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El Luchador
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Follows value investing philosopy, CFA charterholder
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  • Money For Nothing, Silver For Free

    Silver Standard Resources (SSRI) has an unreasonably low valuation. The company currently has one silver mine, Pirquitas, located in Argentina (which is one of the largest in the Americas) and it has two advanced stage development projects, one in Peru and the other Mexico. The silver resource base of its eleven total properties is the largest of the publicly-traded primary silver producers. Its proven and probable silver reserves total 189 million, measured and inferred resources total 1.1+ billion, and total resources including inferred resources total nearly 1.7 billion ounces. The company also has zinc and gold resources. The stock, currently priced near $13.75, is 62% below its 52-week high.

    While I do believe there are serious potential consequences for the future of the U.S. Dollar given the money printing and accumulation of massive debts in recent years, the risks of these various disaster scenarios playing out is not the reason why I believe SSRI is a good investment. The dollar doesn't have to crash, interest rates don't have to skyrocket, nor does silver need to explode higher for an investment in SSRI to payoff. In my view, the value place on the company by the market is just unreasonably low given circumstances today. But if some of these "tail risk" events do come to pass, then with its huge physical asset base, SSRI should provide investors with a means to preserve their wealth, which is an added bonus.

    Why is the market ascribing SSRI a low valuation? I believe there are several reasons for this: a.) the silver price is extremely volatile and there is skepticism regarding the sustainability of current prices, b.) its only operating mine, Pirquitas, has had some operational hiccups since ramping up in 2010, c.) Pirquitas is located in Argentina, which is a questionable business environment to say the least, d.) an economic slowdown in China is weighing on many commodity producers, e.) overall sentiment in the precious metal mining sector is very low currently, and f.) investors have not recognized the hidden value on SSRI's balance sheet.

    What is SSRI worth? As the company only has one operating mine, the company's value is best represented in its assets rather than its current cash flows. As of December 31, 2011, SSRI's book value was approximately $1.05 billion. However, SSRI owns 18.9 shares of a company called Pretivm Resources (PVG) currently worth over $295 million. But because this asset is accounted for using the equity method on SSRI's balance sheet, its value must be adjusted upwards by $195 million to reflect market value. After making two additional adjustment (netting out deferred tax assets and liabilities and assuming the value of an $89 million tax receivable from the Argentine government is worthless) the adjusted book value comes to $1.12 billion, which compares to a market capitalization of $1.11 billion (the company is trading for 1x adjusted book value). Is this reasonable?

    Trading for 1x adjusted book value doesn't necessarily mean that SSRI is cheap; however, when its individual assets are examined, it is clear the market is ascribing minimal value to its resource base. First, the company has nearly $400 million in cash (this assumes the cash balance as of December 31, plus $70 million the company received from Pretivm warrants subsequent to year end), $295 million in Pretivm stock, an additional $33.5 million in marketable securities (primarily Kingsgate Consolidated related to the sale of a property to Kingsgate), and a $5 million receivable due from Kingsgate in 2012. In other words, the value of SSRI's cash and securities exceed $733 billion, which accounts for 65% of its adjusted book value!

    In addition to its cash and securities, SSRI owns one operating silver mine located in Argentina. Pirquitas has an operational mine life of 6.5 years, 84 million ounces of silver reserves, and 224 million lbs of zinc reserves. For 2012, the mine is projected to produce between 8.2 and 8.5 million ounces of silver. Assuming a silver price of $30, Pirquitas should produce at least $50 million in free cash flow annually for the next several years. What is Pirquitas worth? According to SSRI's 2009 annual SEC filing, it cost approximately $333 million to construct, including pre-construction costs. Because discounted cash flow models are subject to significant uncertainty, I will conservatively assume that Pirquitas is worth $300 million, which is less than historical cost (a value higher than this is easily reached with conservative assumptions using a DCF). With cash and securities of $733 million and assuming Pirquitas is worth $300 million, the market is valuing all the remaining equity (ten resource properties with over 1.1 billion ounces of silver proven and probable reserves and measured and indicated resources) of the company for literally next to nothing! As SSRI has about $125 million in debt, an investor would have to pay roughly $1.24 billion to purchase the entire company. Considering that in doing so, an investor would receive nearly $1.03 billion in cash, securities, and an operating silver mine, the remaining proven and probable and measured and indicated silver resources could be purchased for less than $.20 per ounce. At a stock price of around $11.25 and holding the value of SSRI's securities portfolio at current levels, the silver in the ground is free (so maybe the "maximum" downside is 18% assuming a starting stock price of $13.75).

    What is SSRI worth? This is difficult question to answer. It is much easier to determine it is undervalued rather than to precisely estimate intrinsic value, especially considering the company sells a commodity. However, one good indication may be the prices at which SSRI has carried out transactions in the past. I won't go into the details, but over the past couple years, SSRI liquidated two silver properties (Bowdens and Silvertip) and consolidated its holdings in another (San Luis). When these transactions are examined, they reveal similar multiples being paid for resources in the ground, which average (either reserves or measured and indicated resources, not including inferred resources) to around $1 per ounce (and keep in mind these transactions were carried out when silver was trading at much lower prices). Using this multiple and adding cash/securities and the assumed value of Pirquitas, SSRI is worth roughly $25/share (80-90% upside). Of course, not every ounce in the ground will be mined. Some properties will turn out to be uneconomical and/or the silver price might fall dramatically. Or, SSRI might waste its huge cash hoard by investing in projects that don't pan out or its marketable securities may plummet in value (SSRI's securities portfolio is not diversified to say the least)……the list is numerous. These are all legitimate risks and must be considered. However, in my view the market is discounting these risks and then some. At a price around $13.75, SSRI provides investors with a large margin of safety, strong potential for gains, and very cheap "tail risk" protection via exposure to precious metals in environments of inflation and/or currency debasement.

    Disclosure: I am long SSRI.

    Additional disclosure: This article is provided for informational purposes only and should not be considered an offer or recommendation to buy or sell any security. The information contained herein is obtained from sources that are believed to be reliable, but no guarantee is made for accuracy.

    Tags: SSRI
    Apr 23 9:21 AM | Link | Comment!
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