First Majestic's Run-In With The Mexican IRS - Is It A Big Deal?

Summary

• Background information of First Majestic's dispute with the Mexican SAT.
• Details from First Majestic's most recent press release.
• I share my opinion on if this changes my view of First Majestic's investment prospects.

I recently wrote an article about the case for First Majestic (NYSE:AG) and using AG to bet on rising silver prices. You can find that here. Although I was bullish on First Majestic from a fundamental perspective on everything from their mining prospects to their financial performance to prospective silver prices, I overlooked the current ongoing legal dispute they have with the Servicio de Administracion Tributaria which is the equivalent of the USA’s IRS. Here I provide some background information on the dispute and how I’m thinking through this as an investor in First Majestic.

Background

Primero (whom First Majestic acquired in May 2018) acquired the San Dimas Mine in 2010 and had a purchase agreement with Wheaton Precious Metals (WPM) where they would be required to sell 100% of the silver produced to WPMI up to 6,000,000 ounces and 50% thereafter for the lower of the spot price or $4.04 per ounce to increase 1% annually.

Since the price of silver was greater than 4.04/oz while Primero was operating the mine, they paid taxes on the income received from the mine based on the 4.04/oz price rather than the spot price.

Here’s the statement from First Majestic’s financial statements:

To obtain assurances that the Servicio de Administración Tributaria ("SAT") would accept the PEM Realized Price as the proper price to use to calculate Mexican income taxes, Primero applied for and received an Advance Pricing Agreement (“APA”) from the SAT. The APA confirmed that the PEM Realized Price would be used as Primero’s basis for calculating taxes owed by Primero on the silver sold under the Old Stream Agreement. Primero believed that the function of an APA was to provide tax certainty and as a result made significant investments in Mexico based on that certainty. On October 4, 2012, Primero received the APA Ruling from SAT which confirmed the appropriate price for sales of silver under the Old Stream Agreement. Under Mexican tax law, an APA ruling is generally applicable for up to a five year period which made this ruling effective retrospectively from 2010 to 2014.

If the SAT wins the dispute, according to First Majestic, they would have to pay income taxes based on the production that was sold to Wheaton Precious Metals at the market price from 2010 to 2018. This would amount to $157 million dollars according to First Majestic’s estimations.

This would only be to 2018 when the San Dimas acquisition took place as First Majestic signed a completely different agreement with Wheaton Precious Metals at that time. The terms of the new agreement with WPMI are:

• 25% of gold production plus an additional amount of gold equal to 25% of silver production converted to gold at a fixed gold to silver exchange ratio of 70:1 from San Dimas, with provisions to adjust the gold to silver ratio if the average gold to silver ratio moves above or below 90:1 or 50:1, respectively, for a period of six months.

• For each ounce of gold delivered, Wheaton International will pay to First Majestic a production payment equal to the lesser of US$600/oz, subject to a 1% annual inflationary adjustment, and the prevailing market price.

Source: Wheaton Precious Metals News Release

First Majestic is not currently recording any liabilities on its financial statements related to the current dispute. According to their third party advisors, which I assume may be some combination of legal and accounting professionals, they do not believe there’s any reason to record this as a liability at this time. On the other hand, if they were to record a liability for this, it could potentially embolden the SAT to believe they would successfully win the dispute. So I’m not sure I would take this as a positive sign one way or the other.

First Majestic is, however, recording their income taxes receivable in the amount of $15.7 million as a long-term asset as they anticipate this dispute taking longer than one year. In the meantime, Mexico has determined not to deliver First Majestic’s income tax return until the dispute is resolved.

In its latest press release, First Majestic reported that they will be appealing to double taxation treaties which Mexico has entered into with Canada, Barbados, and Luxembourg which potentially makes First Majestic’s case. Here’s a portion of the full press release.

While the Company has made several attempts to seek to resolve its differences with the SAT using both local administrative and legal procedures and those contained within the treaties for avoidance of double taxation, and as well through diplomatic discussions, all such efforts have been met with actions of SAT intended to intimidate the Company, its subsidiaries and its employees, including notifications to Primero to secure amounts it claims are owed pursuant to its reassessments issued in violation of the terms of the Advance Pricing Agreement. These notifications impose restrictions on Primero’s ability to deal with its fixed assets until this matter is resolved.

My Question And Take On The Matter

My main question in all of this is, since First Majestic paid the taxes on the income from selling the silver at the $4.04/oz set price from the WPMI agreement, did Wheaton pay taxes on the difference between the $4.04/oz and the market price? Or was Wheaton taxed for its revenue/income in the United States? I’m not familiar with Mexican tax law but would assume if Wheaton paid tax also, that would be double taxation and it would make First Majestic’s case easy to make. The scenario was not made clear in First Majestic's financial statements. In the case of First Majestic’s most recent press release, it mentions double taxation treaties which makes me think this may be the issue at stake.

If First Majestic loses this battle, it will likely cost them above the $157 million estimate put out by First Majestic due to interest, penalties, etc. This would be a very substantial hit to First Majestic as this amount is greater than one entire year of operating cash flow. However, it would be a one-time expense, and once paid, investors could go back to valuing the company based on its prospective future cash flows.

With that said, I’m comfortable saying that First Majestic is still a really good way to play the prospect of rising silver prices. As I showed in my previous article, a marginal rise in silver prices would significantly increase operating cash flow. I don’t like to be overly optimistic, but as I heard one person say, this whole deal sounds like a good old-fashioned shake-down from the Mexican tax authorities. As a final word, I'm open to other ways to bet on silver and will be doing research in the coming days but still prefer First Majestic.

Lastly, I’m in the process of understanding the different jurisdictions for precious metal mining companies and would love to understand if anyone remembers Mexico treating other precious metals mining companies in this way. If you do, please leave a note in the comments below.

Analyst’s Disclosure: I am/we are long AG. 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.

Comments

[en-ki]

I have to admit that these streaming agreements really baffle me. Where is the economic benefit in selling production at below (way below) market prices. If it is a ploy to move income out of a high tax environment to a lower one, that would make sense and also explain why the tax authorities are looking to overturn the agreement-- but then why did they (tax authorities) make it in the first place?

[Brent Hecht]

@en-ki Ya, sometimes it seems that the person getting the streams is getting a great deal. But usually these agreements are signed during the exploration or development phase of a project as a way to help finance it. You're right, I'm guessing most companies wish they would have found alternative financing because it seems like a great deal for the company receiving the royalty streams. On the upside, First Majestic Silver has now just entered the royalty streaming business on the other side of the deal which at first glance looks like a great deal for First Majestic.
www.globenewswire.com/...

[davidcruse87]

Great article. I laughed at the good old fashioned shakedown comment but it's so true. Hard for me to keep holding at this point when the banditos see $157M for the taking. Getting back in at $5 sounds good though...

[Brent Hecht]

Thanks @davidcruse87 Glad you got a kick out of that and benefited from the article.

[Westexr]

@Brent Hecht

Thanks for writing the timely update.

First Majestic has been one of my favorite miners for many years, because the stock performs very well in relation to the price of silver. For example, when the price of silver increased in early 2016, AG increased about 700% in six months.

I sold all of my AG today. It is just not worth the risk until the Mexico government issue is resolved.

If I remember correctly, the Mexican government approached First Majestic and asked them to buy the San Dimas mine. First Majestic bought the mine, and it appeared everyone would live happily ever after. Then, Mexico had an election. The new administration appears to be in bed with the Globalists and left wing Dimms in the US. Remember when Pelosi was making trips to Mexico and meeting with "Mexican Officials?"

I had read in other places the new Mexican administration is not "mining friendly."

Actually, there are not many countries in the world that are really mining friendly. USA and Australia are the only two I know of. Even Canada is suspect in my book. Remember the Natives and the water issues in the Yukon?

Long some gold, silver, rare earths, platinum, and copper mining companies. And, unfortunately, some Texas Permian Basin oil companies. And, keeping some dry powder.

[Brent Hecht]

@Westexr Thanks for those insights. That is helpful. I agree, it is really strange the way the Mexican tax authorities are treating them. And this could be an indication there's some fire under that smoke. I'm staying long for the time being. Thanks again.

[Chris Guenther]

I think AG is still a solid leveraged play on silver. They have the highest percentage of silver production compared to all the mid to large cap silver miners. PAAS is more solid but has more gold and base metals as a percent of ounces produced. They will survive this, Keith Numeyer finds a way to deliver.

[Brent Hecht]

@Chris Guenther Thanks Chris, you're right, Keith Neumeyer is a salty veteran and hopefully he comes through.

[MaxMaz]

I am the last person willing to defend taxation, which I regard as theft, but if Wheaton does not pay royalties to Mexico on the difference between fixed price and market price, I think AG position is disingenuous, at least regarding the portion not covered by the 5 years agreement.

Any miner could create a shell company in the US or anywhere else and sign a contract like this, thus avoiding paying a substantial part of the royalties. By the way, the same applies to the current contract. Gold price is almost three times the 600$ per ounce mentioned in the article. If they do not have the so-called APA for the new contract, the SAT is going to come back to ask for its pound of flesh on the difference between gold spot price and 600$.

Again, if Wheaton is actually paying to SAT the royalties on the difference of the fixed price and spot price, then this is indeed a gangster-like shake-down.

I was about to enter a position in AG, but this is too much uncertainty. I will stick to SVM, notwithstanding the fact they should have left the Guyana deal go and pocket the (puny) fee for the deal-breaking.

[10010481]

Thanks for writing about this,it brings much needed clarity to a confusing issue.

[fahhya]

Silvercrest Metals is a better bet.

[JCC2015]

Solve the tax issue with a settlement like $WPM did with Canada CRA when the stock was $10 CDN now it's $60 and this goes away.

[mattgrim81]

What a bunch of crooks!!!! Primero paid taxes on the price they received for the silver what does spot price have to do with anything if they weren't receiving it? Especially since you can guarantee silver Wheaton had to pay taxes on the difference received in prices.

[drooyrich]

it is time to sell .. miners outside of USA in company friendly jurisdictions are too few and too risky .. the governments will nationalize mines just as they did with oil fields when they see the boat load of money they will make at higher gold and silver prices .. best is to invest in ETFS that hold phisical (do your homework, many like HSBC are bullshitting you) .. regards

[Brent Hecht]

@drooyrich Thanks for the insights.