Lumina Copper Is Up For Sale, But Who Will Pull The Trigger?

| About: Lumina Copper (LCPRF)
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Introduction

In this article, I'll have a closer look at Lumina Copper (OTC:LCPRF), which owns the gigantic Taca Taca copper project in Argentina's Salta province, close to the border with Chile. I'll start with a background of the Taca Taca project and move over to the main hurdles Lumina will have to overcome to move this project forward.

Thereafter, I will play around with some numbers to determine the fair value of the project and will explain the main risks involved in this story. I will also provide my opinion on Lumina Copper's exit strategy and this will result in my investment thesis at the end of this article.

As trading on the US exchanges is quite limited, I'd highly recommend to trade in Lumina Copper through the facilities of the TSX Venture Exchange, where Lumina is trading with LCC as ticker symbol.

Executive Summary

In this article I'll explain why I think investors are overestimating the political risks in Argentina which is very likely the main reason why the market capitalization of Lumina Copper is 'just' $235M. According to my calculations (which are extremely conservative, using a discount rate of 12% and a copper price of just $2.50/lb, 25% lower than the current price), the project has a value of approximately $13/share.

The initial capex of $3B seems to be the biggest hurdle, but I think this hurdle can be overcome as this is one of the largest copper-gold projects worldwide in a region which seems to be supportive of mining.

However, investors in Lumina Copper should be extremely patient as the company's only exit strategy is to sell the asset and distribute the cash amongst its shareholders. This might happen tomorrow (as a figure of speech) but could also take a few more years, so investors should be aware an investment in Lumina Copper mainly is a waiting game.

Lumina could be bought for a small percentage of your portfolio, but you should be very well aware that its only exit strategy is to monetize Taca Taca and it might take another wile before you reap the dividends.

A background of the Taca Taca project

The Taca Taca project is 100% owned by Lumina Copper and is a copper-gold-moly project in Argentina's Salta province which is located in the northwestern part of the country near the border with Chile. The project is located perfectly as it's quite close to an existing railway and just 75 miles east of Escondida, which is the world's largest copper mine by output.

First mineralization was discovered approximately 50 years ago in the sixties, and subsequently several companies (such as BHP Billiton (NYSE:BHP) and Rio Tinto (NYSE:RIO)) have explored the property before Lumina Copper acquired the ownership of Taca Taca. Approximately 3.5 years ago, Lumina Copper's preliminary exploration plan was aimed to test some geophysical anomalies. Much to the company's surprise, the early-stage diamond drill holes discovered long intercepts of copper mineralization, and from then on the Taca Taca project gained a lot of interest and was immediately fast tracked after intersecting in excess of 200 meters at more than 1.3% copper equivalent.

Lumina continued to drill the project, and has drilled in excess of 130,000 meters to date in almost 300 drill holes, and most of those holes were mineralized which ultimately resulted in the most recent resource estimate which contains an extremely impressive 28.7B (yes, billion) pounds of copper, in excess of 7 million ounces of gold and 850 million pounds of molybdenum. As the total in situ value of the resource estimate is approximately $110B (again this is not a typo, the total in situ value of the project is 110 billion USD), this project is one of the largest copper-gold-moly projects in the entire world and the Lumina management is hoping to monetize this asset.

The main hurdles and risks

Lumina has been unofficially up for sale for quite a while now, but has so far failed to announce a deal, despite (unconfirmed) rumors that mining powerhouse BHP Billiton allegedly offered $19/share back in 2012.

The first risk is the geopolitical risk. After the government of Argentina seized the assets of YPF (NYSE:YPF) from Repsol (OTCQX:REPYY), a lot of investors were frightened by this opportunistic move to nationalize large operations. However, Repsol seems to be considering to accept the compensation offer made by Argentina and will very likely accept it, which means this wasn't a de facto nationalization, but an expropriation with compensation. So people who think that Argentina is becoming the next DRC are just wrong.

On top of that, Argentina's mining laws actually give most of the prerogatives to the provinces. As Taca Taca is located in the Salta province, I think there's a decent chance for this project to be permitted as Salta has supported mining projects before. For instance gold mining company Goldrock Mines (MFNMF) has received its mining permit for a heap leach gold operation approximately two years ago. This strengthens my confidence that Taca Taca will get permitted, because if a heap leach operation doesn't scare the provincial authorities, the Taca Taca processing facility should be even easier to permit because the risks are lower.

That being said, I am convinced that if this project was located on the other side of the border (in Chile), the company would already have been sold.

A second risk is obviously the financing risk. Lumina Copper has released a Preliminary Economic Assessment on the project, and the initial capital expenditure of $3B might be a big hurdle for interested parties. Also keep in mind there will very likely be some cost inflation as the construction start still is a few years away. The additional sustaining capex which totals $1.8B shouldn't be a problem as it works out to be just $65M per year which is definitely bearable knowing the project will produce in excess of 500 million pounds of copper per year.

A third risk is obviously the copper price. Even though copper is currently trading at around $3.30/lb, Lumina Copper based its PEA on a copper price of just $2.75/lb, which seems to be quite conservative compared to the PEAs presented by competitors. However, in the following paragraph I will make a very strict and conservative calculation of the net present value of the project to see if it would be viable at an even lower copper price.

Playing with some numbers

In this paragraph, I will make an extremely conservative calculation of Taca Taca based on a copper price of just $2.5/lb, a discount rate of 12% and a tax rate of 30% to determine if the project would still be attractive using a scenario with a low copper price. I will also increase the initial capex by 10% to $3.3B and the cash cost by the same rate to $1.20/lb. I will add $0.15/lb for sustaining capex, $0.02/lb for exploration costs and $0.08/lb for G&A costs and miscellaneous costs (for an all-in sustaining cash cost of $1.45/lb). On top of that, I will base the fair value on a 90% ownership of the project as I think it's not unlikely the province of Salta wants a piece of the pie. There's a comparable framework in the more northern Jujuy province where the local government takes 8.5% of the project as consideration for its full support, as I explained in my previous article on Orocobre, which operates in the Jujuy province.

Cash Flow per year

Corporate tax at 30%

after tax

Discount rate (12% per annum)

NPV12%

-3300000000

0%

-3300000000

-3300000000

564000000

0%

564000000

1,00

564000000

564000000

0%

564000000

1,12

503571429

564000000

0%

564000000

1,25

449617347

564000000

0%

564000000

1,40

401444060

564000000

0%

564000000

1,57

358432196

564000000

0%

564000000

1,76

320028747

564000000

0%

564000000

1,97

285739952

564000000

10%

507600000

2,21

229612462

564000000

30%

394800000

2,48

159453098

564000000

30%

394800000

2,77

142368838

564000000

30%

394800000

3,11

127115034

564000000

30%

394800000

3,48

113495566

564000000

30%

394800000

3,90

101335327

564000000

30%

394800000

4,36

90477970

564000000

30%

394800000

4,89

80783902

564000000

30%

394800000

5,47

72128484

564000000

30%

394800000

6,13

64400432

564000000

30%

394800000

6,87

57500386

564000000

30%

394800000

7,69

51339630

564000000

30%

394800000

8,61

45838956

564000000

30%

394800000

9,65

40927639

564000000

30%

394800000

10,80

36542535

564000000

30%

394800000

12,10

32627263

564000000

30%

394800000

13,55

29131485

564000000

30%

394800000

15,18

26010254

564000000

30%

394800000

17,00

23223441

564000000

30%

394800000

19,04

20735216

564000000

30%

394800000

21,32

18513585

1,146,395,233

So even under my conservative scenario, the after-tax NPV12% of the project still is approximately $1.15B. A 90% ownership would result in an attributable value of $1.04B to Lumina Copper, which would be approximately $23.6/share. As the project still is in the feasibility phase, I'd think a multiple of 0.3X the NPV would be acceptable for an impressive project like this, which would result in an after-tax NPV/share of approximately $7.

Allow me to make another calculation using a copper price of $2.50 in the first 8 years of operation, increasing to $3/lb in the subsequent 10 years and then decreasing to just $2.25/lb in the final ten years of the mine life to see how this influences the NPV of the Taca Taca project.

Cash Flow per year

Corporate tax at 30%

after tax

Discount rate (12% per annum)

NPV12%

-3300000000

0%

-3300000000

-3300000000

564000000

0%

564000000

1,00

564000000

564000000

0%

564000000

1,12

503571429

564000000

0%

564000000

1,25

449617347

564000000

0%

564000000

1,40

401444060

564000000

0%

564000000

1,57

358432196

564000000

0%

564000000

1,76

320028747

564000000

0%

564000000

1,97

285739952

564000000

10%

507600000

2,21

229612462

830000000

30%

581000000

2,48

234656155

830000000

30%

581000000

2,77

209514425

830000000

30%

581000000

3,11

187066450

830000000

30%

581000000

3,48

167023616

830000000

30%

581000000

3,90

149128229

830000000

30%

581000000

4,36

133150204

830000000

30%

581000000

4,89

118884111

830000000

30%

581000000

5,47

106146528

830000000

30%

581000000

6,13

94773686

830000000

30%

581000000

6,87

84619362

430000000

30%

301000000

7,69

39141917

430000000

30%

301000000

8,61

34948140

430000000

30%

301000000

9,65

31203696

430000000

30%

301000000

10,80

27860443

430000000

30%

301000000

12,10

24875396

430000000

30%

301000000

13,55

22210175

430000000

30%

301000000

15,18

19830513

430000000

30%

301000000

17,00

17705815

430000000

30%

301000000

19,04

15808764

430000000

30%

301000000

21,32

14114968

1,545,108,785

Under this scenario the after-tax NPV12% actually increases to in excess of $1.5B.

I'd like to emphasize again that the first calculation with the $1.15B NPV is my base case scenario. I think I'm quite conservative with the copper price and the discount rate. If the Salta province would for instance publicly support the development of the Taca Taca project, I would feel comfortable lowering the discount rate to 9%, and this is how the NPV will look like with a lower discount rate:

Cash Flow per year

Corporate tax at 30%

after tax

Discount rate (9% per annum)

NPV9%

-3300000000

0%

-3300000000

-3300000000

564000000

0%

564000000

1,00

564000000

564000000

0%

564000000

1,09

517431193

564000000

0%

564000000

1,19

474707516

564000000

0%

564000000

1,30

435511483

564000000

0%

564000000

1,41

399551819

564000000

0%

564000000

1,54

366561302

564000000

0%

564000000

1,68

336294772

564000000

10%

507600000

1,83

277674583

564000000

30%

394800000

1,99

198136807

564000000

30%

394800000

2,17

181776887

564000000

30%

394800000

2,37

166767787

564000000

30%

394800000

2,58

152997969

564000000

30%

394800000

2,81

140365109

564000000

30%

394800000

3,07

128775330

564000000

30%

394800000

3,34

118142504

564000000

30%

394800000

3,64

108387619

564000000

30%

394800000

3,97

99438182

564000000

30%

394800000

4,33

91227690

564000000

30%

394800000

4,72

83695129

564000000

30%

394800000

5,14

76784522

564000000

30%

394800000

5,60

70444515

564000000

30%

394800000

6,11

64627996

564000000

30%

394800000

6,66

59291739

564000000

30%

394800000

7,26

54396091

564000000

30%

394800000

7,91

49904671

564000000

30%

394800000

8,62

45784101

564000000

30%

394800000

9,40

42003763

564000000

30%

394800000

10,25

38535562

2,043,216,641

So by lowering the discount rate to 9%, the after-tax NPV almost doubles. This shows that the further the company is able to de-risk the project, the more valuable it becomes thanks to analysts and investors feeling comfortable using a lower discount rate.

The exit strategy of Lumina Copper

Lumina Copper has no intention at all to develop the Taca Taca project itself and is looking for a possibility to monetize the asset. An outright sale of the company or the project seems to be the most likely solution here, but the main question is what amount of money would someone want to pay for a project like this?

The biggest cliché in economics is that 'the price is what a fool wants to pay for it', but I will make an attempt to calculate how much the project might be worth for an acquirer.

Based on the NPV12%, the project has a value of $1.15B, and I think it's not unlikely a mining powerhouse might be willing to pay up to 0.5X the NPV in this stage, which would result in a target price of $13/share. Based on previous acquisitions in South America which fetched a price of $0.03-0.04/lb, I would say a multiple of $0.02/ in situ lb would be appropriate as the climate to finance these type of gigantic projects have changed. As Taca Taca has 28.7 billion pounds of copper in its NI43-101 compliant resource estimate, I end up with a potential value of $574M, which works out to be $13.04/share.

As a multiple of 0.5X NPV ànd a multiple based on the amount of pounds in the ground results in the same number, I'm quite confident to say that a sale in the current environment might result in a buyout price of $10-13 per share (and possibly more as I have been quite conservative in my calculations and assumptions).

So now the only open question is 'Who'd be interested in a project of this size and be capable to bring this thing into production?'. As a lot of intermediate producers might (and very likely will) stumble over the initial capital expenditures of $3B, I think this project is exclusively meant for a senior producer such as BHP Billiton, Rio Tinto or Vale (NYSE:VALE) which showed interest in this type of mineralization in Argentina when it announced a joint venture with Golden Arrow Resources on one of its copper porphyry projects in Argentina.

However, as the copper might be railed directly to a port in Chile, suddenly some Chinese and Japanese conglomerates are also in play because it's feasible to ship the copper concentrate to Asia without doing the detour through the Panama canal. As the Chinese have already deployed a lot of money in Peru to acquire gigantic copper projects and bring those into production, it might make sense they will try to duplicate this success in Argentina.

Investment thesis

Lumina Copper is a copper play pur sang. Investors in this story should be very patient as it's not certain this project will ever be bought by a major player. However, with more and more commodities becoming more and more scarce, a project of this size will very likely be appealing to big fish like BHP Billiton or some Asian conglomerates which could see this project as an addition to their development pipelines to ensure themselves of a continuous flow of copper being shipped to their facilities.

According to my calculations, a relatively conservative buyout value might be $13/share, but there's obviously no guarantee this price target will ever be met. That's why investors in Lumina Copper could be considered speculators, as the company's only exit strategy is to sell the company or the project.

Lumina offers excellent leverage to the price of copper, and might be useful in any portfolio as a small speculative position which could pay off soon.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I have no position in Lumina Copper yet, but might initiate a position at any time.