Palladon Ventures PLL
July 23, 2010 - 2:06am EST by
2010 2011
Price: 0.05 EPS 0.024 (untaxed) by YE10 0.10 (untaxed) by YE11
Shares Out. (in M): 190 P/E 2.0x 0.5x
Market Cap (in $M): 10 P/FCF 2.0x 0.5x
Net Debt (in $M): 0 EBIT 4 18
TEV ($): 10 TEV/EBIT 2.0x 0.5x

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At C$0.05, Palladon Ventures (PLL.V), which owns a significant minority interest in a Utah-based iron ore producer, is an interesting speculative long, with low downside risk and considerable upside potential (5-10x). 

In March 2010, Palladon Ventures - after several loan extensions - allowed the owner of its debt, Luxor Capital, to convert its $41 m in debt into a 78.3% stake in Palladon Iron Corporation (PIC), now called CML Metals (CML). In doing so, Palladon Ventures avoided bankruptcy, leaving it with 21.7% of CML and no debt.

Despite the considerable dilution of Palladon Ventures' ownership in PIC (now CML), Palladon Ventures shares are now trading with arguably low downside risk (debt free with significant stake in a now operating mining company; trading under replacement value of assets) and with considerable upside potential (5-10x based on a reasonable multiple of pro-forma cash flows by YE2011).


After the "negotiated agreement" (equitization of the Luxor debt), Palladon Ventures has no debt, for the first time in over five years.

Finally, Palladon Ventures shareholders' interests are aligned with the former debtholder - now majority shareholder of CML, Luxor Capital, which has had success buying and selling its stake in the past.

Per SRK Consulting, the replacement value (sunk cost) of CML's infrastructure is about $51 million (unaudited), which is about C$0.06 per share net to Palladon shareholders (above where the stock is currently trading and actually where Palladon and Luxor agreed to "equitize" the debt). This "historical asset & infrastructure value of $51 million" (SRK Consulting) includes: core drilling and assays ($18.5 million), railway in place with rail spur ($20 million), water rights of 2,100 acre feet ($2 million), substation and transformer ($3.7 million), power lines ($1.4 million), mining and road prep ($3.2 million), access and haul roads ($1 million), reclamation bond ($1.3 million). As background, CML's resource consists of Comstock Mountain Lion, including stockpiles (36.6 mT at 45.3%; 43-101 compliant as of August 2009) and additional resources like Rex (152.1 mT at 42.2% Fe; non 43-101 compliant).

Most importantly, CML is now shipping iron ore to the port of Richmond, CA, with first ship expected to be sent to China by the end of July 2010. Having secured a port with infrastructure in place is important because shareholders suffered a horrid 90+% loss from mid-2008 to early-2010 largely due to the company being unable to ship ore out of the Long Beach, CA port. With a new, signed port solution - and the other logistics in place - the company can finally start generating cash flow now. As its June 11, 2010 press release, CML Metals has "now contracted for all the material handling logistics associated with the production and shipment of iron ore." CML has secured "long-term agreements with all required logistics partners, including rail, port, and railcar leasing companies." By shipping now, that also means that CML has secured the necessary permits.

Also importantly, as of June 2010, CML has signed an Offtake Agreement with CKI. Through CKI, the run-of-mine ore will be ultimately sold to Hebei Iron and Steel ("HBIS"), which is one of the five largest steel companies in China. Importantly, the offtake agreement removes the arbitration with CKI and allows CML to eventually sell concentrate (upgraded ore from concentrate plant). CML "expects to be profitable in 2010 and significantly profitable in 2011 based on current market conditions." More specifically, per our discussions, the current margin for run-of-mine ore is about $10 a ton. At prices from June 2010, that implies annualized cash flow around $6 million with 600,000 tones of production and $20 million with current prices and 2 mT of run-rate production by YE2010, which is management's projection. With $20 million cash flow, that implies C$0.024 per PLL share; at 5x net cash flow, that is a share price of C$0.12, more than double where PLL currently trades.

Also importantly, Palladon Ventures has reduced its burn rate significantly, from about $1 million a month in 2009 to about $25k a month as of July 2010. Major annual expenses are now: D&O insurance of $50k per year, legal fees of $30k per year, and audit fees of about $60k per year. President John Cutler (note: Palladon is required to have a "President" to be listed as public company in Canada; Cutler completely failed as CEO to advance the project over two years, but thankfully his only role now is to simply produce timely financial reports) is expected to receive about $60k in compensation and CFO Leonard Sojka is expected to receive about $40k compensation. Jeff Clark (a director whose firm handles the company's accounting) would receive about $24k going forward. Total annualized burn is estimated at around $300k, so the company has about 19 months of cash in hand ($500,000 cash as of late June 2010).


Importantly, CML Metals is building a management team with operating experience, starting with Dale Gilbert as CEO. The Gilbert family formerly operated the mine in the mid-1990s and has several decades of hands-on experience with the mine.

A big catalyst for the stock over the next 2-3 months would be the funding of $40-50 million for a 2 mT concentrate plant. Luxor Capital hired RK Equity, which has raised significant capital for other mining projects, to advise them. Estimated cost per ton of 67% Fe concentrate is about $55 per ton. With spot iron ore prices around $150 per ton in China for 67% Fe, minus $30 per ton for shipping costs, yields $120 per ton FOB for CML, which is over $60 per ton EBIT margin today. At 2 mT, that's $120 million in annual cash flow, which would clearly justify a $40-50 million investment (yields ~4 month pay-back, after a ~6 month construction period). Per our discussion, Luxor is targeting a $130 million pre-money valuation, which would result in 30-38% dilution.

With concentrate plant permitting and construction possible in less than 12 months, the cash flow of $120 million from 2 mT concentrate (with current spot iron ore pricing) would be another significant catalyst. With $120 million in cash flow and 30% equity dilution for the concentrate plant, that implies C$0.10 per PLL share; at 3-5x net cash flow, that is a share price of C$0.3-0.50, which is 6-10 times where PLL currently trades.

Meanwhile, Luxor will attempt to try to sell the company for $200+ million (C$0.24 net to Palladon, up almost 5x from here) before concentrate plant is completed or IPO the company within two years at 3-5x cash flow, which represents C$0.30-0.50 per share (up 6-10x from here).   


The biggest risk is iron ore prices. VIC members can debate the strength of the Chinese steel industry. With about a third of Chinese concentrate production at a cost above $100 per ton and with two large companies (Vale in Brazil, Rio Tinto/BHP in Australia) controlling ~70% of global seaborne iron ore, iron ore prices should remain in the $100-120 per ton FOB range for at least the next few years, in our opinion.


Expansion to 2mT run-of-mine ore

Funding of concentrate plant (could occur by September 2010)

Concentrate plant permitting and construction in less than 12 months, with production in 2H10 (potentially $120 m cash flow with 2 mT)

Sale of company

IPO in late 2011 or 2012 for 3-5x cash flow

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