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A Steel of a Deal

Bob Moriarty
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February 15, 2005

If you have ever wondered what kind of a fool would be driving the wilds of Western Utah on Superbowl Sunday, collecting both a speeding ticket and a flat tire, all in the faint hope of being first to announce finding another supervalue stock, I can answer in a word.

Me.

Ten days ago, George Young of Palladon Ventures (PLL-V $.435; Canadian 24 million shares outstanding Market Cap of about $11 million Canadian; website) announced signing a deal with the bankruptcy court where Palladon would join with Western Utah Copper Company in a Joint Venture to buy the Comstock/Mountain Lion iron properties out of bankruptcy for $10 million US including a $1.3 million dollar bond.

The last deal this good was when the Dutch stiffed the Indians out of Manhattan for $24 bucks worth of beads. However, on second thoughts after considering the taxes in NYC and the inhabitants in general, maybe the Indians got the better part of the deal.

After being halted for four days, the stock shot up to $.52 from $.34 before settling down to close at $.48, up $.14. George was disappointed at the blah reaction. I wasn't surprised. Shareholders clearly don't understand the deal.

I was on the way out to Tucson for the weekend to visit the Tucson Gem show. I suggested to George that I go a little out of my way to get up to Cedar City in Utah and actually visit the mine so I could try to do a better job of explaining it.

In any case, Palladon and Western Utah Copper are going to end up with a giant iron project with past production in the district of 80 million tons and a measured resource of about 114 million tons plus a precrushed stockpile of 12 million tons of ore ready to be shipped measuring 42% iron. Estimates made by the previous owner are that the project may contain 300 million to 500 million tons of ore, not all of which have been evaluated yet.

Iron production began in Iron County Utah as early as 1852 after Brigham Young sent a group of 100 settlers to the area to begin producing iron. Production on a larger scale took place between 1923 and 1995: eventually the Geneva Steel Company went into bankruptcy in 2002. The Geneva Steel Company shipped the ore from the Mountain Lion mine to their steel mill just south of Provo, Utah, built in 1943. Essentially, the mill dragged the mine into bankruptcy even though the mine still contained a vast reserve of high-grade ore.

In stepped Palladon and WUCC. I visited Utah with George Young in September to look over his Milford copper project, also a JV with WUCC. George mentioned looking at an iron project and I knew it was a work in progress. I didn't even guess how attractive it was.

Basically, his JV partner made George aware of the property many months before. Geneva Steel went into bankruptcy in 2002 due to the high value of the dollar and low price for steel and all operations stopped. While state of the art when constructed in 1943, by 2002, the mill was hopelessly out of date and operating at a loss for years. The mine and mill were part of the same company and when Geneva went bankrupt, there wasn't anything wrong with the mine.

Eventually the case made its way through the labyrinth of our legal system and came up for bidding.

George was prepared to go in and bid $5 million for the mine when much to his surprise, a major steel company came in at the last minute and bid $10 million in the open bidding. But the major hadn't done any due diligence and wanted an extension of time to complete the due diligence. George immediately matched the $10 million on the condition that the auction complete at once. And the court agreed.

It's the best deal I've seen in a long time. Not just because he got a major mine and facilities for cents on the dollar but because the price of iron is rocketing.

Essentially, the JV is paying $8.7 million in cash at closing, sometime between now and April 9th, and assuming a $1.3 million dollar bond. George is in discussion with a company that appears ready to fund the Palladon portion. In my view the closing is a done deal.

For the $10 million, the JV picks up about 50 million tons of iron ore contained in a mine with an operating permit, a railway siding capable of taking on 3 trains at the same time, power, and support at the local and state governments eager to see the jobs created and taxes generated.

There are three options Palladon can take to make money out of this operation and I fully expect them to use all three at one time or another.

1. There is 12 million tons of easily loaded, already crushed iron ore grading an average 42% Fe. With iron running $75 a ton, I expect George to get the Mountain Lion Mine into shipping the stockpiled ore within a few months of closing. My guess is that the ore will be worth $20 to $30 FOB railhead. George threw out the figure of $1 a ton to move it into railcars but I'd use a figure of $1.50 to $2 a ton to load it. That gives around a 90-95% margin, which sure beats a red-hot stick in the left eyeball. His cost of getting the crusher and loader back into operation would be well under $500,000 US.

With a train holding up to 100 cars and limited to 180,000 pounds per car, Palladon could be filling and shipping a full trainload of iron ore every three days at 9000 tons per train to achieve the 1 million ton per year goal. I know they will do this because it generates cash and all the other alternatives generate more profit total but require both time to plan and money to create.

2. An alternative to shipping what is relatively low-grade ore is to build a processing plant to upgrade the material to produce iron nuggets. When you ship 42% Fe, you also ship 58% waste rock. And shipping is a giant component of the price of steel. Ocean Freight rates were as low as $10-$15 a ton up until 2002 when increased Chinese demand for all raw commodities caused rates to increase up to 400%. Freight was often the biggest cost in both grains and iron shipments.

By building a facility to process pelletized ore through the "Mesabi Nugget ITmk3" process (sorta rolls off your tongue, doesn't it?) Palladon could create a 96% Fe nugget suitable for shipping directly to steel mills anywhere within economic shipping distance. The plant would add a lot to capital costs but would cut shipping costs 50% and add great value to the ore. The "nuggets" would be suitable for direct feed into other steel mills across the country.

3. The third alternative probably makes the most sense but costs the most money. That is to build a modern state-of-the-art steel mill next to the rail loading facility and go into production of cold rolled steel with a value of $700 a ton and produce 1 million tons of steel a year.

George estimates a cost of slightly over $1 billion to build but the ROI would be incredible. Palladon would have a giant-sized competitive advantage due to the central location with cheap rail cost to the West Coast markets.

Any increase in cost of energy or shipping would actually work to the advantage of Palladon since most steel being sold into the West Coast market has two lots of shipping cost added in the price. The process George and his team are looking into is the HIsmelt Process which involves the pneumatic injection of a mixture of ground Fe-bearing feed material, ground coal, and a fluxing agent into a molten iron bath contained within a 'smelt reduction vessel" (SRV). The hot metal may be charged directly into an electric arc or basic oxygen steel furnace, thus resulting in significant economic advantage over cooled pig iron.

The surplus energy generated from pressure expansion as well as the contained heat of the offgas can also be used for the generation of steam and/or electrical power. When still in operation, the Geneva Steel Company commissioned the design of a HIsmelt power plant to produce a gross electric generating capacity of about 280 MW.

I saw George's Power Point presentation where he briefed the Governor of Utah and his staff on February 4th and a brilliant report on the project written by Dr William Wray of WUCC and Palladon. It's a pretty easy concept to understand if you have all the written materials. But nothing beats a physical visit to the site. Dr Wray's report compared the Net Present Value (NPV) of the mine/1 million ton mill to both a copper mine/mill and a gold mine/mill. If you compared it to the copper producer, the copper mill would ship 220,000 mt/yr and have a NPV of $35.2 billion over the 50 year life of mine and the gold company would produce 1.6 million ounces a year over its 50 year life with a NPV of the same $35 billion. Clearly the iron project involves some giant numbers. The biggest difference is that banks will easily finance steel projects over gold projects.

Initially George Young was going to drive down from Salt Lake City, where he lives, to meet me in Cedar City, some 10 miles from the mine. But at the last minute George had another meeting on February 7th and he sent down Don Foot. I was limited in time myself since I had meetings of my own in Miami so I drove from Tucson to Cedar City on Sunday February 6th (Superbowl Sunday), collecting a speeding ticket and a flat on the way.

I woke early Monday morning only to find two inches of snow on my rental car. Don Foot was supposed to be driving down from Salt Lake City and I knew he was supposed to have bad weather but here I was deep in snow myself. The forecast was for 40-degree weather and I was hoping I would be able to see something at the mine.

Don showed up right on time at 10:00 AM but muttering under his breath at the rotten weather. The day's forecast called for more lousy weather later in the day and he had to go right back in it. At least I was heading in the direction of better weather.

We went about 10 miles west of Cedar City to the mine. I should expand here; Cedar City was actually founded to support the local iron industry in 1851 by Brigham Young. The town grew up with the iron industry and provided a source of labor for many years. Naturally, the local community supports reopening the mine. The town is right next to I-15, the major artery between Salt Lake City and Las Vegas. (Boy, what a contrast those two cities make). Cedar City has a population of over 21,000 people and is near perfect as a support facility. This isn't like being 400 miles out in the Gobi desert.

Don was driving a magnificent species of heavy Detroit iron. I was a little skeptical about its ability to make it up mountain roads in snow and ice but once we got onto the mine road, the slush and mud was so bad that even a 4-wheeler couldn't have made it.

Don got out of the car, and walked a quarter mile to check it out. It was a mess and we were only a mile from the mine entrance. I wasn't about to quit right on the finish line so I asked Don if he was up for a little jaunt in the snow and mud. And off we went on foot.

You can see the dumps from quite a distance but don't get a feel for the size of the operation until you get closer. By the time we got within range of the crushing and loading facility, I realized it was really a big operation. I'm not a mining engineer but I'd guess there is some $2-$5 million in loading equipment and three sets of tracks in the railroading siding. All that costs money to buy and time to build. The day Palladon closes on this deal, it all belongs to them.

We looked over the conveyor system and rail loading facility and then went up the hill to look at the mine. It really is an impressive operation. There is a giant stockpile of ore right next to the conveyor system and it's easy to see how they could have ore shipping in a matter of a few months.

It's easy to see the high-grade iron ore in the stripped areas. This is a mine with a mine plan, a permit and it's ready to rock and roll.

Don proved great company; he walks with a limp from an old football injury but had no problem keeping up. We probably walked a total of four miles through the snow and slush but it's really an impressive operation and it's perfectly suitable to ooh and ah over it like a new baby. It is a new baby.

We made it safely back to town and after a quick lunch, Don headed off to Salt Lake City and I headed south. He was driving right into the center of a big snowstorm and no doubt will be found in the spring when the snow melts. I drove south into brilliant sunshine past Las Vegas on my way to Phoenix and a flight home.

Palladon owns 65% of the JV and Western Utah Copper owns 35%. It's a great deal for both parties. Palladon's 65% interest is a giant portion of a giant project.

The JV does need to cough up $8.65 million in order to close on the project and I have little doubt that George has it in hand. And I imagine they will be shipping ore not all that long after closing. I don't see any giant dilution of Palladon to finance operations. In a lot of ways, it's easier to finance a $1 billion dollar mill than it is to finance a $10 million dollar operation.

Palladon has loads of PhDs working for them and other exceptionally qualified people. George Young is not afraid to hire brilliant people and I was amazed that a person of such stature in the industry as Don Foot would take a day off to show me around a mine. Don's list of achievements in the mining business would take longer to read than this piece.

George Young is going to build a billion dollar company with this project. When he told me about the project and I read all the reports he supplied, I immediately went out to buy some stock. I wouldn't chase the stock and you shouldn't either. But with a market cap of $11 million Canadian, the market doesn't get it. I don't expect any substantial dilution to advance the project and when they get into production, even if just shipping lower grade ore, the market is going to put a far higher valuation on the shares. If you want to own it, be careful, I fully expect it to rocket higher and then come back some.

We expect you to take responsibility for your own due diligence on the company. I like it and I own some but how and when to buy is really your decision. We are not paid to promote Palladon or for this article but they do advertise on 321gold and I am biased. Of course I'm biased, you would have to be a twit not to be biased.

February 15, 2005
Bob Moriarty
President: 321gold Inc
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