Description

·         Noranda Income Fund, an entity designed to provide stable dividends to shareholders, has been oversold due to newly added cautionary language about the end of the supply agreement between Glencore and Noranda Income Fund

·         As a going concern, the Fund is valued today at C$5.12 per share, a 84.2% a premium to the current share price,

·         In an unlikely conservative liquidation scenario, the Fund is valued today at C$3.55 per share, a 27.7% premium to the current share price excluding the value of the smelter itself or its over 800 acres of industrial real estate near Montreal and tidewater

Noranda Income Fund (“NIF” or the “Fund”) owns a zinc smelter (the “Facility” or the “Smelter”) in Quebec, Canada. The Fund was spun off from Noranda Inc. (which was since acquired by Glencore plc) in 2002, and was created to take advantage of the unique income fund structure in Canada. Noranda Inc. received C$225 million in proceeds in exchange for 45% of the Fund; the IPO valued NIF at C$500 million. Noranda Inc. transferred the Facility to NIF and signed an agreement to supply 100% of the Fund’s zinc concentrate requirements for processing for 15 years (the “SPA” or “Supply and Processing Agreement”) until May 2017. In 2002, the SPA began with a processing fee of C$0.352 per pound of zinc metal and had a 1% price increase per year and an adjustment for cost inflation. The initial price as contemplated in the SPA was considered the market price for processing zinc in 2002. The current price paid under the SPA of C$0.40 per pound of zinc metal is approximately 50% above current market rate.

The Fund has been popular with yield-oriented investors as the SPA allows the Fund to produce predictable and consistent cash flows and dividends in the typically volatile commodity sector. The Fund has traded around C$5.00 since 2010 until its Q3 results were released on November 11, 2014. New cautionary language about the end of the SPA and the future viability of the Smelter without the SPA caused the share price to decline over 50%. The statement is in the FAQ at the end of this document.

The decline in the stock price is overdone. The end of the SPA has been well-known since the creation of the fund and is not a surprise. While the amount of the dividend will be much less predictable beyond the life of the SPA, the current stock price is below the value of all of the most likely scenarios.   The Fund will most likely have lower cash flows without the SPA but it is a large smelter that has been consistently upgraded, uses low cost hydropower and sits close to tidewater and as such is likely to remain competitive. In addition, with the collapse in the share price, even in the remote liquidation scenario, investors have minimal downside.

For NIF, there are three possible scenarios after expiration of the SPA: 1) receive market price smelter charge, 2) distribute the liquid assets and close the Facility, or 3) acquisition of the Fund by Glencore or others. For the purpose of this discussion, acquisition scenario was left out. At current price of C$2.78 per unit, the chart at top shows a significant upside to the current pricing.

NIF derives its revenues from three sources:

·         Smelting charge (75% of revenue): Glencore sells zinc concentrate to NIF for 100% of its processing capacity at a C$0.40 discount to the zinc price, and Glencore subsequently purchases the refined zinc concentrate at market price. Essentially NIF receives a C$0.40 per each pound of zinc it processes. NIF receives value for 96% of the zinc contained in the concentrate[1] (known as “payability”), and has been achieving 97%+ in recovery.

·         Zinc premium (12% of revenue): A premium is paid due to the Facility’s location (taking advantage of differential between transportation and logistics costs), as well as marketing and product mix.

·         By-product (13% of revenue): Copper is recovered from the zinc ore and is sold at a 100% profit to NIF. Sulfuric acid is produced as a by-product and is sold to market.

The revenue breakdown somewhat differs from other smelters. Generally, the smelter charge would represent a smaller percentage of the revenue and the free metal component would be greater. Nyrstar typically receives 69% of its revenues from smelter charge[2], 24% of revenue from by-products and 7% of revenue from premiums. Compared to Nyrstar, NIF receives higher premiums due to its proximity to market and product types.

NIF has had stable EBITDA since its inception in 2002, with the exception of 2008 and 2009 due to global economic downturn. Filings from that period stated that the sales agent was unable to arrange for sales and/or temporary storage of sulphuric acid, thus NIF reduced production by 20%. In addition, lower zinc premiums and price deterioration of the by-product negatively impacted the Fund in 2009.

Smelting costs are primarily based on energy (electricity), consumables and labor.

Since going public in 2002, the Fund’s Agent (as defined in the SPA as one providing the concentrate) has changed hands multiple times. In August 2006, Noranda, in its new name, Falconbridge, was acquired by Xstrata. A few years later, Glencore acquired Xstrata Inc in February 2012.

In 2010, prior to the expiry of the tax-free status enjoyed by the shareholders through the Income Trust structure, Xstrata and NIF entered into a non-binding letter of intent regarding the potential acquisition of NIF by Xstrata, initially at C$3.40 per unit. The offer was improved to C$3.90 in August, but the revised offer was rejected by an Independent Committee set up by NIF. The CEO of Xstrata Zinc stated that its proposal was to “consolidate (the Facility) into Xstrata Zinc’s global operations to secure its long-term future and on our considered view, as the operators and managers of the asset, of its prospects on a standalone basis.”

In 2011, Xstrata responded to NIF’s shareholders that Xstrata has no current intention to continue to supply the Facility beyond the expiry of the SPA.

According to the International Lead and Zinc Study Group, 12.8 million tonnes of zinc metal was refined in 2013 and the ten largest zinc producers accounted for 5.8 million tonnes or 45% of the global production. Noranda is the tenth largest zinc producer, representing 2% of global production. Notably, Glencore produced 651,000 tonnes of zinc, or 5% of global production.

There are five smelters in North America and NIF’s smelter is the second largest smelter after Teck’s Trail Zinc plant in British Colombia. The others include Nyrstar’s Clarksville refinery (122,000tpy) in Tennessee, Industrias Penoles’ smelter in Mexico (231,000tpy), Hudbay Minerals’ zinc smelter in Flin Flon (115,000tpy) and Southern Copper’s La Caridad asset (110,000tpy).

Other zinc refiners include: Korea Zinc Group (Korea, KS:010130, EV: US$6.1 billion), Nyrstar (Europe, BR:NYR, EV: US$2.0 billion), Hindustan Zinc (Asia Minor, NS:HZNC, EV: US$10.9 billion), Votorantim (South America, Private), Boliden (Sweden, ST:BOL, EV: US$5.2 billion), and China Minmetals Corp (China, Private). Of these competitors, Nyrstar and Boliden would be the closest comparable to NIF.

General zinc information can be found in the FAQ.

The Fund currently has a market capitalization of C$139.0 million and C$85 million of debt as of Q3/2014. The Fund pays for the concentrate in advance and receives the full value of zinc upon sale of the metal. Thus, its working capital requirements are high. At the end of Q3/2014, the Fund had a net working capital balance of C$125.7 million, which included C$153.5 million in zinc concentrate, C$88.5 million in accounts receivable, and C$116.3 million in accounts payable. At an EV (unadjusted for working capital) of C$223.3 million, the Fund is trading at 1.8x 2015E EBITDA.

The Fund was assumed to continue to produce ~265,823 tonnes of zinc metal per year. This is in line the 2013A production of 265,242 tonnes. Revenue from by-products was assumed to be in line with 3-year historical percentage of total revenue and a zinc premium of US$0.102/lb.

NIF currently carries approx. 20,000 tonnes of zinc metal as finished inventory (which included 5,000 tonnes in Q3/2014), which was assumed that the Fund would continue to carry on a go-forward basis. The 20,000 tonnes of zinc metal has a value of ~C$45.6 million (at US$0.90/lb zinc price).

Both the zinc premium and by-products are priced in US$ and a weaker C$ has a modestly positive impact on profits during the terms within the SPA. US Dollar-Canadian Dollar exchange rate was assumed to be C$1.18 per US$1.00 (vs. current US$1.00=C$1.245)

NIF experienced a challenging second quarter in 2014, as unplanned maintenance outage and equipment failures reduced operating capacity and zinc metal production was lower. The Q3/2014 results returned to normal and, as such NIF’s financial projections were estimated based on 2013 levels.

Quarterly costs for energy, labor and operating supplies were estimated at C$16.5 million, C$16.5 million, and C$10.0 million, respectively, vs. five year averages of C$15.4 million, C$15.1 million, and C$9.6 million. Quarterly SG&A cost was estimated at C$6.0 million, vs. the 5-year average of C$5.2 million.

Payables and receivables were kept as is, in comparable days, as historical average over the last three years. Capital spending is assumed to be ~C$30 million per year. Capital expenditures have averaged C$24 million annually over the last 10 years, though in 2013A, NIF spent C$33.4 million to add silica removal circuit. 2012A and 2011A capital expenditures were C$27.0 million and C$27.3 million, respectively.

Based on these figures, the Fund is estimated to produce cash flow that is able to not only support the C$0.50 per year in distributions, but also would generate material additional free cash flow. The Fund’s EBITDA and free cash flow are expected to be ~C$125-130 million and ~C$95-100 million, respectively in 2015 and 2016. The 2015E EBITDA of C$126.8 million is approximately C$12 million greater than 2013A EBITDA due to 1) higher smelter charge of C$0.404/lb in 2015E and C$0.395 in 2013A, 2) CAD-USD exchange rate of C$1.03 vs. C$1.18, and 3) higher operating cost in 2013A due to maintenance activity that resulted from operating issues in the roaster section.

Catalyst

NIF’s agreement with Glencore will expire in May 2017. The cumulative distribution until expiration of the agreement is projected to equal C$1.21 per share, assuming the current distribution rate of C$0.50 per year. At a 5% discount rate, the NPV of the distributions equal C$1.14. The 5% discount rate is justified due to the steady nature of the distributions and contracted smelter charge.

In that time period, the Fund will continue to pay down its senior debt by C$15 million each year with a final payment of C$15 million due in Dec 2016. At the end of Q1/2017, the Fund is projected to have C$55.4 million in cash (C$1.11 per share), C$132.8 million in net working capital (C$2.66 per share) and no debt.  It is projected that NIF would have approx. C$50 million in rehabilitation and employee-related liabilities based on its 3Q/2014 balance sheet.

According to management (who are employees of Glencore), Glencore may choose to continue to supply 100% of the Fund’s concentrate requirement after the SPA. Continued supply of the concentrate would be priced at the market rate, rather than the inflated C$0.40 per lb. Alternatively, Glencore could choose to terminate the SPA in May 2017. Glencore needs to notify NIF 180 days prior to the termination date of its intention. 

The market rate is determined by three factors: 1) contracted pricing vs. spot pricing, 2) smelter charge, and 3) payability. For this discussion, the smelter charge referred to throughout the document takes all three factors into account. For further discussion on the market rate, please read the FAQ (Questions #13 and 14).

There has always been uncertainty about the intention of Glencore and the impact on NIF’s stock price.  Glencore is among the largest zinc smelter owners in the world.  Glencore recently closed down a smelter in New Brunswick after the closure of a nearby mine.

There are, however, reasons to believe that Glencore would continue its relationship with NIF or that they would acquire NIF itself. NIF’s asset is managed and operated by Glencore, and recently C$30 million was spent on a silica removal circuit to improve its efficiency and ability to receive other types of concentrate. NIF spent C$240.8 million in capital expenditure over the last 10 years. Glencore is continuing to ramp up its Bracemac-McLeod asset in New Brunswick and Trevali Mining’s (TSX:TV) asset could also potentially provide part of the necessary feed.

Glencore’s continued operation with NIF at the forecasted smelting charge rate in 2017 would materially affect profitability. At US$0.212 per lb smelter charge (C$0.2507/lb), EBITDA would drop from ~C$129 million to ~C$38 million per annum. Nyrstar’s current term charges are estimated at approximately US$0.20-0.23 per lb of zinc metal.

If Glencore terminates the SPA and NIF is unable to secure concentrate supply, NIF may be liquidated. After paying distributions through May 2017 and liquidating working capital, the Fund is estimated to have C$246.7 million in cash (C$4.93 per share). The Fund would be liable for rehabilitation of the asset and employee benefits, which are estimated at C$33 million and C$17.6 million, respectively. These figures were estimated based on latest balance sheet estimates plus $2 million per year in additional expenses. As higher closure costs are a real risk, at 150% of booked cost, the Fund would still have C$151.5 million in cash (C$3.03 per share).

In a liquidation scenario, the Facility would be available for sale. Without Glencore’s control of the asset, other players such as Nyrstar, Boliden, and Korea Zinc may be interested in gaining market share.

Boliden recently spent US$51.4 million to increase capacity at its Odda smelter in Norway by 30,000 tonnes (implying US$1,733 of capex per tonne).[1] Based on such figures, The Facility would be valued at US$460 million. In addition, though new western zinc smelters are being contemplated today, the Odda comparison and NIF’s cheap hydro power and location on water makes the likelihood of closure small. Replacement value of the Facility is estimated at $1 billion, though there are very few, if any, greenfield zinc smelters developments outside of China.

The Facility is located 60 miles southwest of Montreal, on the St. Lawrence River adjacent to the Valleyfield Port. The 886 acre land position provides underlying value, albeit the land may be contaminated from 50+ years of zinc processing operations. Industrial lands in the area typically are valued at C$2-3 per square foot, implying total land value of C$75-150 million.  There would be additional value in the scrapped plant, however, as a conservative measure, the C$3.03 per share liquidation value was kept with an assumption of the value of the land and the scrapped facility at zero.

NIF’s valuation should be divided into two parts: 1) the Fund as is from now to the end of the SPA, and 2) the Facility from the end of the SPA, whether by operating in a market environment, by ceasing to exist, or being acquired.

Part 1: Now to End of SPA

The value associated with NIF continuing its operation under the existing SPA is best assumed on the distributions between now and end of the SPA. Assuming the same distribution made since September 2011 of C$0.50 per share annually, there would be a total sum of C$1.2084 per share in distributions made until April 2017, which would represent 44% of the current share price. NPV (5%) of the distributions equals $1.14 per share.

Part 2A: At the End of the SPA – Market Pricing

If Glencore continues its relationship under a new market pricing scheme, the Fund would break even before capex at approximately C$0.18 per lb (US$0.153/lb) of smelter pricing. At the base case of C$0.251 per lb smelter price (US$0.212/lb), the Fund would generate C$38.1 million in EBITDA and C$8.8 million in free cash flow.

The Canadian dollar weakness impact NIF’s profitability in a significant way. The original agreement in 2002 contemplated a US$1=C$1.558 exchange rate, bringing the smelting charge to C$0.352/lb price (US$0.226/lb at US$1=C$1.558). A change in Canadian dollar from $1.18 to $1.25 would increase the smelter charge from C$0.251 to C$0.266, EBITDA from C$38.1 to C$53.0 million, and free cash flow from C$8.8 million to C$20.7 million.

Second, spot vs. term pricing of the smelter charge would impact NIF’s profitability. Spot pricing is currently 34% lower than term pricing. However, NIF should not be expected to fill 100% of its capacity from the spot market. NIF’s business model should follow closely to OEM electronics manufacturers such as Foxconn because the smelting business would not be viable without a term contract.  As a result, smelters ex-China operate with a combination of term and spot pricing.

2018E EBITDA and free cash flow sensitivity to various smelter charges are shown below.

Nyrstar is currently trading at 6.5x 2015E EBITDA, and Boliden AB is trading at 7.1x 2015E EBITDA.[1] Assuming a conservative multiple of 5.0x 2018E EBITDA, NIF would be valued at EV of C$190.5+ million or C$249.6 million in market cap (or, C$4.99 per share). The value of the share discounted to today’s price at 8% discount rate would be C$3.98 per share.

NIF is expected to have C$59.1 million in cash and C$156.7 million in working capital at the end of 2017. The working capital would be funded via equity, and further upside would remain if NIF utilized moderate leverage. Nyrstar and Boliden are levered by 38% and 16% of total EV, respectively. For example, if NIF only borrowed 50% of accounts receivables and inventory, and bought stock/special dividend with proceeds, this would add C$2.12 per share (42.4% additional upside).[1]

Part 2B: At the End of the SPA – Liquidation

If Glencore terminates the SPA, and the Fund cannot secure zinc concentrate at a value above C$0.22 per lb smelter charge, then liquid assets totaling C$3.03 per share (or C$2.41 at NPV₈) could be distributed to its shareholders, net of liabilities.  

The Facility may be auctioned to zinc refiners such as Boliden, Nyrstar, or Korea Zinc. The smelter, based on brownfield capacity expansion capex, would be worth US$460 million. As noted above, the land value may be C$75-150 million. If the smelter is successfully sold, rehabilitation liability would be transferred to the acquirer and an additional C$76 million in cash earmarked for reclamation would be distributable to shareholders (C$1.51 per share, or C$1.20 at NPV₈). An acquisition by another smelter is much more likely than a liquidation.

Other potential may be that Glencore may take the Fund private. As noted above, Xstrata offered to pay C$3.90 per unit in 2010. An acquisition by Glencore is the most likely outcome. However, it has to be mentioned that NIF is controlled by Glencore. NIF has “independent” board members but they are most likely as “independent” as when the White House or the NFL performs an “independent” investigation. As a result, there is a real risk that Glencore hurts shareholders in the short run. The most likely scenario is cutting the dividend to zero. The stock price would most likely be impacted materially. However, the value of the business does not change and cash would instead build on the balance sheet and shares would be even cheaper compared to the ultimate value of the company.

The summary of the valuation is outlined below:

1.      When and how did Noranda Income Fund go public?

Noranda Income Fund went public with an IPO Prospectus filed in April 2002. The offering offered 22.5 million Priority Units at $10 per unit for a total of $225 million.

2.      Please explain the Income Trust/Fund structure in Canada.

Canadian Income Trust/Fund structure was a type of corporate structure as designated by the Canada Revenue Agency that operated as a profit-seeking corporation. This type of company paid out all earnings to unit holders before paying taxes, and was usually traded publicly on a securities exchange. In 2011 all Canadian income trusts lost their special corporate tax privileges, with the exception of real estate investment trusts (REITs) and were required to be converted into traditional corporate structures.

Most Income Trusts converted back to corporate structure to save on corporate costs (it is more expensive to run a trust structure than a corporate structure), but NIF did not convert. There are no laws that prohibit a trust structure, and NIF is taxed by the Canada Revenue Agency as a corporation. NIF’s tax rate is approximately 20%.

3.      What is the capital structure of the Fund?

NIF has two classes of units: Ordinary Units (12.5 million units representing 25% of the Fund) and Priority Units (37.5 million units representing 75% of the Fund). 100% of the Ordinary Units are owned by Glencore and 100% of the Priority Units are owned by public.

Distributions on the Ordinary Units are intended to be equal to those paid on the Priority Units except in a month where distributions on the Priority Units in the month are not at least C$0.08333 (C$0.07795 for May, 2002). Ordinary Units will be exchangeable for Priority Units on a one-for-one basis only after 15 years (or upon the occurrence of certain extraordinary events). Ordinary Units will have substantially the same voting rights as Priority Units. Ordinary units are not owed any dividends in kind.

4.      What was the cautionary language that was added in Q3/2014?

Distribution Policy and Outlook

When not restricted, and as may be considered appropriate by the Board, the Fund's policy is to make monthly distributions to Unitholders. In determining whether there shall be a distribution and the level thereof, the Board reviews periodically the Fund's financial performance, business environment and prospects, and determines the appropriate level of reserves. There is no assurance that distributions will continue in the future, nor is there any assurance that if they do continue, the level or frequency of such distributions will not vary from the level of the most recent monthly cash distribution.

The initial term of the Supply and Processing Agreement ends on May 2, 2017, and with it the favourable pricing of concentrate supply comes to an end. There is a risk that zinc concentrate in quantities and the blend of qualities necessary for the smelter to operate profitably may not be available after May 2, 2017. The Fund is considering several scenarios including the possibility that operations be discontinued. As a result, reserves may be required in advance of May 2017, including to provide for the costs related to a potential discontinuance of operations, with a corresponding effect on cash available for distributions.

5.      What are the details of the Supply and Processing Agreement?

·         Noranda will sell to NIF a minimum of 520,000 tonnes zinc concentrate and a maximum of 550,000 tonnes annually for 15 years at LME price (second month after delivery) less $0.352 per lb payable zinc metal processing fee

·         Beginning in 2004, there is a 1% increase annually in processing fee plus changes in electricity costs (+/- 10% of total processing fee)

·         After 2006, if Noranda sources supply from another third party, the same terms extended to the third party are applicable to existing SPA

·         After the 15 year term, the agreement automatically renews every 5 years unless the facility is sold or defaults

6.      What are the provisions of the extension of the SPA?

Section 9.03 of the SPA discusses the renewal term. It states (with inserted comments in blue):

Section 9.03 Renewal Term

Provided that (i) no Agent (Glencore) Event of Default has occurred and is continuing at such time, and (ii) the Operating Trust has not resolved (and given notice of such resolution to the Agent), at least 200 days prior to the expiry of the Term, to sell, transfer or otherwise alienate the Processing Facility on or after the expiry of the Term, this Agreement shall be automatically renewed for successive periods of five years unless the Agent provides the Partnership with written notice to the contrary at least 180 days prior to the expiry of the applicable Term. Any such renewal shall be on the terms and conditions hereof that the provisions of Section 7.01 and the related terms and conditions of the Basic Zinc Concentrate Arrangement in Schedule A (Terms and Conditions for zinc concentrate requirements) shall not apply and accordingly during any such renewal Term the Agent shall have no obligation to sell, as principal, to the Partnership and the Partnership shall have no obligation to purchase from the Agent any Basic Zinc Concentrate Requirements during such renewal Term. For greater certainty, during any such renewal Term, the aggregate requirements of the Partnership for zinc concentrate or other feedstock shall constitute Additional Feedstock Requirements (which stipulates in Section 7.02 that the Agent is to negotiate, settle, and enter into all Third Party Supply Agreements on behalf of the Partnership).

7.      Can NIF opt-out of the SPA?

NIF does not have the opt-out right from extension. Upon renewal, Glencore would effectively control NIF’s capacity, as noted in Sections 9.03 and 7.02 of the SPA. However, NIF may agree to sell the facility upon or after the expiry of the Term 200 days prior to the expiry of the SPA.

8.      Describe the management of NIF.

NIF is managed fully by Glencore through the agreements explained below. All management are Glencore employees.

NIF has independent trustees who are responsible for looking after the best interests of the unitholders.

9.      When did Glencore assume Noranda Inc’s portion of the agreement?

Noranda Inc. acquired Falconbridge Inc in June 2005 and changed its name to Falconbridge. In less than a year, Falconbridge was acquired by Xstrata in August 2006. Glencore’s acquired Xstrata Inc in February 2012.

In each of such cases, the acquirer kept its 25% interest in NIF and assumed the agreements in place. 

10. What other agreements are in place between Glencore and NIF?

In addition to the SPA, Glencore and NIF have the following agreements in place:

·         Administration Agreement

o    Manager will provide for the Fund all admin services (taxes, public filings, distributions, redemptions, etc) 

o    Initial 15 year term (began in 2002) and will automatically renew every 5 years unless terminated if insolvent, in receivership, or other party defaulted which is not remedied in 60 days

o    Manager receives no fee, but is reimbursed for direct and indirect costs/expenses

o    If Supply and Processing Agreement, the O&M Agreement and the Management Services Agreement are terminated, the Manager may terminate Administration Agreement if the processing facility is sold

·         Management Services Agreement

o    Manager will provide for Operating Trust development and implementation of strategic planning, annual business plan, acquisitions, etc

o    Initial 15 year term with automatic renewal every 5 years unless substantial deterioration of the business not caused by force majeure and will be voted on within 6 months by company's unit holders

§  Termination needs approval by a written resolution of Priority Unit holders and Special Fund Unit holders representing at least 66 2⁄3% of the votes 

§  Or approval at a meeting of holders of Priority Unit and Special Fund Unit holders by a resolution approved by the holders representing 20% of all votes in aggregate or cost basis, or 66 2⁄3% of the votes attached to the Priority and Special Fund Unit holders which are voted at the meeting

o    May also terminate upon same conditions of insolvency, receivership, non-performance of material obligation, or sale of processing facility

o    No fee, but reimbursed for direct and indirect costs/expenses

·         Operating and Management Agreement

o    Manager will operate and maintain processing facility and provide accounting services

o    Manager will oversee employment matters for NIF

o    Manager is responsible for Capital Improvement Plans to be approved by Partnership

o    Manager is responsible for processing, financial reporting 40 days after the end of the month, as well as quarterly/annual information

o    Will be reimbursed for fees, as well as $250k annual management fee with 2% annual increase beginning in 2004

o    Initial 15 year term that automatically renews every 5 years

o    Manager may terminate if one of the following occurs: 

§  Either party fails to make payment and not remedied after 30 days

§  If Supply & Processing agreement is terminated, or other agreements terminated

§  If more than 50% of Priority units acquired, or 50% of Trust or partnership provided 20% of Priority Units are acquired by Noranda or Affiliates and only if every Priority Unit holder received same offer (I assume this is a poison pill for hostile takeover)

§  Same right to terminate O&M Agreement if other agreements dissolved

o    The Partnership cannot dissolve unless Reclamation Release Certificate (as defined in the Acquisition Agreement) has been delivered to Noranda as contemplated in the Acquisition Agreement

o    If O&M Agreement is terminated, Partnership can acquire all shares of Manager

o    Manager cannot dispose of assets or spend Capex without consent of board

o    Manager may not assign its rights in O&M Agreement without consent of the partnership 

11. Where is NIF located?

The Facility is located near the town of Salaberry-de-Valleyfield, Quebec approximately 70 kilometres southwest of Montreal, on an 886 acre site situated on the St. Lawrence Seaway with access to both competitively priced power from Hydro-Qu´ebec’s power grid and an ample road and rail transportation network. The site also provides an abundant water supply for process cooling and access to the skilled workforce in the Montreal and Salaberry-de-Valleyfield areas.

The actual address of the Facility is 860 Gerard Cadieux Blvd., Salaberry-de-Valleyfield, Quebec. The Facility is directly adjacent to the Valleyfield Port.

Google Earth View of the Facility can be seen here.

12. When was the smelter built?

Canadian Electrolytic Zinc Limited was incorporated in 1962 to build an electrolytic zinc plant at the present location. The Facility was commissioned in 1963 with an annual capacity to produce 65,000 tonnes of zinc metal. The Facility has been 100% owned and operated by Noranda since 1996, until Noranda was acquired by Glencore in 2012.

In the years since its construction, the Facility has been expanded by the addition of four roasters and three sulphuric acid plants. As a result of these expansions, production capacity of the Processing Facility was increased to 226,000 tonnes of zinc metal per year and 420,000 tonnes of sulphuric acid per year by 1990. In 1991, a 250,000 tonne per year Vieille Montagne super jumbo fully-automated cellhouse was commissioned at a cost of $150 million.

13. What are the differences between the SPA and market pricing?

Currently, NIF receives C$0.400 per pound of zinc metal produced. Typical smelters typically pay miners for 85% of the contained metal but currently the SPA stipulates that NIF pay for 96% of the contained metal.

As a reference, the initial C$0.352/lb price (US$0.226/lb at US$1=C$1.558) was considered a market term price in 2002 at NIF’s IPO. It is difficult to predict the term price that NIF may be able to receive in 2017.

The market rate is determined by three factors: 1) contracted pricing vs. spot pricing, 2) smelter charge, and 3) payability. For this discussion, the smelter charge referred throughout the document takes all three factors into account.

o   Contract (Term) vs. Spot: Term pricing is an exclusive contract between miners and the smelters. Term pricing is not disclosed and is considered “industry secret”. Generally it is higher than the spot pricing as there is greater assurance for capacity. Spot pricing typically is more volatile and swings greatly depending on the concentrate market. According to Nyrstar, a zinc refiner, zinc concentrate supply is expected to grow in the near future and zinc smelting capacity is fixed

o   Smelter Charge: Smelters charges the miners based on the zinc metal contained in the concentrate it is buying.

o   Payability: The smelter charge explained above is then multiplied by payability to determine the final price. Payability refers to the percentage of the zinc metal the smelter would pay to the miners. Market rate for payability is 85%.

For example, for 100,000 pounds of 52% zinc concentrate (thus containing 52,000 pounds of zinc metal), zinc price of US$1.00/lb, smelter charge of US$0.20/lb, and 85% payability, typical smelters would pay the miner US$35,360 (100,000 pounds * 52% * (US$1.00-US$0.20) * 85% = US$35,360).

The smelter would then process the zinc concentrate at 97% recovery, (52,000 pounds of zinc metal at 97% recovery = 50,440 pounds of zinc metal produced) and sell the zinc metal to the market (50,440 pounds at US$1.00/lb = US$50,440).

14. What is the market pricing? And how was the market pricing estimated?

Market pricing is determined on 85% payability (ie, smelters pay 85% of the contained zinc in the concentrate). Market pricing is estimated at US$0.20-0.23, taking the payability and smelter charge into account.

Approximately 126,000 tonnes of zinc concentrate (or 66,780 tonnes of zinc metal in concentate) would be processed on a quarterly basis, representing 64,910 tonnes of zinc metal produced per quarter at a 97.2% recovery rate. The total zinc metal produced by NIF would be US$128.8 million (or C$151.9 million at US$1=C$1.18).

At 85% payability, NIF would pay miners for 56,763 tonnes of zinc concentrate zinc price less smelting charge per quarter. Assuming smelting charge of US$247/tonne of concentrate (US$0.113/lb concentrate) and zinc price of US$0.90/lb, NIF would pay the miners US$81.5 million per quarter (C$116.2 million).

NIF’s implied net smelting charge (when considering smelting and free metal together) would be US$0.2124/lb zinc metal produced, or C$0.2507/lb.

NIF disclosed in the Q3 Management Discussion and Analysis that “For the nine months ended September 30, 2014, the realized benchmark treatment charge was US$235 per dry metric tonne of concentrate processed (US$456.17 per tonne of zinc metal, or US$0.207/lb), while the spot treatment charge of US$155 per dry metric tonne of concentrates processed (US$300.88 per tonne of zinc metal, or US$0.137/lb).” It further discloses that the EBITDA would decrease by 31% from the current SPA pricing to term pricing, and 87% from the current SPA pricing to spot pricing.

15. What are the key dates for NIF?

October 14, 2016: This is the final date for NIF to identify potential acquirers to prevent Glencore from extending the SPA.

November 3, 2016: This is the date for Glencore to announce extension of the SPA.

16. Does NIF have any exposure to zinc prices?

Until the expiry of the SPA, NIF has very small exposure of 1.2% of its zinc output to the zinc price (the spread between payability of 96% vs. recovery of 97.2%). In addition, there may be a small effect on the zinc premiums based on market demand. Premiums are approximately 21.4% of total revenue. By-products are exposed to commodity prices, mainly in copper through its production of copper cakes and sulphuric acid.

After the SPA, about 12.2% of NIF’s zinc output would be exposed to zinc price (the spread between payability of 85% and recovery of 97.2%).