Morien Resources: Burgeoning Royalty Play Or Taking Private Target?

Summary

• APMCF owns several resource royalty streams with one already generating cashflow.
• APMCF has a large cash balance with several contracted milestone payments to come.
• Aggressive share purchases by both insiders and the company make for an interesting takeover speculation.

Context

Morien Resources Corp. (OTCPK:APMCF or MOX on the TSX Venture Exchange) is a micro-cap Canadian Royalty company. Spun out originally from Erdene Royalty Development Corp. in late 2012, Morien has monetized most of the resource assets that were on its balance sheet, culminating with the sale of its 25% interest in the Donkin Coal project to the Cline Group, who had already acquired the other 75% from Glencore.

As terms of the sale, Morien will receive $5.5 million in cash and a production royalty on sales from the Donkin Project in the form of a gross royalty of 2% on the first 500,000 tonnes of coal sales per calendar quarter and 4% on any tonnage thereafter from the Donkin Project. It has already received the first $2m installment, with another $2m in February 2017 and the final $1.5m in February 2018. Both these payments advance if Donkin goes into production earlier.

Morien estimates on page 11 of its corporate presentation (sourced from a 2011 technical report), that this should generate between $4.6 and $6.7m in royalties annually, once the Project goes into production. This is currently planned to be in 2016 with full production by 2018. Assuming the lower rate, discounting at 10% with a 30-year life with no cashflows until 2018, this projects to be a discounted value at approximately $28m; at the higher rate, it is over $40m.

Morien also has a royalty interest on a Black Point aggregate project for which it estimates an annual value of $250 to $750K, commencing between 2018 and 2021. This is some distance in the future and with an undefined timetable for production makes it difficult to value; I have assumed $250,000 per annum, starting in 2018, also at 10% giving a discounted value of $1.7m. However, using the higher amount of $750,000 per annum gives this stream a value of $5.1m.

Morien has a 1.5% Net Smelter Return Royalty over marketable ore from Banks Island Gold Ltd.'s Yellow Giant Gold Project in British Columbia which is already paying royalties of $200,000 per year. I have assumed this should last 10 years as details on this particular project duration are still being determined due to continued exploration on the property. At a similar 10% discount rate, this gives a present value of $1.23m.

The current cash burn rate is slightly less than $1m annually to allow the company to operate and source new royalty options. Assuming a similar expense level over time, the NPV of these operating costs is assumed to be at $11m.

Combining all these together, I calculate the present value of the future milestone payments and royalties, less its operative costs, to be between $23.2m and $39.3m, or between $0.40 and $0.67 per share. This compares very favourably to the current share price of $0.23/share. Morien has $.07/share in cash with another $.07/share projected to come via milestone payments as downside prevention.

While all this bodes very well and makes the operating case for Morien very compelling, there have been some recent share purchases that could make for an interesting speculative component as well.

On March 16, 2015, the company announced the completion of a Normal course Issuer Bid for 1,190,000 shares at an average price of $0.20 that were purchased and cancelled. Morien is entitled under TSX Venture Exchange policies to purchase up to 1,198,000 shares in any 30-day period up to the maximum of 4,995,300 shares, representing approximately 10% of the company's public float. On April 6, 2015, as a result of Morien's share repurchases, Atlantic Royalties LLC, a subsidiary of The Cline Group LLC, is now a 10.1% shareholder of Morien, by virtue of its holding of 5,950,000 common shares.

The company clearly can afford this as the value of this share purchase is only $238,000, just a dint in the company coffers. More interesting is the Cline Group's accumulation of this position. They have added more than 3 million shares to their initial position. As a private company, they don't need to worry about public markets and can best allocate their capital without that constraint. They may be seeing the same dislocation between Morien's royalty value and its market cap that I have outlined. By taking Morien private, Cline could eliminate the royalty overhang on Donkin that may make it even more compelling.

This is pure speculation, but combining Morien reducing its shares outstanding through the NCIB and Cline accumulating shares on the open market, Morien may be in the early stages of a stealth takeover by Cline.

Scope

The potential upside to Morien can come in two ways.

1) Growth as a standalone royalty play. As I noted above, the share price currently is at a significant discount to the valuation of its currently projected royalty streams. As these are unlocked so will the value in Morien itself.

2) That another company, either Cline or another suitor, identifies this same asymmetry and takes over Morien at a premium to its current valuation. Obviously, this is a speculation only, although the recent share action lends a little more credence to this option.

Catalyst

The key catalyst for any significant share appreciation here will be an announcement that the Donkin Project will be starting production, either in the development stage or at full production. You have three potential scenarios:

1) Cline will, as a private company, know this date before anyone else. It would be in their interest, assuming they see the same benefit to buying this royalty stream that we do, to take Morien private and avoid the royalty and milestone payments. Cline has already accumulated a 10.1% stake in Morien and has been interested in hedging this royalty from the start via its participation in a $1m private placement financing @$0.30 per share in December 2014, shortly after acquiring the Donkin rights.

2) Morien develops into a stand-alone royalty company and can turn the resulting cashflow from Donkin and its other royalties into further royalty purchases. This is possible if Cline feels they have enough invested in Donkin already and don't need to secure the royalty as well, although their actions don't support this, in my opinion.

The CEO of Morien, John Budreski, is a director of both Sandstorm Gold and Alaris Royalty, both prominent players in the royalty sector. This will give Morien access to great intelligence and potential acquisition candidates as smaller sized royalties will move the needle more for Morien than they would for larger companies.

3) Morien is taken out by another large royalty player, such as Altius Minerals (ALUSF). CEO Budreski's connections with other royalty players will potentially prove an asset here.

My personal belief is that option 1 will take place. With a miniscule market cap today at $13.5m CAD, even offering double this price for the 52.7m shares it doesn't own, Cline would still need to invest only about $24.3m CAD in the shares less the $3.5m in future milestone payments, leading to a net investment of $20.8m. This is significantly below the estimated present value of the Donkin royalty alone, let alone the other royalty streams and cash value of Morien. However, if I am wrong, the stand-alone case on valuation is very compelling.

Time Frame

The development plan of Donkin will be the key driver of the time frame. Prior to its sale, Morien was estimating that production should take place in 2016. However, the project changed hands in December 2014 as Cline consolidated its ownership of the project. Cline's subsidiary Kameron has already begun the process of de-watering (removing the groundwater from the area) in February 2015. This process permits the engineers to better evaluate the area and develop a safety plan and from there a business plan to return the mine to production. Cline will be also looking for an off-take agreement for the thermal coal component from local utility Nova Scotia Power. They currently import their coal from Colombia and the United States so the chance to secure local jobs would appear to be a very politically beneficial move. One potential snag is the high sulfur component of Donkin coal that exceeds local regulations, requiring it were to be mixed with lower grade coal. One would suspect that Kameron and the province are already negotiating on this front.

While I assumed a margin of safety in the valuation approach above by assuming Donkin goes live in 2018, I believe this will be advanced, especially due to the potential localized benefits that may encourage the politicians to expedite its support.

Risks

Likely the biggest risk in this investment is the time frame for when the Donkin project will go into production. Since Kameron acquired it completely in December 2014, they have started the process to move it forward but there are many steps to this, including developing a business plan to operate the mine. The coal regulations itself will prove a potential issue due to the sulphur content in Donkin's coal.

As part of this business plan, Kameron will need to find someone to purchase the coal and while there appears to be a supporter with the Nova Scotia government, there is nothing as yet written in stone.

Continued weakness in base metal prices may impact the viability of the other projects that serve to support Morien's royalties as well.

There is also the risk on how Morien handles the funds on hand and whether they are able to accumulate further royalties at a reasonable price or whether they continue with the NCIB.

Summary

Morien Resources provides a significant upside value to its current share price of $.23/share. This is buffered by the current cash on hand of $4.1m and the further milestone payments of $4.3m owed. The remaining variance from its current market value gives significant upside optionality that the Donkin & Black Point royalties either come online to establish Morien as a viable small-cap royalty player or that they are acquired at a premium to current value, either by its partner Cline or another larger royalty player.

Analyst’s Disclosure: The author is long APMCF. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

All amounts are denoted in CAD$