With the thousands of junior mining companies listed around the world, it can be quite difficult to assess which companies will offer long-term value and can actually bring a project into production to generate free cash flows.
Every explorer out there claims to have the best parcel of land with concessions offering strong potential for high grade gold, silver, copper, zinc, or any other resource they can pull out of the ground. Unfortunately history shows that many of these projects never come to fruition for a wide array of reasons ranging from economic feasibility, underlying commodity price collapse, to lack of financing.
Due to the uncertainty the European debt crisis instigated and Basel III capital requirements, banks are starting to shrink risky loans as a proportion of their portfolios and boost their capital tier one ratios. This process makes credit for junior explorers even harder to come by. Of course without financing, a good project is just a piece of empty land sitting on the balance sheet eating away shareholder capital with the passage of time.
Abacus Mining & Exploration Corp. (OTCPK:ABCFF)
Abacus Mining & Exploration Corp. is a junior resource explorer listed on the TSX Venture Exchange under the ticker symbol (AME). AME has a 49 percent interest in the Ajax Project, which is located in South Central British Columbia, Canada. The company's market capitalization is currently about $48.32 million.
KGHM Polska Miedź S.A. (OTC:KGHPF) is a European base metal miner with a market capitalization of about $10 billion. The company owns the remaining 51 percent in the Ajax Project. According to KGHM, it is the 3rd largest silver producer and 9th largest copper producer in the world.
From January to September, 2011 KGHM generated €1.6B in operating cash flows and as of September 30, 2011, the company held more than €3 billion in cash and short-term investments. Thus, there is no doubt the company is capable of financing and advancing pretty much any project to production.
On December 6, 2011, KGHM agreed to purchase Quadra FNX Mining Ltd. (OTC:QADMF) (QUX) for about $3.5 billion. QUX is a base metal producer with the majority of its production in Sudbury, Ontario, Canada. This transaction sheds some light on KGHM's strategy to grow its production, particularly copper. It indicates that a major element of KGHM's growth strategy is an expansion in Canada - a politically stable and resource rich jurisdiction.
The Ajax Project
AME conducted a series drill programs on the Ajax property from 2005-2008, which was followed by a preliminary economic analysis in 2009. In 2010, AME published a Feasibility Study Technical Report with a project Net Present Value -NPV- of $192.7 million.
After additional metallurgical testing and analysis, AME published a Feasibility Study in January 6, 2012, which indicates that the NPV base-case scenario has more than doubled to $416 million. However, using current copper and gold prices the project produces an alternate scenario NPV of $818 million, with cash cost of $1.11/lb of copper with gold credits.
Given the estimated cash flows from the project and strong demand for the underlying commodities, it is easy to reach the conclusion that the Ajax Project is attractive from an economic stand point.
The Ajax project has a Proven & Probable Reserve of 2.96 billion pounds of copper and 2.75 million ounces of gold. The mine's life is expected to be 23 years.
The Joint-Venture Agreement Creates a Near-Term Catalyst
The joint venture agreement between AME and KGHM is interesting and offers a near-term catalyst. According to AME, certain provisions in the agreement provide KGHM with the right to purchase an additional 29 percent interest in the joint venture, increasing its ownership to 80 percent. This will shift the burden of financing on KGHM, a company with deep pockets.
KGHM has 90 days from the date it received the feasibility study (published in early January) to exercise its right to increase its interest to 80 percent. If it chooses to exercise its right under the agreement, it will pay AME a consideration of 29 percent of the Proven & Probable reserves estimated in the feasibility study, up to a maximum of $35 million.
If KGHM chooses not to increase its interest, AME then has the right to purchase KGHM's entire 51 percent interest for a consideration of $37 million.
Risks - What if KGHM chooses to pass?
Given its strategy to move into Canada by bidding for QUX and the desire to grow production, it seems unlikely; however, everything is possible. Recently, the Polish government (which is a large shareholder of KGHM), rejected a share buyback plan worth about $893 million. It has also been rumoured that the Polish treasury might even remove the current CEO.
Whatever the reason may be, if KGHM indeed chooses to pass on its right, it will be a blessing in disguise. This will allow AME to purchase KGHM's interest, which translates to $212.16 million of NPV (based on base case), or $417.18 million of NPV (based on current prices) for $37 million. Essentially nine cents for every dollar in project NPV.
At the same time, it seems AME will lose out on a partner with great expertise and deep pockets. However, one has to consider the fact that Teck Resources (TCK), a major diversified miner with a market capitalization of about $25.64 billion, owns about 19.9 percent of AME.
Therefore, given the Ajax Project's favourable economics and its current interest in AME, it would not be out of the realm of possibility for Teck Resources to increase its ownership, or enter into a joint venture with AME to advance the project. The possibility of a takeover would not be unrealistic either.
Lastly, the company recently awarded senior management, directors and some employees with more than 2.6 million stock options with an exercise price of $0.235 per share. This is an interesting occurrence since the exercise price is not at a discount to market prices, which might signal management's expectations of good things to come.
Disclosure: I am long on the TSX Venture Exchange
Disclosure: I/we 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.