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High River Gold - trading 4 times cash flow

|Includes: High River Gold Mine (HRIVF)
September 23, 2010
Some numbers approximate.
Q3 & Cash
Using yesterday’s gold  price for the rest of the month, it looks like gold will average $1245/oz for Q3 – a $50  increase over Q2. If HRG’s performance is similar to Q2, HRG should show  approx. $53M in cash flow when it announces Q3 results -  probably on November 15th. As of yesterday, HRG’s market  cap is $840M. During Q3 Severstal exercised its 40,674,540 in warrants for approx. $26M resulting in total shares outstanding of 840,218,962. Severstal owns 70.38% (591,362,172 shares) with minority owning 29.62% (248,856,790 shares). The shares in third party companies (mostly in Detour Gold) are valued at  $110M. Once these shares are released by Royal Gold as collateral (expected anytime), HRG should have liquid assets at the end of Q3  made up of  $110M third party investments, $92M Q2 cash balance, $26M Severstal exercise and $53M Q3 cash flow, less $31M debt for a total of  $250M or $.30/share (30% of current market cap).
Bissa News from West Africa
The results of the Bissa Feasibility study were released recently. They show a total of 13.3 million tonnes of mineral resources in the measured and indicated categories, including mineral reserves, grading 2.5 grams of gold per tonne for 1.1 million ounces of gold  -  versus 15.9 million tonnes of resources in 2009 with a gold grade of 1.8 grams per tonne for 0.9 million ounces of gold.  The feasibility study showed that it will require $110M in capital expenditures in 2011 to put Bissa into production. It looks like HRG will fund this out of cash.  Once in production in 2012, it should add 95k oz of annual gold production. Graham Farquharson, a respected mining consultant and Mining Hall of Fame Inductee, recently commented on the Bissa Feasibility study. Here are some excerpts – 1. “Although we have not been to the Bissa property the most surprising element in the press release was the substantial improvement in the gold grade of the resources from 1.8 grams per tonne in the 2009 technical report to 2.5 grams per tonne in the feasibility study”. 2.” there is no reason why the mineralization would not continue with similar grades into the underlying fresh rock.  If that would be the case then there could be easily accessible additional potential underlying the multiple (14) small pits that have presently been identified on the Bissa property”. 3. “ in general we would think that the recent press release should be a positive development for HRG, although we are curious as to how the resource grade managed to change by such an unusually large amount from the previous technical studies. In doing so Severstal has certainly put a positive spin on the project, which would suggest that they intend to move it forward.”
Severstal Gold IPO & HRG Valuation
In the last week Severstal posted on its website a presentation outlining its gold business. Over the last 12 months there has been significant speculation in the media that Severstal Gold will do an IPO and this presentation looks like the first step. In terms of putting a current value on HRG, I have made some deductions from the presentation (linked below) and the Deutsche Bank and Nomura Bank reports that I received on Severstal and its gold division. The Severstal Gold presentation projects 640-670k oz of production for 2010. The presentation projects that HRG’s properties will produce 367k oz or  55-57% of the total. The total resources touted by Severstal Gold is 23.8M oz in gold and silver equivalent with HRG’s properties amounting to 7.4M oz or 31%. Keep in mind, HRG`s percentage of the overall resources should increase as there is a $23M drilling program underway for Irokinda/Zun-Holba, Bissa has much more exploration potential and the 43-101 report for Prognoz outlines 161-369M oz of silver potential (2.5 - 6M oz gold equivalent) in 16 other mineralized zones (HRG owns 50%).  Also, supposedly a new Micon 43-101 study is either partially or fully complete that is rumoured to show even better numbers.
The Nomura Bank report puts a target value of Severstal Gold at $3 - $3.6B (including minority interests). This range comes from using $6,000/oz produced (what Russian miners currently trade at)  to get to a $4B value and they also use 10X  EV/EBITDA to get to $3.1B value. If you take 56% of the value range for HRG, then  you get to  $1.73B - $2.01B  or $2.06 - $2.39/share. If you take the 367k oz HRG will produce in 2010 multiplied by $6,000/oz you get to $2.2B or $2.62/share. The Nomura report does not give any value for HRG’s liquid assets at $.30/share, therefore, I think it would be fair to add this on to the values to get to a range of $2.36-$2.69/share and $2.92/share respectively. Deutsche Bank put the value of Severstal Gold at  $3.45B (including minority interests) after deducting $200M of debt ($100M for HRG). They also used a 10X EV/EBITDA calculation to get to this number due to Polyus and Polymetal (two other Russian gold producers) trading at this multiple. Since HRG will no longer have any debt after Q3, it would be fair to use the no debt figure of $3.65B  and at 56%, HRG’s value comes out to $2.04B or $2.43/share. If you add HRG’s liquid assets of $.30 you get to $2.73/share. Olma Investment company provides the only current coverage on HRG with a  target  price of  $2.19 and says it may raise its price after some clarifications from the company regarding Bissa resources. These valuations could increase soon through the above mentioned drilling program and a possible increase in Prognoz ownership (via debt converted to equity in the bankruptcy process). The London Times reported on September 21 that Severstal Gold is likely to go public in London in Q4  with a valuation at $4B – according to sources close to Severstal. Here are a few quotes from the article; “One banker involved in the transaction said the valuation was likely to hit $4bn or possibly $5bn as details about the assets and the company’s growth programme were disclosed to the market.” “ At least 25 per cent of the gold business will be sold through the flotation, said people close to the company. Morgan Stanley is the sole sponsor of the planned initial public offering. Credit Suisse is joint global coordinator with Morgan Stanley. These banks and Russia-based Troika Dialog are the joint bookrunners.”  If this ‘One banker’ is correct, then HRG’s  56% could reach a value of $2.8B or $3.33/share – close to where it was trading in early 2008. 
Possible Minority Offer?
Only 10% of minority shareholders tendered to the low-ball $.30 offer from Severstal in 2009. Since that time, the stock has traded up nicely, but still trades at a discount   -  possibly due to fears that Severstal might try another minority buy out. I am not convinced that Severstal will  try another  buy out as doing so may result in a negative campaign by existing shareholders. This would fly in the face of the positive message they are trying to get out for their IPO. Also, if the attempt failed, it would have wasted important resources that could have been used to promote the Severstal Gold IPO – a much bigger and more important goal for them. Keep in mind that a Severstal Gold IPO is a way for Severstal to get back most of its investment in the gold sector while still retaining 65 - 75% of the company.  An important sign that they may be satisfied with their ownership percentage in HRG is their exercise of the warrants (at a price barely below trading price) when the warrants weren’t due to expire for several more years. As HRG did not need the money, this to me signified they just wanted to get a final  extra piece of HRG without going down the difficult buyout route. As we know, the current institutional minority shareholders in a media statement in January said they would not sell for anything less than $1.50. Since then, HRG revenues, cash flow, and profit have risen substantially with all debt retired.  My best guestimate is that the institutional group still holds approximately 90M shares out of  248M minority shares. If I am wrong and Severstal does make an offer, I am confident we can  repeat the same campaign as  last time by contacting all minority shareholders. We only need to have 124.5M shares (over 50%) not tendered  to keep HRG from going private.  I think this is quite achievable. Lastly, some minority shareholders have speculated on stock forum sites that Severstal could be buying in the market. I highly doubt that they would risk such trading without filing the required insider trading reports  and Canadian Securities Regulator reports. Such moves,  if discovered, would cause serious problems for their gold IPO and their current London listing – not to mention minority legal action.
Investor Relations
A few months ago I took it upon myself to hire an Investor Relations company – Precious Metals Investments - to promote the HRG story in Germany, Austria, Switzerland. I decided to do this in case HRG management and Severstal would only promote the Severstal Gold story. Germany has become the world’s largest retail purchaser of gold. See article below. I have invested  US$195k in this program and it has been confirmed to me that new European investors (including funds) have been buying HRG since $.75 and continue to buy regularly. I have been told there are no assurances this program will succeed in driving the price up to proper  valuation – but everything helps.  
We look forward to the Severstal Gold IPO moving ahead at the highest possible valuation and hope HRG stock trades up to the mentioned prices. Once HRG is at fair value, then  minority could consider a buyout using Severstal Gold shares as the currency.
Severstal Gold IPO
Severstal  PR on Gold resources and production
Severstal Gold’s presentation
Olma Investment report
Bissa Feasibility Study
HRG’s 3rd party stock investments
Germany, the world's largest retail gold investor 
Chris Charlwood
604-718-2638 f

Disclosure: Long HRG.TO