| 2008 | 2009 | ||||||
| Price: | 3.50 | EPS | |||||
| Shares Out. (in M): | 0 | P/E | |||||
| Market Cap (in $M): | 131 | P/FCF | |||||
| Net Debt (in $M): | 0 | EBIT | 0 | 0 | |||
| TEV (in $M): | 0 | TEV/EBIT | |||||
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In a commodity bull market, you want to own the service providers. If you look at past bull markets, a few producers made phenomenal profits, but the biggest winners were those who helped companies explore for resources and then extract those resources. I don’t think this bull market will be different. The suppliers are already seeing incredible pricing power, and I think this will continue for at least the next few years. Most importantly, as an investor, you are not subjected to the wild swings in commodity price that the producers have to deal with.
Timberline is a specialist in underground drilling through its Kettle drilling subsidiary. This is a great business to be in as a drill costs $600,000 and will do about $250,000 in EBIT a year, so payback is just over 2 years. Rates continue to increase and returns on capital should increase. While the company grew from 6 rigs in calendar Q4 2006 to 25 rigs by Q1 2008, they were unable to earn a profit in the process. Most of this was because of growth costs, as the number of rigs increased four-fold in just one year. Now that growth has moderated, the focus will be on cash flow.
Current Cap Structure Avg Price Cash on Exercise
Common 26.5m
Preferred 4.7m
Total Options 3.02m 2.75 8.31m
Total Warrants 3.22m 2.02 6.51m
Fully Diluted 37.44 14.82m
Timberline will acquire SMD, the
SMD is paid per ton recovered. As metal prices increase, waste tonnage becomes economic. Hence a cost center becomes a profit center as this rock no longer goes to the waste bin, but to the mill. This should have a significant impact on SMD earnings. As metal prices increase, SMD can also be less concerned about dilution and this means using mining methods like room and pillar, designed for thicker veins. On a cost per ton basis, this is significantly cheaper—yet SMD is paid the same per ton of economic ore.
Pro forma 2007 numbers for SMD are 23.8m EBITDA on revenues of 101.4m. Over the past five years, SMD has had EBITDA margins of 22-24%. I think that going forward, those margins will be in the mid to high 20’s. In 2007, SMD was at six mine sites. They anticipate adding two more sites in 2008, or a 1/3 increase. If revenues come in at 135m with a 25% margin, it would have 33.75m in EBITDA. Depreciation significantly overstates actual maintenance cap-ex, especially because most maintenance is expensed as incurred. Therefore, EBITDA and EBIT are roughly the same thing. For the sake of conservatism, I will assume 30m in EBIT.
Kettle Drilling should realize significant benefits without the focus being on growth. These benefits come from synergies with SMD’s operations and the elimination of revenue earn out payments that were paid to the former owners. The company will have 25 drills on average. If they can each earn a below industry average of $200,000 per drill, the company will have five million in EBIT.
The acquisition of SMD will cost $80 million and consist of $15 million in stock valued at $3.21/shr (4,672,897) shares, $20 million in four annual payments out of cash flow of $5m, and $45 million in cash at closing. The company will probably raise about $65 million to pay for working capital and buying out 4.7 million shares owned by the previous owners of Kettle Drilling (Deeds and Kettle). This will be roughly $30m in convertible debt and $35m in equity. It is too early to tell what price the offering will be done at, but assuming a worst case scenario where the offering is done at 3.25, that is 10.8m shares of dilution and $30m of convertible debt at 7% that converts at 5, or 6m additional shares when converted. Finally, Deeds and Kettle had their 4.7m remaining shares purchased for $10m or 2.13/share. This will need to be financed through the offering; though will save some dilution because their shares will be retired.
The post merger cap structure will look like this.
Post Merger Cap Structure Avg Price Cash on Exercise
Common 41.973m
Total Options 3.02m 2.75 8.31m
Total Warrants 3.22m 2.02 6.51m
Convertible on 6.00m 5.00 Eliminates $30m in debt
Conversion
SMD employee 2.00m 3.5 7.00
options
Fully Diluted 56.213 21.82m
This gives you a company with 35m in EBIT.
SMD EBIT = 30,000,000
TLR EBIT= 5,000,000
Total EBIT = 35,000,000
Corporate Overhead = 2,000,000
Interest expense on
$35m in debt at 7% = 2,450,000
NET = 30,550,000
Taxes = 10,692,500
After-Tax = 19,857,500
Per FD share = $0.35
In 2009, the company should be able to do 200m in revs at the same 25% EBITDA margin, or 45m in EBIT.
Corporate EBIT = 45,000,000
Overhead = 3,000,000
Interest = 2,450,000
Net = 39,550,000
Taxes = 14,238,000
After-Tax = 25,707,500
Per FD share = $0.46
For a company with returns on capital over 30% that is growing at least 30% a year, I don’t think that a 15 multiple is unreasonable. Actually, I think it is conservative as many comparables in the mining/construction business trade at 25 multiples. At a 15 multiple, this is worth $7.00 a share in a year. This does not give the company much benefit for better pricing in a tight industry, synergies between the two businesses in reduced overheads, lower interest costs or greatly increased margins from easier mining methods and lower dilution counts. I personally think that the numbers given out by management in the just released proxy are very conservative. Finally, you can almost count on additional acquisitions which should be accretive.
The company has an exploration division. I want to give this no value in this write-up. This division will spend a few million a year on exploration and I believe management will create more than a dollar of value for each dollar spent. Of their properties, the most significant ones are as follows.
Butte Highlands- This former producing gold mine on patented land in
Conglomerate Mesa- Moderate work done by former owners. Newmont delineated 175,000 ounces of gold at .06 oz/t. BHP later did additional work that intersected significant gold including 40ft of .37 oz/t gold in the dragonfly area and 40ft of .15 oz/t gold in the resource area. Timberline did a number of rock chip samples that turned up grades as high as .52 oz/t gold. This has the potential to be a multi-million ounce Carlin style deposit, however it is in
Finally, Timberline has encountered a number of interesting anomalies at its other properties. The plan is to spend small amounts to find out if there’s anything there, then to have someone else spend the real money to drill it out while having timberline maintain a residual interest in the asset. This strategy will create maximum upside while still focused on the cash flows of the core underground businesses.
Finally, the company will be listed on the Amex starting on Monday. That should add considerable visibility going forward.
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