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Back in November I covered the bull case for Thompson Creek Metals (NYSE:TC), a producer of molybdenum through mines in Idaho, and British Columbia. The stock had struggled for most of 2011, hitting a two-year low in October amidst economic fears and the company's difficulty in digesting its acquisition of Terrane Metals in 2010. In particular, cost overruns at the company's newly purchased, but undeveloped, Mt. Milligan gold and copper mine had eaten into the company's reserves, and the traditionally net cash-positive stock was facing a funding gap estimated between $100 and $300 million.

At the time, I argued that TC was severely undervalued on a sum-of-the-parts basis, and that a gold stream transaction was likely to emerge and ease investors' fears about a possible shortfall. Indeed, such a transaction was completed last week, and the stock has jumped some 17% since my November recommendation. Most of the bull run came ahead of the financing announcement; the stock opened sharply higher on Friday following the after-market announcement on Thursday, yet gave back most of its gains. (In the interest of full disclosure, the stock is still down some 12% from my initial bullish piece in October, but let's try to focus on the positive, shall we?)

Thompson Creek's new deal with Royal Gold (NASDAQ:RGLD) amends the previous gold stream transaction, struck in connection with the Terrane purchase in 2010. Royal first bought 25% of the Mt. Milligan gold stream for $311 million, at a cost of $400 per ounce (roughly equivalent to the expected cash costs from extraction), with that cost rising to $450 per ounce past a certain benchmark. Under the amended agreement announced last week, Royal purchased an additional 15% of the stream for $270 million, with the cash costs now a flat $435 per ounce, regardless of the amount delivered. (Based on estimates from the company's third-quarter earnings presentation, the cash cost change should benefit TC. Average payment from Royal to TC over the 22-year projected life of the mine would have been about $425 per ounce, rising to $435 under the current agreement.)

The steeper price paid by Royal Gold in the second round of financing reflects the sharply higher price of gold, of course. The original deal valued the Mt. Milligan gold stream at $1.24 billion, net of mining costs. The additional round gives the gold stream a valuation of $1.8 billion. Remember, this is the net present value of the gold reserves, less the cost of extraction, based on the agreement between Thompson Creek and Royal Gold.

We start our sum-of-the-parts analysis here. Thompson Creek's remaining stake in the Mt. Milligan gold stream is worth, based on the Royal Gold deal, $1.08 billion. Yet the mine also offers extensive copper reserves: an estimated 89 million pounds of production in the first six months of mining. In its Q3 earnings presentation, the company estimates its cash costs per pound of copper at less than 50 cents per pound. At today's prices, we can see that the profitability of the copper reserves will challenge that of the mine's gold reserves:

Gold vs Copper Streams at Mt. Milligan
Metal Current Price1 Cash Costs2 Annual Production2 Annual Profit
Gold $1628.3/oz $435/oz 262,000 oz $312.6MM
Copper $3.74/lb $0.50/lb 89,000,000 lbs $288.4MM

1 -- from Bloomberg, December 21st, 2011

2 -- estimates from TC's 3rd quarter earnings presentation (pdf); gold cash cost estimate from updated Royal Gold financing transaction

The estimated annual profit from the copper stream represents some 92% of the gold stream earnings in years 1-6 of the Mount Milligan project. (Beyond year 6, copper production is expected to decline far less than that of the gold reserves.) Conservatively, we can therefore value that copper stream around $1.5 billion, a 17% discount to the net present value of the gold stream. Again, this is a conservative assumption, based on the relatively similar profit margins and the higher expected copper production in the out years.

Of course, TC has full ownership of the copper rights, making the net present value of its Mount Milligan rights -- 60% of gold, 100% of copper -- at least $2.5 billion at current gold and copper prices. And to reiterate, this is not the market value of the proven reserves over a 20-year life span; this is the net present value of the reserves, less future extraction costs, based on the valuations from the gold stream transaction, estimated cash costs, and current commodity prices. (Per the company's most recent 10-K, Thompson Creek defines cash costs as excluding only "the effect of purchase price adjustments, the effects of changes in inventory, stock-based compensation, other non-cash employee benefits and depreciation, depletion, amortization and accretion." In other words, almost everything is included.)

In addition to its Mount Milligan asset, TC had $365 million in cash on hand as of its third-quarter earnings (ending September 30th). An additional $329 million is due from Royal Gold over the next two years, bringing the total in current and future cash to $694 million. As of September 30, total liabilities -- current and otherwise -- were $1.15 billion. Exclude the $226.5 million in deferred revenue from the gold stream -- which does not need to be repaid, only accounted for in future earnings reports -- and net liabilities sit at $889.1 million. Per the Q3 earnings presentations, future capex required to complete both the Mount Milligan project and the expansion of the Endako molybdenum mine in British Columbia stands at C$987.5 million ($962 million USD). Thus:

Mt. Milligan + Cash, Less Current and Future Liabilities
Asset/Liability Value (MM)
Mt. Milligan $2,500
Cash $694
Total Liabilities ($889)
Future Capex ($962)
Net Total $1,343

At Thursday's close of $6.97, TC has a market capitalization of $1.17 billion. Theoretically, Thompson Creek could sell off its rights to the Mt. Milligan reserves, finish the project, pay every dollar it owes, and pay a $7/share special dividend, a full rebate to each and every shareholder.

Having done so, the company would still have $150 million in cash. It would have $93 million in accounts receivable, and $130 million in inventory. It would have millions in plants and equipment. It would still own the undeveloped Berg and Davidson properties in British Columbia. And, of course, TC also would retain the two molybdenum mines, and a smelting operation in Pennsylvania, which generated $181 million in operating cash flow through the first three quarters, and averaged $110 million in free cash flow annually between 2007 and 2010, despite the collapse of the moly market in response to the 2008-09 financial crisis. (Investors should be aware that moly prices continue to fall, after TC saw a 10% sequential decline in realized price in the third quarter. Yet the company still generated $51 million in operating cash flow and a small profit. Future cash costs should rise to $8.50-$9 per pound in the next two years, but even at currently depressed levels moly is trading above $13. In addition, the two mines have projected life spans of 15 and 18 years, respectively.)

I argued back in November that the market was pricing TC as if the company would botch its funding transaction (CEO Kevin Loughrey had hinted strongly at a secondary gold stream financing in the third quarter conference call) and as if the prices of moly, gold and copper would collapse. Even under those conditions, at $6/share, the company's legacy assets seemed drastically undervalued. Now, even with a 17% rise in the stock price, the excellent terms of the amended Royal Gold deal and some recent strength in commodity prices make TC look even stronger. The uncertainty surrounding the funding of the Mount Milligan project should be gone, and its valuation clear. By itself, that project, at current prices, more than supports the current stock price. The company's additional assets provide the type of cushion that solid value investors seek, making Thompson Creek a solid investment in a traditionally volatile and unstable sector.

Source: Thompson Creek Metals: Funding Gap Closed, Upside Remains