Author's Note: This article discusses a microcap stock. Please be advised of the risks associated with microcap stocks. The text of the interview is an abridged transcription of a conversation between Lazarus Investment Partners LLLP and Silver Bull Resources, Inc. Silver Bull had no input into the selection of the title of this article nor into the commentary that precedes the interview section. Lazarus is a shareholder of Silver Bull and received no compensation for this article.
Introduction. Maybe talent, maybe luck, but our fund has had some natural resource investments that turned out pretty well. After making 31x our money in a mining stock, we've kept a portion of our portfolio invested in up-and-coming natural resource companies as we look to strike gold again. One of these investments is Silver Bull (NYSE: SVBL) (TSX: SVB.TO). We are one of the company's largest shareholders and, despite it being a relatively unknown stock, believe it is one of the largest, most attractive, independent silver resources in the world.
The resource. Vancouver-based Silver Bull is 100% owner of the Sierra Mojada project, located in Coahuila in northern Mexico. The project is in a mining district discovered in 1879 and known for its silver, zinc, and lead. There is excellent infrastructure in place with paved roads, grid power, labor supply, 5 company-owned water wells, and railway to site. The project's total land package contains 40 mining concessions totaling over 52,000 acres. Highlights from the resource include:
- 164 million indicated ounces of silver (71.4 g/t, 25 g/t cutoff)
- 2.2 billion indicated pounds of zinc
- 547 million inferred pounds of lead
- 129 million inferred pounds of copper
According to the November 2013 Preliminary Economic Assessment (PEA), the project has a pre-tax net present value [NPV] of $641 million and an internal rate of return [IRR] of 26.9%. On an after-tax basis, the NPV is $464 million and the IRR is 23.1%. These numbers assume a price of $23.50 for silver, which was a discount to the $24 price of silver at the time the report was prepared.
Silver has since slipped closer to $20. At $20 silver, the pre-tax NPV is $431 million and the IRR is 20.0%. Since the project falls in the top quartile for cash costs per ounce and production volumes, it has a double-digit IRR even at $16 silver and only needs $13 silver to break even. Below is a sensitivity table and if you care to see the full PEA (or NI 43-101 report), it is available here.
Balance sheet. Our view on Silver Bull is that much of the risk is behind us. The company already has extensive drilling completed, which is necessary for defining the resource. With so many other exploration companies, to get in at a low price you have to take a lot of risk and hope that the drill results match up to the big stories mining executives are fond of telling. In Silver Bull's case, the mining district is well known and we already know a ton about the resource from the completed PEA and NI 43-101 reports. We do believe that there is upside to those reports and the company is considering inexpensive studies on areas adjacent to the ore body. Silver Bull has over $5 million in cash and is burning under $160,000 a month. This implies that the company can go over 2.5 years on current cash resources.
2014 milestones. Over the next 12 months we expect to see the project continue to get de-risked. In 2014 the company will focus on getting out a pre-feasibility study followed a few months later by the full feasibility study. Other milestones to look for in 2014 include on the permitting front. Next year we could see final permits for water rights and the remaining area's surface rights. We should also see progress in the environmental impact assessment, although a final answer there is only expected to come once the feasibility report is complete.
Likely to be acquired. The other thing that could very well happen next year is that the company could get acquired. We are not just speculating about a potential sale - Silver Bull is in talks with 13 potential acquirers. Silver Bull's Chairman Brian Edgar was Lead Director of Red Back Mining which he sold to Kinross for $9 billion. The current management team recognizes that they are exploration experts, but have neither the skill set nor the capital base to see the Sierra Mojada project through its estimated 18 years of mining life. They are simply putting all the pieces together so a bigger mining company can walk up to a set table.
One potential acquirer is Coeur Mining (NYSE: CDE) which already took an 11% stake in Silver Bull, and at much higher prices than where the stock trades today (half of Coeur's investment came in at over double the current price). Below you can read what Tim Barry, Silver Bull's CEO, has to say on whether he thinks a bid is more likely to come before or after the feasibility report is complete.
What's it worth? All of this raises the question of what Silver Bull's project is actually worth. Silver Bull's market cap today is just below $50 million. The PEA cites an after-tax NPV at $20 silver of $312 million. If silver catches a bid and rises to $25, that number becomes $529 million.
Earlier this year, a bidding war broke out between First Majestic Silver (NYSE: AG) and Coeur Mining-the same Coeur that owns over 11% of Silver Bull-for Orko Silver Corp. At stake was La Preciosa silver project in Mexico; all very demonstrative of the interest Silver Bull could garner for its own Mexican silver project. Coeur ended up acquiring Orko in a transaction valued at $384 million and paying a 70% premium for the shares. Per ounce of silver in the ground, the transaction took place at $1.70. Silver Bull is trading now at $0.30 per ounce in the ground. At Orko's valuation, SVBL shares should be about $1.75, which is over 5.5x the current price. That transaction was in a different silver environment and this analysis is an oversimplification, but the point is: Silver Bull is worth much more than its market price today.
Let's be clear about one thing: a lot of this has to do with the price of silver. When Coeur first announced its proposal to acquire Orko, silver was near $30 an ounce. As a result of that, Coeur's market cap was around $2 billion, roughly double what it is today and mining companies were feeling great about the world. The reversal in silver prices this year towards the $20 range means two things: first that all mining project economics take a turn for the worse, and second, that M&A appetite from large miners is down significantly. That said, you'll read Tim make the point in the below interview that miners have dwindling resources which are getting to the point that need to be replaced, so he's expecting M&A to pick up in 2014.
So, will Silver Bull be a 10-bagger in 2014? When we hit our 31-bagger (which, by the way, was also with a Mexican property) a few things came together to make the investment work so well. Like Silver Bull, we got in before the asset was fully understood or fully permitted, but when we saw a clear path and reasonable time frame for those things to happen. The other thing that clicked is that metals prices moved upward over our holding period.
Silver is very much out of favor now. What's true for the metal is true in spades for small cap exploration companies. That's one reason why Tim argues in the below interview that it's such a compelling time for the majors to be acquiring - - there's a fire sale in the industry.
In our view, for Silver Bull to hit 10-bagger territory or above, the price of silver will have to move significantly. That can happen, and it can happen quickly-look at the fall from $30 to $20 just this year. Because the Sierra Mojada project breaks even at around $13 silver, every $1 in incremental silver pricing adds incredible value to the project. (This is not a thorough analysis-there's a lot more to consider, including copper, lead, and zinc pricing, but we are trying to hit the highlights.) Thirty dollar silver is only 50% more than $20 silver, but it makes the pre-tax NPV of the project $1.03 billion instead of $431 million, almost 140% higher.
The way we think about it, if one of the 13 companies that has a signed confidentiality agreement with Silver Bull seeks to acquire the company in today's depressed silver environment, we can see making 2 to 4 times our money. But if commodity prices start to improve, and if Silver Bull continues to make permitting progress while remaining on track to get their feasibility out on time, then we think later next year or early in 2015, 10-bagger territory and above is back on the table. This is win/win big - either we make a lot of money, or we make really a lot of money.
We can't control, or even predict silver prices, but we can buy rare trophy assets when they are out of favor and deeply undervalued, and put ourselves in position to get really lucky if a few things crack our way. With Silver Bull's cash balance, we know we have through 2015 to see how the situation develops. Many of our greatest investments have been along these lines - where we don't have a lot to lose if we are wrong, have a base case where we do just fine, but also position ourselves to hit a grand slam if we get lucky. It's not about waiting for luck to fall randomly from the sky, rather sticking around spots where it's plausible for luck to fall and waiting patiently with a bucket to catch it.
What can go wrong? We make no claims to having the golden touch with miners - we've had our successes, but we've also gotten some wrong. No surprise, there are many ways to lose in junior exploration companies - even ones with resources as unique as Silver Bull's.
Silver prices can continue to head lower. Or they can even head higher, but not high enough to awaken the M&A market. Mining companies seem to find ways to spend cash, so it's possible that the current war chest won't last as long as we anticipate. Mexico has a history of being mining friendly, but there's always risk that that can change, especially if populist leaders come to power. The next set of permits Silver Bull is targeting may not come on time, or at all. And we don't know what the feasibility study will say until we get a preview later in 2014.
But if you ask us what concerns us most with this investment, it's not losing big, but that it might be sold too cheaply. What happens in the very possible scenario that the company gets an offer next year to be acquired at a 50% to 100% premium over the current stock price? If only for legal reasons, the Board will have a hard time turning it down.
Sure, we can think of worse outcomes, but recall our situation as investors: we have a long term investment of millions of shares in this illiquid (for our purposes), out of favor stock. We don't make investments like this targeting 50% upside - it's not worth the risk in our view. How many times in our lives will we have the opportunity to be a top two shareholder of one of the most unique mining assets on the planet? We're in this to hit it big. As we described, we definitely see a path for Silver Bull to end up at multiples of its current share price, but there's also a path for it to be snatched away on the cheap by Coeur or another mining company interested in buying one of Mexico's, and probably the world's, most attractive silver assets while the sector is out of favor.
- CEO Tim Barry calls Silver Bull, "one of the top three largest undeveloped silver resources in Mexico that isn't already owned by a major."
- The company's flagship project is in a world class mining region and has very attractive economics with high returns.
- There's a low cash burn and over two years of cash on hand.
- Investment catalysts for next year include a pre-feasibility study, permitting progress, and resource expansion.
- Silver Bull is interested in selling itself and has 13 signed confidentiality agreements in place.
- Coeur, a top ten silver producer with a history of acquiring Mexican silver properties, owns over 11% of Silver Bull and paid for their shares prices 61% and 119% higher than the current share price.
- Silver prices are one of the big unknowns to the story, although the company's project is breakeven with silver as low as $13, and has exponential upside should silver go to levels it saw just earlier this year.
CEO interview. We thank Tim for spending time with us talking through some of the high points of the company. We are pleased to share a transcript of this conversation below.
Tim, perhaps you can start by offering an overview of Silver Bull's resource.
Tim: Sure. The Sierra Mojada asset, which is Silver Bull's flagship project, is located in Northern Mexico in the State of Coahuila. By our calculations, it's one of the top three largest undeveloped silver resources in Mexico that isn't already owned by a major silver producer. In addition to the silver, the project also has a very significant zinc component, which gives the project tremendous optionality in both the base metals and precious metals spaces. The project also has incredible infrastructure, with a paved road and functioning railway right to site, and existing power and water infrastructure.
In our last NI43-101 resource report released in May 2013, we announced a resource of 163 million ounces of silver and just over 2.2 billion pounds worth of zinc at a 25 gram silver cutoff grade, all in the "indicated" category.
What have studies said about the economics of the project, including the cost it would take to bring these assets out of the ground?
Tim: Following the NI43-101 resource report announced in May, we advanced the project through to a Preliminary Economic Assessment or a "PEA" which we filed in November of this year. This report is very much focused on the economics of the project. We were very cognizant that projects with huge upfront capital expenditures just don't fly in the type of market we are currently in, so one of the major challenges was to balance size and metal output versus capex.
I think we got it right, by modeling the economics of the potential mine in the PEA at 8,500 tons per day. What we showed was a very significant mine with exceptional economics and ultimately just how viable this deposit could be. The capex on the project at this rate of mining came in just below $300 million - a very manageable cost even in today's market, with a payback of 2.9 years and producing an average of 5.5 million ounces a year of silver, and just over 65 million pounds of zinc per year as a high quality zinc concentrate. And that's for a mine life of over 18 years. The after-tax rate of return in the report is 23.1% and the after-tax NPV [net present value] is just under $465 million and an all in cash cost per ounce of silver of $6.58 net of the byproducts.
In terms of development of the project, what have been the key milestones to date?
Tim: The key milestones achieved to date have been twofold. The first has been the constant increase of the resource over the last couple of years through a very extensive drill program to get it to the size we have today, and the second has been to push out a PEA in fairly short order which has put some real economics to the story.
It is also no small point that the entire resource falls into what's called the indicated category. To better explain, there are three categories that an NI43-101 resource can fall into. These are "measured" "indicated" and "inferred." Because our resource is "indicated" which means there is a much higher level of confidence in the numbers of the resource than, say an "inferred" resource, we can progress to a pre-feasibility study without any more drilling. This is significant because it means we can focus on advancing other aspects of the project, such as infrastructure and permitting and without the high cost of needing to drill another meter.
Getting this preliminary economic assessment out was a big deal, and I think it has shown to the market that this is a very economic project. We are now in the midst of getting a whole bunch of the various permitting applications underway such as water, surface rights, and environmental permitting. This is the last phase we need to do before ultimately taking the project to feasibility.
And when do you expect that to happen?
Tim: In 2014, we'll be focused on a pre-feasibility. I would anticipate that that should be complete by the end of 2014, though this is subject to market conditions and no significant holdups with the necessary permitting. Once the prefeasibility is complete the next step is feasibility which could happen very quickly thereafter, say in six to eight months, again subject to no significant permitting holdups. And, at that point you can then begin construction of the mine.
Would there be any corporate announcements next year relating to the results of the pre-feasibility study, or at least an early reading of the results?
Tim: Yes. As we go through the various permitting milestones, we'll be announcing them to the market as we go. We may also be doing some targeted exploration on some of the other prospects we have in the area to get them to drill target ready stage.
Should investors assume that someone other than Silver Bull will end up mining this project?
Tim: I am very conscious as to where our expertise and skill set lies as a management team. Presently our expertise is very much as an exploration and development team that can recognize quality undervalued assets work quickly to bring them to fruition. We recognized this with the Sierra Mojada project back in 2011 and I think we have done a terrific job taking this project from when we first came onboard to where it is today - despite the very difficult markets I might add.
To further elaborate on what I mean here, exploration and mining are two very different skill sets and this explains why mining companies are usually terrible at exploration and why development and exploration companies are often awful miners. My background is very much in the exploration and development side of this industry. I have no illusions of grandeur so if Silver Bull was to go on to mine this themselves, I would be making sure we have the right expertise on board with the company, and that would also involve also making sure the appropriate CEO with extensive mining experience was also in place. So, that's option number one on who might mine this deposit.
Option two is simply moving this project on to a major silver or zinc producer. Considering the size of the deposit, the overall grade, the existing infrastructure, and then location of this project, it makes sense this project would be of interest to any silver or zinc producer.
Is selling the project different from selling the company or that's effectively the same thing?
Tim: Good question. For us it would be selling the company for the simple reason that Sierra Mojada is by far our main asset and by selling the company it offers our shareholders the best and easiest way to monetize their investment. There's also a practical reason to sell the company rather than the project in that if we sold the project we would need to pay out dividends or some such thing - which I'm sure would have its inefficiencies, and then also a lot of the permitting and contracts that are already in place may well need to be transferred. In this particular case it would simply cleaner to sell the company
How far along are you in conversations with potential acquirers?
Tim: We've got 13 NDA's [non-disclosure agreements] out on the project. I think investors would recognize the names of the companies who are looking at our project. And I think it's just a process. Any company interested in a project like Sierra Mojada has a certain level of risk tolerance. Their decision point is really to assess at which point they feel comfortable in making an acquisition. Many mining companies have their own internal issues right now and some may just simply not be in a position to make a bid until these issues are sorted. This is an industry wide problem right now.
Do you have a thought on whether an acquirer's interest would come before or after the final feasibility study?
Tim: I think it could come at any time. As I said, it depends on the level of risk that a company who is interested in a project like this is willing to accept. There are two things a company has to consider when it wants to buy a company like Silver Bull; number one, as we continue to de-risk this project, the price only goes up. And number two, an asset like Sierra Mojada is very rare. By this I mean there are not many big silver projects like this out there and so there's a certain amount of competition for something like this. And so, if everyone's waiting for the same point, then you're potentially going to end up with competition. This simply means if a company can recognize the potential earlier in the process they are going to have less competition for it. This takes courage, particularly in a market like this, but it is also exactly how big money is made in this industry, by recognizing value early.
Is that an accurate view on the current market? Meaning, with the volatility in metal prices, can it be argued that all appetite for M&A has effectively been put in the freezer?
Tim: I think that's fair, certainly for some companies. What has happened, industry-wide is that a lot of companies have had to turn inwards to sort out their own operations first and get their own house in order. I think we're still going through that process and you've seen a significant shift towards quality over quantity. This needed to happen, but mining is like a warehouse; if stuff is going out the front door, you've got to have stuff coming in the back door since it needs to be replaced. And we're starting to get to the point again where companies are looking at their dwindling resources and they're thinking about replacing those resources. So I think you will see M&A start to pick up again, particularly over 2014.
The other point I'll make is mining companies constantly have to ask themselves: when is the right time to buy assets? The simple answer to that question is when they can buy them for less than they can actually find them. As everyone knows, exploration is a risky business so there's a lot more certainty in buying assets. And this is the time to buy assets; valuations are rock bottom right now. The smart companies should be on a shopping spree.
Would you comment on the company's relationship with Coeur Mining?
Tim: Coeur is a straight shareholder. They came in via two private placements each for $5 million in 2011. They are obviously not doing it as a stock speculation; it is a strategy where they like to get a position in a company that they like the potential of and see how the company develops. Coeur has taken positions in a number of other companies also. We have been very pleased to have them onboard as a shareholder. They have been great on feedback for the company and it provides us with a good understanding on what a mining company may be looking to understand on the project. They hold just over 11% of total shares outstanding.
Do you recall at what prices they invested?
Tim: Yes. The first private placement for $5 million was done at $0.68 and their second private placement, also for $5 million, was done at $0.50.
And there are no split adjustments, so that compares to a stock price today of $0.30 or thereabout?
Let's turn to silver prices. Regarding the economics of the project--you mentioned earlier the IRR and the NAV--what were the key assumptions there for silver and zinc pricing?
Tim: We did our preliminary economic assessment at $23.50 silver -- at the time, silver was actually at $24 -- and $0.95 zinc. However, we were acutely aware that we were in a volatile silver market and so we went to lengths to prepare a sensitivity table showing the project and its economics at varying silver prices. I think we published down to $16 silver and it still had $135 million NPV and a 10.4% after-tax rate of return. Breakeven for the project on the NPV is just over $13 silver.
What's the upside if, say, silver goes back to the mid-$20's where it was not that long ago? Do you have an idea of what additional upside that could mean for the project owners?
Tim: Yes, very much so. At $28 we get an after-tax rate of return of over 30% and an NPV of in excess of $650 million. 72% of our revenue comes from the silver in this deposit so with the high silver price, we benefit a lot.
Can you help me bridge the gap between the NPV calculated for the project and the market cap today? The NPV you mentioned is almost 10 times the market cap.
Tim: We've witnessed a complete overreaction, verging on hysteria, causing a massive, indiscriminate sell-off in the mining space -- regardless of the quality of the asset. Valuations across the board have been beaten up by this overreaction. There are plenty of reasons for this, and plenty of more qualified people than me to explain why, but I think there's truth in the saying that in an outgoing tide all boats go down. I truly believe our project has been caught by this.
With this said, I think it would be fair to say that Silver Bull has weathered the storm better than most and remained relatively stable. I think this is simply a reflection on the quality of the Sierra Mojada asset and the fact that we have been able to demonstrate that this is a very robust project, even in a lower silver price environment.
Can you reference comparable transactions that investors can use to figure out what the company is worth?
Tim: Sure. The last significant transaction in the silver space was completed by Coeur, with their buying Orko Silver's La Preciosa project. This was done at around $1.70 per ounce silver in the ground. To give you a comparison, Silver Bull right now is trading at about $0.30 per ounce in the ground. I say this to point out that market valuations are very low relative to even a year ago.
The bright spot is that mining isn't going away. It's a very cyclical business and there are a lot of people out there in the emerging economies who need resources. So this will be back. There's no question about it. And will we see the kind of valuations that we saw in 2010 or pre-2008? In my view, unquestionably.
Let me stick on this point. If I'm looking at the Coeur transaction as a comp, that implies a value for Silver Bull at 5 to 6 times the current share price. The NPV value is 10 times the current price. I have to ask myself, "What am I missing?" And I think a lot of investors will have the same question.
Tim: The simple answer is timing. The Coeur-Orko transaction was done at a time when silver prices were much higher. I think the silver price was around $27, $28 when that Orko transaction was first announced, and the price paid then obviously made sense. The silver price has changed a lot since then. What has not changed is the size, grade, location and infrastructure of the Sierra Mojada project. Big projects like Sierra Mojada are rare, and even rarer in viable mining countries like Mexico. The mining industry will be back sooner, I believe, than many think -- the key is to make sure the company remains in good health and we are around and in a position to take advantage of it with a quality asset. The hard work has been done at Sierra Mojada.
Cash resources and cash burn?
Tim: We've got just over $5 million cash in the bank. Average burn rate I believe has dropped below $160,000 a month and that includes maintaining a team down in Mexico and all G&A. So, current cash position easily takes us into 2015 if we need to.
What would you highlight as the important risks investors should be aware of?
Tim: For me, right now, it's the market.
What about risks that are specific to the company and its asset?
Tim: We get questions on the overall grade which again is indirectly a question about the market. The higher the silver price, the lower the grade you can mine. Our average grade is approximately 2.5 ounces of silver, but what a lot of people forget is we also have a very significant zinc component and that does a lot for our cash cost per ounce.
The other thing to highlight in relation to the grade question is that we also have some very high grade portions to the deposit. It's these areas that you would mine first to pay off your capex quickly. Once you pay off your mill, a mine can mine much lower grades and still be very profitable. We are very lucky to have near surface high grade portions of the deposit to target first in our mine plan -- it's this which makes the overall grade profitable.
Looking ahead to next year, what are the key accomplishments you are targeting and the ways you would highlight that management can continue to de-risk the story?
Tim: The biggest way right now to continue to add value to the project is through permitting; so water rights, tying up the remaining surface rights in the area, and pushing forward the environmental impact assessment that every mine needs to complete. That's really the most logical step to de-risk the deposit itself.
I also want to continue examining the exploration upside area. This is a big mineralizing system and I want to make sure we've had a good look at some of the other prospects in the area. If we don't drill some of these targets this year we will definitely make sure some of these targets are drill-ready. I would love nothing more than to put out a positive pre-feasibility study on the Sierra Mojada project and a big hole into a completely new zone on one of our prospects in 2014.
Do you expect in 2014 to have final answers on any of the permits you mentioned?
Tim: Yes, we do. Particularly on water and surface. For the environmental side, we can only submit the full report once we have a detailed mine plan in place, which comes with the feasibility. But there are components of that report that we're already well down the path of completing and that's a fauna and flora study, examination of weather conditions. We've got a tremendous amount of data collected on aspects of that environmental permitting already and, from that we can tell thus far, there appears to be no areas of concern on that front.
Time's up. Any closing remarks?
Tim: Yes. To sum up why I think Silver Bull is an opportunity for investors, it's located in one of the best mining jurisdictions in the world. It's one of the largest undeveloped silver deposits in Mexico that isn't already owned by a major silver producer. It has reasonable capex and great infrastructure and the company has cash in the bank. The work to continue to add value in 2014 is relatively cheap, such as continuing with the permitting of the project and early exploration of the very exciting exploration upside in the area that lies along the same trend as the main deposit.
I also can't emphasize enough the discounted valuations we now see due to what I can only describe as almost a hysterical overreaction across the industry that has created a tremendous buying opportunity for quality assets like Sierra Mojada. Keep watching the news as we continue to de-risk this project during 2014.
Thank you very much.
Tim: Thank you.
Disclosure: The author is long SVBL. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I will not trade shares of SVBL for the next 7 days. My compliance department will provide to Seeking Alpha written confirmation of my adherence to this restriction. This article and, if applicable, the interview herein, may contain historical information and forward-looking statements within the meaning of applicable securities laws with respect to the business, financial conditions, and operational results of the interviewed company (the "Company"). Such statements reflect the current beliefs, views, assumptions, and expectations of the Company with respect to future events and are subject to uncertainties and risks. Many factors could cause the actual results, performance, or achievements of the Company to be materially different from those expressed or implied by such forward-looking statements. Some of these factors may include changes in the markets in which the Company operates and in the general business environment and economic conditions, the loss or gain of customers, unpredictable sales cycles, competitive pressures, market acceptance of new products, inability to meet efficiency and cost reduction objectives, changes in business strategy, and various other factors, both referenced and not referenced in this article. In addition, various risks and uncertainties, including but not limited to those described in reports filed by the Company with the Securities and Exchange Commission or other regulatory organizations, as applicable, may affect the Company's operational results. No obligation is assumed to update any forward-looking statements.