On June 7, 2016, Fortuna Silver Mines (NYSE:FSM) announced it would acquire all common shares of Goldrock Mines (OTC:MFMNF) for a total consideration of C$129 million (to be paid with new shares of Fortuna). In this article, I would like to disclose a few things related to investment projects that may be overlooked by investors, taking the Fortuna case as an example.
Fortuna Silver is a mid-tier silver and gold producer. Currently, the company operates two mines:
- Caylloma in Peru - it is a silver/zinc/lead operation, delivering around 2.0 million ounces of silver in annual production.
- San Jose in Mexico - it is the newest project, commissioned in July 2011. The mine produces silver and gold. In 2015, San Jose delivered 4.9 million ounces of silver and 38.5 thousand ounces of gold.
Of these two mines, the main value driver is San Jose. While Caylloma is a rather stagnant part of Fortuna's mineral portfolio, San Jose is expected to increase its silver production from 4.9 million ounces in 2015 to 8.0 million ounces in 2020.
Fortuna has got plenty of silver. At the end of 2015, the company's silver reserves amounted to 35.9 million ounces. Add to that figure 7.3 million ounces classified as measured and indicated resources and 69.3 million ounces of inferred resources and the total silver mineral base amounts to 112.5 million ounces, of which as many as 85.5 million ounces is held at San Jose.
In my opinion, the acquisition of Goldrock makes sense for Fortuna. Goldrock's main asset is its Lindero project, located in the northern part of Argentina. If the transaction is closed, Fortuna will own three silver/gold properties in Latin and South America:
Source: Fortuna Silver presentation
According to the last Technical Report, Lindero is a porphyry-style deposit, where gold is associated with chalcopiryte. It means that Lindero is different from the current deposits, operated by Fortuna. Both Caylloma and San Jose are intermediate/low - sulfidation epithermal deposits. While porphyry deposits are generally large and low-grade (0.4-0.8 grams of gold per ton of ore) mineralizations, epithermal deposits (especially San Jose) are high-grade vein systems. Therefore, it is kind of a challenge for Fortuna - for example, Lindero will be an open-pit operation while Caylloma and San Jose are underground mines.
As I noted above, Lindero is quite a large deposit. It contains 2.14 million ounces of gold, classified as measured and indicated resources. Additionally, there are 0.61 million ounces of gold in inferred category of resources.
The mining at Lindero should start in 2018. For another 12 years, the mine should produce 1.15 million ounces of gold (96 thousand in annual production, on average) at an all-in sustaining cost of $715 per ounce (in my opinion, Lindero is going to be a low-cost operation).
Further, the total pre-production capital spending is estimated at $166.8 million, of which $14.9 million (value-added tax) will be paid back to the company.
Now, the main point of this article - the project's economics.
Goldrock prepared its Lindero feasibility study using a fixed price of gold of $1,200 per ounce. According to this study, the project should deliver an after-tax internal rate of return (IRR) of 26.5% and net present value (NPV) of $151.8 million (using a discount rate of 5%). In my opinion, these economic measures are very decent. Even using the gold price of $1,100 per ounce, the project's economics are still quite rewarding, with an IRR of 19.9% and an NPV of $99.8 million.
However, wait a moment. All these measures are calculated from Goldrock's point of view. Fortuna, to start the construction of the Lindero mine, has to acquire Goldrock paying the acquisition price of C$129 million or US$100.1 million (using the exchange rate between the Canadian dollar and the US dollar of 0.78:1). Therefore, from Fortuna's point of view, the Lindero economics should look different.
To prove it, I have re-calculated the two basic economic measures (IRR and NPV) taking into account the acquisition price (it means that the acquisition price is added to the pre-production capital spending). Let me show the results:
Source: Simple Digressions
Can you spot the difference? Now the project's economics is not as favorable as before. However, before I go on, let me look at another project, which is currently in the headlines.
Goldcorp and Kaminak
A few weeks ago, the resource world was fixated on Goldcorp's (NYSE:GG) acquisition of Kaminak Gold (OTCPK:KMKGF). To remind my readers, through this acquisition, Goldcorp wants to develop the Coffee project, located in the Yukon area, Canada. Coffee is a huge hydrothermal gold system holding around 5 million ounces of gold (indicated and inferred resources).
The project demonstrates excellent economic measures. Using the gold price of $1,150 per ounce, the after-tax IRR stands at 37% and NPV at $455 million. The all-in sustaining cost (excluding administrative expenses - that is the difference between Coffee and Lindero, where the administrative costs are included) is estimated to be $550 per ounce of gold. The initial capital cost is C$317 million. Well, from Kaminak's point of view, the Coffee project is very impressive.
But are these measures impressive for Goldcorp shareholders? The answer is "Not at all."
Goldcorp has agreed to pay C$520 million to acquire all shares of Kaminak. Similarly, to Fortuna, I have recalculated the Coffee economics, using this purchase price as part of the initial capital. The results are in the table below:
Source: Simple Digressions
Here the difference is very striking. From the Goldcorp's perspective, it looks like the acquisition is uneconomic. Using a discount rate of 5% (which is quite a low figure), the project is going to deliver no value to Goldcorp. Moreover, it should even reduce Goldcorp's value (negative NPV). The break-even point is at a discount rate of 3.9%. In my opinion, this rate is too low to contain all potential risks. So the question is: "Why is Goldcorp buying Kaminak?"
Well, it is not my intention to support the company's management but there may be the following explanations:
- They (Goldcorp) are in urgent need of new mineral resources.
- They think it is possible to squeeze out much more from the Coffee project (add new resources, cut capital or operating costs etc.).
- Kaminak owns a number of other mineral properties where some value may be hidden.
- They are confident the gold prices are at the beginning of the next bull market phase (higher gold prices will have a positive impact on all economic measures).
- There are other values, currently undisclosed.
Summary - Fortuna and Goldrock
Now, let me go back to Fortuna. The acquisition of Goldrock looks much better. Fortuna does not have to look for additional value as eagerly as Goldcorp. The Lindero project is still quite economic, even adjusting all economic measures to the purchase price. What is more, there is hidden value. The feasibility study is built on the assumption that as many as 82.5 million tons of ore will be mined during mine life. However, the measured and indicated resources amount to 117.3 million tons of ore so there is the additional 34.8 million tons of ore to be mined. It surely has value.
Further, apart from Lindero, there is also the Arizaro deposit. This deposit is, in my opinion, underexplored. According to the 2013 estimate, Arizaro holds 568 thousand ounces of gold and 82.5 thousand tons of copper, classified as mineral resources.
Last but not least, higher gold prices should have a huge positive impact on the project's economics.
Disclosure: I am/we are long FSM.
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.
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