March 16, 2009 - 9:47am EST by
2009 2010
Price: 0.15 EPS $0.00 $0.00
Shares Out. (in M): 170 P/E 0.0x 0.0x
Market Cap (in $M): 26 P/FCF 0.0x 0.0x
Net Debt (in $M): 40 EBIT 0 0
TEV ($): 65 TEV/EBIT 0.0x 0.0x

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Palladon Ventures Ltd. (PLL-TSX.V) - CDN$0.15 

PLL has been a disaster since it was first written up, but represents a potentially interesting risk/reward scenario at current valuation levels.  Within the next few months, this stock is likely to be worth multiples of where it is currently trading or it will be worth zero

A research report by Clarus Securities on September 16, 2008 provides background information on the company and the iron-mountain mining project.  In this brief write-up I will focus on the current situation only and possible catalysts.

Why the stock is trading so poorly

In a nutshell, current management has been a disaster. The CEO, Don Foot, has repeatedly over-promised and under-delivered to the point where one has to question whether he may have intentionally misled or outright lied to shareholders.  Back in June of 2008, the company completed the buyout of their joint-venture partner, Luxor Capital, which was financed by a $60 million equity raise (at much higher stock prices) and a $34.3 million seller’s note (including the refinance of some existing debt).  At the time of this transaction, the company had secured a long-term and profitable contract with China Kingdom International (“CKI”) to sell run-of-mine iron ore (which would then be resold to a large Chinese steel mill).  In addition, the company told investors that they would be in production by August 1, 2008 and ready to begin shipping ore by September 2008.  According to Don Foot, all of the logistics (including rail, port and shipping to China) had been negotiated and were ready to go as soon as the lawyers were done finalizing some minor details of these contracts. 

Over the next several months the company stopped communicating with shareholders and nothing happened.  In fairness, the company provides weekly updates on its  HYPERLINK "" website, but nothing of real substance is ever addressed.   In the meantime, iron-ore prices collapsed along with the global economy, and it has become apparent that the company is at risk for not being able to repay its $34.3 million debt with Luxor, which is due at the end of June 2009. 

Where are we today?

With a few months to go before the debt is due, shareholders are still in the dark, the company is not shipping iron-ore, management has lost all credibility, investors are angry, and the stock is trading like the company is about to go bankrupt.  Based on some due diligence and investigation, I still believe the end users of the iron-ore, a very large steel company in China, remain interested in buying Palladon’s iron ore and may even desire a longer-term strategic partnership with the company.  The ore is high-grade and allows the Chinese to diversify away from the Big 3 suppliers (who essentially have an oligopoly on iron-ore supply).  But I have to believe that Don Foot’s credibility with the Chinese is shot, and they may be frustrated with the whole process since the company has yet to deliver under the contract.  In addition, iron-ore pricing has firmed in the last month with spot prices having rebounded from a low of around $60/ton to above $80/ton currently.  PLL’s contract mining group, Gilbert Development, has done an excellent job of ramping up operations at the mine.  There is currently a stockpile in excess of 150,000 tons, a portion of which has been loaded onto trains and is ready to be delivered – but it has no place to go. 

The biggest issues to be resolved are logistical.  After promising investors that he had secured a port at Long Beach and had a 5-year contract with the Union Pacific (“UP”) ready to be signed, it is now apparent that neither was the case.  The company has yet to identify a specific port or sign any contract with the UP.  And I suspect that Don Foot has very little or no credibility with all parties involved. As the company continues to negotiate for any and all logistical options, I suspect that the Chinese are also attempting to lower their contract price with the company since Don Foot has failed to deliver.  And so the company is searching for a profitable solution, but appears to be stuck for now.  And if nothing is done to refinance the Luxor debt, then control of the company will revert back to Luxor and shareholders will end up with nothing.

One other point of interest is that the company performed a high-resolution aero-magnetic survey of their entire property several months ago.  A geologist has been hired to analyze and model the data to better define the entire resource.  A 43-101 compliant drilling campaign could begin shortly thereafter.  The company has added to its acreage position as a result of the preliminary results from the aero-mag survey and has suggested that the resource could be significantly larger than the 170mm tons of known iron ore on the property (based on historic drill records).   

What could happen going forward?

Certainly, management could continue to fumble along and get nothing done, in which case the company goes bankrupt and/or reverts back to Luxor’s control.  Shareholders would get screwed.  I would emphasize that this is certainly a possible outcome and the stock price reflects this.  

However, the Board has recently become much more active in the situation.  A press release on February 4, 2009 announced the formation of an Executive Committee which includes Don Foot, John Cutler and Robert Getz, to manage the problematic issues facing the company, including the refinancing of Luxor’s debt.  The committee is also authorized to pursue all strategic options available to the company.  Interested investors can do some research on Cutler and Getz, but suffice it to say that these guys are experienced with good investment expertise.  That is not to say that they can pull a rabbit out of the hat, but they give the company a legitimate chance at succeeding in the next few months.  Getz and Cutler have basically been assigned by the Board to baby-sit Don Foot and to make sure the Board is involved in all major negotiations and decisions for the company.  In addition, Dale Gilbert, President of Gilbert Development (the company’s contract miner) has also become actively involved in all aspects of the project.  This is a good thing.  I would personally like to see the Board fire Don Foot and make Dale Gilbert the interim CEO.  He has the resources and ability to manage the logistical issues as well as the mining.  He also has a lot personally at stake in this project, having financed millions of dollars in equipment, and he participated in the company’s last financing.

So here are some other optimistic but possible outcomes for this situation:

The logistical issues are resolved soon and the company begins shipping run-of-mine ore and generating some cash flow, in which case refinance options for the debt become more viable.  I’m not suggesting in this credit market that it would be easy or in-expensive (and somewhat dilutive) to refinance the debt, but it is possible.  Another possible outcome if the logistical issues are resolved is that the Chinese steel company refinances the debt and/or makes a strategic investment in the company.

A strategic player buys the company outright or makes a minority investment in the company.  Recent iron-ore transactions have traded for around $5-10 per ton in the ground.  Midwest Corp was acquired by Sinosteel in August 2008.  The price paid as a multiple of EV/ton was US$8.20.  This includes reserves, measured, indicated and inferred, and inferred resources (not sure of the exact split).  Midwest also had 1.5mm tons of immediate production.  Interested investors should also do some research on Vale’s recent acquisition of Rio Tinto’s iron ore mine in Brazil.  My point here is that even if PLL was sold for $1.00 per ton, that would be worth $170 million (and possibly more based on the aero-mag survey).  The current stock price values the resource at an approximate EV/ton of US$0.30 based on 170mm tons of known resource (and less if there is a larger resource).

The company does a larger financing (approximately $75 million) to repay the Luxor debt and finance a concentrator facility.  I know people will immediately say this is a huge stretch in this credit environment and I understand that.  However, a concentrator facility could be built in nine months for around $40 million.  The company could then produce 67-68Fe concentrates.  Concentrate sales (instead of run-of-mine ore) would add about $20ton to the company’s margins.  $20/ton on 2-4mm tons per year is $40-80 million of incremental cash flow.  This may be the only scenario under which a lender/investor might get excited about the project.  Under this scenario, the company would likely delay production for another year while it builds the concentrator and finalizes logistical issues.  And I’m sure any financing option would include an equity component and some further dilution for shareholders.  But there is lots of upside under this scenario.

Any of these scenarios are possible (I’m not saying likely) but would require an active and engaged Board.  It may be too disruptive to the ongoing process to fire Don Foot right now, but it is clear that he is a major problem and this needs to be addressed soon.  If the company does find a solution to the current situation, the stock could easily double or triple or return to levels where the last financing was done, which was $0.70/share.  That represents a very nice return from here.  And all of this should play out before the end of June, when the Luxor debt comes due.  Furthermore, the long-term value could be significantly higher if the company survives the next few months and management is replaced with strong leadership.    


Race against the debt clock: Sale of the entire asset, strategic investment by a Chinese partner, shipment of ore, re-financing of Luxor debt?

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