Village Main Reef, a mining company in South Africa, provides an opportunity to invest in a proven operator running an extremely underfollowed security with multiple optionalities and trading under 1x normalized cash flow.

Background:

Bernard Swanepoel built Harmony Gold into one of the top gold producers in the world, partly by buying marginal gold mines from larger players such as Anglo Gold Ashanti and Gold Fields.  By turning these assets around and benefitting from soaring gold prices, share prices went from R20 in 1995 to close to R170 at peak in 2002.  Making a long story short, but a failed hostile bid for Gold Fields was one of the issues that led to his demise from Harmony.

In what I believe is motivation to prove himself, he acquired a shell company, Village Main Reef, from former owner Harmony back in 2009.  However, the intention now is not to build an empire like Harmony, but to focus on opportunistically buying orphaned or ignored assets, turning them around, and returning as much cash to shareholders as possible.  Make no mistake, the story definitely hinges on high gold prices.  Note however that current gold prices in rand are still north of R450K/kg, which still provides a lot of cushion before some of some of its higher cost operations are no longer profitable.  Also, aside from gold, Village has a very strong call option in Lesego, which I will further describe below.  

Through Village, he acquired Consolidate Murchison, aka Cons Murch, an antimony and gold operation, and then Lesego Platinum.  These assets, like some of the ones that followed were not really shopped around.

Cons Murch was an ignored asset stuck within a large corporation. Bernard was approached to run the asset with the option of buying it at a cheap price. Despite producing over 10K oz of gold per year, the focus was shifted and mine optimized as an antimony producer.  Cons Murch is one of the largest producers of antimony outside China (which accounts for close to 90% of the world’s production), with about 6K tons per year.  Antimony, which is mainly used as a fire retardant, has seen a considerable price appreciation, going from under $6,000/mt in early ’08 to close to $12,000/mt today (after having peaked at close to $17,000 in early 2011), partly as China has tried to restrict exports (partly as it wants to capture more of the value curve and have factories be set up in China rather than exporting the commodity), which has led to buyers around the world to bid up prices for the security of the supply.  In fact, Bloomberg reported on 12/28 that China has cut the first-batch export quota on rare earths by 27% for 2013. Management has indicated that it would be open to divesting this asset as well. 

Lesego is a world class platinum mine, located in the Bushveld Complex in South Africa, home to one of the richest ore deposits on Earth.  It should have a life of mine of close to 50 years and exhibiting a fairly shallow ore body, with very good grades (at close to 6 g/t; note that while Lesego is located in the Eastern Limb of the Bushveld Complex, its grades are comparable with those in the Western Limb, which tend to exhibit the very high grades of platinum in South Africa, but new discoveries are now very deep). The current deposit, signed off by an independent third party, currently sits at 39M oz, which is fairly sizeable. Note that cutoff was 2,000 meters, so could still have additional resources deeper.  This is a true free option as it expects to complete its fully funded feasibility phase in 2013. Once the definitive feasibility study is completed, which would further de-risk the mine, the idea is to monetize or enter into a JV with a larger player, given the sizeable capex that would be required to get the mine into production, something that Village has reiterated it will not do alone.  Lesego belonged to their BEE partner, Umbono, which could not justify listing Lesego separately so saw Village as a good vehicle to house the asset.

However, the story really changed in 2011 with the acquisition of the assets of Simmer and Jack.  Some poorly timed acquisitions by Simmer had frustrated its shareholders, especially Xelexwa, a Black Empowerment shareholder, who turned to Bernard, who also knew the asset quite well as a board member, and orchestrated the takeover (no governance issues here as he recused himself from the meetings, had an independent advisor opine and transaction was overwhelmingly approved). 

Despite volatility in the share price, due to former Simmer shareholders dumping Village shares that had been distributed, Village was able to take possession of the key Tau Lekoa gold mine, as well as the Buffelsfontein (Buffels) gold mine.  In addition, Village got other assets that I ascribe zero value, such as Weltevreden, Strathmore, and a metallurgical plant at Hartebeesfontein (Strathmore, by the way, is one of the largest single gold ore bodies left in the world, estimated at 30M oz, and is very well know and understood; but it is very deep, at roughly 4K meters; although viable at current gold prices, it would require significant capex, say over $1B, to get it into production, which Village will never do – like with Lesego, this illustrates management’s commitment to monetize assets and not build an empire).  I believe Village is looking to monetize any one of those assets. Note that there are currently no costs associated with these assets either.

Another asset that came along from Simmer was the equity and secured debt stakes in First Uranium, traded in Canada.  Village has since been able to monetize most of the equity stake (sold block to Anglo Gold Ashanti) and all of its debt stake in First Uranium (R393M), and has paid out R0.30/share as a special dividend in late July (or 17% of the share price at the time of announcement).  This again illustrates management’s commitment of returning excess cash to shareholders.

In addition to the assets, Village also brought along Marius Saiman, who was initially CFO of Village and now is co-CEO, allowing Mr Swanepoel enough time to focus on operations and turnaround.

Village benefitted from a lot of the capex that Simmer had put into some of the mines, so incremental capex is minimal.  As an illustration of the turnaround, right upon closing in August 2011, Village cut workforce at Buffels by 1/3 to align costs with what had been a decline in production, and was able to show a profit in September, the first in a very long time for that mine.

On 6/30/12, Village closed the acquisition of the Blyvooruitzicht (now try pronouncing that quickly three times; aka Blyvoor), from DRDGold, another publicly traded company in South Africa, which had been changing its business model away from gold mining into a tailings company and finishings, so had been getting rid of assets. I was somewhat surprised they paid in shares, given how cheap those looked, but management felt that payback was extremely quick and also maintains they no longer want to use shares as currency. Purchase price was R150M at a share price of roughly R1.75, or 86M shares, or 8.5% of the company, which increased annual gold production by over 30%.

Recently the Village board approved a potential issuance of debt for future acquisitions.  Management has indicated that there are several extremely compelling acquisition opportunities.  These could be turnaround situations or royalty streams. Today the company has a net cash position, in addition to considerable NOL balances at various of its assets.

Valuation:

Putting it all together, let’s take a stab at valuation. Note that Village has a legacy agreement with Deutsche Bank where it agrees to sell 3,600 oz per month at an effective gold price of $1,125. Given said arrangement is set to expire around the end of Q1 2013, I will provide a pro-forma analysis assuming the contract is no longer in place, and instead reduce the available net cash position. Numbers based on 1/3 closing prices:

In my discussions with management, they believe that Lesego should be worth over $4/oz, which would imply a value to Village of $120M, which would be more than its current enterprise value.  Comps in the platinum space all trade above $2 per 4E resource oz, so I have used that figure as a placeholder for now.

Then the next question is how to value these cash flows.  Rather than looking at multiples, I calculated the NPV of the assets assuming that Tau operates for 5 years, Buffels for 16 years, Cons Murch for 10 years and Blyvoor for close to 20 years.  That results in an NPV of approx $390M, excluding Lesego.  Valuing Lesego at $2/oz results in an implied price of ~ZAR 4.60/share and assuming Lesego is valued at $4/oz, results in a value of ZAR 5.60/share, or over 4.5x the current price.

Catalysts:

Buybacks and introduction of a regular dividend.  At the annual meeting held on 11/30/12, the board authorized Village to initiate a buyback for up to 15% of the shares outstanding.  They have stated recently that they intend to buy back uo to 45M shares by mid-Feb.  In addition, management has been buying back shares regularly, with both CEOs buying throughout 2012 at prices ranging from R1.10 to north of R2.00 (pre-special dividend). 

Disposition of assets. As mentioned above, management has already identified its intention to dispose of Cons Murch.  I believe management would only chose to sell Cons Murch at a price that is accretive compared to its current contribution as shown in the analysis above.

Completion of definitive feasibility study at Lesego – expected to be concluded sometime in mid 1H13.

End of Deutsche Bank gold contracts – scheduled to be fully repaid by March 2013. This will also free up an overfunding that is today set as restricted cash.

Potential coverage and/or ADR program in the US.

Risks:

Gold prices.  Management has commented in the past that R350K/kg is a key level to watch.  Tau, their key asset, however, would likely still make money at that level.

Successful turnaround of some assets – in particular, Buffels and Blyvoor have had spotty performance for a number of reasons (such as unplanned strikes and shaft accidents) which have caused them to detract from the performance in recent quarters.  Management has said that it is willing to shut down Buffels in case it cannot sustain positive results.  The key asset today is Tau, which has been contributing 125K oz of annual production alone. 

Poor acquisitions and resulting higher level of indebtedness and/or further dilution.

Management bandwidth trying to potentially turnaround several assets at the same time.  On this point, management has reiterated that it is unlikely that it will make significant acquisitions before divesting of assets first.

Mine specific issues such as seismic events and strikes, especially at Tau Lekoa.

Share illiquidity.  Trading volume is not very high and could result in price dislocations should a large shareholder decide to change its stake. Recently, Tradewinds, which was a top holder, had to significantly reduce its holdings as it was facing redemptions following the departure of its portfolio manager.  This caused the prices to drop from over R2.00 (again, pre-special dividend), and I believe have yet to recover from such drop.

Buybacks and introduction of a regular dividend.  At the annual meeting held on 11/30/12, the board authorized Village to initiate a buyback for up to 15% of the shares outstanding.  They have stated recently that they intend to buy back uo to 45M shares by mid-Feb.  In addition, management has been buying back shares regularly, with both CEOs buying throughout 2012 at prices ranging from R1.10 to north of R2.00 (pre-special dividend).

Disposition of assets. As mentioned above, management has already identified its intention to dispose of Cons Murch.  I believe management would only chose to sell Cons Murch at a price that is accretive compared to its current contribution as shown in the analysis above.

Completion of definitive feasibility study at Lesego – expected to be concluded sometime in mid 1H13.

End of Deutsche Bank gold contracts – scheduled to be fully repaid by March 2013. This will also free up an overfunding that is today set as restricted cash. 

Potential coverage and/or ADR program in the US.