Silver of the Sierra Madres
August 30, 2004
In real estate there are said
to be three key elements. Location, location, and location. In
my view there should be two prime considerations in junior mining:
cash flow and cash flow. But most often, cash flow is the last
item on management's mind.
If you think about it, junior mining usually has a pretty suckie
business model. As far as I can see, for most juniors, the model
consists of selling shares, drilling holes, selling shares, drilling
holes. And once or twice every cycle the company does a reverse
split to whittle down the number of total shares outstanding.
I can't really think of many companies who have a business model
that consists of making money and increasing share value for
their investors. Is there really any reason to invest in junior
mining stocks beyond the concept of throwing dice? Does anyone
wonder why the industry is in such bad shape? After all, at the
end of the day, if no one in mining intends to actually make
money for their shareholders, why buy the Penny Dreadfuls in
the first place?
The 1997 collapse of Bre-X helped flush out the industry. Not
only the marginal operators but dozens of fairly solid companies
went down the toilet as by 2000 it was quite impossible for anyone
associated with mining to raise money. Everyone in the industry
would like you, the investor, to believe it was all due to Bre-X
but that's just not logical or possible. It has a lot to do with
the failure of the basic business model.
Mining is the art and science of extracting minerals from the
ground at a profit. Notice that I say, at a profit, because over
the long term if a business doesn't intend to profit, investors
won't be interested in funding them. That's where we were in
1999-2001 and where we will be once again if someone doesn't
actually do something positive for their shareholders.
So I was somewhat caught off guard when Brad Cooke of Canarc
called me early in January with what sounded like an interesting
business model. Brad got involved with Endeavour Silver
(EDR-V $1.34 Canadian 18 million shares $24 million market cap,
$9 million cash (all figures Canadian) in early 2002. [website].
The predecessor company was known as Levelland Energy and Resources
which begat Endeavour Gold Corp in August of 2002 and
begat Endeavour Silver Corp in August of 2004.
almost fifty gold and silver properties in Mexico, Endeavour
announced the acquisition of the Santa Cruz silver mine and Guanacevi
processing plant near Durango, Mexico in January of 2004. Rather
than amassing ounces of silver in the ground and sitting on them
until they hatch, Brad came up with a new and perhaps unique
business model in the junior mining arena. Endeavour Silver would
mine silver and process it at a profit. Wow! The very thought
is mind bending: producing silver at a profit. Now that's a unique
In the early 1980s at the time of the Hunt brothers silver boom,
the Guanacevi silver district bragged of over 50 producing silver
mines in an area which had produced over 500 million ounces of
silver during the last 350 years of mining history. During the
1970s the Mexican government constructed a 1400 ton per day processing
plant which served the entire area. But the combination of Bre-X
and $4 silver hammered the Guanacevi district, indeed every silver
mine in the world, and as of a year ago there were but three
operating mines and the government sold off the plant to a group
of local silver miners years ago.
Even at $4 silver, the surviving mines and plant made money but
due to the structure of the original business deal, the profits
were distributed to the businessmen who owned the mine and mill
rather than being reinvested in the mill or mine.
While the business plan of the Mexican businessmen who owned
the mine and mill clearly worked, they could see the advantage
of bringing in a Canadian junior with more access to expertise
and capital. And it gave them an exit strategy where they could
take their money out of the deal and retire.
So in January
of this year, CEO Brad Cooke of Endeavour signed a deal to pay
a total of $7 million to acquire 100% of the Guanacevi processing
plant and the Santa Cruz mine over a four year period. They pick
up an initial 51% by paying $3 million US and spending $1 million
US in exploration by January of 2005. They can pick up the remaining
49% by paying $4 million US more by January of 2008.
What exactly did Endeavour Silver get for their money? Well,
in the first place, the mill alone is worth twice the total purchase
price. The going rate for used plant and equipment in Mexico
is about $10,000 per ton of capacity. So a 1400 ton per day capacity
plant is worth $14,000,000, not in replacement value, that's
higher indeed, but the least value for the equipment would be
The plant operates today at between 10-20% capacity. It has two
circuits, one a flotation circuit for the sulfide ore and also
a cyanide leach facility for the oxide ore. Brad has plans for
increasing total capacity beyond the current 1400 tons per day.
which is doable with minimal capital expenditure.
I went down to Mexico to see Santa Cruz and the mill for myself
with two of my favorite people; Ian Gordon and Rick Langer (Hi, Yo, Silver!) from
Canaccord Capital in Vancouver. What I saw impressed me. Endeavour
is using the exploration budget to actually drive a tunnel to
a newly discovered high grade silver ore vein (550 grams per
ton). Brad Cooke's deal with the mine owners gets a little complicated
and for those who are interested in every sentence, I encourage
you to either call Endeavour or go to their website.
But basically, the money they spend for exploration and development
is treated as a loan and is senior to payments to the mine owners.
In other words, once Endeavour is vested at 51%, when newly found
ore is processed, they get their loan repaid before the 51-49%
split is made. It's pretty much having your cake and eating it,
too. The 51% interest will be vested as of a payment date of
January 28, 2005. I asked Brad about the payment since if he
paid now, he would be vested now. Why did he want to wait until
January 28 to make the payment when he has the money in the bank
was interesting because it says a lot about Endeavour and Brad
Cooke. They could make the payment today and it would benefit
Endeavour at the expense of the existing mine owners. Since the
mine is producing today and ore is being processed and silver
poured into bars, if the miners took payment today, they would
lose half the value of what they are producing. Brad has rejected
short term gain for Endeavour in return for long term good relations
with his partners for now.
I take my own 100-year-old 20oz mold on my trips with me now,
in the hope that I may one day be privvy to a pour. And this
time I was in luck - and had my own 'personal pour.'
And yes, I did pay for every one of the 603 grams of silver.
(As mentioned above: cash flow... cash flow... ).
click thumbnail for large photo
The mill is producing silver
today from three sources. Sulfide silver ore is being shipped
to the mill from the Santa Cruz workings. And ore is being processed
for the other two mines in the area on a contract milling basis
which is quite profitable. But in a unique twist, they are using
weathered sulfide tailings to process through the cyanide circuit
of the mill. These sulfide tailings left over from the flotation
process many years ago have weathered and turning into an oxide
ore grading about 116 grams per ton of silver and 1-2 grams of
gold. So the old ore is doing double duty. It produced profit
before and is producing profit again.
Endeavour Silver stands to gain in two ways from this deal. Even
if there wasn't more ore to be found at the Santa Cruz mine (and
there is) bringing the plant up to a much higher capacity would
create the basis for a good profitable company. Combining with
an aggressive exploration program in a known prolific silver
district creates a high value added mining junior.
Endeavour has worked the numbers out and uses a figure of $3.50
for total mining and milling costs. Other silver producers in
silver rich Mexico can produce for as little as $1.50-$2.00 an
ounce. But owning 100% of the mill adds a kicker. Endeavour can
generate profits in theory and not mine at all.
Obviously there are other issues on Brad's agenda which haven't
been sorted out. His goal is to try to control the entire Guanacevi
district. By owning the only mill, he has already created a situation
in which he can control the district and it pays for others to
work with him. The other mine owners cannot control the area,
no matter what the price of silver. Endeavour owns the only mill.
As far as I can see, this is pretty much a no lose deal on everyone's
part. Obviously the price of silver is an issue. Silver at $2
an ounce won't work. Everyone will simply shut down and wait
for higher prices. But silver at $6-$7 starts to get interesting
and silver at $10 gets explosive.
Brad believes that in two years they can be producing and processing
4 million ounces a year. Based on what I saw on my tour two weeks
ago, that is a reasonable goal. If you work the numbers out at
$6 silver with $3.50 all in cash costs and 4 million ounces a
year, it looks like a cash flow of $10 million per year. With
a total market cap of $24 million, cash flow of $10 million starts
looking very attractive.
We own Endeavour stock from way back when the price was $1.60
Cdn. I'm not upset at seeing the stock at $1.34, it's just a
sign of the insanity of the current market. It's screaming 'opportunity'
for all of those actually paying attention. I'd far rather see
Endeavour vest now, I think there is some lack of premium due
to a perceived lack of certainty of Endeavour actually doing
the deal. But they will hand over a check on January 28th of
2005 and they will vest their initial 51% interest. The money
is in the bank and the ore is ready to start processing.
With all junior mining companies, you are buying management and
little more. Bad management can screw up any project and good
management will succeed even if they have no projects, good or
not. Just look at Wheaton River three years ago with $30 million
in the bank and no projects. And now they are a $2 billion company.
I don't expect to see Endeavour Silver at $2 billion in a year
or two but I do expect them to be a solid, profit-generating
silver producer, even at today's price of silver.
I like the management, I like the project and I love a business
plan based on production at a profit rather than dreams of sugar
plum fairies. We are not paid to produce this report, it is neither
a recommendation to buy or to sell any stock. Your investments
are your responsibility. All due diligance is also your responsibility.
Endeavour Silver is an advertiser and we do own shares. As such
obviously we are biased :)
By the way I am leaving again tonight (Sat Aug 28th) for Northern
Ireland to visit Ireland's only gold mine. So please don't send me email. It's a short trip and I'll be back
in Miami on Thurs. Sep 2nd.
August 28, 2004