Junior Gold Explorer Valuation Observations

Observations on the Canplats Resources Acquisition Bids

By Dennis Boyko
December 28, 2009
Last updated: December 31, 2009 (version 0.13)

The November and December 2009 takeover bids for Canplats Resources (see Canplats News for the latest information on bids) provides excellent data points on the valuation of junior gold explorers.

Combining market metrics defined in terms of:

• stock prices at the close of trading,

• metals spot market prices at the close of trading for gold, silver, copper, lead, zinc and other base metals,

• ore deposit fundamental data from the NI 43-101 complaint reserve and resource disclosures on each exploration project and/or mine project per company,

• fully diluted share counts per company

on several junior gold explorers, gold producers, and Canplats Resources, in the time frames before the first Goldcorp bid for Canplats (October 20, 2009) and after the Penmont bids and Goldcorp rebids, suggests that:

• Junior gold explorers are cheap relative to the established gold producers.

• Canplats Resources valuations could increases beyond end of 2009 valuations and still be a good deal for an acquiring gold producer.

• Average Ore Value per Tonne vs Market Capitalization per ounce of Gold Equivalent is an effective metric for understanding the market driven valuation of gold explorers and gold producers.

The supporting rational is developed in the remainder of this blog by first looking at a recent Canplats Resources presentation, asking and answering a few simple valuation questions and providing motivation in support of a Gold Explorer-Producer Valuation hypothesis. Conclusions are data driven and links to per company GoldMinerPulse Metal Valuation Reports, where all reserve and resource figures used are cross references to NI 43-101 reports and company disclosures, are provided.

Classic Market Capitalization per Ounce of Gold Equivalent Isn't Enough

Slide 23 of 30 in a November 2009 Canplats Resources presentation, shows Market Capitalization per ounce of Gold Equivalent for Canplats Resources, Osisko, Guayana Goldfields and other gold stocks.

The Mkt. Cap/oz AuEq of the 40 companies included in the report averaged US$74.10 (i)

(i) Source: Canaccord Adams gold in situ valuation spreadsheet, Junior Mining Weekly (October 20, 2009)

I believe that presenting just the market capitalization per ounce of gold equivalent is a totally inadequate basis for judging valuation. Based on the above chart, readers do not have any basis for answering a fundamental question such as: does Canplats Resources (CPQ) deserve the same valuation as Guyana Goldfields (GUY) or even Osisko (OSK) on a market capitalization per ounce of gold equivalent basis?

Boiling down the classic market capitalization per ounce of gold equivalent to the essential data provided (i.e. company X has a market capitalization of $Y) yields the chart below.

Although the classic market capitalization chart (i.e. the Canplats Resource slide 23 of 30 above) looks better, the information provided by the second dimension in the Canplats chart is not very helpful -- I doubt any readers have difficulty understanding that $191.63 is much greater than $22.95.

Average Ore Value per Tonne Adds Valuable Information

As demonstrated above, looking at just market capitalization per ounce of gold equivalent on a per company basis isn't sufficient to answer basic valuation questions. This situation can be dramtically improved by adding a second piece of independent data. Specifically, if you chart Market Capitalization per ounce of Gold Equivalent verus Average Ore Value per tonne you immediately get a basis for understanding gold mining company valuation trends.

The following chart, based on October 20, 2009 valuations (stock prices, company reserves/resources, fully diluted share counts and metal prices) and annotated using the Gold Explorer-Producer Valuation chart style developed elsewhere in this blog provides data driven evidence of gold mining company valuations:

Specifically, the Gold Explorer-Producer Valuation charts provide supporting evidence for answering the questions on Canplats valuation versus Guyana and Osisko valuations:

• Guyana Goldfields (GUY) has a much higher average ore value per tonne and therefore has the potential to derive more economic value from each tonne of ore processed. Since ore processing costs are largely independent of metal content, higher valued ore should be more profitable to mine. Therefore a higher valuation for Guyana Goldfields is expected.

• Osisko Mining Corporation (OSK) was being valued beyond producer valuations which appears to be an exception.

• Valuation Exceptions are common: In the October 20, 2009 view, Gamman Gold (GAM), Genco Resources(GGC), and Osisko (OSK) all appear to be mispriced by the market. And to a lesser extent, Goldcorp (G) looked cheap relative to other producers.

The Gold Producer Valuation Hypothesis is developed further and the valuations expections are discussed else where in this blog.

Using the Gold Producer-Explorer Valuation line, it is possible to draw valuation conclusions on junior gold explorers in general and for Canplats Resources specifically.

Fair Market Valuations for Junior Gold Explorers

The bidding activity for Canplats Resources illustrates the degree to which junior gold explorers have been and continue to be undervalued. Prior to the start of bidding, Canplats valuation was roughly in line with other junior gold explorers in that its position on a Gold Explorer-Producer Valuation chart fell approximately on left hand edge of the Explorer-Producer Gap in line positioned by its average ore value per tonne. Since the bidding, Canplats has clearly moved into the Explorer-Producer Gap. However, I believe that Canplats could move even closer to the Gold Producer Valuation Line and still be an excellent buy for a gold producer.

Is Canplats Resources Still Undervalued?

• Even if you assume that the market fully discounts the lead, zinc and silver in situ metal value and just focuses on just the gold in the Camino Rojo deposit, Canplats's December 31, 2009 market capitalization per ounce of gold in the ground would have been $80.95 (it was $43.51 on a gold equivalent basis).

• If Canplats had its Feasibility Study in hand and had the necessary capital available for mine developemnt then Canplats's fair market valuation would be close to the Gold Producer Valuation Line or approximately $160 per ounce of gold equivalent at the December 31, 2009 close.

• If Canplats had been sold at the December 31, 2009 closing price then the top level deal sheet could have been summarized as:

  • purchase price: US$320M

  • In situ gold value: US$635M

  • Silver, lead, zinc credits: ~%45% of in situ gold value

  • Work to be done: mine development work to move the Camino Rojo project to a producing mine

  The deal is very sound on the basis of the in situ gold. Adding the silver, lead and zinc credits into the deal sheet make the deal extremely attractive. Since the above computations are based on the Gold Producer Valuation Line, which incorporates the combined markets best estimates for future gold and metal prices, additional discouting is not required. However, an additional discount for the 2 to 3 year window to account for the mine development work on Camino Rojo would be appropriate -- that is, crossing the Explorer-Producer Gap takes time, money and the right expertise.

• Given that the bidders already have infrastructure in the region which would allow them to reuse surplus equipment, share processing infrastructure, deploy mine development staff, and probably benefit from in country tax credits, I believe that Canplats should be worth a further premium over the December 31, 2009 close.

Based on the above reasoining, I believe that the winning bidder Canplats Resources could go at least another 25% above the December 31, 2009 close and still have a great deal that didn't require a sharp pencil to justify.

Junior Gold Explorer Are Still Undervalued

For other junior gold explorers, I would argue that the fact that the bidding for Canplats Resources up to the end of the 2009 shows the Explorer-Producer Gap is still excessively wide. Although the size of the gap has improved considerably since the October 2009 time frame (largely due to the market revaluing Agnico-Eagle and other mining stocks), further closure of the gap in 2010 is, I believe, a reasonable expectation.

Gold Explorer-Producer Valuation Hypothesis

Each company on the above chart is represented by its TSX trading symbol. The lower left hand corner of each box on the chart marks the company's Average Ore Value per tonne versus Market Capitalization per ounce of Gold Equivalent. Many of the differences between the established gold producers on this chart can be easily justified. For example, Agnico-Eagle (AEM) has a much higher market capitalization per ounce of gold equivalent than Gammon Gold (GAM), Goldcorp (G), or Kinross (K) and this difference is easily explained with you look examine their metrics a bit closer:

• In-situ gold versus gold equivalent: Agnico-Eagle gets more than 90% of its market capitalization per ounce of gold equivalent from in situ gold and silver. The corresponding figure is 60% for Gammon Gold and 72% for Goldcorp.

• Ore Value per Tonne: Although Kinross has approximately 87% of its market capitalizatin per ounce of gold equivalent from in situ gold and silver very much in line with Agnico-Eagle's 90%+, Kinross has much lower average ore value per tonne.
  
  Since, after mine development capital expenditures, the digging, hauling, crushing and processing ore is the main work and main cost factors of producers, one would expect, and it appears to be so, that the higher the value of metal contained in a company's average tonne of ore, the higher the value market places on the company's gold equivalent ounces.
  
  Also, a company with higher ore value per tonne is expected to have more flexibility to continue profitable operations in the face of potential metal price declines and/or engery cost rise since the cost of processing a tonne of ore is largely independent of the contained metal, again justifying higher market capitalization per ounce of gold equivalent.

Gold Producer Valuation Chart

Looking at the difference between Agnico-Eagle and Kinross Gold on the chart, and noting the difference in their respective ore value per tonne, and noting how many other gold producers fall on the Kinross Gold and Agnico-Eagle line suggests a Gold Producer Valuation Line is implicitly computed by the market where as ore value per tonne increases then market capitalization per ounce of gold equivalent also increases. Rational for why such a relationship is expected has been introduced in the Ore Value per Tonne discussion point above. If gold producer valuation hypothesis holds, then an established gold producer with an average ore value of say $100 per tonne (producing mostly gold) would be expected to be trading at a market capitalization of roughly $250 per ounce of gold equivalent barring exceptions situations (e.g. permitting problems, site issues, cash flow failures, etc.). Exceptions are discussed below and in covered more extensively in Gold Explorer-Producer Valuation Exceptions.

Some aspects of the end of December 2009 Gold Producer Valuation Line are unexpected. For example, the fixed per ounce of cost factors for processing gold are apparently outweighed by the market premium assigned to companies with a higher average ore value per tonne. Otherwise, one would expect that a doubling of Average Ore Value per tonne would result in a less than a doubling of the market assigned Market Capitalization per ounce of Gold Equivalent since some of the benefits of the additional gold equivalent extracted per tonne would be offset by the small per ounce of gold equivalent processing cost factors.

Although the Gold Producer Valuation Line is currently shown as a straight line, there is no reason to suspect the "ultimate" version of such a line would be straight. In the extremely limit as ore value approaches the value of equivalent weight of gold, the valuation line should be roughly equal to the expected future price of gold and no higher (why buy ore when you could buy gold bullion in the warehouse for the same price). However, before reaching such an extreme, the market may well place a premium on producers with higher grade ore which could cause the valuation line to curve to right. For example, look at the Gold Producer Valuation Line in the context of a larger Gold Ore Value Chart and consider the placement of San Gold Corporation -- i.e. does the effective valuation flatten (small ore value increases producing much greater market capitalization per ounce increases) before ultimately turning up as the expected future value of gold is approached?

Gold Explorer Valuation

Companies that are primarly gold explorers (i.e. no gold production or very limited gold production) fall well to the left of the Gold Producer Valuation Line. The distribtuion of a few gold explorers suggests that a gold explorer valuation line implicity exists in the current market. Taking Seabridge Gold (SEA) as the Kinross equivalents for explorers (i.e. low average ore value per tonne) and Guyana Goldfields (GUY) as the Agnico-Eagle equivalent for gold explorers (i.e. higher average ore value per tonne), produces a gold explorer valuation line that would be roughly parallel to the gold producers valuation line shifted to the left.

However, there is no reason to expect that a junior gold explorer valuation line should parallel the gold producer valuation line as a quick comparison of the Gold Explorer-Producer Valuation 20 Oct 2009 chart and the Gold Explorer-Producer Valuation 24 Dec 2009 chart shows. Also, gold producers such as Agnico-Eagle and Kinross Gold are extensively followed by very sharp analysts and as a result one would expect their final valuation judgements, as shown by the market closing prices, to fully account for all available information. Since much less data is available for analysts on junior explorers (i.e. you would not expect to find a Feasibility Study for a junior explorer), the junior explorers are not as widely followed, therefore allowing for more pricing execptions to occur.

Gold Explorer-Producer Gap

For a given ore value per tonne, the difference between a junior gold explorer and the Gold Producer Valuation Line (i.e. the Explorer-Producer Gap), is to be expected since gold producers such as Agnico-Eagle, Goldcorp, Kinross, etc. have already raised the necessary capital expenditures required and successfully turned their deposits into producing mines. Gold explorers would on the other hand need to raise capital to complete Feasibility Studies, develop necessary mine infrastructure, build the mine, and a complete a host of other tasks to become a producer at a later point in time.

Typically, gold explorers remain gold explorers while the most promising junior explorers are bought out by major producers. For example, in the Canplats Resources take over attempts, the majors want the Camino Rojo Gold-Silver deposit while the remaining Canplats Resources land holdings will be placed in a new exploration company. In other cases, a management team may operate multiple unrelated exploration companies in anticipation of a future sale of one of the companies to a major producer -- for example, see my blog on Orko Silver and Orex Minerals.

At a very high level, the gap between a junior gold explorer and the Gold Producer Valuation Line can be apportioned to:

• Capital Expenditures required to move an ore deposit from a simple exploration project to fully developed operating mine. Although very much dependent on deposit specifics, costs to develop a new mine tend to range upwards from $200M to amounts past $1B for mega sized deposits.

• Discount as a result of the long time lines required to turn a promising deposit into an operating mine.

• Risk associated mine development execution.

In other words, crossing the Gold Explorer-Producer Gap requires:

• Money

• Time

• Skill

And, of course, a dash of good luck wouldn't hurt either when crossing the gap.

Looking at Exceptions

A quick check of the latest GoldMinerPulse Gold Ore Value Chart confirms that exceptions to the Gold Producer Valuation Line abound. This blog considers the valuation exceptions shown in the charts presented here and also provides a quick look at some of the generic issues that are the root cause of valuation exceptions. A more detailed review of exceptions is provided in a separate blog, Gold Explorer-Producer Valuation Exceptions.

Although Osisko Mining Corporation (OSK) is not in production, Osisko has, as of December 2009, already moved roughly 36% of its in situ gold into the Proven + Probable reserve category and have raised much of the capital expenditure they require to move into production. Therefore it is reasonable that OSK's current market valuation should be close to the Gold Producer Valuation Line and as of data available December 2009, Osisko is effectively being valued as a producer.

Genco Resources (GGC) is an example of significantly undervalued gold-silver producer. The short explanation for Genco is the fact that its existing operation is small scale (however, in late December 2009 Genco did release a Feasibility Study for a 10 times capacity upgrade) plus its La Guitarra mine has only recently come out of a 13+ month illegal shutdown. I have a separate blog on Genco, Removal of Mine Roadblock Equals Stock Appreciation Opportunity, to discuss this opportunity.

Gold mining companies with significant gold hedges would be expected to fall to the left of the Gold Producer Valuation Line since the hedge has taken away ore value appreciation (or depreciation) potential. Likewise, companies with only a small percentage of the market capitalization per ounce of gold equivalent coming from in situ gold would be expected to fall to the left as well. Companies with land title issues, permitting issues, infrastructure issues, and like issues would also be expected to fall well to the left of the Gold Explorer-Producer Gap.

Another important cause of valuation exceptions would be incorrect interpretation of mine data. That is have you, or your source, correctly read the company's reserve and resource disclosures?

Alternatively, speculative pressure in the market could result in a producer falling significantly to the right of the gold producer valuation line. The market does anticipation a future resource and/or reserve upgrade based on positive drill results and/or other fuzzy factors which would appear as exceptions in a Gold Explorer-Producer Valuation chart.

Links

• Market Capitalization per Ounce Computations fully details these who GoldMinerPulse metrics are computed.

• Metal Value Reports: the GoldMinerPulse Metal Value Reports, which are updated after the close of each trading day, for the companies mentioned in this blog are available at: Agnico-Eagle, Gammon Gold, Genco Resources, Guyana Goldfields, Goldcorp, Kinross Gold, Paramount Gold and Silver, Osisko Mining, and Seabridge Gold.

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