After a merger failed to materialize in spring of 2012, Jaguar Mining (JAG) has been trading like it's going bankrupt. Some of this is deserved; the company has had negative cash flow for several quarters despite record high gold prices and is depleting its cash reserves quickly. Worse still, when it recently obtained a $30M credit line from Renvest Mercantile, the terms read like something out of the Godfather movies.
Ultimately, what will determine whether this stock goes from $0.70 back to $7.00 or to $0.00 is its operations. The operations have much to do with management (*new* management is now in place) and access to capital. In the short term, however, the balance sheet explains whether or not Jaguar has the staying power for management to deliver (a higher gold price wouldn't hurt either and may be in the cards).
Below is a discussion on some particular balance sheet issues facing Jaguar which continue to be a cause for concern. In my opinion, the balance sheet is misunderstood, and thanks to new management, Jaguar has a second lease on life with a real chance to deliver.
Current Assets and Liabilities
As of the end of Q3 2012, Jaguar had current liabilities that exceed current assets by $20 million. Current liabilities are those that come due within 12 months. $60 million of the liabilities are composed of accounts payable and notes payable.
The management team discussed these liabilities in the Q3 conference call and apparently half of the liability is accounts receivable financing from a local Brazilian banking syndicate and the other half is leasing accounts for equipment.
Management implied in the call that these current liabilities would likely be renewed in the normal course of business as they have been historically. However, due to the contractual terms of the loans, they need to be located in the current portion of the balance sheet for legal disclosure purposes.
Long-Term Notes Payable
Jaguar has two sets of convertible notes payable totaling $265 million. The first set of convertible notes is in the amount of $165 million and is due and payable on November 1, 2014 (23 months away). The second set of convertible notes is in the amount of $100 million and is due and payable in March of 2016 (39 months away).
To clarify a doubt of many investors, the possibility of delivering stock instead of repaying the debt would only be in the case of the stock having appreciated substantially. With an exercise price of $10+ per share, the convertible debt is not going to be converted to shares; it is going to have to be paid off in full.
Can Jaguar repay or refinance the debt? It's too early to tell. If new management stabilizes the operation with positive cash flow of $30 to $50 million per year, the debt can likely be refinanced. If there is still negative cash flow around the time the debt is due, then JAG will go bankrupt and the convertible debt owners will become the new owners of the company as they have a higher preference in the capital structure.
Management is currently targeting around 100k - 110k ounces of gold production annually for the foreseeable future. At current gold prices, this would give revenue of $150M to $200M annually. Cash flow (currently negative) may improve to slightly positive, but unless the production grows back to 150k ounces and gold prices appreciate, I think it will be lucky to exceed $20M on current production numbers.
At $0.70 per share, Jaguar's common equity is currently valued at around $60M. Gurupi (Jaguar's development asset in Northern Brazil) alone is worth somewhere between $100M and $1B depending on gold prices and Jaguar's financial strength / staying power. I would like to think that it is worth enough to pay off the $265M in debt in full, especially if we see higher gold prices. Based on the balance sheet discussion above, I also believe that Jaguar has the staying power to market this asset correctly and receive a fair price.
If its current operations regain prior production of 150k ounces annually with improved cash costs, the cash flow could grow to around $50M. At a multiple of 5-10, the current operations would be worth $250M to $500M.
Las Vegas Sands Analogy
Another misunderstood stock back during the financial crisis (Las Vegas Sands (LVS)) also had a bad balance sheet. Overly pessimistic investors drove the stock price to under $2 in the spring of 2009. Renewed financing in place and fundamentally solid underlying operations allowed the stock to appreciate over 30 times in value to $60 per share in early 2012.
Tremendous Uncertainty - But Quantified Risk
The moral of the story is when balance sheet issues allow equity to be priced like a call option, the risk reward favors a long to a short. Fixed risk of $0.70 and potential upside of $5.00 - $10.00. That is the kind of asymmetric ratio that delivers outsized returns. A valuation of the equity of around $425 million (my personal estimate) would put the stock price at $5.00 per share and is a nice gain from here.
This stock was formerly greater than $1 billion in market cap. Today it is just a $60 million market cap stock. Goes without saying - this stock can be manipulated up or down on little volume so buyer or shorter beware.
Disclosure: I am long JAG.