Einstein observed that no matter how smart you are or how long you ponder, you can never be certain of how a watch works unless you look inside. He was making a point about understanding the universe, which we’ll leave to physicists and note that it’s exactly the same in business. We can easily study a company or industry from the outside, but we’ll never really know how it works until we get inside. And no matter how much we dig and get comfortable with the story and its management, one can never be certain about a company’s future revenue, cash needs or whether another company is developing a better mousetrap. What we can do is analyze the multiple pieces of the puzzle and try to make sense of all the moving parts.
As you well know, GCM invests in a niche that relatively few investment professionals do. The micro-cap arena is fascinating in that I have access to management and the opportunity to extensively kick the tires. Clients who select GCM must be comfortable with the fact that many of our investment ideas take years to develop. Good examples are the companies mentioned below that we’ve owned 5+ years.
In my year-end 2011 newsletter, we discussed AXT Inc (AXTI), then at $4.17 per share. Kipling’s quote, “to keep your head when others are losing theirs” preceded my AXTI analysis. I stated that AXTI was a company to keep our heads on straight. AXTI ended the this quarter at $6.35, equal to a 52% increase from year-end. Several other companies did well this quarter – Acadia Health (ACHC) +63%, InContact (SAAS) +26%, while several lagged behind such as White Mountain (WMTM)- down 24% (on very low volume). The information below focuses on WMTM (let’s hope for some of that AXTI magic).
White Mountain* (WMTM) is developing a titanium mine near Santiago, Chile. Its Cerro Blanco project will produce a high grade titanium dioxide (TiO2) concentrate. The company’s principal objectives are to advance the Cerro Blanco project toward final engineering feasibility in the second-half of 2012 and to secure off-take contracts for the planned rutile (most common form of TiO2) output. It would be the intention to sell the rutile concentrate to titanium metal and pigment producers (think white paint). Work also continues to investigate the commercial viability of producing a feldspar co-product. The feldspar could find applications in the glass and ceramics industries. For every ton of titanium rutile mined, approximately six tons of feldspar can be produced.
Titanium dioxide pigment has unrivaled properties of whiteness and brightness. The market for titanium pigment is expanding at above trend-line growth rates due to a steep increase of usage in newly industrializing economies. With its physical and chemical properties, titanium metal represents a material for new technological and environmental innovative applications.
While only representing a small portion of the overall use of titanium, titanium metal is experiencing a steep increase in usage as the intensity of use in new generation airliners is significantly greater than in previous designs. It’s the best corrosion resistant metal, has double the strength of steel and has less weight. It is also chemically inert, light, strong, non-corrosive, and non-toxic.
When we first invested in WMTM in 2007, rutile was selling for approximately $400/ton. Spot prices are now going for greater than $2,000/ton. Several things need to occur for our investment in WMTM to be successful. Crucial to its success is the completion of the final feasibility study later this year. The study will include the timing and the ability for WMTM to: get all necessary permits from the Chilean government, its ability to access and or build facilities for water, power, shipping (ports), roads, etc., full disclosure and details of total mineral resources, production capability, commercial contracts, engineering construction, delivery times of heavy equipment, etc. Upon completion, construction and financing decisions can be made with intent of shipping product by 09/2014. Construction would need to begin by the second quarter of 2013 to deliver product by this date.
There are 3 possible outcomes upon the study’s completion:
1. WMTM builds out the mine themselves
2. A joint venture (JV) with a major mining company and
3. Sell the whole shooting match for the Right Price!
My hunch (& strictly my hunch) is that WMTM seeks out a JV partner. If this were to happen, we may give up 60% of ownership for the partner to pick up all mining costs which could approximate $200 million. Let’s work the numbers assuming: we own 40% of the JV, the tax rate is 30%, there are 70 million shares outstanding, and 125,000 tons are mined per year.
– 125,000 tons mined per year (potential to 200,000) and we can conservatively achieve $1,500/ton gross and $1,000/ton net after mining expenses …. thus
– 125,000tons X $1,000(net) = $125,000,000 of titanium revenue per year $125,000,000 minus the 30% tax rate (rounding up) = $90 million. $90 million X our 40% ownership = $36 million. $36 million divided by 70 million shares = approximate earnings of $.50 cents per share.
I believe the $.50c is conservative and using a conservative PE (price to earnings) ratio = 10, one can easily justify a $5.00 ($.50 x 10) share price. Here’s the kicker – no monies for feldspar production have been assumed in this analysis. This could amount to $30 million/year (or $.10c/share) to the 20+ year mine life.
Now you know what I know and have assumed regarding our Chilean mine. WMTM ended the quarter at $1.79/share. Using conservative assumptions, there is significant potential for upside appreciation. During the second-half of 2011, WMTM signed contracts (20% of production) at $1,200/ton, which seemed pretty good at the time. The reason that there has been little news of late and no signed contracts, is due to management not committing future production with rutile prices steadily increasing. Furthermore, there are no new rutile sources to hit the market for a few years. With demand outstripping supply, continued price appreciation is possible. WMTM is down from $2.34 at year-end because the average investor assumes the worst when there is a lack of news, and when the share price drifts down – it must be bad! That’s when it pays to KNOW THE STORY.
*GCM currently owns approximately 3% of the outstanding shares
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