I’ve got one little teaser to look at for you in your Friday File today, and then some quick updates on the companies in the real money portfolio I manage.
The teaser pitch that several folks have asked about is the “Project Ironman” teaser from Marin Katusa, which he’s talking up as a “totally new way to invest in gold” … and, as some of you have already noticed, that same “Project Ironman” pitch was also used by Katusa back in September when he was signing subscribers up for a private placement deal.
So is this the same deal? Well, kind of. It is another private placement that Katusa is selling access to, and the heart of the company is the same, but the private placement is also coincident with a merger that is changing the nature of the company pretty significantly.
What’s the story? Katusa’s real passion is this whole idea of being “in the room, in the deal” and getting involved in early stage projects, usually that have close connections to people who are, to varying degrees, legends in the world of resource investing, folks like Ross Beaty, Rick Rule, Doug Casey, etc. And he also manages a hedge fund that is largely populated with investments by Rick Rule and Doug Casey, so he can also say that he knows, for example, what Doug Casey will have as his biggest investment this year (since he’s actually choosing that investment for Casey).
And much of Katusa’s focus has been on private placements and warrants, which give early investors a nice bit of leverage, so part of what he’s selling in his newsletter subscription (Katusa’s Resource Opportunities, which is $2,500 a year) is access to those private placements. It’s a little bit of a mushy relationship, because Katusa is not actually acting as the broker for these deals and it’s entirely possible that you may be able to get into those deals without a connection to Marin Katusa, but these deals are frequently oversubscribed these days, because financing is suddenly readily available for junior miners again as speculative fervor has started to re-heat, so perhaps getting in through folks like Katusa, who have personal connections to the deal, gives you a better chance at getting an allocation to an attractive deal (I don’t know, that’s just a guess).
The “Project Ironman” pitch last time around was for a deal window that closed on September 26, this time it’s a deal window that closes on February 26. So how is it the same company?
Well, the last pitch was for what was about to become JDL Gold — here’s a quick bit of the piece I wrote at the time:
“… the ‘private placement’ Marin Katusa has been pitching as his ‘Project Ironman’ idea is almost certainly a reference to a private placement he’s facilitating that will fund future development of a company that will be called JDL Gold. That subscription offer seems to have closed, and I don’t know what the terms were on those shares or warrants, whether they had holding periods set or anything like that, but the private placement was for prices that are about a 10% discount to where the prices are today, and it also came with a 5-year warrant, so those are decent terms if the rest of the private placement is appealing….
“There’s quite a bit of risk, of course, and you don’t have to participate in the private placement or pay a newsletter to buy the stock. JDL Gold will be created from the merger of Lowell Copper (JDL.V), Anthem United (AFY.V), and Gold Mountain Resources (GUM.V), and shareholders of each will end up as shareholders in JDL Gold. In effect, this is Lowell Copper buying those other two companies in exchange for shares — so you would receive 1.032 JDL shares for each GUM share and .774 JDL shares for each AFY share. Not surprisingly, arbitrageurs pay attention so those stocks generally trade right where they should based on the value of JDL shares, and there’s almost no chance that the deal will fail to go through (this is pretty low-profile, though, so if you’re interested perhaps you’ll get lucky and get shares at a discount if you’re paying attention — last I checked AFY, for example, was briefly trading at a 8% discount to the current value of the Lowell Copper shares those shareholders will receive).”
JDL Gold hasn’t done much since it was created — though, to be fair, it has only been about six months, and it’s a junior mining company with minimal revenue so the expectations should always be long-term in nature (and dependent on commodity prices — in this case, copper and gold). The price of the stock at the time of the deal was about C$2.14, and it has drifted lower to C$1.84 today. I was mostly unimpressed with the company at the time, largely because the combination of Ecuadorean copper, Canadian gold, and a Peruvian gold mill didn’t make particular sense to me because none of the projects were particularly advanced or synergistic — all it did was make three teensy companies into a somewhat larger one, with potential exploration upside but still no real near-term potential for production.
That’s changing a bit right now, and it’s because of another deal — the one that is being pitched by Katusa here, and to which his talked-up private placement deal is connected (the merger is contingent on the financing deal).
So what’s the deal? The merger of JDL Gold with Luna Gold, which I happened to write about when the merger happened (it inspired me to buy Luna Gold). Here’s how Katusa pitched it — and to be clear, this is not really a “secret”, Katusa has also talked about his JDL Gold investment publicly, including just this week on Frank Curzio’s podcast (which I always enjoy listening to and recommend, by the way).
Here’s what Katusa said on Curzio’s podcast:
“Roman Shklanka who does a lot of geology for me, this is going to be his largest check because he believes that of all the projects we’ve looked at together in the last decade, this one is the lowest risk with the biggest upside. He believes the size of the resource triples, minimally. We’re talking about over 10 million ounces of gold here, high grade, all open pit, in a positive jurisdiction. But because someone else tried to build it in the past, so much of the infrastructure is in place. For $150 million, we can start producing a little over 150,000 ounces and we believe that the mine life will at least double.
“I put together a whole video of the executives of the company here and of the executives and the largest shareholders and they’re all saying, “This is going to minimal, double the mine life.” Then I brought in world class mining experts and they believe that there’s other, easier, lower hanging fruit. Not only can we get 150,000 ounces of production, but we could put a leach pad to get another
30, 40 thousand ounces. I think that project alone is in the lowest quartile of costs. It’s got huge upside potential and we’re paying very cheap for it. That’s how you win in the resource sector.”
In the ad for his newsletter, here’s how Katusa pitches the investment:
“Project Ironman: A Super-Junior Resource Firm Set to Go Public
“Project Ironman’s chief assets are:
“***ASSET #1: One of the world’s richest gold deposits, located in South America.
“This project, which I’m calling ‘Masa’ contains over three million ounces of gold.
“One of the world’s most successful geologists believes the deposit holds over 10 million ounces of gold, which would make it a truly world-class deposit. After he performed a thorough review of the deposit for me, he rushed to invest more than a million into the deal!”
So that’s Luna Gold’s past-producing Aurizona mine, and then Katusa details the assets that made up JDL Gold before this merger (well, the merger hasn’t closed yet — but it almost certainly will):
“***ASSET #2: A gold project I’m calling “Wapiti.” It’s a very rich gold deposit located in Canada.
The Wapiti project will be an easy mine to put into production. Over its lifetime, I expect it will produce more than $100 million in cash flow at $1,200 gold….
“***ASSET #3: A gold and copper project I’m calling “The Flores Project,” located in Ecuador.
“Over the past five years, the South American country of Ecuador has become one of the world’s most sought-after mining jurisdictions. Some of the world’s top resource entrepreneurs have already put millions of dollars into the country.
“The Flores Project is one of the biggest and best “trophy” projects in all of Ecuador. The project has a copper resource of nearly 2 billion pounds of copper…and has the potential to be much larger. There is also huge gold potential in the project….
“***ASSET #4: An asset I’m calling “The Carnilla Mill,” located in Peru.
“This is a modern, high-quality gold processing plant located in the gold-rich province of Arequipa, Peru.
“When gold comes out of the ground, it needs to be processed. This process, known as milling, breaks gold ore away from host rock.
“Companies who specialize in this process are called “toll miners.”
“Toll miners make money by acquiring the rock at a discount to the gold price, processing the rock, and then selling gold ore.”
Marin talks a lot about the “management dream team” and the investors who are coming together with this deal, including David Lowell, who has his 89th birthday in a few weeks and is one of the better exploration geologists in history, famous for finding elephant deposits in South America (his Lowell Copper contributed the Warintza Project, which is what Katusa calls the “Flores Project” in Ecuador, as well as the less-explored Ricardo Project in Chile). Other backers include Ross Beaty, famously called a “broken slot machine” because of his track record in finding winning mining projects, Casey and Katusa, Rick Rule, and Nolan Watson of Sandstorm Gold (which had exposure to JDL Gold and has a large position in Luna Gold, thanks largely to Luna’s default on past streaming deals when their mine expansion failed during the collapse on gold prices).
That’s an admirable bunch of folks to have involved in what will still be a small sub-C$300 million company. The private placement deal will close near the end of February, and the merger will close probably before March is out (it requires votes of shareholders, which will take a little while to arrange). So what’s the deal, and is it worth being “in the room” and subscribing to Katusa’s newsletter to try to get preferential access to the private placement? (You might be able to get access to the placement otherwise as well, I don’t know — you would have to be an accredited investor and contact the company directly to find out.)
Well, the deal is essentially that JDL Gold is merging with Luna Gold to form a company that will be called Trek Mining, and Luna shareholders will each receive 1.05 shares of the combined company. I bought Luna shares myself on the news partly because they were trading at a discount to that valuation, and partly because I like the Aurizona project and have known it for a long time because I have long owned Sandstorm Gold, for whom Luna was the first really big royalty/streaming deal (and created a huge short-term negative for SAND shares a bit later, when Luna stopped producing, because a huge chunk of SAND’s revenue disappeared almost immediately).
Luna is a company with a large and “almost ready” mine that has been ready for investment but has lacked the cash or impetus to move forward, partly, perhaps because investors were scared away by the past “failure to expand” at Aurizona. The Aurizona mine produced for a while, at a high level, but was essentially a first stage “easy” mine that was designed to mill the simple part of the deposit… it got harder to access the higher grade stuff, they had to invest in deeper hard-rock mining, and they did so, but then they had cost problems and water problems and, reading between the lines, probably made some mistakes in designing the mine expansion (that’s just a guess on my part, I’m not a mining expert).
The big, reasonably high-grade gold deposit is still there — I don’t know whether Katusa’s geologists are correct in estimating that it probably has 10 million ounces versus the 1.5 million that Luna has estimated (combining proven and probable reserves with measured and indicated resources), but there has always been a strong likelihood that the deposit is substantially larger, partly because it’s a long-producing gold region and Luna has “greenfields” exploration areas around the mine that haven’t yet seen any real exploration investment. Luna was preparing to raise a couple hundred million dollars before the end of the year, and this combination with JDL Gold will do much the same thing in getting them enough financing that they should be able to easily move forward with the capital investment required (the mine will probably require $150 million in Capex to restart, some of which they could borrow, but having a good $50 million in cash after the financing will give lots of flexibility this year).
What JDL gets is something real and near-term to go along with the large potential copper deposits and the much smaller potential Canadian gold mine (Elk Gold, which is small, 200 ounces of resource estimate, but high-grade), so they get a much more dramatic near-term production potential from Aurizona and the new Trek Mining can now be thought of as a near-production gold company with good financing and large exploration/expansion potential, that happens to have small cash flow from their Peruvian gold mill operation, and a pipeline of potential future copper and gold projects.
The combined company will have a market cap of about C$250 million, and the potential cash flow from Aurizona of $75 million per year for the first five years of production. That will repay the capital investment in the mine in just two years, most likely, and lead to several hundred million dollars in profit over the projected life of the mine… though the mine life will very likely expand, given the huge exploration potential beyond the current resource estimate. That’s arguably worth buying even if you don’t get the exploration assets of JDL Gold — and Luna Gold did have a market cap of around $300 million by itself during the day before their mine expansion project fell apart.
So it’s risky because it’s a bet on a mine expansion that has already failed once, though having a large suite of well-known resource investors in the deal makes it a little less risky in my book (and I’ve had many years to get used to the idea that Luna has a big potential gold deposit that should benefit Sandstorm eventually, though I haven’t felt compelled to invest individually in Luna given their lack of traction at getting the mine expansion back on track during the weak gold pricing years). So I think Luna is still a decent bet, with serious upside potential, even though I don’t ascribe a lot of upside to the JDL Gold assets in the next few years.
It is quite a bit less risky to invest in Luna or in the new Trek Mining through Sandstorm, if you just want one diversified gold investment — and I’d never argue against that. Sandstorm will be a large investor in Trek, both with a substantial royalty on the Aurizona mine (3% NSR, up to 5% if gold goes a lot higher) and with a $43 million convertible debt holding in the company (the other debt is being repaid by the financing, but not Sandstorm’s convertible debt). That isn’t likely to drive SAND shares dramatically higher, but it could certainly be meaningful and Sandstorm is far, far more diversified and steady than any producing miner.
So is the private placement deal worth it? Well, that depends on math — assuming you have to spend $2,500 to get into Katusa’s club of investors to get access to the deal, and were guaranteed access to the deal (you aren’t), would you do so?
The private placement is for C$2 per unit, with each unit consisting of one share of JDL (which will become TREK) and one warrant to buy a share of JDL (or TREK, post name change) for C$3 before October 6, 2021. Those warrants already trade, so we know what the market thinks they’re worth — they trade at C$0.61 now, and the JDL shares trade at C$1.89. So the private placement is certainly worthwhile, assuming no strings (and I don’t think there are any, they didn’t mention any tie-up period or anything, and the warrants are already listed so you wouldn’t be stuck in those waiting for a listing to trade them if you wished) — that’s a combined value of C$2.50 for an investment of C$2. If you’re an accredited investor and want to invest in this anyway, that’s a good deal.
Is it good enough to pay $2,500 for a newsletter to get access, assuming that’s required? Only if the math continues to hold otherwise (i.e., the share prices stay right around where they are now or go higher over the coming weeks and through closing of the deal), and you can buy enough that the C$0.50 per share advantage you get absorbs the $2,500 newsletter cost. That’s a 38 cent advantage per share for US investors, and the newsletter is priced in US$, so that would mean you’d have to buy about 7,000 units of the private placement to have it be worth the investment (assuming that you don’t place any value on Katusa’s newsletter otherwise). That’s US$10,700 — so for some folks that’s a big position to take in something as risky as an emerging mine-builder, but, then again, if you don’t have $10,000 to put at serious risk then you’re probably not the kind of person who’s interested in junior resource newsletters, anyway (or at least, you probably shouldn’t be).
I didn’t want to go through the process of doing the private placement, and considered my 10% discount on the eventual TREK shares by buying a small position in Luna at the time of the merger announcement to be worthwhile because I think Aurizona could be a big mine and generate some great cash flows for them, with relatively minimal operating and capital costs, and I’m content to see if those big investors and geologists can turn JDL Gold’s exploration assets into something big eventually to put a cherry on top of that. But this is, the math says, a good deal for private placement investors IF they can get a share of the private placement — I don’t know how big Marin Katusa’s group is, or whether his investors have trouble getting large allocations to his private placement deals, but this deal, at least, looks to me like a good one.
Which is no surprise since, as I’ve noted, I already invested in the combined company on worse terms than the private placement and am therefore almost certainly a bit biased in writing this for you.
We’ve seen a flurry of quarterly reports since I completed my annual review for the Irregulars and populated the “real money” portfolio that I’ll be following for you in the future, and the only real response I can give to most of those reports is, “that doesn’t change my opinion.”
The reports are generally worth reading, of course — it’s important to remain informed about the companies you own. But they’re almost never worth overreacting to — one quarter should not usually be enough to make or sink an investment thesis, though it can certainly swing your sentiment and make you reconsider an investment if the business is not operating as you expected.
Here’s what caught my eye:
Markel (MKL) is still overvalued, and I still like. I just wouldn’t buy more right now. Markel’s book value rose 8% for 2016, mostly due to strong investment performance, and the stock rose 14% between annual reports — Markel achieved it’s dramatic re-valuation by investors mostly in 2015, but the trend continued in 2016. The business performed well, they had a decent year with solid investment returns, continued good underwriting even in a weak pricing environment for much of their insurance lines, and emerging strong performance from the Markel Ventures business, with no real blow-ups or catastrophes that hurt results… but the stock has done better than the business. Most likely that will normalize at some point and the stock will do worse than the business… that’s what I hope for as a buying opportunity. I’m starting to feel like a broken record on this one, though — with a book value per share of $606, I’d be interested in buying the stock at $790 (investors liked the earnings and that Markel “beat” on revenue, and the shares popped to almost $950, so I’m out of touch with the market on this one).
My little speculations on future cobalt mania have had a little spurt of late, LiCo Energy Metals and eCobalt, but neither has hit manic promotional nuttiness so I’m just holding on, waiting to see if investors really do end up going gaga for cobalt stocks at some point. LiCo has made some news in building its lithium potential, but it’s so early stage that it’s meaningless unless there’s a stock mania (that’s just a $15 million company)… eCobalt is much more “real” and intends to become a primary cobalt producer fairly soon, the next catalyst will be their bankable feasibility study for a “cobalt for batteries” project (the mine is permitted and has been partly built based on previous plans to produce high purity cobalt metal, which is a different end product than the cobalt sulfate used in batteries). We’ll see.
Disney’s (DIS) earnings, announced earlier this week, had the potential to make a big impact on the stock price… but they didn’t — ESPN continued to disappoint and drag down the performance of the networks division, but parks and films did spectacularly well, even better than expected, so the end result was close to expectations. Importantly, Disney indicated that there will be stand-alone streaming products based on ESPN content this year, which will give the first test of how valuable ESPN is outside of the forced basic cable subscription model… and that CEO Bob Iger, who Wall Street loves, is willing to stay in the position longer if needed (his impending retirement has spooked some investors).
And we’ve also seen the first wave of REIT reports — Coresite (COR) ended 2016 with $3.71 per share in funds from operations (FFO), and guided to a FFO range of $4.25 to $4.35 for 2017, so the current dividend of $3.20 is easily supported (that’s a FFO payout ratio of about 75%). They expect to keep growing revenue and FFO in the high teens, so it’s a little risky to pay 20X forward FFO but you’re buying that continuing growth… they’ve also indicated that they expect the growth to be front-loaded in 2017, with the second half of the year showing worse year-over-year growth than the first half, so it might be that there will be buying opportunities to come in this one. Still worth nibbling if you don’t mind paying up for dividend growth, but it’s risky at this price — fingers crossed for prices in the $70s if they have a weak quarter or we get an interest rate shock that brings prices down for all REITs.
And Medical Properties Trust (MPW), Omega Healthcare (OHI) and Ventas (VTR) all reported as well —
MPW had revenue a bit above expectations and reported FFO in line with expectations, and the shares reacted very little, they continue to expect the same $1.35-1.40 in adjusted FFO for 2017 and that will still easily support the current 92-cent annualized dividend (a bit over 7% still).
OHI disappointed and remains the riskiest and highest-yielding of the healthcare REITs, and there remains the real risk that the business is largely reliant on one big payer (though that’s a second-degree risk — all of their skilled nursing facilities rely to a substantial degree on Medicare or Medicaid reimbursement policies, which sometimes change, those skilled nursing facilities pay rent to Omega), but they are well diversified other than that underlying regulatory risk… and they have continued to please investors by raising the dividend every single quarter (albeit very slightly), which shows no sign of changing in the 2016 results. The problem for OHI is in the 2017 expectations, which represent adjusted FFO that will essentially be flat from 2016 — and that’s apparently because the expectation is that their sector will be very challenging this year. Here’s the quote from the conference call:
“… we believe 2017 will be particularly challenging for the skilled nursing facility industry. The combination of labor cost pressures and [census] pressure will continue to challenge operators’ net cash flow. In addition, an increasingly aggressive regulatory and Department of Justice environment continues to divert many management teams’ attention away from patient care to deal with survey and legal issues not to mention the cost of defending and settling these issues. We will continue to work proactively with our operators to identify ways to maintain operating cash flow and manage through these issues.”
That’s more pessimism about 2017 than I would have expected, and it brought the shares down by 5% or so. Omega’s yield is still just 7.5% or so, which is high relative to healthcare REITs but lower than newer peer and Ventas spinoff Care Capital (CCP), which yields 9%. I’ll be curious to see what CCP says in their report in a couple weeks (February 28 is their report date) and how that compares with Omega’s assessment of the industry, but that flat FFO for 2017 makes me cautious for Omega and I wouldn’t be surprised to see it continue to trade down for a bit. Not doing anything with my position right now.
Ventas, as befits one of the “blue chip” firms in the healthcare REIT space, had a solid report, essentially in line (a slight “beat”, depending on whose estimates you were looking at), but is unlikely to post FFO growth in 2017 to any meaningful degree (they’ve guided to $4.12-$4.18, 2016 ended at $4.13). So you’re paying 15X FFO, getting a 5% dividend that will grow slowly, and have the knowledge that the dividend should be safe because it’s less than 75% of “normalized FFO” and the company is fairly steady with no obvious single source of regulatory or other risk (other than higher interest rates). The safest of the bunch, still, but not much room to move up dramatically unless they get more growth than they’re anticipating (or, of course, unless interest rates go down again and investors are suddenly willing, again, to accept sub-4% yields from “blue chip” healthcare REITs like Ventas — as they did this past Summer, when Ventas wisely raised some equity at the peak in the low $70s). Still good for large healthcare REIT exposure, but, as I said last month, the base expectation for this one is “average performance” for a REIT — I wouldn’t count on earning much more than that 5% dividend, I’m confident about the relative safety but not the growth potential.
Qualcomm (QCOM) is perhaps the worst-timed position I’ve taken in a long time — I bought my shares just before the announcement of lawsuits from Apple and the FTC over royalty levels and abuse of market dominance, so my holding is down by 19% or so in a month. I think the legal problems are priced in here, though they could, of course, always blow up into something far larger than I expect (my guess is that these lawsuits will lead to reduced royalties, not to gargantuan penalties) — so my key for Qualcomm is that for my valuation to hold, I still need them to complete the NXP Semiconductor (NXPI) acquisition, which has the potential do be a fantastic deal for Qualcomm, with big and accretive earnings growth and diversification. If that deal falls apart or the legal issues change, I may sell, but I won’t reflexively sell just because it’s down by almost 20% — I’ll have to wait to see how it develops. The earnings were fine, in my book, but completely overshadowed by the legal uncertainties — without the legal pressure, QCOM should easily be in the mid-$70s and now down here in the low-$50s with a 4% dividend yield, so I’m holding right now… but there’s enough uncertainty that I’m pretty glad it’s a smaller position.