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Vatukoula Gold Mines – a year in the life of a gold junior

It’s been a long, hard year for Dave Paxton.

When he moved into the hot seat at Vatukoula Gold Mines (AIM:VGM) last November, operations at the historic Vatukoula mine on Viti Levu in Fiji seemed to be moving ahead tidily. On the day of his appointment, the company released a quarterly production report which showed doubled mining and milling rates in the three months to September 2008, following a successful first gold pour in May, and the recovery of nearly 10,000 ounces of gold compared with 6,000 ounces in the previous quarter. The targeted production rate of 110,000 ounces pa by the end of 2009 looked achievable….

Had Paxton merely been able to preside over a steady ramp-up in production, life would have been sweet. But not only has he had to deal with floods, an ageing and failing mining fleet, and the issue of endless streams of paper to raise capital during a very difficult period, he’s also had to fend off opportunistic takeover attempts and a recalcitrant major shareholder. He must, at times, have pined for his comfortable office at Hichens Harrison!

Vatukoula Gold Mines – previously known as River Diamonds – had acquired the 70 year old mine from a group of vendors, who in their turn had purchased it from Emperor Mines following a decision to close it as uneconomic in 2006. In spite of that closure, with 858,000 ounces of proven/probable reserves and a total JORC compliant resource of more than 5 million ounces, the proposal to recommission the mine as a 110,000 ounce pa operation was deemed sound by consulting engineers CSA Consulting. The transaction was satisfied mainly in shares, and on completion, vehicles owned by Canadian financier Walter Berukoff and mining entrepreneur Michael Silver held 143.3 million shares each, or 17% of the company, with a further 143.3 million held in escrow for purchase by Templar Minerals. But the Templar Agreement was not completed, and the shares – plus a further 200 million of Templar’s existing holding of VGM shares by way of penalty – were claimed by Berukoff.

But back to the mine….

Over October and November, production continued to rise, the mill was up to speed at 87% recovery, and the mine made its first operational profit during October. But the November report – Paxton’s first - carried the first seeds of trouble to come….”in addition to the overhaul programme, a need to acquire additional underground earthmoving equipment has been identified, to increase the volume of material mined.”  As more and more load was being applied to the mining fleet, it was becoming less and less reliable.

By February, although severe rainfall had set back the dewatering programme and pinpointed shortcomings in the pumping equipment, only two days output was lost, yet production declined to 7,470 ounces. Because the majority of costs at Vatukoula are fixed, operating costs (which are stated all-up, omitting only interest and D&A) soared to $915 per ounce. The main culprit, said Paxton, was “availability/utilisation rates of the underground haulage equipment which has limited the amount of ore we are able to transport to the mill.” Staff engineers had been redirected from the refurbishment programme to day-to-day maintenance to keep the existing fleet running. In the same report, the scale of the problem was explained: five underground dump trucks and six underground loaders were required, along with power and pumping improvements, and the capital cost would be $6-8 million, for which funding would be required.

Fund-raising was a gloomy prospect as months of persistent selling – which included Berukoff’s original 143.3 million shares - had brought VGM’s share price down to 0.6p per share from over 4p on re-admission, and $6-8 million meant a lot of new paper. However, needs must, and – in spite of a spirited attempt at the AGM by Berukoff to prevent it – VGM succeeded in attracting £3.48 million in fresh funds. They also attracted a new major share holder when TSE-listed Canadian Zinc purchased most of Berukoff’s remaining VGM holding, leaving him with a call option to buy back 200 million of the shares at 1p each. During this period, city rumours that Berukoff and Canadian Zinc were to make a bid prompted a statement from the company that a number of bid approaches had indeed been received, but all talks were terminated a month later.

The majority of the £3.48 million was earmarked for eight very specific pieces of underground equipment, four of which were immediately ordered, while sourcing for the remainder began. The company also made plans to recommission the disused Smith Mill and construct an oxide circuit, in order to treat stockpiled low-grade oxide ore and add production ounces at lower cost.

By the end of May, even though the new equipment had all been ordered, it was still en-route to Fiji. But the underground team had worked hard with the limited equipment at their disposal, overcoming what Paxton described as a “major hurdle”, and production rose by more than 1,000 ounces to 8,711. The mine returned to profit, as the gold price continued to rise and the increased production – together with a more favourable oil price - brought unit costs down to $680 per ounce, leaving Paxton upbeat about future prospects. The oxide circuit was almost complete, exploration had identified near-surface oxide gold, new duty concessions had been agreed with the Fijian Government, and the company had secured the future prospect of halved power supply costs by committing to buy electricity from a bagasse generating project to be built by the Fijian Sugar Company.

Further cash was raised during June and July, with a subscription of £1.2 million from Canadian Zinc to raise their shareholding to 20% and £415,000-worth of convertible loan notes. Canadian Zinc also secured the right to subscribe for sufficient new shares to maintain their holding at 20% in any future placing and in the event of Berukoff’s call option being exercised. And Paxton himself put £50,000 of his own money where his mouth was and bought 5 million shares in the market.

At last, in July, the first of the new underground fleet began to arrive, several weeks later than expected, though it was too late to make any impact on the August quarter’s underground mining figures. With the low-grade oxides entering the mix for the first time, and a planned move to underground face development rather than 100% mining, output for June-August was poor, at just 6,722 ounces, and costs escalated to over $1,000 per ounce. However, five of the new haulage trucks and loaders are now working, with the remainder expected before the end of the year, and a steady improvement in underground tonnages, as new mining faces are developed, should flow through in the current quarter due to be reported in December.

Given the poor revenue for the final quarter, working capital needs had eaten up some of the cash earmarked for equipment purchase. With three haulage trucks/loaders from the original eleven-strong wish-list still to be ordered, VGM were once again obliged to come to the market for capital. Investors including Sprott Asset Management and Canadian Zinc rallied to the cause, and in a marked contrast to earlier raisings, the planned placing was massively oversubscribed, allowing VGM to collect £9 million (subject to shareholder approval) and add two more trucks to their shopping list….

Even more cash arrived last week, as Berukoff chose to exercise his call option and re-purchased 200 million VGM shares, leading Canadian Zinc to exercise their own option to maintain their VGM holding. The issue of 156 million shares to Canadian Zinc at a 5% discount to market will net the company another £2 million.

But it has all come at a cost to shareholders. On completion of the mine acquisition 18 months ago, VGM had 1.7 billion shares in issue. Following the new Canadian Zinc subscription that has escalated to 2.9 billion.

Mining at least 100,000 ounces pa – which needs a run rate of 9,000 ounces per month - seems as far away as ever, as each setback pushes the production and profit targets further away. But with £11 million of new money in the bank, the majority of the new fleet in place by the end of the calendar year, and funds in hand for the rest, VGM are at last well placed to achieve their ambitions for the Vatukoula mine. By this time next year, the mine should be up to the targeted monthly run rate – indeed, they will have to be in order to achieve their guidance of 60,000 total ounces by next August – and with all-up costs at a conservative $600 per ounce vs $1000 gold, could be generating annual operational profits of £25-30 million. At today’s £42 market cap, that doesn’t look too shabby…

The author holds shares in Vatukoula Gold Mines