Crystallex’s Speculative Shine Begins to Tarnish

Since my last article covering Crystallex (KRY), the share price has surged by over 20% but has slowly begun drifting down again. For most investors, and in consideration of all of the promotion surrounding Crystallex and the perpetually imminent granting of a long awaited environmental permit from the Venezuelan Government’s Ministry of the Environment (Ministerio del Ambiente) MINAMB, the increase is understandable despite being illogical.

This kind of blindness to plain common sense and this type of investment fervor has occurred many times over the years, more recently during the era of the Dot.com stocks that were afforded share prices that could never be justified. Recently, however, there have been signs that Crystallex’s appeal has reached a plateau and is slowly but surely descending. This is not to say that further promotion and a higher share price is not in the cards, but more and more it seems investors are looking beyond the hype and to the facts. This cannot be welcome news for either Crystallex’s executives or its investors.

On May 14th, Crystallex released its unaudited first quarter financial report for 2007. For most companies the report itself would have been damaging to the share price but it was more or less ignored as the short term infatuation with Las Cristinas and some overly optimistic comments from CEO Gordon Thompson were more than enough to offset that. The report itself is bleak and paints a picture of a company caught in the tug of the quicksand of failed corporate management. The only thing keeping it afloat being a contract to mine Las Cristinas which could itself eventually prove to be of less worth than the paper it was printed on.

During the first quarter of 2007, Crystallex recorded a net loss of 8.2 million. Losses are commonplace for Crystallex and have come to be expected as the company has never been able to show an operating profit. While there was a period in time when Crystallex was trumpeting profitable operating figures, that all ended when faced with a TSX and OSC investigation as a restatement of the annual financial numbers showed that the profits for those years were actually misstated and Crystallex had in fact been losing money. Further inspection and reading of the current results do provide a peephole into the future of the company.

As anyone might expect, the first question that arises is why Crystallex continues to lose money on operations even as gold prices realized were 18% higher in 2007 than during the first three months of 2007. Gold sales revenue for the quarter was $6.4 million or $0.7 million less than the previous year. Crystallex produced 13% less gold than in the first quarter of 2006 and sold approximately 25% less gold that it did during the same time last year. Incredibly, the total cash cost per ounce sold was an astronomical $669.00, a 73% increase over the previous year while the realized price for the gold sold averaged $651.00.

The picture gets bleaker when it is realized that total cash cost of sales include mining, processing, mine administration, royalties and production taxes but do not include corporate, general and administrative expenses, depreciation and depletion, financing costs capital costs and reclamation accruals. According to the report, the lower production at the Revemin Mill was attributable, in part , to open pit mining interruptions including low equipment availability, delays in receiving explosives permits and water at the Fosforito pit on the Tomi concession.

In addition, despite mining and milling fewer tonnes in the first quarter of 2007 as compared with the first quarter of 2006, total costs increased as a result of general increase in most operating areas , particularly explosives, mill consumables and labor. A look at the source of the gold produced by Crystallex also shows an increased reliance on refractory ore at the La Victoria property. The report clearly indicates that there are no NI 43-101 compliant mineral reserves to report for the Tomi operations. Open pit operations are projected to cease in 2008 although new resource estimates from an underground drill program are expected in 2007. A check of the Resources and Reserves section of their website suggests it is time for an update as the company is still using 18 month old data to entice investors.

In essence, Crystallex’s projects have virtually run out of ore that can be mined profitably and the company is literally skimming the bottom of the barrel to continue production. As unpleasant as it may be, most of the information provided in the report is standard. It is only as one digs deeper and extrapolates from the information to formulate a forward looking picture of Crystallex that one realizes how truly hideous it is. Crystallex’s entire existence is based upon its contract with the CORPORACIÓN VENEZOLANA DE GUAYANA [CVG] to mine the Las Cristinas deposit. It’s current market capitalization is based upon speculation o! f the successful acquisition of the environmental permit from the MINAMB to initiate construction of the mine and milling facilities. Of the two major issues confronting Crystallex at the moment, the acquisition of the aforementioned permit from MINAMB is secondary to any changes the new mining law may bring.

AsI reported in my last article, in a recent interview with Reuters, the chief main directorate of Planning and Arrangement at the MINAMB, Sergio Rodriguez, said that Crystallex has not acted responsibly in planning their project and that the plans had to be changed to minimize or eliminate environmental objections and that Crystallex consider plans to take advantage of processing the copper deposits at Las Cristinas. This would present a significant problem for Crystallex as their MOA does not include the rights to mine copper and all of their plans are designed to process the gold only. Any forced changes could take more ! than a year to complete. If we assume that Crystallex is grant! ed the p ermit shortly, there is another consideration. While acquiring it would be a milestone , the relative worth of that permit may be extremely limited to investors in the company’s stock. There is a widespread belief, fostered by none other than Crystallex itself, as well as its promoters that this is the “final” permit required from the Venezuelan government.

With Crystallex’s reputation of deliberately avoiding full disclosure by using carefully worded statements, it may be worth a closer look. It has been regularly reported that both Crystallex and their geological neighbor Gold Reserve Inc. (GRZ) had been waiting for the same permit, the Permisso de Afectac´ýon de Recursos (Permit to Impact the Environment), based upon the approval of their respective ESIAs by the MINAMB. Crystallex is still stuck in limbo waiting as they have been for years but Gold Reserve’s wait recently ended when their permit was granted in late March. The questi! on that arises is whether or not this is truly the last permit required to mine the gold The confusion arises from Crystallex’s wording in regulatory documents . In regulatory documents, Crystallex consistently states that “acquiring the environmental permit (is) necessary to allow commencement of construction of the mine.”

The operative word is “commencement.” In some cases they juxtapose a similar statement with assurances that upon receipt, and a few other qualifications, production should commence within approximately 24 months but choose not to discuss the potential for further bureaucratic delays. Reading Gold Reserve’s disclosure provides a different picture. Gold Reserve had been waiting for the Permit to Affect from the MARN and while it has referred to the permit as the “permit to Affect for Construction and Exploitation", comments in its recently filed prospectus clarify that it has only received the permit to construct the mine.

While the issuance of the Authorization for the Affectation of Natural Resources for the Construction of Infrastructure and Services Phase of Brisas does not permit us to exploit the gold and copper mineralization at Brisas at this time, this permit allows us to commence certain infrastructure work detailed below, including various construction activities at or near the mine Site.

Gold Reserve goes on to say that:

We are currently working with the MINAMB on an environmental and social evaluation related to the collective environmental impact of Brisas and surrounding mining and infrastructure projects. During this assessment period and upon the completion of the evaluation, we expect to receive additional permits or authorizations from the MINAMB that relate to additional infrastructure approval and the approval of the exploitation phase. We also continue to pursue additional permits and authorizations from various local, state and federal agencies.

Crystallex does comment, in the RISK FACTORS section of its regulatory filings, that “the Corporation is required to have a wide variety of permits from governmental and regulatory authorities to carry out its activities. These permits relate to virtually every aspect of the Corporation’s exploration and exploitation activities” but the comment is obviously lacking. Venezuela requires a myriad of permits for mining activity from all levels of government but even though most are minor, they can still cause delays and greater expenses as Crystallex experienced with the explosive permit at the Tomi mine. The Permit to Affect is the forebearer of future permits from MINAMB even if it does not guarantee that they will be issued.

It behooves Crystallex to clarify this matter for its investors both current and potential. If the permit is divided into two parts and Crystallex will have to wait for the Permit to exploit, or if it is determined that future financings to complete the construction of the mine may not be available under acceptable terms or at all until the permit to exploit is granted, the reaction generated by investors could be adverse to the share price if they come to feel that they have been intentionally misled. If this permit provides no assurances of further permits, the avoiding of further delays in the production of gold and does not provide Crystallex with any autonomy by providing a cleared path through Venezuela’s all encompassing bureaucracy, what then is the intrinsic value of the permit from MINAMB other than allowing Crystallex to begin financing and building the mine through further possibly dilutive or expensive offerings?.

Conversely, clearing up this disparity may well provide greater confidence to market participants who may have doubts about Crystallex’s progress based upon the Gold Reserve experience. The “Permit” is currently the focus of many investors and , at least in the public eye, that of Crystallex. The issue with the greater adverse potential for the company is the enactment of the n! ew mining law. A new mining law calls for a mixed company regime in which Venezuela would control at least 51% of all mining projects.

In an April 17, 2007 interview with Dow Jones, Vice Minister of Mining Ivan Hernandez said of the Mine Operating Agreement [MOA] that Crystallex‘s operating contract has some clauses that need to be revised and that “It will move from being a contract to a mixed company (jointly owned by the Venezuelan government.)“ In a later interview with Reuters, Mining Minister Jose Kahn contradicted the statements made by Hernandez by claiming that no decision had yet been made. It should be noted that Vice Minister Hernandez and not Minister Kahn has the greater responsibility over mining in Venezuela. Minister Kahn has also let Crystallex down. Instead of confirming the status of Crystallex’s MOA, he only said that no decision had been made. In a May 28th article by Dow Jones Newwire, Minister Khan once again confirmed that no decision had yet been made even though the mining law would be submitted to the President for approval in two weeks. That statement alone suggests that Crystallex’s MOA could be redefined.

President Chavez has already demonstrated a willingness to cancel operating contracts, albeit primarily in the oil mining sector thus far, unless the companies engaged renegotiated the terms and gave up majority control of their projects. Compensation for those companies has not been determined but comments by Chavez suggest that Venezuela would only be willing to pay what the respective companies paid to build the project. He has also recently forced steel company Sidor to make concessions to its operations to avoid nationalization. Losing control of more than 50% of reserves and anticipated production profits is bad enough however Crystallex has another outstanding problem. They have a 100 million unsecured debt outstanding and a reading of the prospectus for that debt shows that there is a clause in that lending agreement that could cause Crystall! ex to cave in upon itself.

The clause reads: Project Change of Control If:

(a) a Project Change of Control occurs and (b) the Corporation (if entitled to do so) does not elect to redeem the Notes, the Corporation will be required, at the request of a holder of Notes, to purchase all or part of the holder’s Notes for cash in U.S. dollars at a price equal to 102% of the principal amount of the Notes plus accrued interest.

Project change of control, as defined in the prospectus reads :

Project Change of Control’’ means the occurrence of any transaction as a result of which the Corporation ceases to beneficially own, directly or indirectly, at least a majority interest in the Las Cristinas Project.

Evidently this means that if Venezuela forces Crystallex into a joint venture proposal and takes more than 50% control of the project, Crystallex is exposed to a potential redemption payment of up to 102 million dollars plus accrued interest. It can be assumed that with a loss of over 50% of the Las! Cristin as project, the share price would drop precipitously which would suggest that coming up with 102 million to pay back debt holders would mean significant share dilution to existing investors.

In accordance with the above information, it is easy to see that Crystallex shares could be worth significantly less than recent valuations literally overnight depending on the whims of the Venezuelan government and decisions by debt holders. Finally, there is consideration of a valuation for the worth of share ownership of Crystallex based upon the best case scenario that changes in the Venezuelan Mining Laws will not affect the company or its contract. On an operational basis, Crystallex is worth much less than its current valuation. After two years of construction, the company plans to produce only an average of about 300 000 ounces per year. As of the last report, since the inception of the Engineering and Procurement Report [EPCM] which costs the development of Las Cristinas at 293 million, Crystallex has spent 181 million on the project but only $115 million is related to the costs governed by the EPCM which means that at least 180 million must be raised to build the mine. The estimated costs are based upon a two year old assessment. Since then costs have risen. As Crystallex disclosed about its Tomi operations, there are general increases in most operational areas “ particularly explosives, mill consumables and labor.” This carries with it the suggestion that costs for Las Cristinas, which Crystallex will not update until after they are granted the permit, have also increased materially which undoubtedly means further dilution.

In addition, as noted, Crystallex’s other operations could soon cease and so, assuming permit granting “sooner rather than later“, during at least 2 years of construction, Crystallex be will require to raise capital to not only build the mine but also to fund everyday operations, pay current and any additional interest on other debt they acquire, final reclamation costs for expired concessions and other costs associated with the company.

Currently, according to Crystallex , as of April 25th 2007, they have 260 million shares outstanding, 291 million shares fully diluted. Using approximate cash cost figures from the yet to be updated study, the earnings per share [EPS] are negligible. Unless the gold price skyrockets, EPS will decrease significantly when dilution for updated costs, administrative expenses, debt payments and other expenses are added in. Making matters worse, no proper valuation multiple can be allocated to can be calculated to estimate a target share price. Crystallex has an operating contract for 20 years with two ten year renewable terms; seven of those years will have expired by the time production at Las Cristinas begins assuming the granting of a permit this fiscal quarter and there is no guarantee of terms of the MOA under renewal terms.

Crystallex’s main appeal therefore is as a takeover target based upon the control it has over the reserves at Las Cristinas. The problem is that not all gold ounces are equal and it is virtually impossible to imagine any other company willing to risk a billion dollars or more to buy Crystallex without concrete assurances that they will get what they pay for and be unrestricted by the Venezuelan government. Unfortunately, as has already been proven, under President Hugo Chavez’s administration, no such guarantees are available.

KRY 1-yr chart

Disclosure: none

Comments

[anon anon:]

could you please disclose your direct and indirect exposure to crystallex? there must be a reason behind this constant agenda of yours. you only ever write about crystallex.

2007 May 30 08:37 AM

[Jim D.:]

It seems to me that while you may think you are being helpful, that it would have been better for us longs if you had made these comments after the permit news comes out. For all of us already in the stock you have hurt out potential profit once the news hits. Food for thought for the future anyways...

So far, it seems to me that facts don't matter with short-term price fluctuations. Only hype matters and that is what I'm interested in primarily. I want to get on board before the hype really hits and dump it. I'll save my longer positions for safer stocks but no one invests in KRY for their nest egg so why state the obvious and hurt the price??

2007 May 30 10:41 AM

[D. Metzer:]

Wow, three pages of material just to 'Tarnish' a companies image. That looks like it took a lot of time and work to put together.
As noted in the first two comments the only point in this blog is to hurt KRY SP. Which brings one to wonder what Bane's real motives are, to go to such lenghts.
It is no secret that The Tomi and La Victoria mines are being played out.
It's regretable that Bane is still using Sergio Rofriguez as a source, since Rodriguez was oblivious to Crystallex's cyanide destruction plan, as he was quoted as saying they had none.
Crystallex's finances are bad, but are exxagerated a bit due to the purchasing of pretty much all the ming equipment. In the long run this should save Crystallex, but for now does seem a bit like puting the cart before the horse.
Still Crystallex is about one thing right now, and that is the Permit.

2007 May 30 11:08 AM

[daniel22898:]

Echo Merriweather's comment here that you should disclose your direct and indirect exposure to crystallex. I do find your long and reiterative arguments a bit suspicious. Your article basically can be used to lambast stocks investment in general as high risk and illogical.

Also agree w/ the_celt_beserk that you tend to pick and choose your sources including sources that have been proven unreliable and/or irrelevant.

And in regards to your speculative conjectures of what future Venezuela laws would be pass and how they might impact the companies profits seem one-sided. This is a rather complicated issue of what should be the proper formula for profits for private enterprises, and for the local people and government. Keeping my comment short, I would say that the signed agreement between KRY and the Venezuela is deemed fair for both parties, and there's no evidence showing either party would want to revoke the agreement.

Mr. Bane, why you wrote such a long piece filled w/ fear and skepticism just to tarnish one company? what's your ulterior motive?

2007 May 30 01:06 PM

[bane2007:]

To those who read my work and took the time to respond, I express my thanks. In answer to the questions posed, I have no direct or indirect interest in Crystallex's stock or its success or failure in Venezuela. I receive no financial incentives or compensation from my article.

For New Yorkers or those who have on-line access, there is an interesting article in today's NY Post about Shake Shack. It is a popular Burger kiosk that has lineups around the corner. Shades of Seinfeld's Soup Nazi. Steve Cuozzo reviewed it and tore it to shreds. The point of mentioning the article is that I may be naive about hidden agendas but the thought did not occur to me that Cuozzo was being paid by a competitor to write the article or that he had ulterior motives. I took the article at its face value, a suggestion not to waste my time or money. I may be missing out on something special but I don't think so. The Crystallex case is only slightly different. Here I get to see the ingredients beforehand and taste it for myself. It only makes me gag.

www.nypost.com/seven/0...

That I am deliberately attempting to hurt the share price of Crystallex is a ludicrous claim. Everything I wrote and referenced is documented in the regulatory filings of both Crystallex and Gold Reserve. If it looks negative, it's because it is. I accept no responsibility for the terrible job Crystallex's executives do.

What I have done is warn people not to waste their time or money by looking at Crystallex as an investment. This is a gamble purely and simply and in the end the pot is not even worth the risk. What stacks the odds against the gambler even more than normal is that the dealer, in this case the management of the company, does not deal fairly. They hide cards up their sleeves, bottom deal and so forth. There is no question about this at all. When they have visited the city, I have spoken face to face with several of the main individuals in the company, some who have already abandoned ship or been forced to walk the plank. I have a good sense of how they operate. Welcome to the snake pit.

My final comment is about my conjectures about the new law in mining to be passed. These conjectures, if that is what you want to call them, are drawn from comments made by the politicians in charge of such things. If you want to blame anyone, blame them but I would make the suggestion that you wait for the law to be passed and see the fallout before deciding who is misleading whom.

2007 May 30 07:27 PM

[knightblaze:]

Mr. "Bane" (Dictionary definition: A source of persistent annoyance or exasperation)

You have a very appropriate handle. Unlike you, I keep things short and to the point. You are a great contrarian indicator with regards to KRY's share price performance and your "articles" usually precede major positive company developments. Readers of Bane's article should beware the motives of anyone writing 3 pages worth of an attack on a specific stock.

An example of the fuzzy logic behind your "article" - "It should be noted that Vice Minister Hernandez and not Minister Kahn has the greater responsibility over mining in Venezuela" - you got to be kidding, where do you live? Bizarro world?

Disclosure: I do own a significant position in KRY shares.

2007 May 31 06:40 AM

[Trey Wasser:]

A message to KRY shareholders.
I happen to agree with Mr. Bane and appreciate his work. One reason why I started to publish my due diligence on SA was my frustration with message boards on individual stocks. The message boards have become nothing but a place for longs to hold hands and perform their cheerleading routines. Anyone who actually does due diligence, like really reading the SEC filings, does comparative valuations of similar companies, or otherwise reveals negative aspects of a stock, is labeled a basher (or worse) and discounted completely. I salute Mr. Bane for his work as he has obvioulsy done his homework and has expressed his opinion very diplomatically. Anyone who disagrees with him should suppport their view as concretely. Better yet, write your own report on why KRY is such a great value and have the guts to submit it for publication. I wrote a report gold.seekingalpha.com/... comparing GRZ and KRY. Just because you are long the stock is no reason to belittle Mr. Bane. You should appreciate someone pointing out the negatives, then do your own research. Anyone who believes that KRY is all about a PERMIT, is simply wrong. KRY is extremely overvalued for what they actually own (or don't own). The MOA has a real problem with no copper production. Leaving the copper in the waste rock will be an environmental nightmare. For this reason, I believe the permit is a long way off and the MOA will have to be renegotiated. Financing will be a real problem for a project in Venezuela that does not inlcude actual ownership of the reserves. There is a reason for the revolving door at KRY headquarters. Ask yourself, why is KRY selling at 4 to 5 times the enterprise value of GRZ? I believe, the answer is that many of those willing to buy or hold KRY at today's price are not doing their homework. Even worse, they are discounting those that do. Mr Bane and I may be wrong about KRY, but that is what makes markets.
Trey Wasser
III-D Capital

2007 May 31 09:30 AM

[daniel22898:]

I was surprised to see the rebuttal by Mr. Bane and a comment post by Mr. Wasser in the defense of Mr. Bane's article. I appreciate the extra time and efforts both gents took in replying to the readers' posted questions and comments including mine.

I have to say that my opinion about Mr. Bane's article and his intention remains unchanged. In fact, I get even more suspicious when he added his comments about KRY management being dishonest "...They hide cards up their sleeves, bottom deal and so forth...."

I am an individual investor. I have owned KRY shares for about 2 years. I have zero connection to any of the KRY employees, past and present. I am not here to defend the KRY management. They are all adults and I trust they can defend for themselves. My request is to ask Mr. Bane to present some evidence to back his claims about the KRY management. To me "Hide cards... Bottom deal" are serious accusations indicating someone is breaking the rules.

2007 May 31 01:54 PM