Back in June, I wrote about Apex Minerals’ Wiluna mine (AXM: Australia). At the time, it was a struggling restart of an old underground mine. I felt that after a number of false starts, the company was taking the right steps to finally achieve profitability. The mill was working at half of capacity so the expensive stuff was paid for. The company just needed to get more ore out from underground to feed the mill. From spending two days on site, I felt like ore production would increase going forward. More feed at a fixed cost operation would create a good deal of cash flow. The company just needed time.
It turns out that I got my analysis right in many ways. The company was able to turn the operation around. During the March, 2010 quarter, the company was producing 4,700 ounces a month with considerable losses. Over the course of the next half year, the company made significant and sequential monthly improvements. By November, 2010, the company produced 6,936 ounces and had reduced the cash cost from March’s $1,485 to $871.
My original thesis was that if the company were successful, it was worth a whole lot more than the 1.9 cents it traded at. If I was wrong, the valuation was depressed enough that I didn’t think I could really lose much money. I basically had half a year to see if I’d either get out flat or have a huge gain.
Well, here we are—I got the analysis right. The business is turning. The company was profitable in the fourth quarter. Ore production continues to increase and cash costs continue to decline. Therefore, I was stunned to learn that the company wanted to do a rights offering at a penny. I can understand why a mining company would want more capital to increase production faster. What I do not understand is why they chose to do a rights offering at a penny. Why not wait for a few more months and raise capital at a nickel when the market realizes that the mine is working?
The problem with rights offerings is that unless you participate, you get diluted significantly—especially because other shareholders are buying stock at a penny. I don’t fault anyone who buys shares at a penny; I think they will make a few times their money in the next few years. This raise will significantly de-risk the mine and increase production. The problem is that the fully diluted share-count increases to nearly 6 billion shares. Even if the company is worth USD $300 million, that’s only a nickel of valuation. When I first wrote about Apex, the Australian Dollar was 82 cents and $300 million would get you 12 cents.
Now I don’t see double digits (in pennies) being possible—there are just too many shares. Of course the rally from a penny to a few pennies is quite attractive, but first you have to put more money into the company. I think there are better uses for my capital. I booked a small loss on the position in local currency terms. I did pick up a 20% appreciation in my Australian dollars, so it wasn’t a total loss—actually it worked out to be about a 20% gain over seven months. Knowing mining, it could have been a whole lot worse.
Mining is one damn hard business. You need to find situations where you can take very little risk to have 5-fold or better upside if right. If given the chance, I would still make the same investment in Apex. In fact, I think it still works out well for shareholders. If there’s a drop to a penny, I may re-evaluate. I just think that there are better places for my money over the next year and there isn’t enough upside from 1.9 cents to tempt me.