SVH Tracker - September 10, 2015: First Point finally back in control of its destiny with 100% Decar acquisition
First Point Minerals Corp made a major announcement on September 8, 2015 that it has acquired the majority 60% interest in the Decar nickel project from Cliffs Natural Resources Inc for US $4.75 million. In addition the 1% NSR First Point held on Decar has been extinguished, as has a 1% marketing fee held by Cliffs. First Point also reported that Cliffs has sold its 14,353,190 share block at $0.0515 to a group of friendly investors rounded up by First Point management, thus removing an onerous overhang from the market. The acquisition of a 100% interest in Decar is a very important development for First Point, owner of a 40% interest in a project that has been stalled since a hedge fund ousted Cliffs management in mid 2014 (see SVH Trackers March 9, 2015 and May 22, 2015). Although First Point made a number of proposals to Cliffs during the past year, all were rejected because Cliffs wanted a substantial cash payment to recover part of the $22 million it spent bringing Decar through the PEA stage. First Point was further handicapped by the absence of a first right of refusal on Cliff's 60%, which became a problem when a third party that included former Cliffs executives attempted to acquire the interest. The table was turned, however, when First Point announced on August 7, 2015 that the farmout to Cliffs had converted to a 60:40 project ownership. In other words, Cliff's' ability to earn up to 75% by completing a BFS disappeared when Cliffs failed to deliver a PFS to earn 65%. Given that no money has been spent by Cliffs since early 2014, it was obvious that Cliffs and First Point were destined for a 60:40 joint venture, but what was not obvious is that when the contractual deadline passed not only was a joint venture automatically created, but along with it came rights of first refusal for both parties. This killed the potential sale to a third party and set the stage for serious negotiations between Cliffs and First Point.
First Point now owns 100% of Decar and is finally in charge of the project's destiny, though in view of extremely weak nickel prices and the unprecedented market aversion to the resource sector, Spec Value Hunters can be excused for asking themselves of what value 100% ownership might be. Without a doubt, at the current nickel price of about $4.50 per lb the Decar project is worthless as defined by the assumptions of the 2013 PEA which was done with a near parity USD:CAD. Because the capital and operating costs were all sourced in Canada as Canadian dollar denominated costs, and are unlikely to have changed much despite the plunge to a 0.75 USD per CAD exchange rate, I have adjusted my discounted cash flow model to reflect the lower USD denominated costs. Initial CAD CapEx of $1,384,000,000, sustaining CapEx of $763,000,000, and an OpEx of $6.90 per tonne milled become in USD terms respectively $1,038,150,000, $571,875,000 and $5.19 per tonne. The NPV graph (Sept 10, 2015) above shows how the after-tax NPV varies at 5% and 10% discount rates at different nickel prices with the currency adjusted costs, whereas the NPV graph (Mar 9, 2015) below uses the initial near parity cost figures. What is important to note is that the NPV (10%) at the USD $9.39 per lb base case nickel price used by the PEA is only USD $391 million with the original costs, but jumps to $1.2 billion at the currency adjusted costs. Especially noteworthy is the implication that the project becomes interesting in the $6-$8 per lb range, which it was not in the original PEA.
Decar will probably still be marginal at $4.50 nickel even if First Point spends $3 million to deliver a revised PEA that incorporates a number of important optimizations to the mining plan. For example, a drill program is planned for the Southeast Extension of the Baptiste Zone which is better located for a starter pit and has higher grades than the starter pit location proposed by Cliffs. During 2014 First Point conducted detailed mapping of the Decar deposit to outline large barren dykes that need not be fed into the mill at an 8% grade dilution cost. Another plan of action is to recover 10-20 tonnes of material from existing holes to create a representative bulk sample on which metallurgical studies can be done. Management thinks the concentrate nickel grade can be improved. It also believes that making concentrate samples available to potential end-users could result in off-take deals that improve the 75% payability assumed by Cliffs in the PEA. Combined with the weaker exchange rate, these improvements could make Decar very robust at $6-$8 per lb nickel, but not likely below $5 per lb.
With regard to the nickel price, record high LME warehouse stocks at 450,000 tonnes indicate that nickel is in a major over-supply situation. However, unlike the case of copper where the over-supply has come from many expansions and new mines, new nickel supply came mainly from the emergence of Indonesia and the Philippines as suppliers of raw nickel laterite ore that is direct shipped to China where existing blast furnace infrastructure, supplemented by new electric furnaces, is used to convert the ore into nickel pig iron. A nickel supply squeeze in 2007 that sent the nickel price soaring towards $24 per lb coincided with a Chinese process innovation whereby the nickel pig iron rather than high purity refined nickel could be fed directly into molten steel to make stainless steel of acceptable quality for Chinese end-users. From negligible output in 2005 the Philippines emerged as the world's biggest nickel producer, accompanied by a surge in Indonesian output that peaked in 2013. On January 12, 2014 Indonesia finally put into effect a ban on the export of raw ore that dropped Indonesia's output from 440,000 tonnes in 2013 to 240,000 tonnes in 2014. The law was first proposed in 2009, and it appears that China stepped up imports well beyond its consumption needs. The Chinese reliance on nickel pig iron reduced imports of refined nickel, which piled up in the warehouses and created downward pressure on nickel prices. During 2015 the downtrend was accelerated by the softening in Chinese GDP growth, and the fallout from China's stock market bubble collapse which precipitated an exodus from holding nickel as a financial asset. The big question is how close is China to depletion of its laterite ore stockpiles? Indonesia appears determined not to resume the direct shipment of ore, and output from the Philippines has been flat. The potential for expanded direct shipping ore from the Philippines is facing environmental headwinds. The weak nickel price has no doubt put development plans for new refined nickel production from both sulphide and laterite deposits on hold. It is reasonable to speculate that LME warehouse stocks have peaked, and will decline during 2016 as China is forced to meet its nickel needs for stainless steel production by importing refined nickel.
It is plausible to argue that nickel prices will recover to a sustainable $6-$8 per lb price range to which there will not be a supply boost response from Indonesia and the Philippines in the form of direct shipping ore. Indonesia's effort to force domestic construction of ferronickel or nickel pig iron production facilities has resulted in only a small percentage of the former direct shipping ore output to be replaced with domestic production. High capital costs and a power infrastructure shortage make it unlikely that Indonesia will be a source of supply growth. The Philippines also seem unlikely to grow output of direct shipping ore. First Point has 118 million shares fully diluted and about $1 million in working capital less the US $5 million loan issued to end up with 100% of Decar. At a CAD $0.06 stock price First Point has an enterprise value of less than $2 million. Is the market correct in judging Decar a bust?
First Point needs to raise another $2-$3 million to execute on its plan for a revised PEA. It now has the option of finding a deep-pocket partner which will fund the project through production, though the company would be very lucky in the current market climate to end up with the 25% it would have retained in the Cliffs deal. The other option is to raise capital from the equity markets, though at the current stock price the dilution would double the fully diluted and still provide nowhere near enough capital to deliver a BFS. First Point cannot start drilling until June 2016, so it need not be in a hurry to conduct an equity financing. Its efforts should be on educating the market on the value potential of Decar and securing a higher market valuation for the project ahead of an equity financing. But the investing public and institutions have been beaten up so badly through exposure to the resource sector during the past five years that their aversion is the inverse to a bubble peak, namely a capitulation bottom. These conditions create true speculative value, though the paradox is that even Spec Value Hunters do not like to buy when a visible uptrend that validates the purchase is not in place. For inspiration Spec Value Hunters should turn their attention to the lender who provided the USD $5 million loan that has put First Point and the Decar project back on track.
The lender has made a five year $5 million loan at 6.5% for which the entire Decar project is security. A 4% fee was paid upfront to the lender. Interest will be paid 1.5% in cash semi-annually, while the remaining 5% will be accrued until the loan matures. These terms are not punitive, but the loan does qualify as a "loan to own" strategy whereby it is conceivable that in five years the lender owns Decar into which Cliffs has already sunk $22 million, and into which First Point will sink at least another $5 million. The problem for the lender is that if circumstances in 5 years make it impossible for First Point to raise the funds to repay the debt, it is because the project has been demonstrated as truly worthless at the then prevailing nickel price. There is a risk that we will slide into a global depression that crashes demand for nickel, or a new supply of low cost nickel emerges to flood the market and guarantee nickel prices below $5 per lb for a very long time. The lender's risk of ending up with a worthless nickel deposit and a $5 million loss is balanced by the 1% royalty First Point has granted the lender on future Decar production.
The value of a net smelter return royalty is based on the price received for the royalty metal. It does not matter what it cost to produce the metal. That is a problem for the project's lenders and equity holders who need profits in order achieve payback and a return. The pre-tax NPV graph above is essentially the same one I produced earlier in SVH commentaries to represent the 1% NSR First Point held in addition to its 40% project interest in Decar. It did not change when I adjusted costs to reflect the lower USD:CAD exchange rate, because it is a slice of the USD revenue side of the equation. Using a 10% discount rate the 1% NSR has a present value of US $21.7 million at the current $4.57 per lb nickel price, and a $47.5 million value at $10 nickel using a 10% discount rate (the yellow line). The value at $4.57 nickel is actually zero because at that price no mine will be built; what seems to have been lost in the royalty craze of recent years is that a royalty is worth nothing if mine development economics require metal prices well above current levels. To adjust for the fact that the royalty will not likely start until 7 years from now, its value has been further discounted to reflect the startup delay, which creates a range of $11.1 million to $22.9 million between $4.57 to $10 per lb nickel (the purple line).
The speculative risks faced by the lender are: 1) what will be the future nickel price, 2) at that future nickel price will the IRR and after-tax NPV of the optimized Decar mining plan meet development thresholds such as a minimum 15% IRR for long-lived, high CapEx projects and an NPV matching or exceeding CapEx that justify a production decision, and, 3) will Decar be turned into a mine? Based on the existing PEA Decar will need a nickel price of $9-$10 per lb to justify development. At $9 nickel the 1% NSR would generate US $133 million in revenue over 24 years worth $42.7 million, or $21.9 million with startup 7 years from now (pre-tax, 10% discount rate). At $10 nickel mine life royalty income is $148 million worth $47.5 million or $24.4 million with 7 years until startup. So the lender is risking $5 million for a payout worth $21.9-$24.4 million. The lender is in effect assigning a 20%-25% probability to a long term nickel price of $9 per lb or better. At $9 nickel the after-tax NPV is US $807 million and IRR is 20% using a 10% discount rate ($1.1 billion NPV and 23% IRR at $10 nickel), which translates into CAD $9.14 per share, 15,000% higher than the current $0.06 stock price. The market is saying that the probability of a $9 long term nickel price is about 0.7%.
Who is closer to the truth, the lender or the market? Unfortunately I do not know the identity of the lender, so I cannot judge if the lender knows what he or she is doing, or is completely delusional and blessed with far too much wealth. Given the extreme aversion of the market to the resource sector, I am inclined to believe the lender is an extremely shrewd investor who is not just betting on the future nickel price, but is also placing a bet on First Point management's ability to improve the economics of Decar. The lower the nickel price needed to breach the development threshold, the higher the probability the lender's bet will pay out, though the absolute payout is lower to the lender at the lower nickel price. As it turns out, assuming there is not much First Point can do about the CapEx, achieving the development threshold at a lower nickel price like $7 per lb through a revised PEA does not change the target valuation for First Point. Ironically, if the former Cliffs executives had closed on the acquisition of the 60% Decar interest with deep-pocketed backing by an outfit such as Resource Capital Funds which financed Noront's acquisition of the Black Thor chromite project from Cliffs, sending a strong signal in the form of a committed backer, First Point would have retained its 1% NSR and possibly doubled it to 2% by not contributing to its 40% working interest in Decar. That 2% NSR would be worth $20-$40 million today; instead First Point's Decar project has a $5-$6 million implied value while the lender has ended up with an asset worth $10-$20 million. However, if the lender is to realize that value of the 1% NSR, it will only be because nickel prices have recovered into the $6-$8 per lb range, First Point has demonstrated the feasibility of developing Decar in that nickel price range, and there is threat of a supply glut from other nickel projects lured back into the development pipeline.
My Good Absolute Spec Value Buy Recommendation of First Point Minerals Corp has always been premised on the idea that the target mineral at Decar, awaruite, a naturally occurring form of stainless steel, has a more benign cost structure than sulphide and laterite deposits. By "benign" I mean that the operating costs have a significantly lower input reliance on energy and processing reagents than laterite and sulphide operations. Once Decar is built it will not have the vulnerability to power and consumables cost inflation that reviving global economic growth will create and which will hit the profitability of laterite and sulphide nickel mines. A key assumption is that the boom in direct shipping laterite ore is over, and that future supply growth will be from conventional nickel mines. The nickel market has suffered from a anomaly that is in the process of fading. The uniqueness of the nickel mineralization at Decar makes this a candidate for a long lived, world class nickel mine with a minimal environmental footprint. First Point Minerals Corp is a Good Absolute Spec Value Buy with an immediate target in the $0.20-$0.30 range where I would like to see the junior finance at least part of the funding it needs to deliver a revised PEA for Decar.
*JK owns shares in First Point Minerals Corp