A Case Study in Due Diligence: Southern Arc Minerals
Omar Boulden
June 19, 2007
Introduction
Let's say that some exploration stock analyst, Joe Schmoe, recommends a stock (for example Southern Arc Minerals), and you are considering buying it. But being the financially responsible person you are, you say to yourself, "Well, Joe seems pretty smart, but I don't know him, and even if I did, it is my money and therefore it is incumbent upon me to do my own due diligence on Southern Arc Minerals." Congratulations for taking personal responsibility for your own finances. The problem is however, even though you are ready and willing to do your own due diligence, you are an inexperienced mineral exploration stock investor. In addition, you are not a geologist. You simply don't know how to perform due diligence on a potential investment of this type (a junior resource exploration company). What questions do you need to ask? What things do you need to research? What are the technical terms, issues and activities associated with the mineral exploration business with which you need to be aware? These are the problems this author grappled with recently and leads to the subject of this article, which is how to approach the dilemma of performing due diligence on exploration companies.
This author's personal belief is that in general, when pursuing a new endeavor in life, a good starting point usually consists of mimicking the approach of successful and experienced people in the field of interest. Therefore it makes sense to find out who some of the experienced and respected people are who analyze and work with junior exploration companies, then determine what criteria they use to pick potential winners. One can then apply the same criteria to his or her potential investment.
After spending many hours on the Web researching the subject, this author has found that certain names are mentioned repeatedly. This group includes some of the industry's most renowned newsletter writers, market analysts, natural resource website owners and geologists such as Rick Rule, Doug Casey, Keith Barron, Paul Van Eeden, Bob Moriarty, Bob Bishop, Brent Cook, Peter Megaw, Lawrence Raulston, Jay Taylor and Al Korelin, among others. Interestingly, most of these experts repeatedly mention many of the same ideas and concepts on what to look for and how to value a junior exploration company. Also, many of the experts stress that, just as in the case of analyzing any company in any industry, one must perform both a qualitative as well as quantitative assessment when scrutinizing the worthiness of an exploration company investment.
Let us go through a due diligence research exercise using Southern Arc Minerals as an example. As a disclaimer, it must be mentioned that this author owns Southern Arc Minerals stock and is therefore biased. (On Yahoo Finance, the stock symbol is SA.V and is traded on the Toronto Stock Exchange and listed in Canadian dollars. In the U.S., there is an over-the-counter listing of this stock with symbol SOACF.PK and is quoted in US dollars). Also note that this author is not a licensed financial advisor or geologist.
Background
Let us first start the exercise with some necessary background information. A typical junior exploration company might have only 10-15 people or so in the entire company. Some of them will work on the technical side (geologists) and some of them will work the "money" side (management). What they are trying to do is find and acquire a property with a volume of mineralization that is significantly large in both size and grade and which is feasible and economic to mine. Simply "finding some gold" is not sufficient, and according to some geologists, really is not that difficult. What is difficult is finding a large deposit of gold that is economic to mine. If they are lucky and/or smart enough to find and prove out such a property, then ideally some senior mining company will want to joint venture with them or simply buy them out at a premium, thus making the shareholders of the junior company rich and happy.
So what are the steps or sequence of events in the exploration process? From the Society of Economic Geologists, Special Publication #3, "Ore Reserve Estimates in the Real World" (third edition), we find the following steps outlined:
(1) Conception Stage: Selection of areas and/or district in which to conduct exploration. Literature search with some field investigation.
(2) Reconnaissance Stage: Broad-scale prospecting. Airborne geophysics, regional geologic mapping, stream sediment geochemical surveys, etc. Purpose is to screen a large area for existence of potential targets warranting detailed work.
(3) Land Acquisition: Stake claims, lease large blocks of ground with few or no known mineral showings.
(4) Detailed Exploration Stage: Detailed geological mapping, geophysical and/or geochemical evaluation of specific target areas. May include some reconnaissance drilling of anomalous areas.
In the detailed exploration stage, the geologists are trying to gradually "window" their way down to where they think the rich mineralization is. Eventually, they will start the much more expensive part of the process, which is diamond drilling to various depths. This is where they hope to show continuous mineralization of significant grade at significant depth and delineate the deposit.
The stock market is very sensitive to the results of this drill-hole activity. In general, the further (both vertically and laterally) the mineralization and the higher the grade, the higher the market will value the company. Obviously, the type of mineral itself (e.g. gold, copper, silver, etc.) will also determine market value. So (to over-simplify), exploration stocks typically move up on the heels of positive drill hole results, since the results incrementally prove out the mineralization, volume and grade of the deposit. In other words, speculation becomes replaced with fact, risk is reduced, and the market can better quantify the company's properties.
Qualitative Analysis
Clearly, the previously mentioned activities require technically astute people well versed in geology as well as business-minded people who have the ability to raise necessary capital. Remember, buying a junior exploration stock is a very speculative endeavor (more likely to fail than succeed), and to improve the odds of success, you need a strong team in place. For these reasons, it is no wonder that having the right people is one of the key criterion that is commonly cited in picking a successful junior. What we want to see are people with years of experience and proven track records of success in the industry with no serious blemishes on their records, such as being banned from trading on a stock exchange, insider trading or felony convictions, etc. Does Southern Arc Minerals, our case-study company, hold up to these criteria?
An obvious place to start hunting for information is the company's website, From the website, we find that they have directors with nearly three decades of experience in the mining industry covering all areas of technical, finance, acquisitions and administrative responsibilities:
-John Proust, CEO, President, Director, has held senior operating positions and served on the boards of numerous private and TSX Venture Exchange listed companies including director of Superior Mining International Corporation, and as a Director of Canada Energy Partners Inc., Western Uranium Corporation, GPJ Ventures Ltd. and KPS Ventures Ltd. In addition, Mr. Proust was previously the President, a Director and the majority shareholder of Canada Talc Limited, an Ontario miner and processor of industrial minerals.
-Doug Leishman, Director was most recently the director of geology and exploration for Endeavour Financial Ltd., a financial advisory firm focused on the mineral industry. Prior to joining Endeavour, he was a senior mining analyst with Yorkton Securities Inc. in Vancouver. He was trained as a geologist and prior to entering the investment industry held positions of responsibility in the exploration sector with various companies in North America, Europe and the Middle East.
-Mike Andrews, Director, is a geologist with over 26 years of research and mining industry experience in gold, copper, coal and iron exploration. He has experience as an operator of gold mining interests in the Philippines and Indonesia.
-Hamish Campbell, VP of Explorations, heads Southern Arc's exploration programs in Indonesia. He is well known and highly regarded within the Indonesian mineral exploration community. Mr. Campbell is a key contributor to the exploration and acquisition strategies. He has been active in Indonesia for over 20 years, speaks Indonesian fluently, and has held mineral exploration positions ranging from Field Geologist to Exploration Manager.
-Robert Vidoni, VP of Project Management. Mr. Vidoni has more than 20 years of domestic and international civil engineering and international development experience, including providing engineering input to infrastructure projects related to the mining industry, open cast mining and tailings facilities. He is fluent in eight languages, including Indonesian.
As part of the due diligence exercise, it behooves one to verify the background claims on at least one of the principals. Who better than the CEO? Since Southern Arc is a Canadian company, we go to www.sedi.ca and click on "access public filings" and then click on "view insider information." We can then do a search on the Proust family name and get the information that more-or-less corroborates the background claims.
To continue our scrutinization of the principals of the company, we also need to determine if there are any flag-raising blemishes on the records of these individuals who are running the company. Have they ever been banned from trading on a stock exchange? Have they been convicted of insider trading? Do they have any felony convictions? Doing due diligence here could be as simple as performing a Google search on the names of the principals followed by the words "insider trading CSA conviction" or "insider trading SEC conviction." When doing this using the names of the Southern Arc principals, no evidence of any wrong doing was found.
What about the ability of management to raise necessary capital for exploration activities? This is critical as exploration is an expensive proposition. Southern Arc's home page clearly states "Southern Arc is the first Canadian junior mining company to have raised funds (IPO - $2 million and, subsequently, $1.4 million in January 2006, $3.03 million in March 2006, and $2.1 million in April 2007) and to be concentrating in Indonesia since 1997."
Another thing that is prudent for us to investigate is insider activity with respect to the company stock. If insiders were selling a large percentage of their holdings, this would obviously be a major red flag. Conversely, insiders buying a large number of shares would be a vote of confidence for shareholders and potential shareholders.
Let's research what the CEO, John Proust has been doing. See the following link:
https://www.sedi.ca/sedi/SVTItdSelectInsider?locale=en_CA
Select "insider family name" -> starts with Proust (leave given name blank)
Enter data of transaction range June 1, 2007 to June 18, 2007.
Select "common shares"
Select "Issuer industry classification:" -> None
Click "search"
Click "view"
Here, we see that he has recently bought approximately 300,000 shares of Southern Arc Minerals stock and now holds over 4.5 million shares.
Once we have established that the company has a solid management and technical team in place and that they are personally invested and continue to invest in their company, we should focus on trying to understand what the goals of the company are and what strategies they will use to achieve their goals. From Southern Arc's website:
"Southern Arc's intention is to advance properties that hold the potential of becoming one million ounce gold resources or greater to exploitation." Their strategy is outlined on their website as follows:
* Target geographical Sunda-Banda opportunities in a highly mineralized region that has been underdeveloped over the last 10 years with the exodus of junior mining companies after the 1997 Southeast Asia economic crisis.
* Undertake a systematic approach to the mineral evaluation of the Sunda-Banda region, particularly the islands of Sumatra, Java, Lombok, Sumbawa and Flores, for the identification of new opportunities.
* Utilize available existing data bases, which allows for a cost-effective evaluation, targeting and acquisition of advanced minerals prospects.
* Complete organized evaluations and the advancement of mineral prospects from early identification through to surveys and drill programs and, where there is a sufficiently large resource of one million or more ounces, to exploitation.
* To continue to develop strong relations with the local, regional and national levels of government, NGOs and the local communities.
* To develop significant symbiotic relationships with large mining companies such as Newmont Corporation.
* To become the premier mineral exploration and development company in Indonesia.
Once a company's basic strategy is reviewed, one must then examine the geographic region they are targeting. Does the region make sense from both a geological perspective and from a geopolitical perspective? The politics of the region is an extremely important consideration, because some of the most prospective geological regions in the world might make very poor exploration targets due to the political climate in which they exist (e.g. Angola). Let us apply the geological and geopolitical criteria to Southern Arc's target geographic area, Indonesia.
From a geological perspective, Indonesia is ranked as one of the best places in the world to explore for minerals. In 2005, Canada's Fraser Institute ranked Indonesia as the 4th most mineralized region of the world. Some of the world's largest reserves of gold, copper, nickel, and coal have been found in Indonesia. Indonesia is among the top 10 producers in the world for gold, copper, nickel and tin. Its world-class mines include Grasberg (Freeport-McMoran) and Batu Hijau (Newmont). The following link shows an interesting graphic on the plethora of gold and copper deposits in Southeast Asia:
http://www.jogmec.go.jp/mric_web/MMAJ_FORUM/SteveGarwin/SteveGarwin/SGslide12_800x600.html
Clearly this is an area where there are an abundance of minerals and potential mines that are just waiting to be found. But what do we know about the geopolitics, investment climate and bureaucracy in Indonesia?
A search on the web reveals that the Fraser Institute's 2005/2006 Survey of Mining Companies ranked Indonesia as a 22 (out of 100) for investment climate. Why the unfavorable ranking? One of the reasons is that Indonesian mining has long been perceived as an unfavorable jurisdiction for mining due to competition between national and regional authorities for control over the country's natural resources. In addition, there has been much uncertainty and difficulty with the country's long-standing Contract of Work (CoW) regime.
The CoW issue prompted the author to query Southern Arc's investor relations department. The company explained the CoW to this author as follows: "The CoW is a contract to perform work on behalf of the government, in this case the exploitation of a mineral resource as the mineral resources legally remain the property of the people/state. There have been 7 generations of CoWs since 1965, each one progressively evolving into a better legal instrument. It is the prevailing Indonesia mining tenure regulation and is internationally acclaimed by both industry and financial institutions alike, as the safest means to secure property tenure, along with being a proven financial guarantee to future capital investments in the case of a production scenario. In the agreement both parties' obligations and compensations are clearly spelled out and CoW's terms have thus far always been adhered to in the Indonesian mining business notwithstanding Indonesia's perhaps notorious reputation in other activities for reneging on contracts or 'reinterpreting' contracts, etc. CoWs come with provisions for future arbitration, if perhaps required, usually to be set at a third party location, often Singapore, but could be elsewhere outside Indonesia, conceivably even at the International Court at the Hague. However, there has never been much need for such measures as typically all the wrangling occurs during the negotiations for the granting of a CoW. Once a CoW is in place then a mining company can go ahead with all the activities that lead to and implementation of mineral resource extraction."
Basically, Indonesia's mining laws contemplate the granting of mining rights under contracts between government and private sector contractors. CoWs are in theory "negotiated" but in practice have followed a series of evolving standard form agreements. Obtaining a new CoW has been a complex and sometimes impossible exercise for some companies. Clearly this is an area of risk for the company and thus investors.
However, that being said, it seems the Indonesian government has recently been reforming legislation and making efforts to become more mining friendly. From Southern Arc's website, "the Indonesian Government is currently drafting a new Mining Law as it relates to mining activities in Indonesia." Southern Arc states that they will provide updates with regard to the new Mining Law as more information becomes available.
This author also discussed the issue with investor relations at Southern Arc. The message from the company was that they had a very strong working relationship with the local government and that the government was trying to help them be successful. Specifically, they stated, "With respect to possible interference or a stay of further advancement to exploitation on the part of the Indonesian government to, say, Selodong, we feel this is highly unlikely. Currently, there is no such sentiment at any of the levels of government, much less the central government, which has supported and encouraged all of Southern Arc's activities to date. This is evidenced by the fact that all applications for permits, licenses, etc. have been met with a minimum of red tape, usually within 40 days or less, which traditionally has been most unusual in a country renowned for official obfuscation. Furthermore, there is strong public pressure, at times even in the form of street protests, to advance mineral properties to production, particularly on Lombok and Sumbawa islands, as people are clamoring for jobs and for the development of the area that mining brings. For instance, Newmont's presence with their Batu Hijau mine has brought about strong local infrastructural development and about a 2000% increase in the prosperity of the nearby communities, where people traditionally lived in near-abject poverty. The Western sense of CSR is very much welcomed. Politicians at all levels of the Indonesian governments are strongly cognizant of the sentiment and therefore have also been supporting Southern Arc's activities."
Let us get back to the subject of the CoW. Has Southern Arc been able to obtain one, at least for its flagship property, Selodong? As of June 8, 2007, the company stated, "The CoW for Selodong has not been finalized yetnegotiations are to start once the Indonesian negotiations team has been ratified by the Department of Mining & Energy." This being the case, not yet having the CoW needs to be cited as an area of risk.
It is likely that another reason for the unfavorable perception of exploring/mining in Indonesia is the lingering stigma of the Asian currency crisis of the late nineties, as well as the Bre-X scandal. For those that don't know, Bre-X is the name of a former Canadian exploration company operating out of Indonesia. This company committed securities fraud by "salting" (sprinkling) its samples with gold dust to make it look like they were sitting on a huge gold deposit. The company was basically the "Enron" of the mining industry. But should this be an area of concern for a potential Southern Arc investor? In this author's opinion, no. Common sense dictates that this could have happened in any country, and there is no reason that Indonesia, one of the world's most mineralized areas, should be shunned by exploration companies and investors due to the Bre-X scandal.
Southern Arc is clearly taking advantage of the fact that other exploration companies and investors have been "gun-shy" with respect to Indonesia for at least some reasons that don't exist anymore.
Southern Arc is also leveraging a great deal of work already performed by the previous owner of some of their properties, Newmont Mining. This appears to be sensible strategy and spells opportunity for Southern Arc and Southern Arc investors, in this author's opinion. We will discuss this in more detail later on in this analysis.
As mentioned earlier, stocks tend to move sharply on drill results. Because of this, it is imperative that the integrity of that data is not questioned. This leads to the topic of what an NI 43-101 is. National Instrument 43-101 (NI 43-101) is a rule developed by the Canadian Securities Administrators (CSA) and administered by the provincial securities commissions that govern how issuers disclose scientific and technical information about their mineral projects to the public. It covers oral statements as well as written documents and websites. It requires that all disclosure be based on advice by a "qualified person" and in some circumstances that the person be independent of the issuer and the property.
A qualified person (QP) as defined in NI 43-101 as an individual who:
a) is an engineer or geoscientist with at least five years of experience in mineral exploration, mine development or operation or mineral project assessment, or any combination of these;
b) has experience relevant to the subject matter of the mineral project and the technical report; and
c) is a member in good standing of a professional association.
So, is Southern Arc compliant with NI 43-101? Near the end of Southern Arc's news releases, one will find a statement similar to, "The information in this release has been compiled under the supervision of Southern Arc's Vice President of Exploration, Hamish Campbell, B.Sc.Geology, MAusIMM... Mr. Campbell has sufficient experience relevant to the style of mineralization under consideration and qualifies as a Qualified Person as defined in terms of NI 43-101."
In addition, assay results need to be handled independently. What assay laboratory does the company in question use? Are they licensed? Are they ISO 9000 Series accredited? In the past, there have been cases of unlicensed assayers and analytical laboratories that had no history of working with mining companies suddenly churning out numbers. If the company can't or won't tell you the name of their lab, they should be avoided.
When the question of lab analysis was posed to Southern Arc Minerals by the author, investor relations responded, "Our assays are performed independently by an outside laboratory that holds no interest in Southern Arc Minerals and which therefore holds no bias." The CEO, John Proust, also followed up by stating that "all assaying of samples was undertaken by the ITS laboratory in Jakarta. ITS is one of the world's largest product and commodity testing, inspection and certification organizations. The Jakarta laboratory is ISO 17025 accredited and employs a Laboratory Information Management System (LIMS) for sample tracking, quality control and reporting."
The last topic we want to address in the qualitative analysis is whether there are any industry experts who have an opinion about the company, and if so, what is that opinion? Are any respected analysts in the field endorsing the company? If so, this should boost our confidence level. For Southern Arc, we find that Bob Moriarty of 321gold.com is very bullish on the company.
We also find that Bob Bishop of the Gold Mining Stock Report (see a little blurb on Bob Bishop at Cambridge House) came out with an endorsement on June 14, 2007 in Gold Mining Stock Report Alert #407 by stating, "This week and last, I have also added to Southern Arc [SA/$1.49], for reasons I made clear in Alert #405, but also because what could be a huge hole is in progress, and because company president John Proust was buying his stock on the sharp selloff earlier this week. When someone who already owns or has exposure to eight million shares, all of it owned at much lower prices, is buying 400,000 shares on the market, that's the kind of vote of confidence I like to see.
According to Proust yesterday, drilling on hole #3 was at 640 meters, most of it in apparent mineralization, and results can be expected about one week after drilling stops on this hole. The drill's suggested limitation is 700 meters, but at 640 meters, drilling was becoming very difficult. Whether it stops here or keeps going, hole #3 appears to be further evidence that the Selodong intrusive represents a very large copper-gold system."
Quantitative Analysis
Once we have decided that an exploration company meets our qualitative requirements for investment potential, we wouldn't be diligent investors until we perform a quantitative analysis to value the company. We do this to make sure that the stock price we are paying is reasonable. Not doing a quantitative analysis would be tantamount to buying an Acura TL for $100,000. Now, an Acura TL is absolutely a fine car, but it's not worth a hundred grand. As investors, we want high quality at a great price.
An exploration or mining company can be valued in much the same way as one values real estate. That is:
1) Potential for the future.
2) Value of the materials contained by the property.
3) By looking at the "comps" (comparing to similar entities)
Let's stick with items 2 and 3 above, since it is easier to assign numbers using those methods.
What method or algorithm are we going to use for our valuation analysis? We will look at each of our company's properties which have been drilled and assayed and then:
1) Determine the value of the "in-situ" (still in the ground) metal for each property
2) Determine what percentage of this value the market assigns on average for in-situ metal of the same type (metal still in the ground is worth much less than metal which has been extracted, refined and is ready to sell)
3) Multiply this percentage by the in-situ value of the metal
4) Take the results from 3) for each property the company owns and add them together
5) Compare the results from 4) to the market capitalization for the company to determine whether the company is overvalued, undervalued, or fairly valued
What we want is for the number we calculate to be much greater than the market capitalization of the company. If this is so, we have identified a potentially undervalued asset. However, this is not the end of the story. Because there are always numerous categories of risk for exploration companies, the stock market will typically discount the value of the company by some factor which is commensurate to the risk. As an investor, you need to decide for yourself if the market is assigning too much weight to the associated risks (both known and unknown). But let us not diverge. Let us continue with our "hard number" valuation analysis.
For Southern Arc, most of their properties are in the very early exploration stages and a valuation analysis based on mineralization of all their properties is not feasible. However, their Montong Botek location in their Selodong property has enough drill hole data for us to attempt to quantify the value of Southern Arc Minerals. Since our analysis will be based solely on this property and we will use conservative numbers when dealing with any parameter which has a range of values, our estimate will necessarily be conservative, other risks not withstanding.
We start by trying to determine the value of the metal in the ground. We can do this by calculating how much one tonne (2205 lbs.) of ore is worth and then multiplying that by the number of tonnes in the ground. To figure out how much one tonne of ore is worth, we need to look at the drill data the company has released to date. As of this writing, they have completed three deep holes with results available for the first two (the third hole results are pending). The first hole, MB001, showed an average grade of 0.28% Cu (copper) and 0.42g/tonne Au (gold) for 442.2 meters. The second hole was drilled in the opposite direction and assay results showed an average grade of 0.30% Cu and 0.40 g/tonne Au for 384.65 meters. These numbers are fairly consistent which helps simple calculations.
To calculate the value of one tonne of ore, we can use Doug Casey's convenient program at http://www.caseyresearch.com/ (click on the link on the right called "Calculator: What's That Rock Worth?"). To be conservative, we will use 0.28% Cu and 0.40 g/tonne Au. The result based on today's market price of Cu and Au is that one tonne is worth US$29.65. Note also that the ore samples from the two holes were showing significant concentrations of molybdenum. This would add a few dollars to the per/tonne value, but we will ignore that to be conservative.
Now we need to determine the number of tonnes in the ground. The density of the ore in tonnes/cubic meter can be assumed to be roughly 2.5. So if we can figure out the number of cubic meters of mineralization we have, we can multiply that number by 2.5 to determine the number of tonnes in the ground. The tricky part is determining the number of cubic meters we have (i.e. the volume of the mineralization). The reason this is tricky is because only two deep holes have been both drilled and assayed and two holes are not sufficient to fully delineate the mineralization in three dimensions. (Incidentally, the reason holes are drilled at an angle is because this helps the geologists delineate the mineralization in three dimensions with fewer holes). In addition, we know from the assay results and geologist reports that we are dealing with a gold-rich copper porphyry system. In an ideal cross-section, such porphyry systems look like giant upright lightbulbs. They can have considerable vertical extent. See page 5 of May 15, 2002 Straight Talk on Mining issue at the link:
http://www.straighttalkonmining.com/docs/pdf/stom17.pdf
Coming up with an equation to describe the volume of a lightbulb with a long stem is not going to be worth our while, especially in light of the fact that we only have data on two deep drill holes. Thus, we are going to have to make an assumption. We are going to assume that we can approximate the volume of the deposit with a cube whose sides are equal to the length of mineralization in the second hole. This was the shorter length and therefore more conservative. How confident one is in this assumption should factor into the total risk one assigns to this investment.
Getting back to our calculations, we find that the volume is 384m x 384m x 384m which is 56,623,104 cubic meters. Multiplying this by the density of the ore, 2.5, gives us the total number of tonnes, which is 141,557,760 tonnes. Multiplying 141,557,760 tonnes by the dollar amount per tonne, US$29.65 results in an in-situ value of approximately 4.2 billion U.S. dollars if our assumptions are correct. Expressing the numbers in a different way, we can say that their property contains at least 1.82 million ounces of gold and 873 million pounds of copper. So are the assumptions correct? Only the results of future drill holes will tell us for sure, but this is the best we can do at this time. The assumptions we are making are part of what makes this a speculative endeavor. However, this is also why an exploration stock may be discounted by the market and is what allows us to get in at a favorable price.
We have now completed 1) from our valuation algorithm. Now we have to determine what percentage of this value the market assigns on average for in-situ metal. There is a very useful and interesting website that compiles and calculates the types of numbers we are looking for. It is at:
http://www.resourcestockguide.com/mining/comparison_table_page.php?p=1|1|3|0|0|33|0
If one looks at the column called EVPU (Enterprise Value Per Unit), we can see how the market is valuing one (equivalent) gold ounce in the ground for various exploration companies. The range is quite large, from $251/ounce to $1.7/ounce. (Compare this to the spot price of gold, which is approx. $655/ounce at the time of this writing). If we take the average of the 60 companies listed, we get about $63/(gold equivalent) ounce, which we will conservatively say is about 9% of the spot price of the mineral. Now remember, this was for gold in the ground. What about the copper, which is approximately 3/4 of the value per tonne? Here, we will make an assumption that the market will value in-situ copper at about 9% of the above ground commodity price as well.
Now, we take 9% of the 4.2 billion dollar in-situ value of the ore and we obtain US$378 million. Since this is the only Southern Arc property we can legitimately value based on mineralization, we will skip step 4 from our algorithm. Now that we know that the market "should" be valuing Southern Arc at US$378 million, we can compare that to the current market capitalization of the company. We can get this information from the TSX here.
We see that the float quoted market value is about C$71million. But let's be conservative. Let's calculate the market cap by using the fully diluted number of shares. We can find this information at www.sedar.com, but we'll use the more current information we find at Doug Casey's website. (We trust Casey, but even if his number is incorrect, it will be even more conservative for our analysis.) This can be found at the bottom of the following link:
http://www.kitcocasey.com/cpr.php?id=37
This shows that the number of fully diluted shares is 66,918,336. If we multiply that by the current market price of C$1.63, we get C$109,076,888. Multiplying this by the US/Canada exchange rate - found here at Yahoo! Finance - results in a market capitalization of US$102,128,690.
So, what does all of this mean with respect to the share price? It means the market is currently valuing SA at less than three times what it's share price "should be" based on the mineral content of just one of their properties. Southern Arc Minerals is clearly undervalued if our assumptions prove to be correct. To be safe, let's go back and revisit a few assumptions we made.
We assumed the market would assign a value of 9% of the commodity price for both the copper and gold underground. We showed that the 9% factor was reasonable for gold. However, the copper makes up _ of the value of the ore. Let's be really conservative and say the market will only value the copper underground at 5%. Then, going through the math, the market should value the in-situ copper at $US150,000,000 and the in-situ gold (still assuming 9%) at US$107,000,000. Adding these numbers together results in a value of US$257,000,000. This shows that the stock is still undervalued by a factor of 2.5.
What about our assumptions based on the volume of the mineralization? We calculated the volume based on only two holes. A third one in a different direction has been completed as of this writing with assay results pending. If it shows the same type, grade and length of mineralization, it would go a long way to validating our assumption of volume. Maybe there are clues out there which will allow us to "connect-the-dots" and possibly draw reasonable conclusions.
Let us go to the Southern Arc web page where recent activities at Selodong are discussed.
Here, we see that "the program called for each hole to be drilled to 600m." They also state that "drill holes are stopped short or extended beyond the planned 600m based on valid geological reasons." For the first hole, MB001, they state, "The hole was terminated at 476m because visually the rock material looked non-mineralized for the last 50 to 60m." So basically, they stopped drilling at a depth of 476m because the drilled rock at 416m started looking different than the rock they had been pulling up. Now, the third hole, MB003, is the hole for which we are waiting assay results. They state MB003 "was started on May 19 and was terminated on June 14 at a depth of about 643 m." Since they continued past 600m, it is reasonable to infer that the rock material did not change visibly. The web site also implies that the drilling would have continued past 643m if not for the fact that "deteriorating hole conditions were encountered that the on-site drill supervisor considered was a high risk for the recovery of down-hole drill pipe and casing." They only stopped because they were afraid the drill would be lost or damaged. The appearance of the rock material brought to the surface must not have changed. If this is so, then there is a good chance it is also mineralized. A skeptic might argue that maybe there was no significant mineralization in any of the rock, and if this was the case, there might also be no visible change in the rock. This is unlikely if one looks at the diamond compilation drilling map for the Selodong Prospect at:
http://www.southernarcminerals.com/s/West-Lombok.asp?reportid=138743
Here, we see that previous Newmont drilling at PSG004, PSG015 and PSG015B were all in the vicinity of MB003. All Newmont holes showed significant mineralization. Given all we know, it is highly likely that MB003 will show continuous mineralization of significant grade at depth. This gives us more confidence that our assumption on volume of mineralization will at the least underestimate the deposit. Couple this with the fact that the CEO bought hundreds of thousands of shares on the open market as drilling was wrapping up on the third hole, and our confidence level is even greater.
Now, we have looked at the assay results from two drill holes, but we need to consider if this property will be appealing to a senior mining company. After all, we want to eventually engage with a senior. We should compare the property in question to mature properties of the same type that have been brought to exploitation by seniors. We also need to do a little research on mining.
The website http://en.wikipedia.org/wiki/Mining, explains that there are two broad category types of mining - surface mining and sub-surface mining. Sub-surface mining is much more expensive than surface mining due to the time and cost of developing the infrastructure. Creating the shafts and drifts (digging, steel, concrete, timber, ventilation) along with facilitizing the mine with electricity, air and water can cost in the neighborhood of a billion dollars and take several years to develop for an underground mine. This is why surface mining is much more appealing to a senior producer.
So what kind of mine would Montong Botek be? Looking at the news releases from the company, we see that for the MB001 hole, only the first 33.8 meters was not mineralized and for the MB002 hole, the first 18.1 meters was not mineralized. This first layer that is not mineralized is called the overburden:
http://en.wikipedia.org/wiki/Surface_mining
The overburden for Montong Botek is thin enough that the property will clearly lend itself to surface mining techniques. This translates into a lower capital investment for a senior, as well as the ability to recoup investment costs sooner.
What about the grade of copper and gold found in the Southern Arc property? The drill results showed an average grade of about 0.30% Cu and 0.40 g/tonne Au. Are these numbers any good? Tough to know if you're not a geologist. Well, let's compare the numbers to a mature mine in Indonesia that is well-regarded as being a world class mine - Batu Hijau. The following link shows that Batu Hijau averaged 0.55% Cu and 0.42g/tonne Au as of 2002:
http://www.datametallogenica.com/pages/minidisc/html/batuhijau_files/BatuHijau-fieldmine/page.html
We can also see how the numbers change with depth at Batu Hijau:
http://www.newmont.com/en/operations/indonesia/batuhijau/index.asp
So, we can see that grade of gold at Montong Botek is world class, and the grade of copper, while not quite at the level of Batu Hijau, is at least "in the neighborhood."
Summary
We have gone through a case study on doing due diligence on a mineral exploration company using Southern Arc Minerals as an example. We have looked at:
1) Management - experienced team with the ability to raise capital and with no blemishes on their records.
2) Geologists - technical background and experienced in the exploration geography (Indonesia)
3) Company strategy - take advantage of a highly mineralized region that has been under-explored
4) Insider stock transaction activity - CEO buying hundreds of thousands of shares recently
5) Geopolitics- an area of risk historically, but risk appears to be diminishing going forward
6) Rights to exploit the mine at Selodong - CoW pending, but an area of risk nonetheless
7) Disclosure of technical data and assay results - NI 43-101 compliant
8) Assay sample analysis - handled independently by ISO 17025 compliant lab
9) Industry analyst endorsements - Bob Bishop and Bob Moriarty.
10) Valuation analysis of in-situ resources, research on how the market typically values in-situ resources and comparison to current market value of company - shows that Southern Arc Minerals appears to be undervalued by the market
11) Risks and assumptions on calculations listed above - volume assumptions due to limited drill hole data, assumptions on market value of one in-situ resources relative to another (gold vs. copper), etc.
12) Appeal to a senior producer - open pit, which is preferable to underground type mining
13) Comparison to mineral grades of a world class mine - similar gold grade to Batu Hijau, slightly lower copper grade than Batu Hijau
Conclusion
When making an investment of any type, it is in one's interest to perform due diligence on their investment. Even if one knows little or nothing about the industry related to the investment, the wealth of information available today on the Web leaves one with no excuse for not doing his or her own research. For this work, the author borrowed ideas from such industry notables as Rick Rule, Doug Casey, Keith Barron, Paul Van Eeden, Bob Moriarty, Bob Bishop, Brent Cook, Peter Megaw, Lawrence Raulston, Jay Taylor, Al Korelin and others. As a disclaimer, the author would like to once again state that he is not a licensed financial advisor or a geologist. If you make money on Southern Arc based on this work, it is your money to keep. If you lose money on Southern Arc based on this work, it is your loss. So please, do your own due diligence.
Jun 18, 2007
Omar Boulden
email: oboulden@cox.net
:P
hoffe es sind keine Fehler drinnen 
