Recently, Mr. Sinclair, the President and Chief Executive Officer, issued an insult-laden press release in an attempt to dispute my analysis of the valuation of Tanzanian Royalty Exploration Corp. (TRX) Mr. Sinclair makes four main assertions.
First, his opinion is that I am part of a coordinated attempt with a major short seller to depress the company’s share price. Second, he believes that I ignore the value of the Buckreef project. Third, he implies that my analysis is materially incorrect because I relied on the latest audited financial statements rather than the more recent interim financial statements. Finally, he implies that Tanzanian Royalty has found gold based on the company’s recently acquired interest in the Buckreef project.
Mr. Sinclair makes the baseless allegation that I am working in concert with a short seller. I assure Seeking Alpha readers that I am not. For the record, the only hedge fund professional with whom I have had correspondence is a Seeking Alpha user Greier Capital purporting to be Chris Gibson, a large shareholder of TRX.
Mr. Gibson asked if I would be amenable to him posting a response to my article. I told him that I looked forward to reading his analysis. He published his analysis last week. I had hoped for a more in depth financial analysis. Further, the short interest in the stock is not particularly high with only about 5.5 million shares sold short, making short interest as a percentage of the float about 6.5%. I find it curious that the management of a company with a relatively normal short interest would be so focused on short sellers.
With respect to Buckreef, Tanzanian Royalty Exploration acquired the rights to the project in Dec. 2010. This is a quote from Joseph Kahama on January 9th 2011.
It was during the first speech where I learned that initially there were 37 competing bids from various companies for the Buckreef Mine Re-Development Project. The list was later reduced to eight after the first round of inter-ministerial consultations with industry experts. Out of the eight, a final short list of three companies emerged. All finalists were competitive and qualified in their own respects, but a winner had to emerge.
It defies credibility that an asset the company acquired for C$3,000,000 in a competitive bidding process with 37 bidders would be worth significantly more seven months later. Plus it appears that all Tanzanian Royalty Exploration has done to increase the value of the project is to review the data from the previous owner. This is a quote from the National Instrument Technical report exhibit 99.1 on form 6K filed February 2/22/11 regarding that acquisition.
TRE has not undertaken exploration on the Buckreef Project to date as it only recently acquired the licences in December 2010. TRE plans to initiate a Pre-Feasibility Study as part of the process to fast track the project to production.
To date the company has not announced the completion of a pre-feasibility study on the Buckreef project. Additionally to date, Tanzanian Royalty Exploration has yet to even conclude the joint venture agreement with STAMICO. On the STAMICO website, the Buckreef project is listed with this comment:
Through STAMICO an international competitive bidding was conducted and finalized in early December, 2010 in order get serious investor to finalized (sic) the feasibility study and open up a mine.. The Tanzania Royalty Exploration Corporation (TANZAM 2000) was awarded the bid. The Government remains with 45% while the parner (sic) holds the 55% shares. The JV agreement is to be concluded soon.
To repeat, a competitive bidding process valued this project at $3,000,000 in December 2010.
The third point raised by Mr. Sinclair, is my use of the financial statements from August 2010 when interim statements are available. The financial statements used were the last audited, annual statements available. I should have been more careful and precise in stating that fact. I used the last audited statements because the company has disclosed a material weakness in its internal control over financial reporting (see page 7). That issue aside, the amount of cash raised through the private placement and debt issuance subsequent to August does not alter the analysis of the value of the assets. From an accounting perspective, the amount of cash raised increased the book value by about $0.10, hardly a material change. Nor does it alter my conclusion that the company has insufficient cash to develop the Buckreef project.
That assertion is confirmed right in the recent press release:
It is the company's opinion that the posting is a coordinated attempt with a major short seller to depress the Company's share price as it investigates financing opportunities for its feasibility stage Buckreef Gold Project in Tanzania.
My opinion is that the company would like to point to acquisition of the Buckreef licenses as significant component of the value of the company. However, the acquisition does nothing to alter the total assets on the balance sheet, or the book value of the company. From an accounting standpoint, all the acquisition does is reduce the asset, cash, and increase the asset, mineral properties.
Based on Canadian disclosure standards, the Buckreef project contains gold resources. The terms describing the mineral resources claimed by the company are defined in the standards issued by the Canadian Institute for Mining, Metallurgy and Petroleum.
Since according to accounting standards assets are not marked up on financial statements, the key for equity investors is to determine the actual value of the Buckreef resources. On April 15, 2011, the company reassessed the economic viability of its mineral resources and increased the assessment of mineral resources at Buckreef to 303,000 ounces Measured Resources, 101,000 ounces Indicated Resources, and 590,000 Inferred Resources by lowering the cutoff grade to 0.5 gram/ton.
The standard valuation technique is to compute a net present value. I modeled the Buckreef project using the following formula which sums the probability weighted discounted cash flows from each classification of resource.
Where n = the year, r = the discount factor, P1 = the probability that the measured resources are economically viable, P2 = the probability that the indicated resources are economically viable and P3 = the probability that the inferred resources are economically viable.
The probabilities would be subject to change based on the results of a feasibility study. I calculated the NPV based on 10 years of production using a range of probabilities from 0% to 65%, and r values ranging from 7% to 12%. I use the current price of gold.
Since there is no feasibility study, although Mr. Gibson alludes to one, my estimate of extraction cost is based on the public disclosure of the cost of nearby projects. In all but the more optimistic cases, the present value of the Measured Resources is less than the current capitalized costs on the balance sheet. Further, the value does not begin to approach the market capitalization. Even if I include the resources with lower levels of confidence in the analysis, I cannot achieve an estimate of the assets that even remotely supports the current market capitalization.
This is the CIM guideline for Inferred Resources which supports assigning a low probability to the inferred resources.
Due to the uncertainty that may be attached to Inferred Mineral Resources, it cannot be assumed that all or any part of an Inferred Mineral Resource will be upgraded to an Indicated or Measured Mineral Resource as a result of continued exploration. Confidence in the estimate is insufficient to allow the meaningful application of technical and economic parameters or to enable an evaluation of economic viability worthy of public disclosure. Inferred Mineral Resources must be excluded from estimates forming the basis of feasibility or other economic studies.
Further NI 43-101 2.3 (1)( b) states Prohibited Disclosure (1) An issuer must not make any disclosure of the (pdf) (b) results of an economic analysis that includes inferred mineral resources. Due to the uncertainty, an analyst might completely exclude inferred resources. Arguably, the discount rate of 8% that I apply to the project is too low given that this is a revival of an abandon project. Additionally, I have not estimated the capital expenditure required to start production. Including that figure would further reduce the value of the project.
In his analysis, Mr. Gibson arrives at a value of $300 million, which includes the inferred resources. Even with that value, I wonder how he can justify the over $600 million market capitalization of the company. Additionally, keep in mind that he acquired most of his position prior to the Buckreef announcement so he should be able to identify additional projects with over $600 million of value as a basis for the stock price in December 2010.
Mr. Sinclair seems to think that my statement, “even if Tanzanian Royalty Exploration managed to find gold“, is ridiculous in light of the company’s published resources. As far as I can determine, the company has only published resources relating to the Buckreef project.
Tanzanian Royalty Exploration did not find the gold, they acquired it. From the company’s SEC filing prior to the Buckreef acquisition:
The Company has no mineral producing properties at this time. The Company has not defined or delineated any proven or probable reserves or resources on any of its properties.
I could be wrong but that doesn't sound like the disclosure of a company that has struck gold.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
