Formation Capital Corp. FCO.TO
December 15, 2005 - 7:02pm EST by
2005 2006
Price: 0.25 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 35 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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Formation Capital (FCO) owns the Idaho Cobalt Project (ICP), one of the world’s two primary cobalt (Co) deposits, and numerous other deposits. Co prices should increase dramatically over the next three years due to a growing demand/supply deficit. Conservative Co price projections imply the NPV/share of the ICP alone exceeds C$1.00.

I. Description:
Formation Capital owns the ICP, an advanced Co project at the final stage of feasibility, and the fully permitted Big Creek Hydrometallurgical Complex (BCHC). FCO also owns interests in gold (Au), silver (Ag), copper (Cu) and uranium (U) projects in Mexico, Idaho, and Saskatchewan.

The price outlook for Co is bullish. Per a report by Dr. Hannelie de Beer, a Co market expert, 2005 worldwide Co consumption and supply are expected to be 54,776 and 48,916 tons, respectively, implying a deficit of 5,860 tons. By 2010, this deficit is projected to increase to 10,151 tons with consumption and production at 76,317 and 66,166 tons, respectively.

FCO has the potential to be one of the lowest cost producers of Co in the world and the only source of primary Co production in the US, one of the world’s largest Co consumers.

Abundant reserves and long mine life:
There are three know deposits on the ICP: Ram, Sunshine and East Sunshine. Ram and Sunshine’s proven and probable reserves are 16MM lbs of Co, 12MM lbs of Cu, and 21,400 oz of Au (1.26MM tons grading 0.64% Co, 0.49% Cu, and 0.017 Au oz/ton). Measured and indicated resource contains 44MM lbs of Co, 50MM lbs of Cu, and 55,000 oz of Au (3.7MM tons grading 0.61% Co, 0.68% Cu, and 0.015Au oz/ton). The measured and indicated resources suggest a mine life of 15 years. This resource estimate conforms to Canadian National Instrument 43-101.

Considerable potential exists to expand the reserves and resources. Of over 20 known target zones, only four have been drilled and of those, only two are included in the reserve and resource calculation. The majority of 43-101 resources are on the Ram. Relatively little drilling has been done on Sunshine. The East Sunshine zone is not included in the resource estimate.

Big Creek Hydrometallurgical Complex (BCHC is fully permitted):
The BCHC provides a cost advantage by allowing FCO to avoid refining and smelting costs, which typically account for 20%-25% of production expense, and increasing Au and Cu credits, thus making FCO one of the world’s lowest cost producers of Co.

The BCHC will have the capacity to treat 17,000 tons of Co concentrate annually and produce 2,450 tons of Co (4.9MM lbs). Plans are to source 1,500 tons from ICP and to secure up to an additional 950 tons from toll customers. According to management, the estimated replacement value of the BCHC is between US$50-90MM. The current market cap of FCO is US$35MM.

II. Cobalt (Co):
Co is usually a by-product of Nickel (Ni) and sometimes Cu. It can also be processed from slag, a more complicated and expensive process than refining. FCO should become the world’s second primary (i.e. non-by-product, non-slag) Co producer. The only other pure Co producer is privately held Managem’s Bouazzer mine in Morocco. FCO is a publicly traded, US-based Co pure play with US$ costs and with economics independent of Ni prices.

Co demand grew at an average annual rate of 11% from 1994 to 2000. FCO’s ICP, with planned production of 1,500 tons/year, would represent approximately 3% of current annual worldwide demand and 15% of North American demand. The long-term average Co price since 1975 is US$13/lb while the average price during most of the 1990’s was over US$20/lb.

A May 2005 report by CRU Strategies, Inc. presented to the Cobalt Development Institute (CDI) projects Co price between $20-25/lb from 2006 to 2008 and between $15-20/lb for 2009 and 2010. “Prices will have to remain high enough to support Chinese production as without their collective refining capability their will not be sufficient cobalt.”

In 2006 and 2007, two significant (1,000 ton/year or greater) Co mines will come into production, Inco’s Voisey’s Bay mine and Inco’s New Caledonian Goro mine, respectively. In 2009, Adastra’s DRC Kolewezi mine comes on line with 1,500 tons/year. Smaller mines on line before 2010 are BHP’s Ravensthorpe mine in 2007 (could reach 1,000 tons/year by 2009); the DRC’s Meterox mine in 2007 (could reach 1,000 tons/year by 2009); Sumitomo’s Philippine Rio Tuba – Coral Bay mine in 2005 (could reach 500 tons/year in 2006); and Formation Capital’s ICP mine (could reach 1,500 tons/year in 2008). All of the above production forecasts are given 100% credit in de Beer’s 2010 supply projection of 66,166 tons.

The CRU report to CDI ( detailed five supply scenarios raging from 58,000 tons to 69,000 tons of supply by 2010, with three supply scenario between 61,000 and 62,000 tons. Four of these scenarios show supply below Hannelie de Beer’s 66,116 ton 2010 supply projection, estimate also assumes committed projects such as Goro, Voisey’s Bay, Ravensthorpe, etc. all start at capacity and on schedule.

Given the long lead times on mining projects, optimistic timeframes, questionable IRRs of certain projects, increasing worldwide environmental permitting requirements, political instability and delays, and engineering and equipment delays and shortages, the high end of supply forecasts at projected times are rarely achieved.

Co consumption by end market, geography and use (as well as the projected growth rates by use) are available in the de Beers report and/or at

Two rapidly expanding industries will increase Co demand:
1. Gas to liquids technology
2. Hybrid vehicles

1. Gas to liquids (GTL)
The GTL process converts natural gas (NG) into easily transportable liquid products. GTL is significantly safer than the highly combustible liquefied natural gas (LNG) alternative to recovering NG. Via GTL, Stranded NG can be recovered using a high Co content catalyst (the Fischer-Tropsch conversion catalyst) that converts the NG to clean burning synthetic diesel fuel. There is strong demand for this clean diesel in Europe and billions of dollars have been invested in GTL infrastructure that will soon require thousands of tons of Co.

My research suggests a 100,000 barrel/day synthetic diesel plant requires an initial 5,000 metric ton Co charge and an additional 250 metric ton Co recharge annually.

In Qatar alone, GTL plants that will produce more than 500,000 barrels/day in total are either planned or already under construction. Companies involved include Sasol/Chevron (130,000 b/d), Shell (140,000 b/d), ConocoPhillips (80,000 b/d), ExxonMobil (102,000 b/d), and Marathon (100,000 b/d). Other large GTL projects planned in Australia and Nigeria.

2. Hybrid electric vehicles
Typical non-hybrids passenger cars contain almost zero Co. The average size passenger vehicle with hybrid technology requires 7 lbs of Co. The number of hybrid vehicles models is growing rapidly.
-Currently hybrids (8): Chevrolet Silverado, Dodge Ram, Ford Escape, GMC Sierra, Honda Accord, Honda Civic, Honda Insight, Toyota Prius
-2005 hybrid additions (8): Acura MDX, Acura RL, Dodge Caravan, Lexus RX 400h, Mercedes Benz E320 CDI, Toyota Camry, Toyota Highlander, Toyota Sienna
-2006 hybrid additions (7): BMW 5 – Series, Chevrolet Malibu, Honda Pilot, Mazda Tribute, Mercury Mariner, Nissan Altima, Saturn VUE
-2007 hybrid additions (8): Chevrolet Equinox, Chevrolet Silverado, Chevrolet Tahoe, Ford Fusion, GMC Sierra, GMC Yukon, Mitsubishi Eclipse, Toyota Avalon

Among the models above are the world’s top selling cars, such as the Camry, Accord and Caravan, and the world’s largest cars, such as Chevy’s Tahoe and GMC’s Yukon, which will require more than 7 lbs of Co/vehicle. “In the future, the cars you see from Toyota will be 100% hybrid,” Kazuo Okamoto, executive vice president, told reporters in Frankfurt on 9/13/05.

According to a Minor Metals Trade Association ( and SFP Metals Ltd. March 2005 report, “Co emerges as the minor metal most affected by hybrid vehicle production … hybrid-driven vehicle consumption is set to impact the Co market hard. Based on [this report’s] estimates for the growth of hybrid vehicles, the new cobalt demand generated will be in the range 2,650 metric tons to 3,800 metric tons by 2010 and 5,500 to 8,500 by 2015.”

The MMTA/SFP report continues: “Sourcing of the extra cobalt demand generated from hybrids will doubtless impact the market. Today the Co market is tight. This year and at the recent CDI conference in Paris, Philip Tomlinson of the metals consultancy CRU Strategies said there was currently “strong demand for cobalt…In the short term, demand will be constrained by supply” leading to prices to be in the range $18 to $25 per lb through to 2008. With Co producers all running at full steam, evaporating DLA stocks and no major new projects due to come online for at least 18 months, providing the additional cobalt units for hybrid vehicles may not be straightforward.”

The CRU presentation went on to say that lithium-ion battery “shipments will increase from 1.3 billion in 2004 to 4.5 billion by 2020. This means that, without cell content reduction, demand could reach nearly 40,000 tons by 2020.” Li-ion batteries have the highest power-to-weight ratio, are the longest lasting of all rechargeable batteries, and are therefore the leading battery used in hybrid vehicles. Li-ion batteries contain 6-9 lbs of Co.

Chinese Co demand: A driver of Co demand growth
2001 - 2,340 tons
2004 - 11,487 tons

III. Valuation:
Mine Development Associates of Reno, NV, a mining engineering firm, has run various scenarios for the ICP. Two valuations are as follows:
1. @ $13.80 Co/lb
PV-10 is US$77.6MM or C$89.2MM, and C$0.56/share
PV-8 is US$93.4MM or C$107.4MM and C$0.67/share
2. @ $19.40 Co/lb
PV-10 is US$164.1MM or C$188.7MM, and C$1.18/share
PV-8 is US$191.0MM or C$219.7MM and C$1.37/share

The above NPVs include $65MM of start-up capex. The model assumes annual average production of 3MM lbs Co (no credit is given for toll business), 1.73 MM lbs Cu and 3700 oz Au. The price assumptions are $1.25/lb Cu and $425 Au. Cost/lb of Co is $5.82 before Cu and Au credits and $4.82 after credits, the lowest cost of any Co producer.

160MM shares are assumed because warrants and options are way at out of the money (41.1MM warrants strike @ C$0.50 and 6MM options @ C$0.33). Assumed C$/US$ exchange rate is 1.15:1. Additionally, FCO has $9MM of cash, $2MM of precious metals inventory which add US$0.07 to the above valuations. FCO has zero debt.

At FCO’s current price of C$0.25, one is buying the ICP for between 16% and 40% of its NPV (and drilling is not complete on the three ICP properties) at conservative Co, Cu and Au price assumptions. Excluded from this valuation are the Black Pine Co deposit, the Morning Glory Au deposit, and the Queen of the Hill Au deposit, which are all located in Idaho with accessibility to the BCHC. An investor also gets for free two U deposits (Virgin River and Kernaghan Lake), the high grade El Milagro Ag/Pb/Zn project and the Compass Lake Au project. One U project, Virgin River, is especially exciting and could have significant near-term value.

Virgin River Uranium Project (VRP):
This write-up will not attempt to assign values to all of FCO’s assets because the ICP and the BCHC alone carry values multiples higher than FCO’s current market cap. However, drilling results from the VRP could come within a couple months and be a near-term catalyst. FCO owns 2% (and has first right of refusal on acquiring an additional 8%) of the VRP in a joint venture with senior U producers Cameco and Cogema. Cameco (market cap = US$10B, ticker: CCO, TSX) is the world’s largest U producer. Over C$6MM of drilling has revealed that the character and style of the VRP high-grade mineralization is similar to the MacArthur River deposit currently operated by CCO in Saskatchewan.

FCO’s 10/14/05 press release states: “According to Cameco, the uranium intersections obtained in DDH VR-18 are the most significant ever encountered along the entire Dufferin/Virgin River Trend in more than 25 years of exploration. Preliminary radiometric data from the 2005 program is considered very encouraging and the Company is looking forward to releasing final assay data as it is made available.”

No one can know the value of the VRP, but McArthur River is worth about C$3.6B, based on it’s generation of over 60% of CCO’s U production and CCO’s NAV attributable to U is about US$6B. If the VRP ends up being worth only 25% as much as McArthur, FCO’s 2% interest would be worth C$18MM, which is half of FCO’s current market cap. The value of their right of refusal to acquire an additional 8% could be significant but has not been counted.

Alternative valuation:
The one brokerage covering FCO, Jennings Capital, has a fully diluted (206MM shares) NAV of $C375MM or C$1.82/share for the entire company. Jennings NPV (8%) for the ICP, Ram and Sunshine only (East Sunshine excluded), is C$275MM or C$1.34. The Jennings valuation uses production of 3.3MM lb Co, 2.6MM lb Cu and 2700 oz Au annually (price assumption are Co = $16/lb, Cu = $1.00/ lbs and Au = $400/oz). Jennings then adds $20MM for East Sunshine, $20MM for the Mexico and Saskatchewan properties, $20MM for the Big Creek complex, $8MM for excess Ag and Co refining capacity, $32MM in working capital and zero debt to reach C$375MM. Black Pine, Queen of the Hill and Morning Glory appear to be ignored.

V. Conclusion
FCO shares are severely undervalued. NPVs of the ICP/BCHC that use conservative Co, Cu and Au prices are multiples higher than FCO’s current market cap. These NPVs also exclude any processing of Ag, Au, Co, and Cu at Black Pine, Queen of the Hill and Morning Glory at the BCHC. The replacement value of the BCHC alone is multiples of FCO’s market cap. Additionally, FCO owns four properties outside of Idaho, two of which are substantial U deposits. Near-term catalysts clarifying the real value of FCO shares include a drilling report on the VRP this month; the final Definitive Bankable Feasibility Study and Draft Environmental Statement in 1Q06; permitting in 2Q06; and a growing demand/supply Co deficit driven by limited supply and increasing market share of GTL products (synthetic diesel) and hybrid vehicles.

Disclaimer: We own shares of FCO and may buy or sell these shares at any time without notice. The information contained in this write-up is believed to be correct, but should not be relied upon. We undertake no obligation to update the write-up if new information arises.


Cameco assay on Virgin River in 4Q05
Final Bankable Feasibility Study in 1Q06
Draft Environmental Impact Statement in 1Q06
Final permitting in 2Q06
Project financing completion in 2Q06
Increased use of synthetic diesel
Growing percentage of hybrid automobile production
Rising Co prices
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