Finding value in mining and exploration stocks is not always easy. Firstly, you need to know where to look; and that’s often outside the most obvious places. You also need to recognise that no two investment propositions are ever identical. So it’s rarely, if ever, a case of comparing apples with apples.

Companies who have successfully articulated their value to the market are usually well covered and well supported. Well covered in the sense that there are already a myriad of investor opinions, complimented by broker notes and perhaps, a sprinkling of media articles.  And well supported in that discussion boards will wax lyrical on the virtues of the company and how rosy the future is looking.

However, as befits the exploration business, to stay one step ahead of the herd one often has to venture off the beaten track and perhaps search out those companies which are not well understood, or loved by the market.

Obviously, the more straight-forward the business model, the easier it is to get your head around. So a company with an intricate portfolio of components is going to look like hard work from the off; demanding hours of diligent analysis before you will even know if there is any real value potential. And this is the point where most investors will simply give up.

It is most unusual for a company to actually set out to create a complex model; though it can often be taken down that route, either through adapting to challenges it has faced or through opportunities presented along the way. And it’s also not unusual to find that such businesses tend to be run by a more entrepreneurial and adventurous breed of management.

So when you do come across an interesting but complex proposition, it will pay to make your first approach with an open mind. This may seem somewhat ill-advised, given the conventional market tendency towards caution. And let’s face it; at the best of times, the small cap market can feel like it’s been booby-trapped with more tripwires than a “Mission Impossible” film set. But if there’s value to be had, you can be sure it won’t be staring you in the face and likely as not, hiding away in exactly these kind of places.

Take for instance Electrum Resources (LON:ECR) formerly Mercator Gold.  The company elected to change its name in order to avoid any confusion with a similarly named US organisation.  By the way, Electrum is an alloy of gold and silver .

We think the name change is particularly poignant because it marks the beginning of a new phase in the company’s development; a potential value inflection point for a business that has previously faced some challenging times.  We don’t intend to dwell on the past; it provides the investor little advantage in the fast changing exploration environment. But it is important to recognise how the business has evolved since the dark days of 2008.

Electrum Resources, as Mercator Gold, was previously focused on the development of its main project, the Meekatharra Gold Mine, in Australia.  Operational difficulties at the mine, combined with related cash flow problems, meant the mine operating company, Mercator Gold Australia Pty Ltd, entered voluntary administration pending refinancing.  Full information regarding this can be found from the 13.10.08 announcement.

As the old saying goes “If you fall off a cliff, you might as well try to fly. After all, you’ve got nothing to lose .......”

Mercator did indeed fall off a cliff and few held out much hope for their survival.  But survive they did, and for the last two years they have been working hard to build a diversified portfolio of assets, the breadth and scale of which, we would suggest, many investors are not fully aware. Such is the extent of its evolution that the company bears little resemblance to the original Mercator Gold.

So we thought now, would be a good time to produce a Value Proposition for the newly named Electrum Resources.  And as the title suggests, diversity is key as ‘All that glitters is not only gold’.

We would also point readers to the Podcast Interview we conducted with Patrick Harford, Managing Director of Electrum Resources which can be found here.

Stability through diversification

The lessons of over exposure to a limited project portfolio can be painful, but in the case of Electrum, well learnt it seems.  As a result the management team have built a diverse mix of assets which we, for the sake of clarity, have classified in groups as follows:

-          Multi Commodity Investment & Exploration

-          Renewable Energy

-          Metals Manufacturing

Each portfolio group brings different challenges and opportunities, but subject to successful operational and financial management, value crystallisation opportunities abound.

Dealing with each area in turn:

Multi Commodity Investment & Exploration

Silver Swan:

Electrum has experienced a material degree of success with regard to its investment in Silver Swan.  After selling certain licences constituting, amongst others  the Austin project near Meekatharra Western Australia, Electrum received 10million shares in Silver Swan Group Limited (ASX: SWN).  These have since been sold generating in excess of A$3million for the company, which is impressive when compared to the few hundred thousand dollars spent developing the licences up to the point of sale.

This kind of value crystallisation is what investors yearn to see and one hopes, will also be achieved from the 4 million performance shares Electrum still holds, which will immediately convert to ordinary (read saleable) shares in Silver Swan should the company identify Indicated Mineral Resources of 350,000 ounces of gold equivalent or more from the transferred tenements.

The question we had until recently was – how serious are Silver Swan in moving this project forward?  Well the company’s recent announcement demonstrates a certain keenness with regard to progress.  And with an initial resource statement of approximately 135,000 ounces gold equivalent (based on April 2010 prices) they are certainly well along the road already.

Moreover, the latest Silver Swan updates on 30th September and 27th October point to even more success with the latest drilling campaign.

So we are quietly optimistic that Electrum might just get its 4 million shares sooner rather than later.  If they do, at current prices (A$0.31 per share) the shares would be worth a further A$1.25 million to Electrum.  But by then, there is every possibility that the share price may be somewhat higher reflecting the demonstrable success of their exploration programme.

THEMAC- Copper Flat:

Copper Flat is a copper/molybdenum/gold/silver project situated in New Mexico, USA.  Electrum secured an option to acquire Copper Flat in July 2009 under a deal requiring a number of stage payments set with timescales that enabled the company to conduct extensive due diligence.

So extensive in fact that Electrum dispatched two drill rigs to the project shortly after the option was acquired and conducted drilling and assay testing to verify and evaluate the potential for expansion of the pre-existing 45million short ton historic Copper, Molybdenum, Gold and Silver reserves.

This due diligence went on for some time but, after an option extension, $1million in first stage payments were finally made by 31 March 2010.  Further stage payments of some US$8.85m were due to be made by 14 February 2011, extendable to 16 May 2011 subject to a $150,000 extension fee.

However events have since overtaken, with a reduction in exposure and change in strategy as announced on 16^th March 2010 which means that the Copper Flat project is to be sold to THEMAC Resources Group (TSXV:MAC.H), and under this agreement THEMAC is to fund or reimburse (from the date of the agreement) all project expenditure by Mercator or New Mexico Copper Company Inc (the local holding company, since renamed Copper Flat Corporation) including option payments.

THEMAC agreed to raise additional funds of at least C$5 million and thereafter issue to Electrum 10.5million THEMAC shares and 10.5million warrants exercisable at C$0.28, valid for a period of five years.  Electrum also supported THEMAC through an initial placing completed in May, acquiring 4 million shares at C$0.15 per share, with attached warrants valid for one year and exercisable on a one for one basis at C$0.28 per share.

Electrum confirmed on 8th November that C$10.2m had been raised by THEMAC, subject to approval at THEMAC December 2010 AGM.

All in, reflecting the acquisition shares and those acquired under the initial placing, Electrum would hold 14.5million shares in THEMAC and, assuming a share price of C$0.255 (the placing price) at the time, this would have a market value of C$3.74million or £2.34million at current exchange rates.  This, readers will note, would equate to some .6 pence per Electrum share.  With the conversion of Electrum warrants the holding could be worth considerably more.

Through their additional work, including drill programmes, THEMAC and Electrum have been able to secure an increase in the latest NI43-101 resource estimate to 107 million short tonnes at 0.33% copper indicated and 46 million short tonnes at 0.24% copper inferred.  This resource was calculated by SRK Consulting and released to market on 25 May 2010.

Also, on 9^th July 2010 THEMAC and Electrum announced the findings of a NI43-101 Preliminary Economic Assessment for Copper Flat which indicated a mine life of 17 years, a payback of just 20 months from start of production and an NPV (6%) of US$144 million.  This PEA only included the Copper and Molybdenum content; the Gold and Silver content has yet to be brought into account within the resource, though this is the next priority.

New Gold/Base Metal – Argentina:

On 7^th October 2010 Electrum announced the acquisition of the Sierra de las Minas and Los Aquirres gold/base metal projects in La Rioja Province, Argentina.  Upon the announcement, we conducted an interview with Patrick Harford to which you may want to listen.  This acquisition effectively provides Electrum with key strategic territory in an exciting mineral Province where the company plans to undertake rapid exploration hopefully leading to mining operations.  As evidence of the potential, historic geochemical sampling results from the Sierra de las Minas licence include values up to 153g/t (approximately 5 ounces) per tonne and 9.4% copper.  It appears clear that successful development of this project could lead to a highly valuable asset for Electrum.

Paniai Gold is a pre-IPO company scheduled to list on the NSX in Australia in Q4 2010 and in which Mercator holds 50million shares.  The company’s primary asset is the Derewo River gold project in Papua Province, Indonesia. Over 100,000 ounces of gold has been extracted over the last decade using basic mining techniques and Paniai Gold intends to materially boost production using more sophisticated methods.

Further information can be gleaned directly from the 12 April announcement which outlines the planned listing. The announcement confirms progress made at the Derewo River project (in which Paniai Gold holds a 50% interest, with 50% being held by a local company) and notably the early stages of construction for the planned alluvial mining and additional exploration programmes.

Meekatharra:

The Meekatharra gold project was the key asset held within the Company’s portfolio until October 2008 when they announced that the holding company, Mercator Gold Australia Pty Ltd (MGA) had entered administration.

Cutting to the chase, Meekatharra Gold Corporation, a company that plans to list on the Toronto Securities Exchange, has submitted an offer to acquire the assets of MGA from the administrators and this has been accepted.Electrum is expected to receive a stake in the listed company thereby retaining an interest in its legacy asset going forward. Of additional significance are the substantial tax losses currently held within MGA and which, on completion of the asset transfer, should be available for MGA to utilise and from which Electrum will thus benefit.

There is some sensitivity regarding the amount of tax losses available and ultimately how these will be recovered. It is reasonable to assume however that the recovery to Electrum should be substantial.

Renewable Energy – Sticking it where the sun does shine!

We discussed earlier Electrum’s drive to secure a diverse portfolio of investment and exploration projects. On that note, on 15^th June 2010 the company announced an intriguing deal which will add another dimension to their portfolio. Namely, renewable energy.

In essence, Electrum has entered into a strategic partnership with Remote Energy Solutions who specialise in providing Solar & Renewable energy solutions to the mining sectors. The partnership will develop the Warm Springs solar power project which, not exactly by chance, is rather close to the Copper Flat project.

The partnership was born out of a combination of factors which have presented an interesting opportunity:

The Copper Flat project is going to require a robust source of power, and typically this would be expected to come from connection to the grid. But being located in New Mexico, where sun does some serious year round shining, offers up one rather distinctive alternative to complement the projects grid connection (transmission lines for which remain in place from previous mining operation). Here we are obviously talking solar power.

Under a new government backed initiative to promote renewable energy solutions, New Mexico has been designated as a “Super Hub” for connecting electricity generated by Solar and wind sources to the US power grid and that obviously makes Copper Flat a prime target for a Solar power solution!

The plan is to build a plant with an initial production capacity of around 20MW, which would be sufficient to supply the needs of Copper Flat. But given the scale of the opportunity now envisaged, and the incentives available, it looks like a stand-alone solar power business may well be conceivable, feeding power to the grid for external consumption. This could see the plant expand and grow in scale to 80MW.

Feasibility and permitting are expected to cost up to US$750,000 with initial cost of plant construction around the US$60-80million mark, though if increased to 80MW, we would be talking about plant costs in the region of $250m. These are substantial figures, so how would a Company of Electrum’s scale expect to finance such an enormous project?

As referred to previously, in the US, the move away from fossil fuels to alternative energy solutions has now become a desperate priority. And particularly in the US, when needs must, the speediest and most effective drivers for change often employ some compelling financial incentives.

In this respect, there are currently some very creative financing mechanisms being developed which will enable these kinds of renewable energy deals to come together. In addition to direct grants and flip structures in the tax system, there is also a very useful mechanism called a “Power Purchase Agreement” (or PPA) which has been tried and tested worldwide. This is effectively an agreement with a major utility provider which confirms that, when built, the Utility Company agree to purchase power generated by a plant.

This is a key element in gaining project finance. Once a PPA is in place, such is its value as collateral that the project can effectively become self-financing from then onwards. According to MD Patrick Harford, the company are “well advanced in negotiations for securing a number of PPA’s”.

There is also the significance of up to 8 years’ worth of tax credits specifically in relation to Solar Power Purchasing Agreements (SPPA) as can be seen here.

With a PPA in place and back to back project funding secured, Electrum would then be able to move the project through an IPO process and then onto a listing. The end game would ideally leave the company with a significant stake in the venture with no on-going financial commitment.

You can read Remote Energy Solutions (RES) own comments on the project at the RES website here.

Electrum will hold a minimum stake of 70% in Warm Springs Renewable Energy Corporation with RES holding an initial 10% rising to 30% as they contribute to the costs of construction. The Warm Springs project is scheduled to undertake permitting in 2010 and construction is targeted to start in 2011.

Finally, another advantage, this time for the Copper Flat project itself, would be that by employing a Solar power solution, the project would be substantially reducing its own carbon footprint. So if successful, the strategic partnership with RES will not only substantially increase and diversify Electrum’s New Mexico interests, but it will also help smooth the way for efficient permitting/approvals at Copper Flat, whilst providing a source of sustainable and cost effective energy to run expanding operations.

Metals Manufacturing – ACS Asia

In November 2008, Electrum purchased, from Tyco International, a 70% stake in ACS Asia, a steel products manufacturing business based in Thailand. The total consideration paid for the business was US$2m. At the time the company was keen to acquire a revenue generative cash flow business which also had growth potential.

ACS looks like it fits the bill, with Electrum announcing in its interims on 12th May 2010 that turnover for the six months to 31st March 2010 was up 70% or £1.3m to £3.16m and that ACS's gross margin had increased to 28% from 24% in comparison with the six months to March 2009.

The business itself is primarily focused on manufacturing cable support systems which are used in commercial construction, infrastructure and also in mine construction. Put another way, every time a new commercial construction goes up – or an older one is refurbished - these sorts of products are required to support the miles of trunking and cables often hidden beneath the false ceilings.

It has to be recognised that this asset was purchased at the depths of the global recession and the price paid certainly looks to reflect this. The Tiger economies of the far-east were amongst the first to emerge from the down turn and activity, particularly in construction, is very much back on track. Therefore the company believes ACS Asia has considerable potential for expansion.

Furthermore, a new potential opportunity was recently recognised by the company, which would involve some cross-pollination between ACS and the Warm Springs project. It became apparent that the large scale construction project at Warm Springs will need the types of steel products which ACS are perfectly suited to manufacture. Whilst the specifications have yet to be established, it is understood that the scope of the project could represent a substantial opportunity for ACS. In the mean-time this development has now resulted in ACS quoting for work from a number of Solar energy providers.

Whilst the ultimate intention is to leverage the value of ACS as an asset, perhaps through a listing or, even an outright disposal, the current focus is on fattening up ACS through a growth in revenues and profitability. Based on the last reported accounts for the business, it would appear that this process is on track.

Money Money Money:

Well despite the aforementioned myriad of projects and interests, ultimately it all comes down to money. If the finances are perceived to be sound, investors relax and can begin to look to the value the company is working to create. Ergo, all things being equal, the share price should move to reflect shareholder appreciation.

If there are perceivable chinks in the financial stability going forward, investors tend to focus on any exposure and away from value potential across the portfolio. The key concern until recently was how the company would deal with a convertible loan of £2.565 million which was due for repayment in mid October 2010.

This convertible loan being a legacy issue which was originally set up in October 2007 to fund development of the Meekatharra Gold project. Of course the Electrum portfolio now includes potentially valuable assets, some of which could be well in excess of the convertible loan. By that we mean principally the THEMAC holding and the tax losses related to Mercator Gold Australia Pty Ltd.

However, the announcement on 14th September provided details of the proposed solution, involving an extension by three years and a revised conversion price of 1.1p per share. This, it must be noted, is significantly less than the original convertible price, but nearly 50% higher than the price at the date of announcement. The proposal was also subject to loan note holders approval on a meeting scheduled for 29th September. Having now been approved, this now draws a line under a highly material financial stability issue for the company.

We would note that as outlined in the audio interview, Electrum has a SEDA equity facility to draw down up to £4million if required and the company boosted its cash position with a £300k draw down during October. So working capital exists and with the loan extension confirmed, the company looks now to be on a secure financial footing, as it pursues its ambitions as a diverse mining house.

A final thought....

When a company sets out on an aggressive growth path, the risks tend to multiply and the route to shareholder value can often be an adrenaline ride.

Electrum Resources, is on such a route. It’s has an array of assets with significant value generative potential and it intends to waste no time in driving them up the value curve. To extend the nautical term, the fastest “tack” is always gained when sailing “close to the wind”, but that is also where the dangers are heightened. The current share price will obviously factor in and reflect the degree of risk involved.

If management can finalise the THEMAC Copper Flats deal; if they can secure the rights to the substantial tax losses in Mercator Gold Australia Pty Ltd; if they can continue to grow ACS and prime the company for a market listing or disposal at profit; if they can continue to build the other portfolio elements including gold exploration success in Argentina; then those investors buying shares at around 1.1p could achieve substantial capital appreciation.

Let’s not forget that Michael Silver, Chairman, purchased a further one million shares on 31 August 2010. £6,700 won’t exactly break the bank, but not a transaction for somebody to undertake without a certain degree of confidence in the future!

And just to help reinforce the message, it may be worth reading the latest Edison Research note dated 28th September which highlights a potential discount of 82.7% to 91.1% to certain ‘sum of the parts’ valuations.

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Patrick Harford talks to Paul Johnson of MiningMaven about the acquisition of the 100% interest in the Sierra de Las Minas and Los Aquirres gold/base metal projects in Argentina.

Interview published 7 October 2010