May 01, 2010 - 10:07pm EST by
2010 2011
Price: 15.82 EPS $0.00 $0.00
Shares Out. (in M): 635 P/E 0.0x 0.0x
Market Cap (in $M): 10,000 P/FCF 0.0x 0.0x
Net Debt (in $M): 200 EBIT 0 0
TEV ($): 10,200 TEV/EBIT na na
Borrow Cost: NA

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I recommend shorting IVN and buying QUA $ for $. Aside from QUA’s 25% free cash flow yield, over 3 years, QUA will develop Chilean low-cost copper (Cu) production resembling that of IVN’s Mongolian copper gold project, Oyu Tolgoi (OT), causing QUA to outperform IVN by ~200%.


By subtracting the value of IVN’s public investments from IVN’s EV, one can calculate OT’s EV per avg annual lb of Cu production. Applying this EV per avg annual Cu lb produced to QUA’s similarly low-cost Chilean production (also starting in 2013) implies a tripling of QUA’s market cap.


IVN’s value, excluding its ownership in public investments, stems mostly from its 66% ownership of OT. Subtracting IVN’s public investments from IVN’s EV, OT trades at an EV of ~$7BN. (In subtracting value of public investments, mainly SouthGobi and Ivanhoe Australia, I assume no tax liability from monetizing because such liability can be deferred--indefinite deferral makes the NPV of such liability 0. If deferral is short, the liability would materially increase OT's EV.)


OT's capex is projected to be ~$5.5BN. Assuming IVN only needs to fund its 66% share of this capex, IVN's EV should grow by ~$3.6 billion, funding OT construction from today through 2012. Thus, near the end of 2012, OT's EV should approach $10.2BN. (If IVN needs to fund more than 66%, as Mongolian govt may choose not to fund it's share, OT's EV will be higher. The recent shareholder rights amendments suggest equity financing)


Excluding ramp-up years 2013 and 2014, OT will produce between 0.7 and 1 billion lbs of Cu annually with avg annual production of 842MM lbs (also 244koz Au and 3.1MM koz Ag) through 2041 at an avg annual ~$0.30/Cu lb cash cost using current spot prices ($1175/oz gold and $18.5/oz silver) prices as credits throughout the life of the project.


IVN’s 66% of 842MM lbs is 556MM lbs annually. Thus OT's EV should approach $20/avg annual lb of Cu produced) by 2013.


QUA’s EV is ~$1.3 billion. It has 3 producing assets:


  1. Robinson (Nevada): avg annual production of ~140MM lbs Cu and 100koz Au at $1.20/Cu lb with reserve life through 2017.
  2. Carlota (Arizona): avg annual production of ~65MM lbs Cu at $1.30/lb from 2010-2018.
  3. Franke (Chile): avg annual production of ~65MM lbs Cu at $1.30/lb from 2010-2018


QUA also has a Chilean copper, molybdenum project called Sierra Gorda (SG) with a projected start-up in 2013 with ~300MM annual Cu lbs at ~$0.80/Cu lb expected life of mine operating cost and 25 year mine life. In the first 8 years, however, SG operating costs are estimated at ~$0.30/lb (assuming $12/lb moly and $1175/oz Au), while OT's are ~$0.05/lb. QUA recently sold 50% of Sierra Gorda and Franke for US$900MM to a Chinese partner.


QUA also owns 10% of Far West Mining, which has a Chilean iron-oxide, copper, gold deposit called Santo Domingo (SD) projected to begin production in 2014. Far West projects SD can produce ~140MM lbs of Cu on average at an operating cost of $0.01/lb using $40/ton iron and $635/oz Au. At current spot iron ore (~$160/t) and $1175/oz Au, however, SD’s operating costs are massively negative. Per the May 2008 Technical Report on Sedar, SD can produce 4MM tons of iron and 367koz of gold annually on average. An incremental $120/t for iron ($160/t current price vs $40/t assumed in Technical Report) and $540/oz for Au ($1175/oz current price vs $635/oz assumed in Technical Report) implies an incremental $680MM in credits, i.e. cost per Cu lb of production  falls to -$4.75/Cu lb! Though such cost seems oddly low, Far West claims that SD is “on the very low end of new production cash cost for copper.”


To put the above in perspective, if QUA bought another 10% of Far West Mining and SD’s Cu production stays at 143MM lbs annually, assuming current spot Cu, Fe, and Au prices, QUA’s life of mine operating costs from combining SG and their share of SD would be lower than OT’s.


I believe QUA sees another SG in SD and will fund it with the same Chinese partner. Recent drilling and Far West’s May 2009 resource report, which shows ~50% growth in resource, suggest that SD Cu and Fe production will grow from the levels in the May 2008 TR.


At today’s EV of $1.3BN,QUA can invest $250MM more in SG to fund it fully, buy another 10% of FWM for $40MM, and still have an EV near $0 by 2013 if current Cu and Au prices hold.


Here’s the math on QUA’s EV approaching $0 by 2013:


From 2010-2013, QUA should produce ~240MM Cu lbs annually (range is from 230MM to 250MM) at operating cost of ~$1.25/lb. Today’s Cu curve is ~$3.50/lb for next several years. The Au curve is ~$1175/oz. At such prices, these assets could generate ~$540MM in annual EBITDA. Assuming no interest expense (as there is no debt at these US assets), 20% effective corporate tax, and $40MM in annual maint capex (probably too high), free cash flow to equity would be ~$400MM through at least 2017.


If QUA does not spend cash on other projects, in 2013 the IVN/QUA snapshot is as follows:


1. IVN: ~$10.4BN EV with 560MM in avg annual production at LOM operating cost of ~$0.35/lb.


2. QUA: ~$0 EV with 240MM in avg annual production at life of mine operating cost of ~$1.25/lb from Robinson, Carlota, and Franke, which finish producing by 2018. At least 178MM lbs annually on avg in Chilean production (150MM lbs Cu from SG and at least 28MM lbs from SD) starting in 2013/2014 at LOM operating cost of $0.33/Cu lb with mine lives of at least 25 years each.


3. If QUA SG/SD 178MM production is valued at $20/lb, EV is ~$3.6BN. QUA’s share of capex will be ~$1BN, suggesting ~$2.6BN equity value of SG/SD production to QUA, i.e. ~$26/share. At current spot prices ($17.50/lb moly, $3.50/lb Cu, $160/Fe, $18.50 Ag, and $1175/oz Au), SG’s NPV is ~$4BN while SD’s is $3.6BN, translating into $2BN to QUA from SG and $720MM to QUA from SD, assuming 20% of FWM. At same prices for IVN, I get an NPV/share of ~$20.


Other thoughts:

  1. If QUA hedged production near $3.50/lb Cu, they could probably mine lower grade ore at Robinson et al, albeit at higher cost, extending mine life. Sensitivity of mine life to lower grade is an important factor to consider if QUA hedged its production.
  2. Hedging would increase financing risk if it requires margin. If Cu spikes, QUA would have to increase cash in margin account supporting hedges.
  3. My guess is QUA will own more than 20% of FWM.  
  4. QUA could sell its gold production to a royalty purchaser at a 3-5% discount rate, with an upfront payment, creating $200MM in value.



QUA/FNX deal:

Backing out the ~$9.00/share implied value of QUA's share in SG/Franke (based on State Grid transaction) and using current spot prices, QUA trades at ~40% FCF yield. Ex IVN, comps trade at ~20% FCF yield. The valuation reflects shareholders disliking this deal.


If assume FNX bought by QUA at NPV, which seems conservative given QUA's awareness of QUA's discount to NPV, and deal passes, sharecount roughly doubles, roughly halving outperformance to 100% over 3 years.  


Cash build and production at SG and SD
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