If it looks too good to be true...
...it probably is. But you knew I was going to say that.
Everyone knows that if something looks too good to be true, it probably is. But the key word, the driving force, is the word probably. Notice that I didn't say anything about definitely. Never trust any wisdom that "everyone knows." Everything that "everyone knows" is certainly nonsense.
I went to Peru to visit a mining project last week. I flew to Lima, spent the night at a hotel right at the airport and got up early to fly to Trujillo in the north of Peru to visit the La Arena gold/copper project of Rio Alto Mining. (RIO-V) And my conclusion after a very short visit was it literally looks too good to be true. That's why the company is selling for maybe 25% of what it should be selling for. It looks so good no one wants to believe their lying eyes. But it is just as good as it looks and it's for certain not too good to be true. It's the real deal.
Let me give you a little background so you can put it into context. Cambior discovered the project in 1994 and began to advance it. They spent $30 million to complete a 60,000-meter drill program outlining a 4 million ounce gold resource and an additional 2.9 billion pound copper resource. Cambior was taken over by Iamgold in September of 2006.
To be technically correct, La Arena is more precisely defined as a gold-rich copper porphyry containing about $13 billion dollars of minerals at their gross metal value. That's a fairly meaningless number because they won't mine that much and they won't recover that much but you can use it to compare one project to another. Any $13 billion dollar project is pretty big. Actually any 4 million ounce gold project is pretty big. Any 2.9 billion pound copper project is pretty big as well.
After developing the project to the feasibility stage, Iamgold decided they should sell the project. Iamgold is a $5 billion dollar company. Believe it or not, this is a small project for them from a gold perspective. And they don't want to be in the copper business. Too small for them, in the wrong area, just right for someone else. The project went through a bidding process and by December of 2007 Iamgold agreed to sell La Arena to the then private Rio Alto for the princely sum of $47.55 million.
Things were going just fine until the Global Mining Crisis hit in September of 2008. Like many other companies in mining that were project rich and cash poor, Rio Alto suddenly found themselves without cash even though they had been promised financing for the $47.55 million and $30 million for an open pit, heap leach operation. With their backs against the walls, they did a sort of friendly merger with cash-rich but project-poor, Mexican Silver Mines. The merged company ended up with about 75 million shares outstanding, $5.5 million cash to move forward with the project and management shared across what had been two companies.
Before the merger with Mexican Silver, Rio Alto sat down with Iamgold to renegotiate the deal. The original deal called for all cash terms. Iamgold settled for an option on the project with a $1 million dollar payment in Rio shares, a $30 million dollar work commitment to earn 38.7% and a final payment of $47.55 million US to be paid by December of 2012. A key issue in the renegotiated deal was that Rio Alto was able to get Iamgold to agree to allow Rio access to 100% of the cash flow from production from the gold oxide project. In other words, you build the mine and pay for it out of 100% of the cash flow from production.
That's a deal, that's a hell of a deal. Or course Rio Alto wants to spend the $30 million to earn in 38.7% of the project as soon as possible. They envision a cost of $30 million to have the open pit oxide gold being stacked and leached by Q4 of 2010 at a rate of 10,000 tons per day. First year production will be 50,000 ounces at a grade of about .7 gpt Au advancing to 24,000 TPD in 12 months with annual production of about 100,000 ounces of gold a year for 5-6 more years.
The copper has been leached out of the oxide ore so there will be no copper production until Rio has finished with the 540,000 ounces of gold production from the oxide portion of the mine. By then Rio will have generated enough cash flow to be able to finance a plant doing 10 million tons per year at a grade of .4% Cu and .3 gpt Au. The mill will use a conventional crushing circuit and ball mills combined with a flotation plant to produce a copper/gold/moly concentrate. Rio anticipates production of about 100 million pounds of copper and 60,000 ounces of gold over a 15-year mine life.
Rio Alto's General Manager Jaime Soldi met me in my hotel. We flew up to Trujillo and drove about 4 hours to the project. It's a porphyry project, looking at the core doesn't tell you much but we went over the maps and their plans. The oxide portion of the deposit sits on top of a hill, there will be a low strip ratio and gravity will help save money, as the leach pads are a short distance down the hill in a small valley.
Porphyries are typically very large but low grade. With a starter pit grade of about 1 g/t gold, this is a fairly high-grade system. We would go over the numbers once we got back to Lima the next day. But there are six mines totaling over 20 million ounces of gold within 30 km of La Arena. Barrick's giant Lagunas Norte gold mine producing some one million ounces of gold a year is located only 18 km to the west.
The project has a lot of blue sky. Cambior wanted to define enough gold to make a production decision and they would have but they were taken over by Iamgold who didn't need the project. It's perfect for a junior who has mid-tier expectations.
The project is located at 3,400 meters elevation and since we didn't need the headaches and lack of sleep that accompanies a quick visit to higher altitudes we promptly returned to Trujillo in the late afternoon, had an early dinner and got a good night's sleep. The next day we returned to Lima. Jaime took me to the office of Rio Alto for a technical brief by the consultants working on the project design.
Their figures show a cash cost of production per ton of gold oxide ore of about $4 a ton for the first year, decreasing to $3.50 a ton once production levels of 24,000 tpd are achieved. That's a lot lower than I expect to hear from even a heap leach scenario so I questioned the number. I'm more comfortable thinking in the $6-$8 a ton range.
To save startup costs and management issues, Rio Alto is taking the approach of using contract miners and Peruvian consultants for technical design of the project. They have passed the project numbers by five contracting groups, some of whom are working in the immediate area. The number of $4 a ton is rock solid. Peru has an efficient and inexpensive power grid and they will be buying power for about $.05 a kilowatt-hour.
Metallurgical tests show that Run of Mine (ROM) ore will deliver about 70% recovery over 120 days of cyanide leaching and 76% over the Life of Mine. (LOM) The gold is located in the fractures of the rock so crushing to a smaller size isn't required. That saves energy and capital.
Back of the envelope calculations by yours truly show a gross metal value at today's gold price of about $35 a gram of $24 a ton gold and net revenue of $16.75 at a recovery of 70%. There isn't a business in the world or a mine in the world that wouldn't think a 75% margin is just great. Rio can produce gold with costs of $4 a ton and revenue of $16.75. They think they can produce gold at a total cash cost of about $420 an ounce over the 5-6 year life of the gold oxide project.
If La Arena was the first project in this area, I'd seriously question the numbers. But with production of over a million ounces of gold a year nearby with the same ore and the same issues, I'd call Rio's plan a slam-dunk. They aren't reinventing the wheel; they are using a cookie cutter to do exactly what everyone else in the neighborhood is doing. All of the issues they expect to run into have already been sorted out by others. All they have to do is execute a plan that has been tried and proven.
After the technical briefing I visited with Alex Black, COO and Director so I could sort out all the questions I had. Alex, who lives in Peru with his gorgeous wife, had been President and CEO of the original Rio Alto prior to the merger with Mexican Silver. He was the driving force who was responsible for identifying and picking up the La Arena project.
Rio has done a lot of things really right. While top management is Canadian and Australian, it's a Peruvian run project. Many Canadian juniors come to Central and South America without understanding local issues. From the gitgo, this has been a Peruvian project. They are using experienced contract mining and contract technical people.
They understand they don't need to create an empire, just need to get a simple project into production cheaply. I looked at their G&A figures as part of the cash costs and realized I wasn't dealing with the typical Canadian junior trying to do a stock promotion and surrounding themselves with a highly paid staff of dozens. These guys are miners and they intend to get this into production cheaply and earlier than promised at a lower cost than promised.
Unlike many of the other Canadian juniors operating in Peru, Rio understood the value of listing on the Lima Stock Exchange. That's a really smart move. They were able to do a $6.1 million PP in late 2009 easily on the exchange. It's a good move others would be wise to emulate. The Lima exchange has in the past given a higher value to silver and lead projects than Vancouver. Right now Vancouver is setting the price for Rio Alto shares but I suspect that in the future, Lima will be the market maker and Vancouver will follow. I believe companies who list in Lima will have higher market values than those who don't.
So after much rambling on my part, we get back to the central issue. Rio Alto looks too good to be true. For an investment of about $80 million total, they will own a mine with an equivalent of 10 million ounces of gold or 5 billion pounds of copper equivalent. That's $8 an ounce. That's like stealing. And it almost is. Because when they have invested the $30 million necessary to put the oxide gold portion of the mine into an open pit heap leach production, they can use 100% of the cash flow to pay off Iamgold. That does seem too good to be true.
But you have to look at it from Iamgold's point of view. They own 8.67% of the shares of Rio and stand to receive about $47.55 million more for a project they want to get rid of. They would be thrilled to get paid out of cash flow. If you use Desert Sun's Jacobina project as a model, 105,000 ounces of gold production a year was worth $700 million. If Rio Alto falls on their face and totally fails, Iamgold gets the project back. If they put it into production, Iamgold makes a lot of money. That's a good deal for everyone.
Including Rio Alto shareholders.
There is an issue I do want to cover because I have my own point of view on the subject. I hate shareholder dilution. Rio has several options to choose from in financing the project to production. They are well cashed up now with about $6 million in the bank. They need another $25 million by May when the big expenses start as they build the gold oxide mine. They finance by issuing shares or by borrowing against the project or they can do a gold loan and forward sell some or all of their gold.
The stock is absurdly cheap by any model. With a market cap of only $35 million Canadian they are getting less then $3.25 an ounce US for their gold. That's absurd. They already have 93 million shares outstanding. At some point, when you have issued hundreds of millions of shares, the shareholders get no value out of production. I would not like to see them do an equity financing. Likewise, borrowing money seems foolish if it was even possible. Any lender would demand and get harsh terms sweetened by a boatload of shares issued far too cheaply.
But they could do a gold loan where they presell gold for delivery in the future at a set price. They get the money now and deliver the gold in the future. They know what their costs are so can work out just how much they need to sell to raise the $25 million. That's what I would like to see. I don't want to see a lot more dilution; it will kill the future of the stock for shareholders.
If you look at the comparables, the other similar juniors at a pre-production stage, they get between $21 and $206 an ounce for their gold ounces. I suspect that the convoluted deal they had to cut with Iamgold confuses the issue but it's a pretty simple deal once you understand the history and motives of both Iamgold and Rio. It's a good deal for both of them. It's an exceptional deal for shareholders, far better than the original deal. It's just a deal that looks too good to be true and all that's going to take is someone to come along who can explain it in a simple way.
Regular readers of 321gold are well aware that I have a bias for production stories, especially gold production stories. The world's financial system is coming unglued as you read. In the end we will go back to a gold backed currency because there is no other choice as every country in the world defaults on their massive debts. When that happens, you want to own shares in a gold mine because they will have turned into, well, into a gold mine, literally.
Rio Alto has brilliant management. They understand Peru, they understand La Arena and they have a plan that is excellent for shareholders. They will be in production this year. This is the sweet spot where most of the risk has been taken out of the deal. I don't even want to spend any more time discussing how silly a price of $3.50 an ounce for gold is. It's absurd and won't last for long.
I am going to buy some shares. I like the story. I am not paid to write this piece, they are not yet advertisers but I would be shocked if they don't feel like shouting out their story from the highest hilltop. I am biased but in a good way.
As always, we don't share in your profit so we don't share in your losses. I'd encourage you to go to their website and follow the story. Please take some responsibility for your own life and finances and do your own due diligence.
Rio Alto Mining