Palladon, A Sad Tale but True
Of all the companies I have been involved with in the past eight years, one stands head and shoulders above the rest for the most potential and the worst performance by management. I've seen a lot of outright crooks and fools but the story I am about to relate is about a company that couldn't have failed. But if management is determined enough, they can screw up a wet dream.
But first, a few words of warning: in 1998, the CFTC attempted to regulate the new market of OTC derivatives. The head of the CFTC, Brooksley Born, realized that with a total notional value of an incredible $27 trillion dollars, unregulated derivatives could bring down the world's entire financial system.
The PTB on Wall Street and in Washington got together and shot down any attempt to corral the Wild West market of OTC Derivatives. She was told in no such uncertain terms that if the CFTC began to regulate derivatives, the US financial system would collapse. They were right; the US financial system is going to collapse. In fact the entire world's financial system is going to collapse. All because of derivatives.
Long Term Capital Management collapsed a few short months later while holding $1.25 trillion worth of unregulated Derivatives. I wrote a piece about the dangers of derivatives in January of 2002. By then derivatives had reached the unimaginable level of $100 trillion. By the demise of Lehman Brothers last year, derivatives were $700 trillion.
It's all fraud and nothing the government has done has done anything except privatize profits and socialize losses. We have moved about $23 trillion dollars from the balance sheets of the failing hedge funds and banks onto the backs of American taxpayers. When the impact of what the government has done sinks into the thick skulls of Americans, there will be a revolution. Americans who have lost their homes, their jobs, their pensions and their future are going to be pissed.
Even the most devout gold and silver bugs generally don't understand the difference between money and wealth. Gold is not wealth. Silver is not wealth. Silver isn't even money. When the system does collapse and that's right around the corner, we are going to go to a gold standard because no one in the world is going to trust paper money any more. When that happens, silver will become money because under a gold system, the coinage of preference is silver. But gold and silver will still not be wealth.
Wealth is the possession of an asset that generates profit. A gold mine should be wealth but gold itself isn't wealth. Even something as mundane as an iron mine will be wealth. I just came back from visiting what should be one of the most valuable iron mines in the US.
Napoleon said that he would rather that his generals be lucky than skillful. You can always beat skill but you can never beat luck. I don't know what Napoleon would have said about generals that were lucky but lied a lot.
George Young of Palladon (PLL-V) got lucky in March of 2005. He had just put in a bid for an iron mine in Utah to buy it out of bankruptcy for $10 million. The mine came with a resource, a rail line and a mining permit. He bid for the mine in February of 2005, the price of iron was $38. In March, the yearly price reset took place. The price of iron soared to an incredible record $65 per dry metric ton unit.
He got even luckier the next year as prices rocketed to $78 a mere 14 months after he bid for what is now called the Iron Mountain project.
All well-run mining companies are the same. Poorly run mining companies are dysfunctional in their own unique way. Palladon at the time was about as dysfunctional as they get. The company had an $11 million dollar market cap and had just put in a bid of $10 million US to buy the iron mine and pay it off within 60 days.
George Young, attorney and President of Palladon at the time assured me that the $9 million he needed for the purchase was a done deal. His partner in Utah, Western Utah Copper was responsible for the other 10%. That's pretty much two lies in a single paragraph. Young was a director of a new Royalty company and Young told me that if all else failed, they would fund the $9 million. Wrong. There was no 43-101 or formal feasibility on the Iron Mountain project so they couldn't fund such a deal. He knew that. I didn't.
And his dealings with WUC have always been the source of a lot of questions. Western Utah Copper was given a 10% interest in the Iron Mt project but WUC had no money. In effect, WUC was getting a 10% carried interest essentially for free. WUC would be an anchor around the neck of PLL for years and they contributed nothing positive. George knew that. I didn't.
After my piece, the stock shot up as high as $1.28. George Young should have been in high cotton, the market cap of the company was now $30 million. As the April 9 deadline for the payment approached, George indicated funding might not be quite as easy as he had predicted. That was sort of a lie as well. Or the understatement of the century. No one wanted to touch George with a ten-foot pole.
I have a lawyer twin brother who had just settled a big case and had a wad of cash sitting in the bank looking for a nice home. I set up a meeting between my brother, another large investor friend of his and George Young. According to my brother, Young was a complete goof who wouldn't say what he wanted. Young talked for two hours about how great the project was but couldn't be pinned down as to what he wanted. That's always a bad sign.
As the April deadline approached, Young knew he had to do something. In a state of panic, he approached Luxor Capital in New York who had bought a few million shares in the open market. He essentially told them that their multi-million dollar investment was going to be worthless unless they bailed him out. That's the one thing I know he said that was true.
Luxor loaned PLL something like $10 million to complete the deal with the court in exchange for 75% of the outstanding shares in PLL. Here's where the deal started getting really dysfunctional. Since Young was carrying WUC for 10%, the PLL shareholders would only end up with 15% of the project.
Since that was in effect a change of ownership, it had to be put to a vote. Shareholders would not approve of giving away the company in exchange for a tiny part of the deal. I pointed out at the time to Luxor that while they appeared to have done a great job of negotiation for themselves, the real question was, did they want to own 100% of an iron mine because with only a 15% ownership share, PLL and George Young really didn't have much incentive to work hard. In the end, Luxor realized what I said was true and took a much smaller piece of the company and made the money advanced into a loan and actually loaned PLL money to advance the project.
The issue always was, just how soon could the project be put into production. With the incredible increase in the price of iron from $38 to $78 in 14 months and eventually up to $140 by 2008, the fastest and cheapest way to make money was to direct ship ore.
The ore at Iron Mt is rich but not that rich. The 43-101 resource only recently completed showed a grade of 45.3% and an additional non-43-101 resource of 152.1 million tons at 42.2%. But when you are shipping 45.3% ore, you are also shipping 50% waste rock and shipping is expensive. In years past, Palladon could have and should have done resource drilling to confirm the resource and should have done a scoping study and later a feasibility study to determine the most professional and financially responsible way to advance the project. With an iron project, it's often easier to raise $500 million than to raise $25 million.
Everyone got tired of George Young and his pretty much constant lying. No one really understood what was going on and there was a real lack of direction. George had set up a corporate culture of deception. I talked to him dozens of times, I talked to his replacement, Don Foot, dozens of times, I talked to their PR hack dozens of times and I really never understood either where they were or where they were going.
As early as May of 2005 at the New York Gold show, Young was telling me they were going to ship ore in six weeks. I looked at him in astonishment when he said it. Either he was going to accomplish things faster than anyone in mining history or he was lying through his teeth. Guess which.
George Young got fired as President in the fall of 2005 but the company kept him on as a director. His culture of deceit continued on for years. Don Foot took over as President. In August of 2005, the company announced they would deliver 1 million tons of concentrated ore to China in the next 12 months. That was a lie.
Luxor advanced more money to Palladon and ended up with 50% of the project. For doing little more than being a millstone around the next of Palladon for years, WUC got a $500,000 finder's fee.
I really like Don Foot and he wasn't nearly as deceptive as George Young but he wouldn't tell you anything negative. Palladon made promise after promise for years and you could ask questions about status time after time and all you would be told is the feel-good BS. You would never be told of the issues.
As an example, in May of 2006, Don Foot was projecting shipping as early as Q4 of 2006. If it had been true, the company would have been minting gold bars. The price of iron went up and went up and went up. It was all rubbish. Even though they were using Gilbert Development as a contract miner, none of the promises from the company were ever true. Gilbert did their job but Palladon just couldn't get their act together to provide the financing when it was promised.
Gilbert Development did an incredible job at Iron Mt. I was there last week and met with Keith Gilbert. They had a couple of hundred rail cars loaded and ready to go. The mine was pre-stripped and ready to produce, Gilbert had even ordered 4 400 ton trucks in anticipation of shipping 2 million tons of ore a year. It's all sitting there doing nothing at all.
In June of 2008 Palladon completed a major financing and agreed to buy out the 50% interest in PIC from their long patient partner, Luxor Capital for $65 million. They paid them $40 million in cash and agreed to pay the remaining portion by June of 2009.
Finally in September of 2008 all the promises from George Young and Don Foot came together and the company was ready to ship ore at the incredible price of $70 a ton FOB Long Beach for 55% Fe.
There was one slight hitch. The world was in the worst financial crisis in history. Long Beach, their shipping port, was packed with goods that couldn't be moved. Palladon tried to find an alternative port but couldn't before the demand for iron plummeted and there was no more profit to be made direct shipping ore.
I've made the comment before that while I am lied to half the time when I talk to mining executives, it's not nearly as bad as the computer business where Barbara and I were lied to 100% of the time. Indeed, the computer business is filled with liars. When Bill Gates leased DOS to IBM for the first IBM PC, he didn't own it. When Steve Jobs was paid for a computer game written by Steve Wozniak Jobs failed to pay Wozniak his promised 50%.
But mining lacks one important factor found everywhere in the computer business. Because of Moore's Law, computers and computer bits are on a constant price decline. All computer companies have a constant sense of urgency. On the other hand, most of the people in the mining business are in the business of collecting a paycheck and there is no sense of urgency.
In spite of all the misrepresentations and outright lies on the part of management at Palladon, if they had actually shipped and caught the high prices for iron a year ago, the high price would have bailed out their stupidity. They didn't.
Don Foot was fired in March of this year. The Board of Directors finally realized the situation was critical and replaced Foot on a temporary basis with John Cutlet, a current shareholder and director. None of the normal business developments had taken place in the four years that Palladon had controlled Iron Mt. there was no 43-101, no scoping study, no feasibility study. Palladon had bet the farm on direct shipping iron ore and then dawdled until the market evaporated.
A month later the BCSC halted the stock pending PLL filing outstanding financial statements. It was the perfect storm. They didn't have a shipping port; every single shareholder had lost money. Two Presidents in a row had been fired, the price of iron had dropped so low that it wasn't worth shipping and now the shares were halted.
I got a phone call from a large shareholder in Palladon about a month ago asking me to travel to Utah to see the project and to talk to management about the company and the project. I wasn't all that inclined, I happen to be one of those long suffering shareholders who looked like a dummy for writing about the company in the first place. I agreed but warned them that I had some tough questions and I wasn't in a mood for any more feel good BS, I had had enough in the last 4.5 years.
I went out last week to visit Palladon. It was a short in and out visit.
First the good news; for the first time ever, Palladon is doing the things they should have done years ago. A month ago they released a 43-101 PEA report (Scoping study) on Iron Mt showing 40.35 short tons of 45.32% Fe allowing a 15 year mine life and a 24% ROI producing 1 million tons of DRI (Direct Reduction Iron) a year. The Net Present Value of such a project was estimated at $763 million at an 8% discount rate. The current market cap of PLL is about $12 million in comparison.
The capital costs for that sort of plant and equipment would be in the $700 million dollar area. In addition, while I was in Utah I brought up the idea of starting off with Palladon installing magnetic separation units so they could ship high-grade iron concentrate. That cost would be in the $50-$80 million dollar range. They could permit and install that in a relatively short period of time (12-18 months) and be shipping a high grade, higher value product that would be economic at today's prices for iron.
There is a giant monkey wrench in the works that has capped the share price and has things pretty much at a standstill in terms of real progress. Palladon still owes Luxor Capital about $39 million. Luxor has been very patient and has extended the term of the loan twice. PLL was supposed to have paid $5 million to Luxor by October 15th and the remainder by December of 2010. Luxor has extended the payment date of the $5 million to December 4th, 2009.
For all practical purposes, that date acts as sort of a gun to the head of Palladon. Public shareholders currently are not putting a high value on the company due to the fear that Palladon could be in bankruptcy if they do not reach a resolution on the debt. Funds or strategic investors with a longer-term perspective are probably not interested in putting nearly $40 million into the pockets of someone else. Putting $40 million in the ground is one thing but paying off a prior investor is yet another.
However, Luxor has agreed to convert 35% of their debt into equity in a larger financing. According to the press release on June 26 announcing the initial extension of the debt, "Luxor has agreed that after sixty five percent (65%) of the total amounts payable on the Luxor Loans has been paid in cash, at the Company's option, the balance of the Luxor Loans can be converted into Palladon common equity at the most recent share price used to refinance the Luxor Loans, provided that the amount raised in such financing is at least US$10 million and other conditions have been met." There is probably around $39 million in debt outstanding, and the cash requirement to take that out is 65% or $25 million with $14 million being converted into equity at the deal price. That may be an alterative that is attractive to existing investors or a strategic partner if you believe SRK's estimated $763 million valuing in the PEA report, which is only based on 20% of the total current and historic resource.
I fault the prior management of PLL, Don Foot and George Young for creating a monster by their lack of basic candor. They created the environment where Luxor Capital and Gilbert Development don't trust anything coming from Palladon. But that was then and this is now.
As I said almost 5 years ago with iron at $38, this is one of the most strategic iron mines in the US. It has the potential to supply DRI or nuggets to steel mills in North America at highly competitive prices. It can also supply high-grade concentrate and/or nuggets into the Asian markets.
All of the prior problems were management issues, not issues of price or mining. It's fully equipped, it's fully permitted (with minor additional permitting required for concentrate and more extensive permitting required for DRI or nuggets), there is a world of expansion potential and for the first time in many years, Palladon has adult management.
Luxor is in the driver's seat. With the stock at $.08 or so, there is a question as to whether the company can raise the $5 million (or the entire amount) necessary to hold Luxor off for another year or pay them off entirely. But Luxor has made money on the deal; they were paid $40 million a year ago. They can convert their debt to equity and still be whole.
There are things we can take as givens. Luxor doesn't want to own 100% of an iron mine. It is in their best interest to have a smaller piece of a far bigger pie. In my view, present management is going in the right direction and can raise the $50 million for magnetic separation units or $705 million for a DRI or nugget plant. They would likely get into production with concentrate, which is less capital intensive, then ramp up production of DRI or nuggets over time. A DRI or nugget plant could start at 0.5 million tons per year for capex of around $250 million, then additional capacity could be added over time. An IRR of 24% is very healthy for an iron mine and mill. I highly suspect management is talking to Luxor and there will be some sort of meeting of the minds that will be a win-win situation rather than the negative sum game that has been a Palladon product for most of the last 10 years.
For investors, it's this simple. Either Palladon raises the $5 million to extend the debt through year-end 2010 or they raise the $25 million minimum required to take out the debt. Alternatively, Luxor and Palladon could come to terms on an alternate agreement by December 4th or they could give the company additional time to review its options. It's entirely possible that Palladon could be forced into bankruptcy by Luxor if Luxor really had their heart set on an iron mine in Utah for Christmas. If they do, then the price of PLL will go to zero. It would take two years for Luxor to get their hands on the mine as it wanders through already crowded bankruptcy courts but in the end Luxor could have the mine if they wanted it.
Luxor and PLL could come up with terms where perhaps Luxor took a position in Palladon and forgave the loan. Or the company can raise the $25 million required to pay off the debt with the balance converted into equity. That would make the most sense to me and I think to them. It would be far better to start off with a clean slate, and I am certain there is a lot of Chinese money that would love to invest in a Utah iron mine if the slate was clean. In that case, lucky PLL shareholders would be sitting on shares worth a lot more than $.08.
So either Palladon goes to zero in 6 weeks or it will be above $.50. The NPV of the project is $763 million; it should be worth a lot more than a $13 million dollar market cap for even just part of it. I think it's pretty much a slam-dunk and mathematically it makes a lot more sense to buy at $.08 than to sell. I am a buyer in a big way and I already own a lot of shares.
I like the project, I like PLL management, I like Gilbert Development and I like Luxor. I think together as a team everyone can win and those are the stories I love to tell.
Palladon is saving cash and is not an advertiser. We have owned shares in Palladon for years and I have bought more lately. We are biased and that should be taken into account before you make any investment decision.
The photo gallery of my trip is here.