Apex Silver Mines Might Be a Promising Short Play Now

 |  Includes: SIL, SSUMY
by: J. Christoph Amberger

Crashing commodities prices are not just putting hedge fund managers into a jam, they're also putting resource producers at risk. The price surge triggered by the commodities super-cycle had been a boon to large-scale miners in particular. Soaring prices for oil, nickel, copper, and molybdenum made the exploration and development of marginal sources not only feasible but profitable. Across the world, mines (especially silver mines) re-opened that had been abandoned as too expensive a decade and a half ago. (The only fly in the ointment was the falling dollar, which made operating expenses in non-dollar countries relatively more expensive.)

Just take gold: With stocks are as volatile as nitroglycerin, gold should be trading above $2,000 an ounce! But the dollar insurrection has shaken up the commodities markets. Some experts now put gold's downside at $500... even $400. What if they're right? (That's the reason we developed a gold hedge strategy that insures you will make money on your gold position either way. Find his Special Report on the Members Only Reports section of HotStockConfidential.com.)

But as the world economy moves into recession, credit locks up, and commodities prices continue to fall, we predict that a large number of mines will again be abandoned over the next three months, and that a sizeable number of mining companies will file for bankruptcy. We have picked up rumblings that one of these companies might be Apex Silver Mines (NYSEARCA:SIL). Of course, we cannot tell for sure.

Some of the information we have obtained could not be verified independently. Other bits may qualify as "insider information". But most of what we have compiled here is easily documentable in public sources. We have a couple of rules here at TFN. We don't spread rumors. We don't trade on insider information -- we publish it when we find it. And we don't trade on our own recommendations -- unless we disclose it to our readers. With appropriate warnings that you should do some digging on your own before you make a decision to buy, borrow, or sell shares.

According to our sources, the only important asset Apex currently owns is its 65% share in Minera San Cristobal (MSC), a sizeable silver, zinc, and lead mine in southwestern Bolivia. The problem is that the Bolivian government, inspired by its petro-Communist neighbors in Venezuela, has recently raised applicable mining taxes, increasing the income tax rate from 25% to 37.5% when prices meet specified thresholds and eliminating the creditability of the complementary mining tax against the income tax.

These changes will result in a higher income tax burden, and hence cost base, for the company. But there appear to be internal issues as well that point at lack of financial stability:

  • Entry into a Material Definitive Agreement for a $225 million Senior Secured Loan arranged by BNP Paribas at LIBOR + 3.5%, secured by all tangible and intangible assets owned by Apex and all its subsidiaries (8-K Filing dated Dec 8, 2005).
  • A complex derivative instrument required by the Senior Secured Loan which represents a current liability of over $450 million. This hedge accrues losses at a rate of approximately $115 million per month. (8-K filing dated August 12, 2008.)

Our source writes:

This Facility requires a first payment of the principal by Dec 2008 AND completion of Minera San Cristobal construction at full production by year-end 2008. Apex will not be able to comply with this requirement and thus the senior lenders , by contract, may require payment of the principal in full and settlement of the hedge position.

As early as the third quarter of 2006, the company had to sell 35% of Minera San Cristobal to Sumitomo (OTCPK:SSUMY) for $224 million in cash and a Deferred Payment Agreement valued at $108 million (8-K filing of September 8, 2006). This past May, analysts expressed concern about the multi-million-dollar funding requirements of the San Cristobal silver mine in Bolivia. In response, Apex announced it had reached an agreement with joint venture partner Sumitomo Corporation to sell the rights for deferred payments to Sumitomo for $70 million.

Effective March 9, 2007, Apex Silver entered into an Indemnification Agreement with each member of its Board of Directors and its executive officers, "agreeing to indemnify each director and executive officer to the fullest extent permitted by law if he/she is made, or threatened to be made, a party to any threatened, pending or completed action, suit, or proceeding by reason of his affiliation with the Company. "The Agreement provides for the advancement of expenses incurred in defending or participating in any proceeding." (8-K filing dated March 15, 2007.)

Our source believes the company was able to survive for the last three months by settling the Deferred Payment Agreement of $108 million it had with Sumitomo for $70 million in cash, taking a loss of over $30 million in the transaction (8-K filing of July 8, 2008); and by tapping into a line of credit of $50 million from Sumitomo (8-K filing dated August 15, 2008) which was recently increased to $75 million (8-K filing dated October 3, 2008). Sumitomo has the option of exchanging debt for a greater share of Minera San Cristobal. Meanwhile, the company urgently needs cash to continue operating the mine, make the first payment of the principal to the senior secured lenders, make good on the accrued hedge losses, and restructure the senior loan because it will be unable to comply with the requirement to have MSC completed by Dec 2008.

This is what the company writes in its August 12, 2008 8-K filing:

Notwithstanding this new line of credit, the company believes that it is likely to require a significant restructuring of its operations or indebtedness based on the foregoing factors and its projections with respect to the San Cristóbal mine. The company has engaged Jefferies & Company, Inc. as its financial advisor to assist it in reviewing strategic and financial alternatives, which could include new debt or equity financing, a sale of additional interests in San Cristóbal or in one or more of the company's exploration properties or a restructuring, refinancing or amendment of the Facility or the related metal derivative positions.

With the current worldwide credit meltdown, it the only realistic source of cash for Apex now is Sumitomo. Here's what could happen in the next weeks:

  • Sumitomo may purchase the Loan Facility ($225 million) at a discounted price from the Senior Secured Lenders, which are desperate for cash and will book a receivable of $225 million from Apex exchangeable for shares of MSC, as in the case of the recent loans.
  • Sumitomo will pay the accrued derivative liability and book a receivable from Apex. Our source speculates: "For those SIL shareholders that were hoping for some big company to purchase SIL at a premium, the sad news is that Apex executives, in effect, are selling the only significant asset (MSC) to settle the huge liabilities it has."

When all is said and done,

Apex may owe Sumitomo more than $700 million. Considering it bought 35% of MSC for $294 million ($8.4 million/percentage ownership in MSC), this is more than enough to get 100% ownership of MSC. With Sumitomo sole owner of MSC, Apes Silver Mines Ltd. becomes an empty shell with some unwanted liabilities and Chapter 11 in the very short term. Of course, also some very angry shareholders. (Auditors PwC: look out for the class action lawsuit.)

Yesterday, SIL was trading at $1.56 a share, down from its 52-week high of $21.33.

Stock position: None.