Thesis

Tara Minerals (TARM.OB) is a company worth at most $20M (likely much less), but boasts a market capitalization higher than $100M. How did a company that has only raised $6.7M from the sale of common stock since its inception (see the first line under cash flows from financing activities in the most recent 10-Q) turn that into more than $100M in market capitalization? The company has paid millions of dollars in stock for expenses, most notably "IR services," in an effort to artificially bolster the stock price.

• Price Target: <$0.32
• Current Price: $1.75
• Return: 82%+

Background

Tara Minerals was incorporated in 2006 and began trading on the OTCBB in 2008. Tara Gold Resources (TRGD.PK) is the parent of TARM and previously owned 71% of its stock until TRGD started to distribute  its TARM shares in May 2011. TRGD will continue to distribute its remaining shares of TARM. TARM focuses on acquiring and exploring industrial metal prospects and TRGD focuses on gold and silver prospects. As a result, TRGD has the first right to acquire any gold or silver prospects and TARM has the first right to acquire any industrial metal prospects.

Properties

Don Roman Groupings

This includes Pilar, Don Roman, Las Nuvias, Centanario, and the La Verde mining prospects. The total purchase price was $2.4M as of 12/30/10. As of April 2011 TARM agreed to buy La Verde for $140K and 830,000 shares. As of 12/31/10, $3.5M had been spent on processing plant facilities, processing equipment, and related mining equipment. You can find this information in TARM's 10-K. In May 2011 TARM purchased the right to mine the Tania Ore Property for $6 per tonne removed for the first 500,000 tons and $7/ton afterwards.

In June 2011, TARM agreed to a deal with 3 options: 1) the buyer can purchase 30% of the of Don Roman Groupings in exchange for at least $2M in capital expenses on the project within 120 days and an additional minimum of $6M in capital expenses within 12months; 2)  the buyer can earn an additional 20% by spending an additional minimum of $5M within 24 months; 3) the buyer can spend an additional $1M within 90 days to earn 50% of the net revenue of all current and future iron ore projects within Mexico. The deal is also subject to certain minimum production requirements. Since the second option to purchase an additional 20% is cheaper than the first, the counterparty will likely exercise none or both options unless the project goes south in between. A total of $13M (not including third option) will be spent if both options are exercised. Ignoring the option value, this implies the following valuation: 50%*(Don Roman Groupings current value + the $13M in required spending) = $13M. As a result, the current value is less than $13M since we didn't consider the option value which would have lowered the valuation.

The third option for a 50% interest in the iron ore projects is different. The 50% interest that can be purchased for $1M in spending applies to net revenues. It is unclear if this refers to the gross profit of the projects or the top line revenue of the projects. The normally used definition would imply the latter, but to be safe and give this a higher valuation, let's assume it means gross profit. That values TARM's iron ore projects at less than $1M (using the same math as above) since we are ignoring the option value of the deal, which would lower TARM's implied valuation.

Godinez Joint Venture

In July 2010 TARM entered into a JV where other companies provided the Mina Godinez property and TARM will pay for all operations. TARM will receive 60% of profits until costs have been recouped and then 40% of profits after that. The other parties have in essence "sold" 40% of their property for whatever the cost is to operate the property. However, TARM hasn't "paid" for this 40% ownership yet. Since TARM has no employees outside its 3 officers, it would have to outsource the job of operating the Godinez property. Because TARM provides no additional value, their 40% ownership would be worth what they pay to operate the property. As of 12/31/10, TARM has paid $0 to operate the property. This property is prospective for gold and since its parent, TRGD, has the first right to acquire gold projects, we know TRGD must have passed on this opportunity. You can find this information in TARM's 10-K.

Picacho Groupings

Adit Resources, an 87% owned subsidiary of TARM, owns Picacho. From July 2009 through March 2010 Adit paid for this property with a $650K promissory note, $580K in cash, 320,000 shares of Adit common stock (which it claims to value at $2.50 even though it says the fair market value was only $0.75 at the time), and 437,500 shares of TARM (which it claims to value at $4 even though the stock was at $2.25). This totals to $3.8M. If you use fair market values for the share prices, it totals to $2.5M. In their 10-K (where you can find all of the above information), TARM says they believe this property has the potential for more than 1M ounces of gold. This is extremely odd given the low purchase price for this property. I am very surprised that TARM's lawyers and auditors allowed such language in their SEC filings, especially since TARM has no reserves. In addition, its parent, TRGD, has the first right to acquire any gold or silver project. So if TARM owns it, we know TRGD passed on the opportunity.

In January 2011 Adit made a deal with Yamana Gold to raise capital and have an option to buy into the Picacho property. Adit will be required to spend $2M on the project and Yamana can purchase a 51% interest by spending $5M on the project and paying Adit $1M. Yamana can increase its interest to 70% for an additional $9M in spending and paying Adit $2M. Here you can back out what Picacho is being valued at ignoring the option value in the deal. (Picacho's current value + $2M in required spending by Adit + $5M of spending by Yamana)*51% = $6M. This simplifies to Picacho's current value = $4.8M. It makes sense to do this math with the first option because the embedded value of the first option is less than the second as the second is only exercised in a lower probability scenario since it is more expensive. This way, the unknown variable in the equation is smaller. As a result that transaction, we can be sure that that Picacho's current value is less than $4.8M since we didn't consider the value of the option which would lower the valuation. TARM owns 87% of Adit, so the value of Picacho to TARM shareholders is less than $4.1M.

Pirita was purchased for $310K in 2009. $170K still needs to be paid for. In the Q1'11 10-Q, TARM said it may terminate this agreement and return the property, so I will assume this occurs. In March 2011 TARM agreed to buy La Palma for $93K and 460,000 shares (which had a market value of $0.85 at the time), making the deal worth$484K.

Insiders and Questionable Findings

Insiders are not shareholder friendly. In 2010 due to outrageous option awards, the CEO (who is only expected to spend 20 hours a week devoted to the company-see 10-K) and Controller had total compensations of $2.5M and $0.8M, respectively. While other insiders barely had any compensation, it is absurd that 2 individuals would earn 5% of the undiluted market capitalization (as of the end of 2010) of a company in a given year.

On Complaints Board someone has accused the CFO of selling worthless stock to Military personnel.

In 2008 and 2009 the CEO of Adit, Robert R. Wheatley, was the Director of Exploration for Yamana Gold, the counter party to TARM's Picacho deal. Wheatley also held various management positions at Yamana's predecessor, Meridian Gold. Adit's Chief Geologist, Peter Mejstrick, was a Consulting Geologist for Meridian Gold. These connections make me question if TARM's deal Yamana was an arm's length transaction.

Biocurex (BOCX.OB) is a seemingly unrelated biotech company. However, their Post-Effective amendments for registration statement filed on 7/9/10 with the SEC mentions Tara Minerals 8 separate times (search for "Tara" in the document). This could be a simple mistake made by a company who created filings for both firms which only reflects the incompetence of TARM's service providers, or it could point to some unknown relationships that haven't been properly disclosed. While the former is better, neither are good for TARM.

On 7/18/11 the SEC revoked TRGD's registration pursuant to Section 12(j) of the Exchange Act. Section 12(j) reads:

The Commission is authorized, by order, as it deems necessary or appropriate for the protection of investors to deny, to suspend the effective date of, to suspend for a period not exceeding twelve months, or to revoke the registration of a security, if the Commission finds, on the record after notice and opportunity for hearing, that the issuer, of such security has failed to comply with any provision of this title or the rules and regulations thereunder. No member of a national securities exchange, broker, or dealer shall make use of the mails or any means or instrumentality of interstate commerce to effect any transaction in, or to induce the purchase or sale of, any security the registration of which has been and is suspended or revoked pursuant to the preceding sentence.

It is clear that TARM's parent, TRGD, has failed to comply with federal securities law.  TRGD and TARM have the exact same management team comprising of 3 officers (and no other employees).

Promotion

In February 2010 TARM issued 122,944 shares valued at $1.85 for IR services. Also in February 2010 TARM issued 1,250,000 shares valued at $2.15/share and 1,250,000 warrants (these appear to have an immaterial exercise price so should be treated as shares granted) for IR and banking services. In August 2010 the company issued 75,000 shares valued at $1.50 for IR services. In 2010 the company issued 1,000,000 (this was lowered to 500,000 in Q2'10) options with a $2.15 exercise price for IR services. In September 2010 TARM issued 200,000 options with a $1 exercise price to an unrelated third party for IR services. TARM has spent millions of dollars in stock on IR services even though the company is worth less than $20M.

TARM has paid Joe Noel 150,000 shares for consulting services. His firm, Emerging Growth Research gives Research Briefings and stock recommendations. You can check out his website here. Timothy Sykes, who is probably the most outspoken person against stock promotions, has Joe Noel on his list of soulless stock promoters. Let's look at the long-term performance of the other stocks he covers:

His average return for the stocks listed on his site outside of TARM is -55%. Moreover, if you exclude the 2 recently covered stocks held for less than 2 months, his average is -63%. In fact, only 2 out of the 18 stocks held for more than 2 months had a positive return. This looks even worse in light of the fact that during this time period the general market increased significantly.

Joe compares TARM to Scorpio Mining. The two aren't even in the same league. Scorpio mining has revenues, is profitable, and has known reserves calculated in an NI 43-101 technical report. As you can see in their SEC filings, TARM has none of these qualities. Scorpio Mining's Price/Book ratio is 2.7 and TARM's Price/Book ratio is 31.5. But let's assume Joe Noel is right and that Scorpio is a good comp for TARM.  Applying Scorpio's P/E, P/S, P/CF, and P/B ratios to TARM would result in a $0, $0, $0, and $0.15 price per share, respectively.

Valuation

In December 2010 TARM offered certain debt holders the opportunity to exchange their notes into shares at $0.50/share. As of the end of December 2010, that represents a 58% discount to the share price. Why would the company do this? This means they couldn't raise equity to pay off that debt at prices anywhere near the market. I also think this shows that insiders know their stock is wildly overvalued and knew they were still getting a good deal by converting their debt at $0.50. This makes me believe the value is less than $0.50.

The most recent time TARM raised capital was in May 2011 and it issued 1,643,333 units (one share and one warrant with a $1 exercise price) for $0.30. You can find this information in the Q1'11 10-Q. Since the warrant had some value, this implies shares of TARM are worth less than $0.30.

As of 3/31/11 (see Q1'11 10-Q), TARM had $0.4M in current assets, $2.9M in deferred tax assets, and $0.1M in other assets. I do not take out the portion of these assets that belong to the 13% of Adit that TARM doesn't own but is included in its balance sheet. This would lower TARM's valuation. TARM raised $750K in May by selling royalty rights. I will not add the $750K and I will not deduct the royalty payments from the value of the properties as the two should be equal. Ignoring the value of the options in the deals, the properties are worth $18.6M. $0.1M is the cash portion of the La Verde purchase which was agreed to after the end of Q1'11. Total liabilities as of 3/31/11 were $4.4M. This values TARM at $17.5M.

The cost of these properties was $7M as of 3/31/11, which you can find in the most recent 10-Q. If you add in La Verde's cost, assuming the highest closing price in April 2011 to value the share portion of the consideration to be the most optimistic, the total cost increases to $7.9M, which is substantially lower than the $18.6M value calculated above. Either TARM's assets have appreciated 125% in value or the embedded value of the options that we previously ignored is very material. I believe it is the latter, but again to be safe, and come up with a higher valuation, let's go with the $18.6M value for the properties and the $17.5M valuation for the company.

As of 3/31/11, TARM had 58,479,987 shares outstanding. Add 830,000 shares for the La Verde transaction and 1,643,333 shares for the capital raise in May 2011. Add the additional 2,500,000 shares for the future Yamana capital raise. This equals 63,453,320 shares. The capital raises add $3.0M in cash, which makes the total value of TARM $20.5M or $0.32. 1,000,000 options are in the money with respect to that share price as they have a $0.05 exercise price. Accounting for these options keeps the share price at $0.32.

Risks

The charade could last longer and insiders can keep fooling investors into buying more shares in private placements.

It's difficult to find shares to borrow and you could be forced to buy back borrowed shares at higher prices.

Summary

TARM is grossly overvalued due to a very aggressive IR campaign that the company has been paying for with stock. Thanks to recent deals, TARM's properties are easy to value and its shares should fall more than 82% to less than $0.31 after the market realizes the true value of the company.

Disclaimer: This article is intended for informational purposes only and you, the reader should not make any financial, investment, or trading decisions based upon the author's commentary. Although the information set forth above has been obtained or derived from sources believed to be reliable, the author does not make any representation or warranty, express or implied, as to the information's accuracy or completeness, nor does the author recommend that the above information serve as the basis of any investment decision. Before investing in a security, readers should carefully consider their financial position and risk tolerance to determine if such a stock selection is appropriate.

At any time, the author of this article may trade in or out of any securities that are mentioned in the article as long or short positions in his own personal portfolio or in client portfolios that he manages without disclosing this information. At the time this article was published, the author was holding a short position in TARM.OB either in his personal account or in accounts that he managed for others.

THIS ARTICLE IS NOT A RECOMMENDATION TO BUY OR SELL ANY SECURITIES MENTIONED. THE AUTHOR ACCEPTS NO LIABILITY FOR HOW READERS MAY CHOOSE TO UTILIZE THE INFORMATION PRESENTED ABOVE.

The market is exuberant from all the deals TARM has recently completed. Once investors take a deeper look into the numbers, they will realize that all these deals have done is highlight exactly how overvalued TARM is. Once this occurs, the share price will likely fall substantially.

TARM is strapped for cash. It defaulted on an equipment capital lease in Q1'11 and had to return the equipment. It has raised some cash since, but has even more expenses coming up. Once investors realize the true value of TARM, it won't be able to continue raising cash by issuing shares. This would be disastrous for TARM.