Description

If you believe in a long-term bull environment for gold supported by increased BRIC buying and world-wide inflation, then HGC is a company with clear valuation visibility 1 year out, and with a solid business plan in place for increasing value over the next 5 years. The company is a near-term production situation, with a solid growth profile of advanced exploration assets, as well as the pedigree and connections needed to acquire accretive projects.

Hawthorne gold went public in April of 2007 with a mandate to acquire gold assets in British Columbia, Canada and bring them into production. The assets being targeted are specifically those that have incurred millions of dollars in expenditures in the past, in order to all but eliminate exploration risk. BC was chosen because it is one of the best jurisdictions in the world for mining in terms of political risk. Ounces of gold resources or gold production located in BC receive the highest market valuations of any in the world.

The synergies involved in having a stable of projects with close geographical proximity are important to this story: the company is able to hire operations, permitting and senior geological staff and utilize them to capacity year-round; drilling teams and construction teams can circulate between properties, giving the company economies of scale and more bargaining power with employees, suppliers and contractors; travel expense is a minimum. Overall, proximity greatly reduces timelines in getting to production, as well as associated costs.

The company also enjoys excellent connections with financial markets specifically in Europe where the company, and its sister company Adriana Resources (iron ore), have raised the bulk of their funds through institutional private placements on a non-brokered basis.

Management

Management pedigree is absolutely critical when purchasing a junior mining company. Richard Barclay and Michael Beley, the team that founded Eldorado Gold and Bema Gold, head up Hawthorne. They are veterans of the gold industry and have put mines into production again and again.

Mike Redfearn, VP Operations, is a veteran mine manager. His experience includes 15 years with Teck Cominco’s largest operations including Red Dog; mine manager of the CanTung tungsten mine in NWT; and lead on feasibility work for bcMetals’ Red Chris project, the success of which led to a takeover by Imperial Metals. The company has the team in place to be producing today, which is rare in a junior mining company of this size.

Mr. Redfearn’s experience is important because he has spent his career in the same operational environments (in terms of terrain, grades, metallurgies, environmental and Native American considerations, etc.) in which all of HGC’s projects are located. The similarities between the Red Chris project and the Frasergold and Taurus projects are striking. This gives investors the confidence of knowing that capex, cost, throughput, and other estimations used by management in assessing the long-term viability of these advanced exploration projects are realistic.

Jim Sparling, leads the technical team, an incredibly well-respected geologist. Pat McGrath, CFO, 36, is a very sharp guy, young and very hungry.

Merger with Cusac Mines

Recently the company signed a definitive agreement with Cusac Gold Mines, another junior miner. Cusac has been a family run company for 20 years. The projects were discovered by the family patriarch, and many of the senior management and employees at the mine were family members. The company operated in a lurching stop-start manner, raising small amounts of capital opportunistically every now and then when the gold price was up a little. The company never engaged in a systematic, professional geological assessment of its claims.

Last year, following an issue of convertible debentures against which the company pledged key assets (including its permitted, operational mill and tailings facility), the company erred in its geological modeling and failed to recover gold. A water problem in an underground drift, caused due to improper setup (i.e. not accounting for water seepage) hampered production. Without the money to pay the coupons on their debentures or the option payments on their Taurus property, the company was teetering on the edge of bankruptcy. Enter Hawthorne.

The market has yet to understand the importance of this merger, as it is transformational for the company.

Projects

Table Mountain-Cassiar Belt-Northern BC

Acquired from Cusac gold mines. This is a high grade 15gpt underground vein system, which has produced off/on for 20 years. The project has been de-risked as much as a gold project can be. The metallurgy is proven, and gold is recovered using very easy gravity/flotation extraction. This is the preferred low cost method of recovering gold. Current resources are of about 40k oz which is common of a smaller underground operation. The property has a fully permitted and operational 300tpd mill and tailing facilities. The mill is easily expandable to 400tpd, according to management. Replacement value on the PP&E alone in the current environment is estimated by management to be north of $20M. Resale value would be much lower, however, around $10M. The company is currently in talks with several institutions regarding a senior secured loan against the PP&E at Table Mountain.

The company plans to do underground development work starting spring 2008, to delineate 1-2 years mine life, then begin producing immediately. At 300 tpd, 15gpt, payable gold production is of +40Koz/yr, with cash costs sub $400/oz (implied costs of about $180/tonne ore all-in). Production is targeted to start early 2009. The company will then look to expand production to 50-60k oz through a mill expansion.

Pre-tax cash flow from this asset using $900 gold: roughly $20M

Conservative valuation on this asset assuming production of 40k oz: $100M

The company intends to use cash flow from Table Mountain to help fund development of their larger projects in order to limit dilution.

Taurus has a 43-101 compliant, 1M oz open pittable resource grading 1.04gpt. Mineralization begins directly at surface and is highly continuous. Again mineralogy here is very simple quartz hosted, disseminated gold mineralization, with extraction and high recoveries not a problem. Several recent drill holes not included in resource estimate have been very promising, indicating much higher grades than those included in the resource number. There appears to be a high grade zone of 6gpt about 15m thick. The company believes there is the opportunity to easily add 1Moz to this deposit during 2008 through additional drilling. In the 1980’s, a resource company named Cyprus put together a 2.5M oz resource on these same claims, but the data is not NI 43-101 compliant, and so is not relevant.

The company is planning a 10k tpd operation, open pit, producing roughly 90koz/yr of payable metal. Production is targeted to start in 2012. Capex is likely in the range of 150M-200M (adjusted for future capex inflation). This production scenario would naturally be expanded if exploration shows a 2M+ oz resource.

Ultra-conservative valuation on a 2M oz resource located in BC: $100M - $125M

The project also has great infrastructure, with a paved road to within 40km, all year road after that. Power lines to 30km. Previous operators in the 1980s approached the project looking for high grade zones and hoping to mine underground. HGC will take cutoff grades down to 0.3gpt (from the 1.1gpt used on the historical 350k oz resource) and mine lower grade mineralization in between lenses along with the high grade zones. This will result in a blended head grade of about 1gpt in an open pit operation with a low strip ratio of about 1:1, since mineralization begins almost at surface.

The company believes the 2008 drill program should yield a minimum of 2Moz on 2km of strike, and this resource will be used for preparation of the feasibility study. There is a further 8km of strike that the company intends to explore in years to come. The development steps here are very similar to the Taurus project. The goal is production in 2012, at roughly 25,000 tpd for about 240k Oz per year. Likely capex of around 250M-300M (adjusted for future capex inflation). This project is VERY comparable to Kinross’ Paracatu in terms of mineralogy. Kinross uses throughput of 50k tpd, and is able to drop their cut-off grade to 0.18gpt, with a blended head grade of about .45gpt. http://kinross.com/operations/brazil-paracatu.html

Ultra-conservative valuation on a 2M oz resource located in BC: $100M - $125M

Sum of project valuations: $300M - $350M

Milestones achieved by roughly Q1 to Q2 2009

Current Share Structure - Rough numbers

Shares after merger with Cusac: 23M (27M FD)

Insiders: 5M (7M FD)

Institutions: 4.5M (6.5M FD)

Shares from merger: 7M

Shares in float: ~5M

MCAP at $1.99 = $46M ($54M FD)

These numbers point to a valuation north of $6-8 per share within 12-16 months, even assuming large amounts of dilution. Debt financing could potentially make equity ownership even more accretive.

With respect to downside, if only one of Hawthorne’s 3 projects turns out as expected, the company is worth twice the current price, even with dilution. Also, we don’t need to wait too long to find out, as success or failure will be apparent within 12 months.

Looking into the future, the company could potentially be a producer of 300k oz per year by 2012, and could be generating $150M of pretax cash flow using a pretax margin of 500$ per ounce. Average market valuations of 10x pretax cash flow for a producer of this size would indicate a market cap of $1.5Bn, and an average multiple of $3,000-$4,000 of MCAP/OZ of Production indicates roughly the same.  This is obviously a long way out, and plays no role in evaluating the current buying opportunity.

Catalyst