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HYCROFT MINING HOLDING CORP HYMCW
July 24, 2020 - 4:21pm EST by
NYsu21
2020 2021
Price: 1.90 EPS $0.31 $1.02
Shares Out. (in M): 57 P/E 36.6x 11.2x
Market Cap (in $M): 645 P/FCF -32.2x 12.9x
Net Debt (in $M): 82 EBIT 17 82
TEV (in $M): 727 TEV/EBIT 41.9x 8.9x

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Description

  • (Note: The price in the “Financial Information” headline is the warrant price, while the rest is info for the common)

Many people are currently stressing the value of investing in gold, whether as a store of value with interest rates at historically low levels, an inflation hedge with central banks around the globe printing money, or a hedge to a market that still has a lot of uncertainty (and elevated volatility). Recent bullish investor commentary includes big names such as

However, many of us here are not commodity investors, and buying gold at the highest level in almost 10 years certainly does not seem like a “value-investment”. We have been looking for an investment that can hedge the risk of inflation and vast printing/distortion going on globally, while still fitting within the value mandate.

HYMCW are warrants in an early production stage, single-asset mine located in a Tier 1 jurisdiction that are severely mispriced due to a recent SPAC merger process, a past bankruptcy, a new technology handicap, and a lack of coverage/following in the name. Each 5 year warrant entitled the investor to purchase 1 share of HYMC with a strike of $11.50. Similar to other SPAC warrants, there is a cap of $18.00 based on the price of HYMC closing >$18.00 for 20 trading days within a 30-trading day period. HYMC trades at a massive discount to the above analyzable factors, representing 352% upside for the common and thus 1998% for the warrants (intrinsic only due to the cap). 

(Common Upside)

 

(Warrant Upside)

 

Elevator pitch below:

  • Both HYMC and HYMCW are mispriced due to the below factors, many of which are misunderstood or will eventually be overcome:
    • Recent SPAC merger process & Lack of Coverage/Following: These two go hand-in-hand, but a recent SPAC process with a very quiet marketing period has resulted in somewhat of an orphaned stock. To date there is no coverage and volume has been light. While there have been some write-ups on the name, there is not any major institutional following as of yet. When/if there becomes bank coverage, the massive valuation discount should compress.

       

    • Allied Nevada Bankruptcy: Hycroft’s predecessor, Allied Nevada, went bankrupt in 2015. This was due to a confluence of factors, including a high debt load, declining commodity prices, and an inferior mining/production model. Current Hycroft has none of these things, as they have much lower debt, gold prices are +22.9% since the deal announcement/46.2% since the technical report while silver prices are +28.0%/+31.5% respectively, and Hycroft has completely changed their mining process to avoid the pitfalls that led to Allied’s bankruptcy. 

       
    • New Technology: Hycroft is using a new oxidation and heap leach process that has not been proven at scale production. The process was developed in response to failures when the mine operated as Allied Nevada. While both test and pilot runs have exceeded expectations in terms of recovery, the chemistry is known to work, and management believes strongly in the process, many investors are likely taking a wait-and-see approach. 
  • Using comparable valuations for Junior Gold producers, HYMC should be valued at $51.35. Lower valued competitors point to a price of $29.84, still 163% upside, while more aggressive valuation accounting for Hycroft’s move to being a scale producer point to $77.03 as upside. Additional valuation confidence comes from:
    • Allied Nevada was once a $4bn+ market cap company (equivalent to ~$70 of current HYMC), demonstrating the enormous value in the mine, which is one of the largest gold and silver deposits in the world.
    • There has been ~$600mm in capital invested ($400mm by Allied on pre-stripping, infrastructure, roads, etc + $200mm from owners on technology and mine re-start), meaning HYMC currently trades at just 1.2x invested capital.
    • Jr gold producing peers from the SPAC proxy are up on average 47.3% since the deal was announced (median 40.3%) and both sides determined $10 was fair value. GDXJ is up 45.6%. As mentioned above, gold prices are 46.2% above the technical report and silver prices are 31.5% above. Hycroft is only up 9.6%
  • There is upside from higher recovery in the technical report, M&A potential, and licensing potential of the oxidation/heap leach process.
  • Upcoming catalysts include enhanced coverage, increased production at the mine, further increasing gold/silver prices, and a potential warrant buyback
  • The warrants are the most liquid way to express this idea, with an ADV since deal close of 277,024 vs the common at just 17,263

Hycroft Background

Hycroft is a single-location, production stage gold/silver mine located in Nevada. The Hycroft mine commenced operation in 1983 (then the Crofoot-Lewis open pit mine). Vista Gold Corp acquired the mine in 1988 and was placed in a care and maintenance program in 1998 due to low gold prices. The mine was then acquired in 2007, with operations restarted in 2008 under the “Allied Nevada Gold Corp” name. It traded at a valuation of >$4bn at it’s peak, before going bankrupt in 2015. You can find a write-up from mojoris on VIC in 2012 with some more info on the Allied Nevada stage of the operation. Hycroft emerged from bankruptcy in late 2015 with funding from Mudrick, Whitebox, Highbridge, Aristeia Capital, and Wolverine Asset Management. The company has since been working on a demonstration plant for it’s new heap leach and oxidation process for extracting gold and silver since, with a focus on raising money to complete it’s ramp-up process before hitting scale production.

The mine has produced >2.0mm ounces of gold and 7.5mm ounces of silver historically, and according to a press release “hosts one of the world’s largest gold and silver deposits, with proven and probable mineral reserves of ~18 million gold equivalent ounces”. 

Enter MUDS, a SPAC run by Jason Mudrick and Mudrick Capital, a renowned distressed debt investor, which reached an agreement to take Hycroft public in January 2020.

MUDS Transaction

The MUDS transaction, primarily executed by the Hycroft shareholders, was designed to give Hycroft a more attractive capital structure, give the company cash for the ramp-up phase of production, and take the company public.

  • Transaction Cash Sources: The cash from the transaction comes from a combination of:
    • $12.4mm SPAC trust value
    • $150mm Sr Credit Facility from Sprott Private Resource Lending II (of which $70mm is drawn)
    • $25mm forward purchase agreement from Mudrick
    • $75.96mm PIPE from pre-deal Hycroft shareholders
    • $30mm 1.5% net smelter royalty

  • Transaction Uses: The funds will be used to pay for: 
    • Ramp-up costs of the mine (projected at $65mm; this is “cash on the balance sheet” to be used for CapEx/OpEx/working capital in the ramp phase
    • $132mm debt paydown
    • $13mm transaction fees
    • $3.4mm in additional cash on the balance sheet (above that earmarked for ramp-up costs)

Also, $80mm of previous 1.25 Lien Notes was exchanged for $80mm of the new notes, giving the company a total indebtedness of $150mm pro forma.

The pro forma share count and capital structure are below (note the fully diluted share count uses the treasury method on the warrants with a strike price of $11.50 and a share buyback value of $14.25):

Hycroft Current Standing

The Hycroft business is pretty simple…they mine gold and silver to be sold into the market. The Hycroft mine is an open-put heap leach operation, which essentially means they use large (think millions of square feet) lined “leach pads” which ore (often crushed) is dumped onto and then chemical separators are dripped over the ore to extract (“leach”) the precious minerals into a solution, which is then drain down to the liner and out to be collected.  The gold and silver are then put into unrefined gold bars and metal-laden carbon respectively and sold into the market.

Activities at Hycroft began to re-ramp up in December 2018, with construction, refurbishment, crusher commissioning, hiring, and other mine restart activities beginning. Hycroft began active mining operations in April 2019, with gold and silver production beginning again in August 2019. The restart phase has been undertaken with the goal of demonstrating Hycroft’s unique oxidation and heap leach process. While the heap leach process mentioned above is relatively common, Hycroft has a unique process in which they oxidize the ore ahead of time using a proprietary process, which is designed to increase recovery and lower costs, as well as allowing onsite conversion from concentrate to gold bars (discuss Allied Nevada bankruptcy and shipping concentrate below). An outline of the process Hycroft is using below (per definitive proxy for the MUDS merger):

Since emerging from bankruptcy, Hycroft has completed a pilot test of the oxidation and heap leach process, and is now in production mode, working on scaling up. 8,593 ounces of gold were sold in 2019 and 52,036 ounces of silver were sold. They are in the process of constructing a new major leach pad, which should be completed in 2020, and will allow Hycroft to really begin scaling their production. The below slide from an investor presentation in May 2020 shows the scheduled production ramp as laid out in their feasibility study:

Hycroft also benefits from extremely low CapEx spend, which is driven by the large prior investment. Allied spent >$400mm on pre-stripping, infrastructure, roads, a crusher, refinery, truck shops, admin buildings, stripping the mine to the sulfide level, and more. Their oxidized heap leach method also helps reduce costs by not needing a mill and roasters for oxidizing the ore. This drives CapEx (in the feasibility study) at a fraction of peers:

This all drives the below FCF, based on underwriting gold prices of $1,300 and silver prices of $17.33, which drives a NPV -5% of $2.1bn. This is what makes HYMC so attractive. The NPV -5% has increased to ~$4.2bn due to current gold and silver prices while the stock has barely moved:

This is all laid out in the technical report/feasibility study, which for gold mining companies is an extremely rigorous (was put in place by regulators to help enhance oversight in the gold industry). These are standardized reports used for all gold projects. The technical report lays out an NPV -5%, which is what is typically used in valuing gold miners (especially early stage/junior producers), and gold stocks typically trade at a P/NPV off of this. As mentioned above, the NPV of HYMC has increased greatly with the increased stock price. The below sensitivity is per the technical report:

The below snapshot of our model just takes the production schedule used in the feasibility study and multiplies by current spot price (as opposed to the above set levels). We then discount back the cash flows at 5% (NPV -5%):

To get the updated NAV, we adjust the difference between the spot case cash flows above and the base case in the technical report. We backed into ~70% of the increased spot price being realized as cash flow per the gold and silver sensitivity (scale of operating costs). Taking 70% of the increased discounted cash flows and adding them to the unaffected NPV -5% used in the base case of $2.1bn gives us our updated NPV -5%:

Allied Bankruptcy

Most investors, us included, will look at the bankruptcy of Allied Nevada in 2015 as a cautious tale of the situation that raises some flags. However, there are a lot of differences between Hycroft and how the mine was positioned at that time. The three key differentials in our mind are:

  1. Debt Load: Allied Nevada had a debt load of >$540mm when it filed for bankruptcy. This compares with just $150mm in debt pro forma, with only ~$82mm in net debt. Allied’s debt load, combined with the below factors, ultimately restricted it’s flexibility and pushed it into bankruptcy. In addition, Hycroft’s current business plan is to ramp up slowly, using cash flows to support further expansion as they ramp up to run-rate production in 2027. This allows them to avoid raising additional capital beyond that done as part of the MUDS transaction, increasing operating flexibility and not needing to worry about excessive debt. 
  2. Gold/Silver Prices: Falling gold and silver prices, again combined with the high debt load and flawed mining/extraction process hit all at the same time, a perfect storm that took Allied under.

  1. Mining/Extraction Process: The mining and extraction process suffered from a few setbacks, which ultimately led to the current oxidation and heap leach process that they are using now.
    1. Concentrate Shipping: Allied shipped concentrate instead of producing gold onsite as Hycroft is doing.  The former CEO called this their “biggest technical flaw” as shipping concentrate is very difficult due to conditions outside of the US. Hycroft producing gold doré onsite should help to eliminate this risk and lower the working capital tie-up.
    2. Costs: As mentioned, the current oxidation process is decreasing the all-in costs for Hycroft. Many mines have struggled with economically justifying the expensive costs of mining, and given the lower ore grade in the Hycroft mine, it is more sensitive to these costs. The goal of the initial oxidation methods was to develop an economically viable process that would be less expensive to build and operate than autoclaves, in addition to the above goal of eliminating the need for offsite concentrate sales.
    3. Lime/Cyanide Process: At Allied, they ramped up production very quickly at a time when lime supply was in shortage. The original heap leach process (without oxidation) involved pre-treating the ore with lime, stacking it on the leach pads, and then dripping cyanide over the ore to leach the precious metals. With a lack of lime available, Allied continued to dump ore onto the leach pads anyways and planned to “catch up” by dumping additional lime on the ore as it came in and hoping the cyanide solution would disperse the lime down. This created two problems: (1) working capital became excessive as large amounts of ore were dumped onto the leach pad that wasn’t processed (inventory just sitting on the leach pad) and (2) when the lime was dumped on in bulk and got wet, it hardened and formed a barrier which slowed the leaching process by creating a barrier the pregnant solution could not get through. This stopped Allied from reaching it’s production and revenue targets. Below is a link to a lawsuit on the matter discussing in more detail if interested: http://securities.stanford.edu/filings-documents/1051/ANGC00_01/2016113_r01c_14CV00175.pdf.
      1. Hycroft will not suffer from the same issues as (1) the oxidation process results in less ore being stacked at a time and has Hycroft laser focused on monitoring both mill conditions and leach pad conditions and not having supply issues similar to the above and (2) the slower ramp in regards to production mentioned as a deterrent to issue 3(b) above [costs] also has the added benefit of not having Hycroft rush to ramp production without proper pre-treatment.

Valuation

As mentioned above, the main way to value junior gold producers is using a P/NAV multiple. Differences in multiples can be attributed to factors such as the jurisdiction (Tier 1 = safe or lower tier where the government could seize the asset?), number of assets (single asset will be higher risk), grade quality, life of mine, size of deposit, etc.

As seen below, multiple presentations from competitors listed in Hycroft’s proxy for the MUDS merger show potential comps trading at P/NAVs mostly ranging from 0.5x-1.0x. 

  • Alamos Gold trades at 1.03x, and their “intermediate” producer average traded at 1.14x, although this is likely not the best comp given the ramp-up state of Hycroft:

(per Alamos Gold July 2020 Investor Presentation)

  • Victoria Gold is probably the best comp for Hycroft. Victoria is a single mine asset in a safe jurisdiction (Canada) which is ramping up production. Hycroft management has said they see Victoria as slightly behind them in terms of production ramp up. Victoria had done ~38k oz through June 2020, while Hycroft is targeting ~90 oz of gold equivalents (silver oz converted to gold based on$1,900 gold vs $22 silver). Per Victoria’s investor presentation, they see themselves trading at 0.74x P/NAV vs an average of comps they are targeting of 1.11x. This also aligns with BMO, who in their PT on Victoria said they are using a target multiple of 1.25x P/NAV -5%, which they say is “toward the top of the range of developers approaching commercial production and appropriate for the quality of the Eagle mine and jurisdiction”. 

(Victoria Gold July 2020 Presentation)

  • Argonaut Gold, another comp listed in the Hycroft definitive proxy, trades at 0.43x P/NAV. They list their peer average at 0.9x (typo aside) in their most recent June 2020 investor presentation:

(Argonaut Gold June 2020 Presentation)

  • Finally, Hycroft listed Junior Producers as it’s comps below. These trade at an average multiple of 0.65x :

(Hycroft May 2020 Presentation)

HYMC current trades at just 0.16x P/NPV -5%. Below shows potential price targets at: (1) Argonaut’s 0.43x multiple per their latest investor presentation, (2) the median multiple from HYMC’s May presentation for Junior Producers, (3) Victoria’s multiple per their latest presentation of 0.74x, and (4) the average of Victoria’s peers listed in their presentation of 1.11x (still a discount to BMO’s target multiple for Victoria):

We can get comfort with the current valuation, downside protection, and a sense of value based on the rally in peers since the deal was announced, the capital invested to-date, and the historical value of Allied Nevada (which is the exact same asset):

  • Peer Peformance: The peers listed in the proxy have rallied an average 47.3% since the deal was announced (median 40.3%) and both sides determined $10 was fair value. GDXJ is up 45.6%. As mentioned above, gold prices are 46.2% above the technical report and silver prices are 31.5% above. Hycroft is only up 9.6%.

     

  • Allied Nevada Historical Value: Allied Nevada was a $4bn+ market cap company at it’s peak. While it can be argued that this was clearly overvalued given the ultimate bankruptcy, it points to the potential value of the minerals in the mine if operated properly. Allied Nevada’s largest issues were operational, and had they been able to execute it could be argued this $4bn valuation, representing ~$70 a share, was fair. 

  • Capital Investment: To date, there has >$600mm in capital invested in Hycroft, whether it was from the old Allied Nevada, or current investors in things like crusher refurberation.  That gives the current Hycroft just a 1.2x EV/Capital Invested ratio, pointing to downside protection.

 

Upside Optionality

While the price targets above based on peer multiples already represent extreme share appreciation, there is also the potential for further upside optionality:

  1. Higher Recovery Rates: The technical report on which the NPV -5% is based for HYMC uses recovery rates of 65% for gold and 71% for silver. As mentioned in the presentation, recovery rates of >80% have been observed with what has been produced so far. A large part of this is due to higher oxidation levels due to being on heap leach pads outdoors, and was to be expected. This should be a repeatable result. 
  2. New Tech Licensing: HYMC has a patent pending on their oxidation and heap leach process. They mentioned the benefits of (1) lower costs to operate, (2) ability to easier produce gold doré vs concentrate, and (3) the higher recovery rates seen. This technology is being patented (patent pending) and could eventually be licensed to other companies or garner a higher multiple.
  3. M&A: As a scaled, single asset in an attractive jurisdiction, there is scarcity value to HYMC. This could result in them being an attractive takeover target for a major.

Risks

  1. New Tech: The largest risk is that the new oxidation and heap leach process does not work as well as planned. Despite being tested, having a pilot program run, and now being produced at a ramp-up level, it has not yet been proven at full scale operations. If this process does not work, there is a risk the mine economics could be more expensive and thus the NPV would be lower.
  2. Working Capital: Alongside this, there is a risk that working capital issues could hurt the company. Once the ore is on the leach pad, it is essentially working capital and ties up cash flows until it can be leached, processed, and sold into the market. If HYMC tries to ramp-up too aggressively like Allied did, or the oxidation process gets thrown out of wack (it would not destroy the product, but would need to be re-oxidized, thus increasing the delay in realizing the cash flow), they could end up with large amounts of working capital and need to raise additional funds, diluting shareholders or increasing debt.

     

  3. Warrant Buyback: A warrant buyback could be both a catalyst and a risk. As a risk, Hycroft could realize the inherent value and offer to buy out the warrants for a substantial (but still heavily discounted) premium. A 30% premium may entice warrant holders to take their profits and run, but they would be leaving multiples of that on the table. 

Catalysts

  1. Sell-side coverage initiating & further company marketing

  2. Enhanced mining: Victoria points out in their presentation how producers >200k oz a year garner a higher multiple. This will also show that the technology works at scale. HYMC is ramping up this year with the addition of another leach pad, and in 2021 should see much larger volumes of production.

  3. Further increasing gold and silver prices

  4. Warrant buyback: While this is also a risk as mentioned above, clearly this would be a catalyst to demonstrate the value and result in a quick pop

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Catalysts

  1. Sell-side coverage initiating & further company marketing

  2. Enhanced mining: Victoria points out in their presentation how producers >200k oz a year garner a higher multiple. This will also show that the technology works at scale. HYMC is ramping up this year with the addition of another leach pad, and in 2021 should see much larger volumes of production.

  3. Further increasing gold and silver prices

  4. Warrant buyback: While this is also a risk as mentioned above, clearly this would be a catalyst to demonstrate the value and result in a quick pop

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