Kaisers comments
Tue Apr 15, 2003
Kaiser Tracker 2003-09: Mountain Province - Same Time Same Place Next Year
Publisher: Kaiser Bottom-Fishing Report
Author: Copyright 2003 John A Kaiser
--------------------------------------------------------------------------------
Kaiser Bottom-Fish Tracker 2003-09
April 15, 2003
Mountain Province Diamonds Inc (MPV-T: halted at $1.06 MPVI-OTC: US $0.45)
Same Time Same Place Next Year
On April 15, 2003 De Beers once again provided evidence why it is not the partner of choice for diamond exploration juniors with an advanced diamond play as it revealed a decision to postpone a prefeasibility study at Kennady Lake for another year. Mountain Province Diamonds Inc (MPV-T: $1.06) and Camphor Ventures Inc (CFV-V: $0.41) were halted at company request around 1:00 PM EST for dissemination of the news as both stocks were starting to weaken. Mountain Province continued to trade on the OTC Bulletin Board throughout the rest of the day, trading as low as US $0.37 before bouncing back slightly to close at US $0.45 on 618,700 shares. That translates into about $0.63 Cdn, much lower than the $1.06 prevailing at the time of the halt, and substantially lower than the $2 level that prevailed prior to the April 4 valuation news that modeled values had suffered a decrease rather than an increase. This shock had left little hope that the updated desktop study would deliver the target 15% internal rate of return, but I had expressed confidence that De Beers would anyhow proceed with a feasibility study for strategic reasons. Unfortunately, other strategic considerations carried greater weight, and, contrary to the apparent expectations of De Beers' Canadian team, somebody upstairs pulled the plug.
Upcoming DIAND tribunal decision the next key news
When TSX trading resumes on April 16 Mountain Province will open sharply lower, with a proportional drop expected in Camphor. I expect Mountain Province to bottom in the original $0.50-$0.75 top priority bottom-fishing range as disgusted speculators bail out and speculators with a 1-2 year horizon move into the market. As investors start to understand that De Beers has only postponed a prefeasibility study so it can explore for additional tonnage and wait for certain unrelated problems to sort themselves out, an accumulation uptrend in Mountain Province will gradually develop, particularly if during the next couple weeks the DIAND tribunal awards the nearby LA 26-30 claims to GGL Diamond Corp (GGL-V: $0.32) and De Beers. If the latter happens we will see GGL become the focus of market speculation as De Beers tests the bluesky potential lurking at the head of the Gravy Train, and GGL raises the big bucks needed to drill test targets on its 100% owned CH project west and southwest of Diavik in the Lac de Gras area. Both Mountain Province and Camphor are passive companies whose management does little more than hold shareholders' hands and draft news releases in response to periodic exploration reports from De Beers. That was fine when it looked like Kennady Lake could make it as a world class mine, but now that De Beers has declared the situation to be otherwise, burnt out speculators are going to seek out the livelier action possible in a junior which is in charge of its destiny while also holding an important stake in an area I continue to believe will see a world class mine developed in the next five years.
Proposed mining rate implies a mine life of only 11 years
The US market reaction is overdone because it treats the Kennady Lake project as dead when in fact De Beers has simply bought some time to allow it develop the additional tonnage needed to make the project more robust. The desktop study envisions developing the 5034 and Hearne pipes as well as the top 140 metres of the Tuzo pipe at an annual rate of 2 million tonnes. At this mining rate the 22 million tonne resource would be depleted within 11 years, just over half the typical 20 year life for a world class mine. In a harsh Arctic setting like the Northwest Territories where mines have to be expensive self-contained operations on a par with a moon base, and reclamation is no small cost, no major mine with such a short life will ever be built. The original Ekati mining plan depleted the higher grade Panda, Misery and Koala pipes within the first ten years, saving larger low grade "filler" pipes like Leslie for the second half. BHP was able to take this risk because it knew that the Ekati project contained over a hundred pipes of which only a fraction had been properly sampled. The odds were good that BHP would find better pipes to plug into the mining plan, and this is indeed what has happened. At Kennady Lake there is no such abundance of pipes, and so De Beers cannot so easily build a 20 year mining facility on the hope that additional tonnage will eventually be found. The Kennady Lake property is large and has many unresolved indicator mineral trains, but De Beers apparently believes that small dyke-like bodies are the primary source of the indicator minerals.
Searching for extra tonnage at Kelvin-Faraday and Doyle Lake
Where can De Beers get additional tonnage? The Kelvin-Faraday dykes may offer an additional 5 million tonnes of high grade kimberlite, perhaps more, but at this stage no resource has been delineated. The news release clearly states that De Beers will spend the rest of the year exploring the Kelvin-Faraday area and will update the desktop study around this time next year. This hardly constitutes a death blow to the Kennady Lake project. De Beers may also be considering the possibility of significant additional tonnage from the adjoining Doyle Lake project of GGL Diamond Corp. Part of this property consists of the LA 26-30 claims, which appear to host the source of a prominent regional indicator mineral train with exceptional pyrope (G10) chemistry. One possible source may be a diamondiferous sill like kimberlite discovered in 1996, but there may be other pipes or dykes in the vicinity. De Beers has spent $6 million to vest for 60% in the Doyle Lake claims, leaving GGL with a carried through production 40% interest similar to that shared by Mountain Province and Camphor. Most of that money was spent on and about the sill, with more detailed exploration on the rest of the claims prevented by a DIAND ministerial decision which reversed the Mining Recorder's earlier decision and threw the claim status into limbo. The ensuing legal dispute is about to come to an end, with a decision from the DIAND tribunal expected by the end of April. If it goes in GGL's favour, De Beers will probably move very aggressively onto the property with a delineation-mini bulk sampling program on the sill and targeting work on the rest of the claims. The so-called Gravy Train has such an abundance of grains that it is hard to imagine that it all originates from a puny sill with potential for only a few million tonnes. The Doyle Lake project might have potential to be developed as a standalone mine, but a likelier scenario is that it can provide the tonnage needed to keep a mine at Kennady Lake going at 2 million tonnes per year for 20 years. To be honest, if I were in De Beers shoes I would want to see what the Doyle Lake property has to offer before spending big bucks on a prefeasibility for a tonnage challenged cluster of pipes.
Short mine life kills net present value
The updated desktop study included some pleasant surprises. De Beers has projected capital costs at Cdn $600 million, which is slightly more than projected in the 2000 desktop study, but considerably less than the Cdn $900 million and $1.3 billion costs of Ekati and Diavik. The pleasant surprise comes in the operating cost, which has dropped from Cdn $81 per tonne to $56 per tonne. This decrease was achieved by boosting production to 2 million tonnes per year. If we use the latest modeled numbers and an exchange rate of 0.68, the 5034 pipe would generate gross annual revenue of Cdn $308 million and pre-tax cash flow of $196 million for 6.5 years. Assuming a tax holiday, payback could be achieved within 3-4 years. When Hearne kicks in gross revenue for 3.5 years will be Cdn $246 million and pre-tax cash flow will be $134 million. During the eleventh year the Tuzo pipe would kick in and provide similar cash flow. The problem with this scenario is that on an after-tax basis the net present value discounted at 10% drops below Cdn $300 million. With error margins of 30% characterizing the desktop study, this value is not really worth De Beers' trouble. The internal rate of return implied by the desktop study, which has not been disclosed, is apparently somewhere between 5-10%, well below the 15% target the agreement mandates as a goahead for a prefeasibility study. Oddly enough, the prefeasibility study for the Victor pipe also had an IRR below 10%, but De Beers is now doing a final feasibility study and already letting contracts for development work on the Victor pipe.
De Beers keener to develop 100% owned marginal projects
The Victor pipe apparently has a mineable resource of 25 million tonnes, a grade in the 0.2-0.3 ct/t range, and a published rock value of Cdn $94 per tonne. Why is De Beers eager to develop Victor? The answer lies in the quality of the diamonds, which the math says average around US $300 per carat. That is a very high value. I have seen a photograph of all the diamonds recovered from Victor laid out in dishes according to bulk sample hole, and it was a dazzling sea of white. Victor's diamonds are top notch; Kennady Lake's diamonds are a motley assortment with good white diamonds showing up here and there. When Victor goes into commercial production the recovered value will likely exceed the modeled value. The Kennady Lake pipes may have a small sub-population of "super diamonds", but their impact is offset by the abundance of poorer quality diamonds. In addition, De Beers owns 100% of Victor as well as 15 other pipes, some of which are being bulk sampled right now. Because De Beers has 100% of the risk at Kennady Lake but only 60% of the reward, it has less incentive to take risks with Kennady Lake.
Geopolitics, uncertain economic outlook, financial concerns
Both Snap Lake and Victor are at the permitting stage with every indication of going into production when fully permitted. Both are 100% owned De Beers projects and both will have hefty capital costs. When De Beers privatized itself in 2001 it ended up with US $3.6 billion in debt. In December 2002 it made a US $710 million prepayment that reduced its debt to US $2.5 billion. Like any wise party these days, De Beers is eager to eliminate debt. The near term economic outlook is very cloudy, particularly for diamonds, a luxury consumer item. It is quite conceivable that De Beers is under financial pressure. Another reason that may discourage De Beers from rushing ahead with Kennady Lake is politics related to environmental permitting, aboriginal economic benefit agreements, and pressure to supply stones to cutting facilities in the NWT. Being overly eager to develop a diamond project that looks marginal could send a wrong signal that ends up undermining the project's economics. Can a company like De Beers make a project look marginal? In the name of conservatism any project can be made to look marginal. The news says nothing about how the parameters are handled over time. Is De Beers inflating costs while deflating diamond prices over time? Is it socking the project with a 10% "marketing fee"? Has it built unusual contingencies into the financial model?
Kennady Lake a victim of circumstances
One thing I do not believe is that De Beers is trying to make the Kennady Lake project look bad so it can buy the juniors out cheaply. Mountain Province and Camphor are carried through production. They have no funding requirements. They can sit back and outwait De Beers. As operator De Beers has certain disclosure obligations it must fulfill before it can make a takeover bid. If management of the juniors should conclude that disclosures do not paint a full and fair picture, it can raise such a "conflict of interest" stink that the bid would fail. If anything, the Kennady Lake project is a victim of broader goals.
*Of the above mentioned securities JK owns shares only in GGL and Camphor