Investment Hypothesis: Baru Gold Corp. (OTCMKTS: OTCQB:BARUF; TSX.V: BARU) is attractively priced relative to the cash flow capability on its Sangihe gold project. In addition, their second Miwah project provides significant potential upside. I have written previously about BARU (links here and here) and remain optimistic on the name given the math which yields a potential of 10x to 22x the current valuation if Baru is able to make further progress. The title of my last article “The Waiting Is The Hardest Part” proved surprisingly prescient. Baru has suffered a loss in investor sentiment because of lengthy project delays that were outside of their control. The two-year delay in production timelines have dropped the share price dramatically. However, today I write of catalysts – not delays. I believe the recent developments will transform the company. Baru has a signed a contracting agreement with a local Sangihe resident to restart a recently producing gold mine on Sangihe. The August 8, 2023 announcement with a local Indonesian miner CV. Mahamu Hebat Sejahtera (“MHS”) has the potential to change the fortunes of Baru shareholders. MHS will immediately start operations and the first gold pour is expected within two months. Interestingly, insider share purchases have increased recently. Dr. Shidan Murphy, a senior advisor and Independent Director of Baru, has significantly expanding his holdings on the open market and in private placements since May 2023. Dr. Murphy is now the largest individual insider and now holds over 3.3% of the company. Baru has clear levers to drive growth and its stock valuation. In addition to cash flow, Baru now has the option to do additional licensing for small portions of its Sangihe CoW or can simultaneously develop the broader Sangihe project themselves. The economics of these levers are extremely attractive relative to the current market cap. In addition, the investor essentially gets a free option on the economic value of Baru’s claim on the huge Miwah gold project. To put that option potential in perspective Baru once traded at a market valuation of USD $600m based on Miwah alone. The market cap today is USD $11m. Recent News and Implications On August 8th Baru announced that it had signed an agreement with mining contractor MHS that allows them to produce gold on 15 hectares of Baru’s Sangihe project for 5 years, starting immediately. Some key points here: - The 15 hectares includes a recently operating mining area which should speed the process to mine for gold. Per the press release MHS expects production within 2 months.
- Baru will receive approximately CAD $670,000 ($500,000 USD) in three payments over the next month or so. Baru has already received CAD $87,000. If MHS does not make the 2nd payment, then the agreement is terminated, and no further monies are owed.
- MHS will use its own capital to develop and expand this mining area. Baru will not contribute capital to this development.
- Baru will be responsible for co-supervising, refining, and selling the gold as well as distributing the funds. MHS will receive 65% of gross receipts and Baru 35%.
- A key thing to understand about the 65%/35% split is that Baru does not have direct production costs related to its 35% split. In other words, they receive the ore with no mining or sustaining costs. Their margin on the ore will be 100%. Baru is responsible only for Corporate expenses.
- Importantly, Baru expects to conduct additional bidding for other areas within the 50 ha. MHS initially wanted to contract the area but Baru preferred to open competitive bidding. This will drive additional value for Baru shareholders. Baru anticipates receiving a at least CAD $6 million related to closing the deals currently in negotiation to bring the entire 65 ha into operation. Any funds received would be in addition to an ongoing split of mined gold ore.
- MHS agrees to abide by the same environmental standards that govern Baru for this property and oversight will be co-managed by Baru. This includes the prohibition of mercury.
- This was a cash / operating agreement and no stock transaction and importantly no stock dilution occurs as a result.
Deeper Dive The informed reader will know that on August 3rd BARU had issued a press release stating that it had a Memorandum of Understanding (MOU) with MHS to operate on 65 hectares in return for a payment of $6m CAD over 3 months. This was exciting given that this was roughly equivalent to the market cap of BARU at the time of the announcement. To gain a better understanding for this article I contacted Baru to understand more about the opportunity. In particular I wanted to understand why they only awarded 15 ha in exchange for CAD $670k. A recap of some key points from that discussion is immediately below: - Baru did not believe that it was in their best interest to contract the full 65 hectares to one company because it might limit both financial and operational flexibility.
- Baru intends to conduct competitive bidding for licenses on the additional 50 ha.
- An initial smaller area of land will allow Baru and MHS to gain experience working together and resolve any issues related to oversight of labor, operations, and environmental compliance.
- MHS can operate at full capacity on the initial 15 ha for at least the next 12 months and thus the ongoing cash flow to Baru for its 35% portion described above will not be affected. The mining area can be subsequently expanded in a competitive bid.
- This was a previously operating mine including heap leach pad which will allow for a faster start to production. Baru believes they will achieve cash flow within 2 months.
- The fact that a local and knowledgeable mining company was willing to pay $6m CAD upfront for the exclusive rights on 0.15% of the Sangihe CoW area underscores the value of the overall asset.
Financial Implication of the MHS Deal and potential additional round(s) of Competitive Bidding Disclaimer: These numbers are initial estimates as the agreement has just been signed and operations need to commence etc... I present “Conservative” and “Base” scenarios to give the reader a better sense of the range of outcomes. The numbers below are for the next 12 months as well as per month ongoing. I also present a discounted cash flow (NPV) analysis based on a 5-year timeline. Key Assumptions: Gold ore mined: 500oz per month. My understanding is that they believe this could be more like 1,000oz per month. Split: 35% to BARU consistent with agreement Net realized per oz: $1,000 USD “Conservative” Scenario $1,500 “Base” Scenario. Gold price is roughly USD $1,950/oz at time of writing. The discount is meant to account for taxes and any additional costs such as processing and transportation that may be required . Please note I have left quite a margin of safety in these calculations based on gold price alone as there will not be $450 in costs ($1500 “Base Scenario”) and certainly not $950 in costs (Conservative Scenario”). Initial start time: 6 months Conservative / 2 months Base. |