Description

I believe Mawson West Ltd (MWE) trades at ~1x 2015 earnings and 25% of NPV. Current earnings will expand with the commissioning of MWE’s main copper project, Kapulo, in the DRC.

MWE was 1^st written up on VIC in Sept 2013 by value_31. 

Given its $50MM in net cash today, MWE will have little to no net debt after Kapulo is commissioned, generates cash from its Dikulushi project through 2015, and trades at half of book value despite insider buying in the summer of 2013 and my projected 2015 free cash flow of $70MM at current copper futures curve.

Given a 2015 free cash flow yield of ~100% at current copper futures prices, MWE allows for the creation of an exceptionally cheap synthetic copper put.

I believe MWE is undervalued because investors’ perception of the political, execution, and trading illiquidity risks are much higher than my view of such risks.

DRC political risk: higher taxes or confiscation of mining license/nationalization

I have seen only one instance where the DRC confiscated the mining assets of a public company. In 2010, the DRC confiscated First Quantum Mining’s 3 DRC mines. In 2012, as part of a settlement, First Quantum was paid $1.25bn for these assets, which had a pre-confiscation book value of $1.1BN. MWE’s African book value (ie assets in the DRC) at 12/31/2013 was $140MM. The following link provides color to this history and the DRC’s attitude toward corruption:

http://www.canadianbusiness.com/business-strategy/how-first-quantum-settled-with-enrc-for-compensation-over-congolese-mine/

Skeptics may cite DRC’s mid 2013 ban on exporting copper concentrate as reason for MWE’s cheap valuation. My response is that DRC has rescinded this ban 3 times over last few years and most recently acknowledged that the lack of power supply in the DRC makes such bans unreasonable. MWE insider buying and MWE’s continuing investment in Kapulo underscores my response.

A counterargument to my response is that the DRC announcing these bans shows a lack of DRC stability or thoughtfulness. My counter is that the DRC has had many years to confiscate mines, especially when copper was near its peak, yet I have seen it do so only once and paid for it later. Moreover, Glencore recently added to their DRC exposure by buying more of Katanga Mining and Freeport McMoran, Lundin Mining, and Ivanhoe Mines will invest billions on brownfield expansion (Tenke Fungurume) and greenfield development (Kamoa). 

MWE’s largest shareholder, MMG, is owned by the Chinese govt, which has invested billions in the DRC. MMG bought the former parent of MWE, Anvil Mining, in 2012 at a long term copper price of at least $3 per lb, indicating MMG’s comfort with DRC political risk.

In an Oct 2013 interview, MMG’s Congo General Manager stated MMG seeks to expand in the Congo and/or neighboring Zambia:

“MMG strongly believes that the DRC and the Copperbelt represent tremendous opportunities and we want to expand our footprint here (in the DRC or Zambia), while making sure that our presence will positively influence the economic prosperity of Katanga and its people.”

 (Source: http://gbroundup.com/2013/10/24/miles-naude-general-manager-mmg-congo/)

The DRC has had reason to revoke MWE’s mining license given an over 1 year old disagreement with MWE on taxes. MWE’s 2012 annual states that the DRC has claimed $6MM in tax that MWE does not believe it owes (see Contingencies Note 27 in 2012 annual report and page 18 of 2013 annual report). If MWE sensed high risk of confiscation, such extended disagreement would be unlikely.

Perhaps to change public perception, the DRC has publicly stated its intent to lower the stakes it is granted in new projects.  In a March 2014 Reuters article entitled “DRC may relook state share in mining projects” the DRC states they have lowered the DRC’s proposed stake in new mining projects from 35% to 15% and are now “discussing moving down to 10%.” On a negative note, they are still discussing tripling royalties from 2% to 6%.

The DRC does not want to alienate foreign capital, especially Chinese, given plans by foreign investors to double DRC copper production over the next several years and develop other DRC resources (oil, gold).  

Execution risk:  2 components: Kapulo financing and production risk

Financing risk: can MWE finance Kapulo?

MWE is waiting on lenders to fund the last third of its flagship project, Kapulo. They indicate Kapulo will be commissioned in 4q14, which requires imminent funding.

Why I believe the financing will occur:

MWE obtained $30MM in loans for its Dikulushi project and the Kapulo project seems robust based on feasibility study, grades, and current copper price.

Given MWE has repeatedly disappointed investors (see value_31 writeup regarding “inflection point,”  the surprise equity financing in late 2012 and the Kapulo project commissioning delays), the replacement of MWE’s CEO and CFO due to such disappointments , and the insider buying in mid 2013, I believe they are sensitive to further disappointments . If they saw big obstacles to Kapulo’s financing, I doubt they would intentionally disappoint investors by perpetually delaying imminent funding and have continued investing in Kapulo (they invested $3.3MM in 4q13).

I encourage skeptics to call MWE management and/or raise this question on the next public call.

Production risk: will Kapulo production and costs resemble those in its feasibility study?

~90% of copper production globally is at $2.25/lb or below while 50% of production is at $1.50/lb or below. The Kapulo feasibility study projected an average of $2/lb cash cost, including sustaining capex and royalties, neither being material. MWE has stated it intends to build a larger project than the one in the feasibility, lowering the cost per lb as higher fixed costs are more than offset by larger production.

In short, Kapulo’s break-even EBIT copper price should be between $1.50/lb and $2/lb.

Given Kapulo’s 3% copper grade (which I understand is 3x the global average) and my assumption that the cost will be below $2, I take the mid-point, $1.75/lb as EBIT break-even. Kapulo will not pay taxes for first 5 years of production as new projects have a 5 year tax holiday.

Catalyst