From time to time I've posted notes about MOK. Today I've written a longer assessment explaining why this looks like a promising investment. Comments are welcomed!
1. A Good Deposit in a Good Location 1.1 These days, a grade of 1 gram/ton of gold for an open pit mine is considered decent. Detour's grades are in that ballpark, as are Osisko's reserves at Canadian Malartic. Argonaut's grades at Magino are a little less than a gram per ton. Osisko's grades at Hammond Reef are quite a bit lower than 1 gram/ton, depending on where you draw the cut-off line.
The 2013 Resource Estimate for Moss Lake sets out an open pit resource of 1.38 million ounces of gold at 1.1 grams/ton (measured & indicated) plus an additional 1.62 million ounces (inferred), also at 1.0 grams/ton. The proposed pit has a strike length of 3.2 km, a width of apx. 1.2 km, and a maximum depth of 750m. The authors of the Resource Estimate add:
- The zones encountered at the Moss Lake deposit have significant possibility to expand as all the extensions are open. The only limitation is the property boundary to the NE that is close to the deposit;
- The potential is high for upgrading Inferred Resources to Indicated Resources with more diamond drilling in all of the zones;
- The potential is high for adding new resources in the extensions of known zones with additional diamond drilling;
- The potential is high for identifying new parallel zones with additional diamond drilling;
Not only is this an attractive deposit, but it is open in all directions!
1.2 The metallurgical results were also good. The News Release of 13-Dec-12 included these points:
- The gold is free-milling by conventional cyanide leaching at reasonable grind sizes.
- Recoveries from these methods ranged from 79% to 93% over a 48 hour retention time.
- Recoveries from low grade composites (0.53-0.57 gAu/tonne) ranged from 79% to 83% with residues (tails) grades ranging from 0.09 to 0.12 gAu/tonne.
- The mineralization is clean with respect to deleterious elements with low to undetectable concentrations of heavy metals, arsenic, selenium, lead and uranium as determined by ICP-Scans.
- ABA tests (acid/base accounting) indicate tailings are unlikely to be acid-generating
The third bullet point listed above is particularly important for the project economics, because it means that significant gold recoveries will be possible from the low-grade portion of the ore body (down to 0.5 g/ton), which will support the economics of the PEA.
1.3 The project site is an hour's drive from Thunder Bay, Ontario, and is close to Highway 11. It's less than 70 km (as the crow flies) from Osisko's Hammond Reef project. This is not a remote project that will require expensive infrastructure for roads or power.
2. Coming Up: A Good PEA
Some of the numbers to watch for in the upcoming PEA will be the capital costs, the operating costs, the cashflow / payback calculations, and ultimately the Net Present Value. I'm going to mention a few similar projects, and use those numbers to take some wild guesses as to what MOK's PEA might have in store for us.
2.1 The initial capital costs in the 2009 PEA for Hammond Reef came to $614MM, for an operation of 50K ton/day. These numbers are dated and will no doubt go up significantly when Osisko issues the PFS this year. Prodigy's 2011 PEA for Magino, came to $406MM, for a 20K ton/day mining operation. Spanish Mountain's 2012 PEA for its project set out an initial capital cost of $756MM, but that was for a 40K ton/day mine plan.
I'm going to suppose that MOK's upcoming PEA will have a 20K ton/day mining plan, with capital costs of about $500M -- thus, in the same ballpark as for Magino, but allowing for an increase because of inflation.
2.2 The 2009 PEA for Hammond Reef projected life-of-mine cash costs of $442/oz. In the 2011 Magino PEA, they came to $496/oz. Osisko's actual cash costs at Canadian Malartic for 2012 were $907/oz, but they're projecting the cash costs to drop to about $800 in 2013. Detour's life-of-mine cash costs are projected to be $749.
For my calculations, I'll assume cash costs of $800/oz.
2.3 Time now to do some back-of-the-envelope calculations. A hypothetical mining operation at Moss Lake, running at 20K ton/day, should generate about 230K ounces of gold annually, over about 12 years. If we assume a gold price of $1350 and cash costs of $800, then that should generate operating free cash flow of about $128MM/year. I'll deduct $20MM per year for exploration, sustaining capex, and G&A, which leaves us with $108MM net cash flow (before taxes). Over a 12 year mine life, the net present value of that cash flow, discounted at 5%, should be about $950M. If we then deduct the initial capital costs ($500M), we are left with a NPV of $450M (pre-tax) and a payback time of about 5 years.
Obviously, my calculations are very rough. But if the actual PEA numbers come in anywhere close to my numbers, they would indicate that the theoretical true value of MOK could be close to $9 per share!
3. Comforting Financials
3.1 When someone is considering an investment in a venture company that is not producing income, two big concerns are the cash burn rate and the dilution rate. Let's look at how well MOK does on these criteria. Exactly 10 years ago (the spring of 2003), the company had about 34 MM shares outstanding. Since then there have been no share rollbacks, and today there are about 47 MM shares outstanding (51 MM if we include the about-to-be-issued new shares that will shortly be granted to Wesdome in lieu of repayment of the 2011 $2 MM note).
So a shareholder who bought MOK in 2003 has experienced a total dilution of about 33%, over a period of ten years -- during which time the project has advanced via drilling, resource estimates, a topographic survey, and a metallurgical assessment, all of which will culminate in a PEA that is now almost finished. Not many venture mining companies protect their long-term shareholders with such a low dilution rate, on a project that is actively moving ahead.
The low burn rate and dilution rate is only possible because cost control at Moss Lake Gold is very tight. None of the directors or officers are paid. Wesdome provides the office space, accounting and administrative support, and the fees that Wesdome charges back to MOK are very modest.
3.2 On paper, the balance sheet looks bad, with a working capital deficiency. But don't worry about that current liability -- it's a short term note payable to Wesdome, the majority shareholder, and that loan will be converted to shares at 50 cents per share -- which is more than three times the current share price! Wesdome knows the value of this project.
4. Good Outlook
4.1 The MDA released on 30-May-13 stated:
The Company expects to release results of the Preliminary Economic Assessment in the first half of 2013. We want to share and define the economic conditions necessary to support a hypothetical mining operation at Moss Lake with our shareholders, the market and our directors. We must have information to establish strategic direction.
So, after the PEA is received, the strategic direction will be assessed. I can think of several possible directions that might be pursued:
i) Management might continue to push the project forward with additional in-fill and step-out drilling, leading to a further Resource Estimate, and ultimately a Pre-Feasibility study.
ii) Management might look for a JV partner who will earn an interest in the Moss Lake by moving the project along.
iii) The project might be sold (possibly with retention of a minority interest by Wesdome).
iv) The project might be put on the back burner until market conditions improve.
4.2 To assess which of these outcomes in 4.1 is most likely, we must try to see it from the perspective of Wesdome, the majority shareholder. Read through Wesdome's Corporate Presentation dated May 2013, which was given at their most recent AGM. Some recurring themes are:
- controlling costs (slides 4, 10, 31);
- optimizing cash flow (slides 4, 24, 31) and earnings (slide 9);
- keeping the dilution rate low (slides 4 & 15).
But they've got challenges:
- they may need a new tailings pond (slide 25);
- they want to follow up on promising discoveries at Eagle River (slide 20) and Kiena (slides 28-29);
- to increase production they need "infrastructure investment" at the Eagle River Mill (slides 10, 31).
The Eagle River Mill is a problem for Wesdome right now, since its capacity is only 1000 tons per day. That would be OK if Wesdome was only pulling up high grade underground ore, but now that they've opened the nearby Mishi open pit mine, there's limited capacity at the mill to handle the huge quantity of potential mill feed. Mishi has 5 million tons of ore graded at 2.1 g/t, which could be fabulously profitable with cheap open-pit mining techniques -- if only there was sufficient mill capacity to process that ore. And upgrading a mill can be an expensive proposition.
4.3 Considering Wesdome's apparent priorities, does it sound like a company that is going to invest a lot of money into advancing the Moss Lake project at this time? I think not. Thus, I rate option (i) in 4.1 above as having a very low probability.
What about option (iv) -- putting Moss Lake on the back burner? Well, doing that would be more consistent with Wesdome's conservative corporate culture. But having taken some steps since 2011 to move the project along, I think that Wesdome will prefer to keep up the momentum, and that the other two options will be more attractive than putting the project on hold.
So then, will it be option (iii) -- looking for a JV partner -- or (iv) -- putting the project up for sale? My guess is that Wesdome would go either way if good enough offer came along. But my bet is that their preference will be to sell Moss Lake. Why?
- They clearly don't like borrowing or issuing shares to raise funds - and it will cost plenty of money to advance Moss Lake.
- Right now Wesdome needs extra cash for their own core projects
- Frankly, they've just never demonstrated much interest in Moss Lake. It's a long way from their other sites, and until recently they don't seem to have thought about it very much.
Thus, my guess is that Wesdome is planning to sell Moss Lake, and deploy the cash to support its flagship properties, the most urgent matter being the upgrade of the Eagle River Mill.
Remember that in 2010, Osisko paid $372MM for Hammond Reef, a resource that was about twice the size of Moss, but otherwise rather similar, and in the same region of the province. If Moss Lake were valued by the same metrics as Hammond Reef to be worth, say $150 million, then Wesdome's share of that sale price would give it plenty of cash to work on its exploration objectives and infrastructure upgrades. I think that this prospect will appeal to Wesdome.
4.4 Now for the more interesting question as to the outlook specifically for Moss's minority shareholders. At this point, we're just barnacles on the ship, and we're going along for the ride whereever Wesdome takes us. But I wouldn't be surprised if Wesdome is thinking of buying out the minority shareholders, and perhaps sooner rather than later. If Wesdome became the 100% owner of MOK, that would give them more flexibility as far as dealing with the Moss Lake project, especially if quick negotiations and decisions needed to be made. Take another look at the words quoted earlier from MOK's recent MDA:
We want to share [the PEA results] with our shareholders, the market and our directors.
It may be that one reason for sharing the PEA results is so that MOK's shareholders, WDO's directors & shareholders and WDO's market analysts will have enough information to assess what a reasonable buyout price would be.
4.5 Finally, we get to the icing on the cake. We know that take-over offers typically include a premium of around 35-50% over the recent share price of the target company. Thus, Wesdome could offer MOK's minority shareholders a takeover price of 20 cents per share, and be well within the boundaries of the usual practices on the venture exchange. But Wesdome has a problem -- if I am correct that their objective will be either to sell the project, or option it to a JV partner who will earn-in an ownership share, then Wesdome might be shooting themselves in the foot if they start out by making a low-ball offer to MOK's minority shareholders. Wesdome will want to persuade potential purchasers (or JV partners) that Moss Lake is a valuable project, and to do this they will need to offer a price to MOK's minority shareholders that is in the same ballpark as the price that they themselves would like to receive from an ultimate buyer.
5. Risks & Potential Rewards
5.1 Every venture company presents risks and potential rewards. Some risks might be:
- Wesdome might put MOK on the backburner and let the company languish, without any marketplace exposure, such that the minority shareholders end up marooned with a low-priced illiquid investment.
- The project is located less than 20km from Quetico Provincial Park and the water from Snodgrass Lake (at the site of the deposit) eventually flows into the Park. This location may eventually present challenges with obtaining environmental & mining permits. Furthermore, the mine plan may require that Wawiag creek be rerouted, and that Snodgrass Lake be partially drained, and these proposals could be problematic.
- If the price of gold falls significantly lower, the value of all development projects, including Moss Lake, will be negatively impacted.
5.2 On the other hand, an investment in MOK presents a huge potential upside:
- As noted in 2.3 above, the upcoming PEA might perhaps set out a pre-tax NPV of $450MM, which would theoretically value MOK at nearly $9 per share.
- Of course, in today's environment, nobody is going to pay $9/share for MOK. But last year Argonaut paid $341MM for Prodigy, which valued Magino at around $54 per ounce of gold. In 2010, Osisko's purchase of Brett valued Hammond Reef for $372MM, which valued Hammond Reef at about $55/oz.
- It's quite realistic that someone today might pay $40 to $50 per ounce for Moss Lake, which would amount to $120MM to $150MM -- thus $2.40 to $3.00 per share. Indeed Osisko might be a potential buyer, because Moss Lake would nicely complement their Hammond Reef project, and the proximity of the two sites could lead to some economies of scale for them if they developed the two projects in tandem
- In today's market there are many undervalued venture companies. However, I suggest that not many investments present an upside potential of 15 to 20 times the present share value, with relatively modest downside risk.