Introduction

Before we get started, let’s do a quick checklist to see if a First Quantum short makes sense.

·         Canadian mining company?  Check check check.  I know, I know…it should be two checks but when you put “Canadian” + “Mining” together, there is some real synergy.

·         Promotional management team? Check.  People think they are super awesome because they bought a big, money losing mine in Australia and made it make money (except it loses money now).   

·         Contrarian bet, and in fact loved by long-only community? Check.  The view has been that copper is the “best” commodity (tighter supply/demand, declining asset base) and that First Quantum is the only company delivering growth projects right as supply/demand is at its most strained over the next couple of years. 

·         Assets toward higher end of the cost curve?  Check.  The company’s existing projects are firmly in the 2^nd/3^rd quartile of the cost curve – and this is acknowledged by the sell-side.  Sentinel (discussed below) is in the 3^rd quartile, while the company’s major development mine in Panama (opening in 2018/2019) is potentially 1^st quartile (hey, it works on paper).   

·         New Project Development risk? Check.  New project opening as we speak (Sentinel), and another $6 billion development project underway (Cobre Panama). 

·         Levered? Check.  At copper spot in the mid 2s/lbs., let’s say 7x.  That’s a lot. 

·         Covenant issues? Check.  Legitimate chance of breach in early/mid 2016. 

·         Potential liquidity issues? Check.  Covenant issues probably end up exacerbating this issue as the banks tighten the reins.  

·         Bond yield conflicts with equity story? Check.  The bonds yield ~13-14% and trade in the high-70s/low 80s…while there is a C$5billion market cap).  Before some recent market-soothing commentary by management, the bonds were in the 60s.  Somebody is wrong.  You don’t have bond yields of 14%+ and equity caps that big as a % of EV. 

·         Legitimate country risk? Check.  Major assets in such delightful places as Zambia.  There have recently been massive power issues in Zambia that have impacted results at Kansanshi and the expected ramp-up of Sentinel. 

·         Commodity price dependent in midst of a potential global slowdown? Check.  50% of worldwide copper demand is from China.  Enough said. 

Well then!  At current copper prices in the ~$2.40/lbs. range (and certainly anything much below), First Quantum stock has a legitimate chance of being a zero.  That’s what generally happens to over-hyped, over-levered, development-dependent mining stocks at the tail of an economic cycle.  However, let’s just put a price target of C$3.00 to leave ourselves some room.  In any case, I spend the bulk of my analysis below evaluating First Quantum’s base business and its Sentinel project, but even I I’m wrong, there are multiple ways to win on the short side (leverage, execution risk, covenant breaches, etc.). 

First Quantum is a copper mining (some nickel, which doesn’t make money at even the EBITDA level) that owns and operates assets around the world from Zambia to Australia to Panama. 

Here are two keys to the First Quantum short: 

Base Business

First, the base business doesn’t generate much free cash flow at current levels.  After cutting through the confusing mix of metrics, run-rate EBITDA-CapEx (at spot) is probably in the ~$300-600 mm range.  This is versus an enterprise value of $10 billion.  In other words, the base business can’t possibly account for where the business trades today.  I would also note that a number of the company’s mines (Las Cruces and Guelb Moghrein being the most meaningful) have mine lives set to end in the 2020 timeframe.  These deserve valuation discounts if you’re using an EBITDA multiple (as one example).