Summary
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Allied Nevada has only $13.6 million in cash, but they have $75 million in debt obligations per year for the next several years.
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Allied was relying on $1,300 gold and $21 silver to cover those obligations, now gold and silver are below that and moving lower.
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Allied Nevada's policy has been not to hedge, but they announced in their latest 10Q that they could start to hedge production.
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The stock could decline drastically if gold and silver keep moving lower and Allied Nevada doesn't get any hedges put on.
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Hycroft is a great project, and Allied Nevada should just be acquired. Fair value is around $500-$600 million.
Allied Nevada (NYSEMKT:ANV) has backed itself into a corner as their cash has dwindled to almost nothing, yet they still have $570 million in debt and have no way to build their $1.3 billion expansion at Hycroft.
Below is a look at Allied Nevada's balance sheet as of June 30, 2014. They have $13.6 million in cash, but have $74 million in short-term debt and $496 million in long-term debt.
(click to enlarge)
(Source: Yahoo Finance)
They need to get some hedges in place as their projections for covering all debt obligations were based on roughly $1,300 gold and $21 silver prices.
How Allied Planned To Fund Its Debt Obligations
A closer look at the debt position shows that the majority of the debt is from the 8.75% Senior Notes due in 2019, and the rest is from capital leases on the equipment. 
(Source: Allied Nevada)
The interest on the June 2019 notes is about $31.5 million per year as the company entered into a cross currency swap which dropped the effective interest rate down to 8.375%. The company's capital lease and term loan obligations are for the purchase of mining equipment. The following is the repayment schedule for those capital leases as of June 30, 2014. I should also point out that the company has $47 million in assets held for sale in which $28.8 million of capital leases are related to.
(Source: Allied Nevada)
So as you can see, Allied Nevada has a hefty amount due in interest on the debt and capital lease repayments. Over the next 3 1/2 years the majority of those capital leases will be repaid, but when you combine it with the debt interest, that is roughly $75 million per year that Allied Nevada will have to come up with to satisfy those obligations.
In the latest 10Q, Allied Nevada says:
At current metal price levels and using our 2014 target adjusted cash costs per ounce of $825 to $850, we believe future cash flows from operations, together with our $13.6 million of cash and cash equivalents and $75.0 million Revolver, will allow us to meet our needs for working capital, capital expenditures, debt service, and other liquidity requirements associated with our operations for at least the next 12 months.
The Hycroft heap leach operation will still be producing around 250,000 ounces of gold and 2-3 million ounces of silver per year over the next few years. At $1,300 gold and $21 silver, the cash flow generated from this production will take care of all of the interest expenses and other liabilities. But gold and silver are now below that, if they go lower then Allied is going to have a short-term funding problem.
The company expected a cash balance of negative $3 million to negative $13 million at the end of this year, again though, that was using much higher gold and silver prices. Allied Nevada does have a $75 million revolver($66 million is available) which it could tap right now if it wanted to, but to protect itself it needs to start hedging.
Allied Nevada's Policy On Hedging
In Allied Nevada's 2013 Annual Report they stated the following:
We do not currently enter into forward sales or other significant hedging arrangements to reduce the risk of exposure to volatility in metal and commodity prices. Accordingly, our future operations are exposed to the impact of any significant decrease in gold or silver prices and any significant increase in commodity prices. If such prices change significantly, we will realize reduced revenues and increased costs. While it is not our current intention to enter into forward sales or other significant hedging arrangements, we are not restricted from entering into such arrangements at a future date.
In Allied Nevada's latest 10Q they state:
To protect future per ounce cash margins from changes in metal prices, we may consider hedging a portion of our metal sales over the next six to 18 months with forward sales agreements; however, as of August 4, 2014 had not entered into any such transactions.
So it looks like Allied Nevada went from a no hedge policy to a we will hedge policy. And that is what they need to do, if they haven't already.
It Might Be Time To Just Sell The Company
Given the low cash balance, the debt load, the $1.3 billion price tag for the Hycroft mill expansion, and the now declining gold and silver price, it might just be better for Allied Nevada to be acquired.
In Allied Nevada's latest 10Q, the company said:
We are working on financing strategies based upon the prefeasibility study's estimated capital cost and have engaged Credit Suisse Securities (USA) LLC and Scotia Capital, Inc. to help us find an investment partner(s) to assist us with financing the mill expansion project.
Allied Nevada's goal is to be completed with this process by the end of the year. The company says it's open to a joint venture, silver stream, financial investment, or a combination of those and other opportunities(i.e. buyout). A JV or a buyout make the most sense. A silver stream or financial investment doesn't really help Allied Nevada that much.
There is no doubt that interest is high for Hycroft. It's in a great jurisdiction and the mill expansion will be a big cash flow generator.
The Hycroft mine is located in Nevada. As of now it's just a heap leach operation as the oxide ore is only being mined. For 2014, Hycroft is expected to produce 230,000-250,000 ounces of gold and 1.7-2.0 million ounces of silver. The heap leach can produce this amount for about 2 more years (2015-2016), and will continue to produce gold and silver for years after that, but at much lower levels. Hycroft still has substantial upside due to the amount of sulfide ore it contains, but Allied Nevada needs to spend a lot of money to build a mill for these sulfides.
As of December 2013, Hycroft had 8.8 million ounces of gold and 412 million ounces of silver in reserves that could be pushed through this mill.
(click to enlarge)
(Source: Allied Nevada)
The company released a Pre-Feasibility Study on the Hycroft mill expansion back in April 2014. Below is a look at how this mine will operate. It's a is a substantial project, there is no denying that. However, Allied Nevada simply doesn't have the resources to construct it.
(click to enlarge)
(Source: Allied Nevada)
Allied Nevada Could Have The Same Fate As Orezone Resources
Back in 2008, there was a gold company called Orezone Resources, which owned the Essakane project in Burkina Faso. I was following the company because Essakane was a very solid project. It was going to produce 300,000 ounces of gold per year over a minimum nine-year mine life at an average cash operating cost of US$358 per ounce.
There was one problem though that Orezone had. At the time the market was crashing and money was tight. Orezone had to come up with $350 million more to complete Essakane. It arranged for financing of the project in August of 2008, but with credit markets freezing up the financing never came to fruition. That left the company scrambling for cash. Raising $350 million at that time was pretty much impossible since its market cap was only about $50 million, as the stock had plummeted about 85%.
In December of 2008, IAMGOLD(NYSE:IAG) announced it was acquiring Orezone for $139 million. IAMGOLD got one heck of a deal. As the saying goes, when there is blood in the streets, buy property, that's exactly what IAMGOLD did.
Orezone and its shareholders owned a great mining deposit. However, there were no other options but to sell out as the company didn't have any money left to develop Essakane. Essakane has been a solid cash flow producer for IAMGOLD during the last 4 years.
Why do I tell this story? Because Allied Nevada is now in a similar position.
What Happens If Gold And Silver Keep Declining But Allied Doesn't Hedge?
Hycroft should produce about 250,000 ounces of gold and 2-3 million ounces of silver per year for years 2014-2016 (silver production is around 1.7-2.0 million ounces for 2014). Allied Nevada has about $75 million in debt obligations per year during that time, plus figure about $15-$20 million in cap-ex. At $1,300 gold and $21 silver, those are covered. But look what happens when the price of gold and silver move lower.
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Gold Price
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Silver Price
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Pre-Tax Cash Flow
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$1,300
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$21.00
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$112.5 million
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$1,150
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$17.00
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$67.5 million
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$1,000
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$15.00
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$25 million
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That's pre-tax cash flow. Allied is going to have a big funding gap to fill if you factor in taxes and lower gold and silver prices.
Gold and silver are now moving down hard. If they keep declining and Allied Nevada doesn't hedge, then the shorts will be all over the stock given the company's current predicament. They could drive the price down to ridiculous levels just like they did with Orezone, as Allied Nevada would be scrambling for cash.
If gold goes down to $1,000-$1,100 and Allied Nevada has no hedges in place, then they are going to have to take a buyout. They will have no other options really. Look what happens after 2016, the heap leach production declines dramatically. Yet they still have $31.5 million in interest payments on the debt during 2017, plus $33 million in capital lease payments that year, plus interests on those capital leases. They would be losing over $50 million in 2017. Not to mention the losses during 2015-2016.
(Source: Allied Nevada)
What's The Price Tag On Allied Nevada?
Ultimately I think this ends in a buyout or a JV deal. That's what needs to be done. I hope Allied Nevada doesn't sell a gold stream or dilute shareholders instead in order to help fund the debt.
So the question that most Allied Nevada shareholders want an answer to is what is Allied Nevada worth at the moment?
Notice the $786 million in Net Tangible Assets at the bottom of the balance sheet. Even though the company doesn't have any cash and is saddled with debt, they still have substantial assets. The company has $881 million in Property Plant and Equipment on the books, plus it has several hundred million of ore on the leachpads. Part of this ore is counted as PP&E on the balance sheet above. They have more than enough assets on the books to cover all of the liabilities including the debt. Allied Nevada currently has a market cap of $361 million, so it's trading at less than half its Net Tangible Asset Value.
The After-Tax NPV(5%) on the LOM at Hycroft is $1.68 billion using a $1,300 per ounce price for gold and $21.67 per ounce price for silver. That LOM is 2014-2033, it's not just for the Hycroft mill expansion. So it's the rest of the heap leach and the mill.
I should also point out that according to the technical report, 2014 has negative $10 million in cash flow. If a buyout occurs the acquiring company would still have a $1.68 billion return even if the acquisition closes in early 2015.
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After-Tax NPV(5%)
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$1.68 billion
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Since Allied Nevada has $786 million in Net Tangible Assets, one could make the argument that a $786 million buyout price would be too low of an offer. However, as I mentioned above, the company has ore on the leachpads that is counted as an asset on the balance sheet. That ore is worth about $350 million. Since that ore will be used to generate its share of the $1.68 billion in NPV(5%), you must subtract it from the book value. Now you are down to $436 million in terms of Net Tangible Value for Allied Nevada. I just want to point out that the $350 million in ore is still an asset on the balance sheet, it's just in this case we are trying to determine the value of Allied Nevada separately from that of Hycroft.
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Net Tangible Assets
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$786 million
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Net Tangible Assets Minus Ore On Leachpads
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$436 million
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If you factor in the interest on the debt that would be acquired, which right now runs $31.5 million per year from now until mid 2019, I think the fair value for Allied Nevada's assets is around $250 million. That also includes some depreciation on the assets. Given the $1.68 billion NPV(5%) for Hycroft, I figure that it's worth about $250-$350 million. When you add it all up, the fair value for Allied Nevada is about $500-$600 million. That's the buyout price I would expect. That's substantially higher than it's trading at today, but probably less than most shareholders expect. It's the debt obligations that are ultimately dragging down the value of Allied Nevada.
Conclusion
Allied Nevada's only has $13.6 million in cash at the moment, but the company has about $75 million in debt obligations per year over the next 3-4 years that it must fulfill. Current production from the heap leach operation at Hycroft can cover those debt obligations, but that is using a roughly $1,300 price for gold and $21 price for silver.
While Allied Nevada's policy has always been to avoid hedging, the company announced in its latest 10Q that they are now open to the idea. Given the decline in gold and silver, they need to do this or else they won't be able to cover their debt obligations should gold and silver decline even more.
In the end I think the better option is for Allied Nevada to just be acquired. I think the fair value would be around $500-$600 million.