In light of the news that Nick Mather is stepping down as CEO of SolGold (LSE:SOLG) (TSX:SOLG), after pressure from shareholders, we thought to share highlights from a report we wrote for Club Members in October 2020. We called some of the issues now being raised and questioned the financing structure too.
SolGold is an exploration and development company known around the globe partly for its Australian management and listings in London and Toronto, and partly for its work in Ecuador. The discovery of the three billion tonne Alpala resource at the Cascabel project in Ecuador has captured the imagination of retail, institutions, and mining companies alike, and at times in the past, the market capitalisation of the company has been a billion US dollars. With mighty share price rises and falls over the years it has been a wild ride, with many factors influencing the share price from its lows in late 2015 to a high in mid-2018, and falls and gains since then.
NOTE: This is only a short excerpt, not the full 50 page report which can be found in the Club. It was originally published in October 2020.
NOTE: We don't short stock or get paid to write hit pieces. If we are invested, we say so. This report, on the whole, is not critical of Solgold, but did point out some red flags that needed addressing.
Solgold Plc (“Solgold”) (LSE:SOLG)(TSX:SOLG) is an exploration and development company known around the globe partly for its Australian management and listings in London and Toronto, and partly for its work in Ecuador. The discovery of the three billion tonne Alpala resource at the Cascabel project in Ecuador has captured the imagination of retail, institutions, and mining companies alike, and at times in the past the market capitalisation of the company has been a billion US dollars. With mighty share price rises and falls over the years it has been a wild ride, with many factors influencing the share price from its lows in late 2015 to a high in mid 2018, and falls and gains since then.
A generalist fund manager once reported to CRUX Investor that mining is one of the few sectors that can give him the ‘sex and violence’ needed to spice up a diversified portfolio. Solgold has certainly delivered on that front, with prices moving from 1.4 pence to 46.5 pence (exploration), a steady decline to below 20 pence (“boring” and expensive studies), and then back up to 40 pence (exploration again).
The wild ride has also, of course, been affected by external factors. Ecuador continues to open up (albeit stutteringly) to commercial mining, manifest in the commissioning of the country’s first large scale mines, Fruta del Norte (gold) and Mirador (copper) in 2019. Furthermore, the broader mining industry continues its hunt for Tier 1 assets, and Tier 1 copper assets in particular, capable of sustaining production for decades into the future. For a number of reasons (geological endowment relative to exploration history, politics, and economics - in a nutshell) Ecuador is one of the best places to explore for porphyry copper deposits in the world. Accordingly Solgold has been, and still is, involved in a complicated corporate dance with industry partners lining up as potential suitors for co-development or buy-out.
The many variables and parameters may leave CRUX Investor and you, dear reader, scratching heads, trying to fathom out what Solgold is really worth. How much value can one ascribe to Cascabel? How valuable is the rest of the exploration portfolio? Is Porvenir going to be as good as Cascabel, or will it be better? What are the capital demands on Solgold as it pursues its exploration and development goals, and how much dilution, therefore, can be expected? In the face of so much complexity, CRUX Investor has gone back to basics. Building a house? Get your foundations right. And in this case that means doing a deep dive on Cascabel. At the end of the report a short section considers the value of the exploration portfolio.
CRUX Investor has reviewed the viability and the value of Cascabel and the Alpala PEA. As always great store is set on industry norms, and little truck is given to wishful thinking from the Company trying to persuade consultants that “this time it will be different”, or indeed consultants not wanting to offend a high value client by presenting bad news. Unfortunately, the truth can sometimes hurt. As always Crux Investor gives you a blow-by-blow account of its thinking in the chapters that follow, here is the summary of that thinking:
Solgold is the successor company of Solomon Gold Plc, which changed its name when the focus of activity moved to Ecuador in South America. The company has amassed a large landholding in country with 76 concession areas of which approximately 42 are distributed among thirteen priority projects and the remainder (approximately 34 concessions) are barely discussed by management. The thirteen priority projects include Alpala, Porvenir and Rio Amarillo among others. CRUX Investor will return to the exploration opportunity, commitments (and associated liabilities) of holding 76 concessions later.
The most advanced project is the Alpala Cu-Au porphyry in the far north of the country. Solgold has worked at Alpala since 2012 when it first came into Ecuador. The company stake has reached 86.1% beneficial interest, of which 85% is held directly and the balance through shareholding in Cornerstone Capital Resources Incorporated (“Cornerstone”), the company originally controlling Alpala. It is worth nothing that Cornerstone, in return, states that it has a 21.4% beneficial interest in Cascabel comprised of a direct 15% interest in the project financed through to completion of a feasibility study and repayable out of Cornerstone’s share of project cash flow, plus an indirect interest comprised of 7.6% of the shares of SolGold Plc. Relations between the two companies have deteriorated over time and are currently hostile.
The mineralised system at Alpala is very large and attracted the attention of two major mining companies: Newcrest International Pty Ltd (“Newcrest”) and BHP Billiton Plc (“BHP Billiton”), and they are now the two largest shareholders in Solgold holding 13.57% and 13.64% stakes respectively. More recently (September 2020) Franco Nevada acquired a 1% net smelter return (“NSR”) royalty in Alpala for US$100 M, which can be increased to US$150 M for a commensurate increase in the royalty to 1.5%. The funds will be dedicated to completing a feasibility study at Alpala, and reaching a final investment decision. Solgold and Franco-Nevada are discussing a potential precious metals offtake stream of up to US$1 billion to contribute to development finance.
The Company has released 3 resource estimations, each with roughly the same amount of metal, but with increasing confidence levels. The latest resource estimate effective March 2020 has almost all in the Measured and Indicated (“M&I) categories, which makes it possible to declared reserves for the project, should a feasibility study be positive. Solgold expects to release the results of a pre-feasibility study (“PFS”) within the next few months, delayed because of restrictions imposed to prevent the spread of the COVID-19 virus.
The economic studies assume that block caving will be the mining method for Alpala, which is logical as the low average grades mean that a low cost mining method is needed. The high-grade core only starts at around 600m below surface, makes open pit mining unattractive with the huge amount of low grade material needing mining before better grades are reached. Hence the employment of the lowest cost underground mining technique available: block caving.
The block caving advantages of high productivity and low operating cost do, however, come at a price of technical risk. Block caving is very inflexible, has a number of pre-requisites that cannot be established with great confidence before start of mining, requires huge capital investments at the start, has a very long lead time and slow ramp-up, and can pose great dangers should the company make wrong assumptions for rock mechanical and geo-hydrological conditions. It is for this reason that block caving operations are only undertaken by real experts, by mining companies with appropriate experience (and balance sheets). It is no surprise that the industry parties invested in Solgold, BHP Billiton and Newcrest run block cave operations.
Without the benefit of a feasibility study this CRUX Investor valuation had to draw on a production schedule in a preliminary economic assessment using mineral resources estimated in November 2018. These resources contain slightly less metal than the 2020 estimate, but at higher grades of 0.41% Cu and 0.29g/t Au in M&I resources compared to 0.37% Cu and 0.25g/t Au in 2020. The implication is that the PFS should have a lower average grade in the schedule than for the PEA. Moreover, the PEA seems to ignore dilution as being important, as the average feed grade for copper exceeds the resource grade by 3% and the gold grade treated exceeds the resources grade by 7%. CRUX Investor views this as overly-optimistic considering that according to a reference publication on block caving states: “with care, mining recoveries in the order of 80% with dilution below 25% can be achieved”. And this is not the only case of rose-tinted glasses being worn.
This study concludes that Wood, the agency responsible for the PEA study, has been generally far too optimistic in its assumptions. In addition to the overly high forecast grade, Wood suggests a 531/10/2020 pre-production period of 4 years and ramp-up to full production of 60 million tonnes per annum (“Mtpa”) of 6 years, which is far shorter than for comparable operations. Cash operating cost assumptions of US$10.60/t are very low in comparison with costs of US$10-US$20/t seen in similar operations. After analysis of the Alpala data, Crux Investor arrives at a cash operating cost of US$19.65/t.
The PEA capital estimate of US$2.8 billion is very low with a provision for the process plant being one third of what can be expected for the plant size for the anticipated tonnages. EPCM rate are a fraction of what these are in practice and the contingency of 11% bears no relation to the stated accuracy of +/- (forget the minus) of 35%. On many levels the most optimistic case has been taken by Solgold, which is a significant Red Flag. CRUX Investor calculates that initial capital expenditure of US$5.3 billion is a more realistic figure for development of this asset at the proposed tonnages in this location.
CRUX Investor, in preparing this valuation has made a number of adjustments bringing the PEA assumptions in line with industry norms, using the large body of benchmark figures that are available in the literature for reference. With these adjustments, and accounting for investments in working capital and including the tax on dividends to non-residents, a real-world valuation was reached, and unfortunately that real-world NPV is negative. It is worth saying again, using benchmark (CRUX Investor) assumptions and spot metal prices on 26 October 2020 of US$3.08/lb Cu, US$1,902/oz Au and US$24.20/oz Ag, the NPV7.5 value turns negative compared to US$3.5 billion in the PEA at initial capital expenditure of US$2.8 billion. Ouch. This is a huge Red Flag for a Company with a market capitalisation of almost US$1 billion.
Not only that, but perhaps CRUX Investor is not the only house to have recognised the technical challenges and limitations of Alpala? The resignation of the Newcrest Director in June 2020 from the Board is also a Red Flag. News articles at the time attributed the move to disagreement with the Franco Nevada financing that Solgold lined up. Note that Newcrest’s man was a block caving expert, and Nick Mather (Solgold CEO) was actually quoted as saying, “Craig Jones is a block cave mining expert. If you are intending to help look after the future of the company, why would you take your block cave mining expert off the board?” Quite! Our point exactly. Could it be that Newcrest reached the same conclusion as Crux Investor, and has taken a step back from the Board for technical, not financing reasons?
Where does this leave us? The share price at 26 October 2020 of £0.37 converts to a diluted Enterprise Value (“EV”) of US$890M. Clearly the EV is a massive premium to the CRUX Investor NPV, so either the market is willing to go along with the PEA value, or it rates the blue-sky potential of all other Solgold prospects highly. CRUX Investor does note that prior to recent regional exploration fanfare, the EV had shrunk to US$520M, which is still at least US$520M more than the calculated NPV of Alpala.
With Solgold having commenced drilling programme at 3 projects (Porvenir, Rio Amarillo and Blanca) that seem to be very large mineralised systems, the premium may well be mostly relating to high expectations for exploration results. At one of the targets, Cacharposa within the Porvenir project area, the company reported on 19 October that it had drilled 893m of visibly promising mineralisation in the first hole and was still in mineralisation after drilling 258m of hole two. Good comparables are available in the market for an exploration porphyry story – a recent Big Wave Porphyry Copper event organised by Arlington Group covered six explorers with porphyry projects at various stages of development, and valuations, as shown in the table below. The most appropriate comparable is Solaris Resources, with great results from Warintza, additional project potential in the portfolio, and a fully diluted market capitalisation of US$475M. Porvenir could prove to be as good as Warintza from initial indications, and the recent share price pop on Porvenir news added about US$255M to the market capitalisation of Solgold, which is in-line with the Warintza valuation.
It is always good to have exploration results, but how is the company going to pay for the regional programme? And to whom will the value accrue?
CRUX Investor notes that Solgold faces considerable expenditures in the future. The Company spent US$57M on Cascabel and other Ecuadorian projects in the year ending 30 June 2020, and a similar annual spend is anticipated going forward. It has allocated the US$100-150M from Franco Nevada to cover these costs. The kicker, however, is the cost of the regional programme.
Exploration commitments for the 75 concessions that are not Cascabel are likely to be around three hundred million dollars in the next 2 years, possibly more. Under article 38 of the Ecuadorian mining law, if the Committed exploration budget that won the concession in the bidding process is not spent within the 4-year exploration cycle, the Company needs to pay the government a minimum of 80% of the uninvested total. Red Flag alert, Solgold is facing exploration and development study requirements of possibly US$340M in the next 2 years (estimates of US$360M of promised Exploration Commitments less estimates of US$20M completed). The company is faced with the choice of either diluting the capital structure, or selling exploration projects as they mature to fund the Company. Cash on hand as of 30 June was US$47M.
Solgold wants to be a major mining company, which is an admirable ambition. It also is doing good work on the ground, which is also admirable. The problem is that all of this work needs funding. With 2.2 billion shares in issue, further dilution is probable. Raising, say, US$200M at 40c, would mean another half a billion new shares issued. The market capitalization of the company will grow, but the value per share would not necessarily, especially if the company remains weighed down by Alpala.
Cui bono? Imagine this as a crime scene. Who benefits?
The people and country of Ecuador certainly benefit as Solgold is working professionally and well, even if it has fallen about US$300M behind in its regional exploration programme. Still, the money will come, either as payments to government along with the return of projects, or as direct investment in exploration.
BHP Billiton benefits as it has the largest shareholding in the company already, and the cost of holding and waiting is trivial relative to its balance sheet. It makes no difference to BHP how many Solgold shares are in issue, it is interested in allocating capital to growing its copper division for the long-term, and it is not even that concerned about the share price. BHP knows the power of a good porphyry deposit, as it owns stakes in several. BHP can afford to wait. Ultimately it can even postpone the development of Alpala indefinitely if other projects offer better returns in-country.
Management benefits as it is paid handsomely to do the job, and grows its position thanks to incentive schemes. Common shareholders, however, will bear the brunt of the funding requirements in the near term. Alpala is a drag on the rations, exploration commitments in Ecuador are large, and overdue, and need funding urgently. Dilution is coming. Expect more growth in the number of shares than in the value per share.
In summary, holding shares in Solgold must be seen as a 3-way game of chicken. BHP Billiton is the largest shareholder and given that it has stated it wants to grow its copper division it must be attracted to the optionality of a major land position in Ecuador. Management of Solgold obviously want to emerge as heroes and build a major mining company, and will be racing to produce exploration results that move the needle on the share price before raising lots more money. Common shareholders are desperately waiting for a shoot-the-lights-out drillhole from the regional programme to add another half a billion dollars’ worth of value, and tempt BHP Billiton into making a bid for the entire Company. The likely outcome is that BHP Billiton will be patient, while Solgold will issue more stock to fund its exploration commitments. Alpala does not float the Crux Investor boat, and it is unlikely to add buoyancy to the Solgold share price at current copper prices.
The pros and cons of Solgold have been covered throughout this report, and so this section is little more than a collation of the points. The Red Flags and Green Lights should not be taken out of context and instead should be viewed as discussion points for the Company or the investor to address.
Alpala is a low grade deposit with a narrow high-grade core buried 600m below surface
Infill drilling for the latest MRE resulted in the average grade of the deposit falling, despite tonnage staying the same
Block caving is a challenging mining method only to be undertaken by proven experts with significant operating experience and strong balance sheets
Block caving is especially difficult in high rainfall and seismically active areas such as northern Ecuador
Pre-production and ramp-up times of four years and six years respectively are unrealistically short
Newcrest withdrew its representative director, an expert in block caving, from the Board in June 2020
Metallurgical testwork has been carried out on above-average grade material, and results on low-grade material are different. There is metallurgical risk with the deposit, as per the PEA
Capital and operating cost estimates used in the Alpala PEA are unrealistic
Using benchmark, industry standard costs, the NPV7.5 for Alpala is negative. The project is extremely marginal
Remaining exploration commitments made in 2016-2017 with a 4-year time horizon are likely to exceed US$340M, and could be as much as US$600M.
Article 38 of the Mining Code states that uninvested sums must be paid to the government and licences returned
Solgold has US$47M available for G&A and Regional Exploration. Further share issues are likely
Valuation of Porvenir and the exploration portfolio is fair at US$300M and this could rise to match Solaris Resources on approximately US$500M. The challenge is to make the EV of US$834M rise, when Alpala has a negative NPV7.5
BHP Billiton is more likely to benefit in the future than common shareholders from Solgold
Ecuador presents many operating challenges, including a history of anti-mining activism, and a historic (but changing) lack of government support
Ecuador is the premier mining destination if one is looking for well mineralised copper porphyries and gold epithermal deposits
Ecuador government needs mining as a mainstay of the economy
Solgold has a global presence and a strong brand with an Australian management team, and listings in Canada and the UK
Responsible operations in Ecuador with mostly local employees, good training and CSR credentials
Solgold has more licences in Ecuador than competitors, with 76 concessions and 13 projects (including Cascabel)
Financial flexibility for Cascabel from Franco Nevada with the option to increase the NSR to 1.5% and US$150M, plus the promise of a precious metals stream to contribute to the build-capex
Top-tier backing from BHP Billiton, and Franco Nevada.
Porvenir discovery is exciting, highlighting the potential of the regional portfolio
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