January 12, 2011 - 3:04pm EST by
2011 2012
Price: 1.42 EPS $0.00 $0.00
Shares Out. (in M): 265 P/E 0.0x 0.0x
Market Cap (in $M): 376 P/FCF 0.0x 0.0x
Net Debt (in $M): -41 EBIT 0 0
TEV ($): 335 TEV/EBIT 0.0x 0.0x

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Crocodile Gold is a junior gold mining company based in Toronto, operating a gold mining property in Northern Australia.  The company was essentially formed to purchase these Australian assets out of bankruptcy from a company called GBS Gold International.  GBS was forced into bankruptcy in the fall of 2008 when the company was unable to refinance their debt.  A poorly managed GBS had experienced trouble getting the cash costs low enough to make the mines worthwhile in an era when gold prices were significantly lower than today's quoted price.  Adding to their problem at the time was the uncoupling of the Australian dollar versus the US dollar and gold prices.  This created a problem whereby GBS was making very little profit per ounce produced at a time when accessing capital markets became impossible.
Current management, mostly from Goldcorp, is attempting to develop this property into a highly productive mine with significant production growth.  The company's land package consists of about 3,500 square kilometers of land in Northern Australia that currently produce from three open pit mines (during dry season) and one underground mine.  They are also operating one mill to process ore, and working to get another mill online.
Why the Opportunity?
Crocodile Gold purchased these assets from GBS Gold in June 2009 (about a year after GBS ran into financial trouble).  It wasn't until June 2010 that the company was finally able to commence commercial production from these assets.  The key issue was that both the mines and the mill needed more rehabilitation than was expected after it had been through the liquidation process.  As you can imagine, GBS Gold put zero capex into the property for a prolonged period of time.  As such, Crocodile Gold has missed their production targets in terms of timing (and today announced slightly less than expected 4Q2010 production given the rain that Australia has experienced over the past couple of months).
Importantly, the issue is mill throughput, not ore quality.  This is the key factor that seems to be misunderstood by investors.  Yes, the delays have been frustrating.  Yes, it is important to hold management accountable.  However, the present value of the business is only slightly diminished by these delays if you believe, as we do, that management is ultimately capable of reaching targeted production levels.  The asset quality is there, so it is just a matter of time before production levels reach targeted levels.
It is also important to note that while gold prices are important in this situation, the primary driver of success will be the start of production from their underground Cosmo mine which should start in about six months.  That mine alone should increase production by 100,000 ounces annually (from 81,800 in 2010 from other mines during the 7 months in which the company commercially produced).  We believe the Cosmo mine will be a very successful mine based on conversations we've had with various people involved in this situation.  Furthermore, we believe that Crocodile has several assets that have not yet been explored that could yield significant reserve upside over the next few years.
What is the Opportunity?
Simply put, the opportunity with Crocodile is to participate in significant production growth once the Cosmo mine comes online, and radically falling production costs as mill throughput benefits from Cosmo ore.  As Cosmo comes online, we believe Crocodile production will rise north of 50% in 2011 and another 50% in 2012 to around 200,000 ounces.  At that point, we believe cash costs will be around $700/ounce.  Obviously higher gold prices create additional profit, but the primary issue here is the success of the Cosmo mine along with other opportunities on their existing property.  In addition to near term production growth, there appears to be an opportunity to at least double production growth from our estimated 2012 levels over the next few years. 
There are some additional opportunities as well, but they act as options that may or may not be valuable.  First, Crocodile is part of a joint venture with Thundelarra Exploration that allows Crocodile to participate in the discovery of other metals discovered by Thundelarra on the Crocodile properties.  On November 10, 2010, the two companies announced discoveries of uranium, platinum, palladium, and gold.  Crocodile has all the gold rights and various carried interests in the uranium, etc. rights.  Second, there appears to be some interesting gold exploration opportunities for Crocodile on their property.  On December 2, the company announced successful results from the Mt Bundy project (an area on the north side of the property).  At this time, we are not placing value on either of these two opportunities or on any other exploration potential that the company may pursue.
The Balance Sheet:
The balance sheet (and our numbers about TEV above) deserve some comment.  As of the last earnings release, the company had $9.5M in cash and no debt.  However, in November the company issued 20M additional shares (included in our fully diluted sharecount) and an over-allotment of 3M shares.  Crocodile received $32M in cash for these additional shares.  This cash should be sufficient to get the Cosmo mine going by this summer, though a clear risk with this investment is further dilution at the current share price.
It should be noted that the company generated positive operating cash flow during 3Q2010.  However, the capex budget far exceeds OCF at current production and investment levels.  In our valuation discussion below, we essentially assume that the cash currently on the balance sheet is used to fund mine development and thus are thinking about this from the market cap perspective, not TEV.
What's it Worth?
In this case, it seems useless to put together any type of single point DCF models.  The assumptions regarding production levels, the gold price, cash costs per ounce, etc. are just too difficult to model.  Rather, we decided to run a number of simulations that would look at dozens of potential scenarios and essentially arrive at an intrinsic value based on the averaging a whole range of outcomes.
It should be noted that management believes the value of the infrastructure to be $200M.  We are not including this value in our simulations because we are instead arguing that this is a going-concern and the infrastructure is needed to produce gold.  However, if the Cosmo mine is underwhelming, this $200M of capital provides an interesting downside floor of about $0.75/share.  Further, if Cosmo is a total failure, there is still production in the neighborhood of 100,000 ounces per year for some period of time.  Under that scenario, it seems more likely that the company would sell the company.
For starters, the base assumptions are that we have a property here with a 20-year life at which point all the economically viable gold will have been mined, and thus there is no terminal value to this business.  We also use a 20% discount rate to account for the risky nature of this project.
We have a worst case scenario of 100,000 ounces per year of production (just for reference, they announced 22,300 ounces of production in 4Q which is part of the rainy season).  That scenario also includes gold prices falling to $800, and cash costs remaining high relative to their peer group since they would lose some economies of scale.  It is under this scenario where the infrastructure value may be interesting because the company may not earn high enough returns on capital to indeed justify a $200M infrastructure investment and the resulting overhead as an independent company.
The best case scenario in our simulation would be that the Cosmo mine is successful allowing the company to reach the 200,000 ounces by 2012.  It would also mean that recent exploration success would create opportunities for production growth for a number of years.  Here, we use a gold price of $1,300 and the economies of scale that get cash costs per ounce down to $650 (though those rise over time with inflation).  We do not consider any scenario that has gold prices starting above $1,300.  Finally, based on some conversations about the ultimate recovery potential here (and these are educated guesses, not precise) we do not model any recovery north of 85% of what many think of as the ultimate level of reserve potential over time.  We are trying to be conservative with both gold prices and ultimate recoveries.
To sum up -- we have essentially modeled roughly flat production over time up to getting 85% of total estimate recoverable resources.  We have modeled the gold price between $800-$1,300 as the starting point.  We have cash costs anywhere from current levels, down to the best case of $650/ounce.  In between those parameters are literally dozens of potential outcomes that we essentially weighted with equal probabilities.
Based on our qualitative research, and the described quantitative approach to valuing this asset, we arrive at a valuation of around $3.25/share again using our 20% discount rate.  From the other direction, we expect an IRR in the 30's% based on our estimation of various probability-weighted scenarios.
Investing is the art of finding very favorable risk/reward opportunities and then sizing them appropriately.  There is clear downside to this investment if the company fails to successfully get the Cosmo mine into production.  We think they will succeed with Cosmo at some level.  If management is even remotely close in their estimate of future production, this stock is very cheap.


The company will likely provide estimates for 2011 (and future) production and cost estimates within the next several weeks.
Production of gold from the Cosmo mine this summer would significantly reduce overall company risk and provide a very solid valuation floor.
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