Northern Orion NNO cn
June 30, 2003 - 4:13pm EST by
2003 2004
Price: 1.40 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 150 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV (in $M): 0 TEV/EBIT

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Northern Orion (NNO) is a relatively small mining company which has very recently acquired a 12.5% interest in the low cost Alumbrera gold/copper mine in Argentina for US$90 million from BHP Billiton. This transforms Northern Orion into a significant copper/gold producer and adds 525 million lbs of copper and 887,000 oz gold into Northern orion reserves. This stake of 12.5% was acquired in conjuction with a JV partner, Wheaton River, which also acquired 12.5% from Bhp. Wheaton(WRM) had earlier in March acquired a 25% interest in the same project for $210 million (or almost a 20% premium) from Rio Tinto. What makes NNO very interesting is the potential for the adjacent Agua-Rica deposit.

The NNO story is complex to describe but very compelling for several reasons:
1. Reasonable Acquisition Price: The 12.5% stake was acquired for 60% of projected pro-rata life of mine cash flows - for gold producers, the rule of thumb is normally 150% of life of mine cash flows due to the optionality in the gold price.
2. First-class mine: Alhumbrera was commissioned in '98 for a total cost of $1.3 billion when gold was $400/oz and copper was $1.10/lb - no expense was spared. This is accordingly a unique project with almost no sustaining capex requirements and no permitting issues.
3. Free Cash Flow: BHP financed $28 million of the purchase price which will be paid out of NNO's share of project cash flow in 2004 and 2005. (The NNO share of the cash flow is $32mm and $24 mm in 2004 and 2005). In 2006-2008, the free cash flow/share will be about 30 cents, dropping off to about 20 cents averaged over 2009-2012. Most gold projects do not produce free cash flow.
4. Valuation discrepancy: NNO has a NAV of about c$2.50 at $350 gold price and 80 cents copper price, discounted at 8%. This discount to NAV seems to happen for mixed metal producers whereas pure gold producers usually command a significant premium.

What has the potential to convert NNO from just a copper/gold play to a 'home-run' are three underappreciated factors:
1. Super-low cash costs: Due to the 'cadillac' mine and the devaluation of the Argentine peso, the Alhumbrera mine is possibly the world's lowest cash cost operator - all proections/budgets by WRM and NNO have been at copper costs of 20 cents/lb but in May(latest info available) they were at minus 5 cents - an unheard number and due to the benefits of byproduct cost accounting where the gold revenue is treated as a credit to the copper cost.
2. Agua-Rica: NNO controls 100% of Agua Rica which contains 21 billion lbs of copper and 12 million ozs of gold. The strategic value to NNO of acquiring the stake in Alhumbrera is to figure out a way of integrating the Agua-Rica project with Alhumbrera when the ore grade in the latter starts to deteriorate in 2008. Based on the company's projections, it will require a convyor/tunnel system to move the ore from Agua-Rica to the processing area, a distance of 34 miles. This will cost about US$250 but has a NPV of US$250 miilion or more than twice today's market cap. Production cash costs are estimated at 10 cents/lb, about the lowest cost in the world.
3. Commodity price leverage: Most gold investors pay very large multiples of cash flow and NAV due to the optionality in the gold price. However, copper prices ar4e also hugely volatile - 20 cent move in copper on 15 bn lbs is worth $ 3 bn, an almost unimaginable abount for a c$150 mm market cap company. If china, India(and the world) are going to grow, they are going to use a lot of copper.

Unfortunately, the story is slightly confusing - but there are very few places in the world where you have true 'home-run' potential.


1. Strong cash flow from Alumbrera copper-gold mine will become apparent in the next quarters 2. Wheaton River owns 37.5% of the Alhumbrera project and is busily talking up the economics of the project 3. Northern Orion is conducting a feasibility study on development of the Agua Rica project which should be completed by early 2004 and highlight the huge reserves.
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