Global seems to lag Passport. In particular, Prospect Global has deposits that are deeper underground, less continuous, and more costly to mine. In addition, Prospect Global's mining footprint includes federal park land that might delay its permitting by over five years. Lastly, Prospect Global will need to negotiate with Passport, its competitor, in order to use its land both for mining and for access to the railroad.

For investors, the biggest difference between Prospect Global and Passport is their immediate cash needs. Specifically, Prospect Global needs $125 million by July 31, 2013, $50 million of which is due by December 24, 2012, to finance its remaining 50% acquisition of its major operating subsidiary (American West) from Karlsson Group. Passport only needs $55 million for all operations until 2014. In summary, Passport only needs 44% of the cash that Prospect Global needs, and it has an additional six months in which to obtain it.

On October 26, 2012, Prospect Global revealed its plan to obtain the first $50 million of this $125 million by issuing 30 million new shares. This equity raise diluted shareholders. Prospect Global will likely finance the remaining $75 million from a $100 million investment that Apollo Global Management will make if Prospect Global meets certain conditions. The critical conditions include the completion of a bankable feasibility study that confirms certain findings (estimated capital costs, operating costs, mineral grades and resources, and production rates) of the preliminary economic assessment. Unfortunately, there are many hurdles to overcome in order to produce this bankable feasibility study, and the convertible security financing will also be dilutive to shareholders.

Both companies are racing to become the basin's first producer, and the financial statements of interest by Apollo Global Management and Sichuan Chemical are only expediting the competition in Arizona's Holbrook basin.

Conclusion

Demand for potash is widely expected to continue to increase due to population growth, demand for higher crop yields and rising living standards in developing countries. Arizona's Holbrook basin contains up to $1 trillion of potash, which is a key nutrient for large-scale farming. Two of the three companies in the basin offer investment opportunities in the public markets. Passport appears temporarily undervalued to Prospect Global: $36 million versus $130 million, respectively, despite similar land sizes and Passport's lower cash needs, shallower deposits, and access to the railroad.

Of course, both companies are valued at only a tiny fraction of their potential future size if they can make it to final production. With the support of the state government, strong cooperation of Native American tribes, a willing labor force, and significant investment of prestigious firms like Apollo, the Holbrook basin will help America reduce its dependence on foreign potash.

Source: $1 Trillion Of Potash: The Race For Arizona's Holbrook Basin