On the 14th of February 2017, Kerrisdale Capital published a report with their short thesis on Northern Dynasty Minerals. The company’s share price plunged from $3.18 to a low of $1.37, a 57% decline. I’m long the company’s shares and I would like to pick apart their short thesis.
“The Pebble deposit is not commercially viable.”
We don’t know that for sure. It depends on gold, silver and copper prices 7-10 years from now. What we do know for sure is that this is the largest undeveloped gold-copper project in the entire world. That’s worth something.
“Though very large, the Pebble deposit is relatively low-grade, meaning that large amounts of raw material would need to be processed to extract small amounts of valuable substances like copper, gold, and molybdenum.”
Google “heap leach”. While this may sound illogical to the lay person, industry analysts know that it is possible to mine low-grade ores quite profitably. It all comes down to mine economics, which depends on location, size of the deposit, surrounding infrastructure, type of mining method adopted, availability of skilled labour etc. The highest grade underground deposits might be uneconomic while extremely low-grade surface deposits might be economic – it all comes down to project economics which we will get to know once they perform an updated PEA/PFS.
“In the past decade, Northern Dynasty has hired at least two major engineering firms to prepare preliminary feasibility studies of Pebble laying out its economics in detail, yet it has failed to publish their findings – because they were damning.”
I don’t know if this is true, but let’s assume it is. What of it? Investing is future oriented. As an investor, I want to know whether I will profit from owning this stock over my investment time horizon. Past gold and copper price assumptions might have signaled that developing this project would be uneconomic. But what if gold and copper prices rose significantly over the next decade?
Just take a look at the size of the deposit. Massive is an understatement.
From the company website:
“The current resource estimate includes 6.44 billion tonnes in the measured and indicated categories containing 57 billion lb copper, 70 million oz gold, 3.4 billion lb molybdenum and 344 million oz silver; and 4.46 billion tonnes in the inferred category, containing 24.5 billion lb copper, 37 million oz gold, 2.2 billion lb molybdenum and 170 million oz silver.”
If gold prices regained their 2011 peak, the company will add roughly 47 billion dollars to its bottom line. The market is valuing the company at $600 million. If copper prices doubled, add another 156 billion dollars to the bottom line. These are life-of-mine figures, but the initial capex is also going to pay off over the life-of-mine so this puts the high capex into perspective. And this is not even considering the inferred resources or further exploration potential. There’s a saying in mining circles that the best place to discover a monster deposit is near another monster deposit. That optionality has value, although that value is subjective. But at current share prices, that optionality is not even a consideration. If the mine gets built, investors are assured a long-life steady cash flow with gold and copper price optionality. Will Apple or Facebook be around in 25 years? No one can say for sure. Will a functioning mine with expected 25 year mine life be around for 25 years? Highly likely. (25 is merely a number pulled out of thin air to make a point).
“With little cash on its balance sheet and few people under its employ, Northern Dynasty needs massive financial and operational backing to even consider developing the Pebble deposit. But what potential partner would willingly bear such a wide range of unquantifiable and potentially catastrophic regulatory risks? More importantly, what potential partner would gladly incinerate billions of dollars of value by building a mine that can’t produce an adequate return on capital? We believe that Northern Dynasty is on its own. It will never develop the Pebble deposit and has no other source of potential value; it’s worthless. “
I’m going to address this line by line.
“With little cash on its balance sheet and few people under its employ, Northern Dynasty needs massive financial and operational backing to even consider developing the Pebble deposit.”
Jan 11: Northern Dynasty Announces US$25 Million Bought Deal
Jan 12: Northern Dynasty Announces Increase To Bought Deal Offering Of Common Shares
Jan 26: Northern Dynasty Announces Closing Of US$37.444 Million Bought Deal Offering
Consider what this means. A bought deal is when an investment bank commits to buy all the shares at a pre-determined price. They take the risk of not being able to offload it onto investors. The bought deal was 50% oversubscribed. Does Northern Dynasty need massive financial and operational backing? Yes. Does the evidence seem to indicate that they are progressing towards that goal? Yes.
“But what potential partner would willingly bear such a wide range of unquantifiable and potentially catastrophic regulatory risks?”
Ones who think they have a shot at acquiring a long-life mine in stable US at attractive valuations. If countries like Iraq and Libya attract oil companies, who know and work with “a wide range of unquantifiable and potentially catastrophic regulatory risks” in foreign jurisdictions where the rule of law is unstable, the misgivings pointed out by this short report will not deter a large diversified/ copper miner. One man’s stability is another man’s instability. It depends on tolerance for risk, which the mining industry deals with on a day to day basis.
“More importantly, what potential partner would gladly incinerate billions of dollars of value by building a mine that can’t produce an adequate return on capital?”
And here we get to the beauty of this ‘research’ report. Throw in some analysis validated by facts, then go off the deep end and pepper it with nonsense designed to create an impact. How does the short seller validate the statement? He doesn’t. He knows he can’t and so doesn’t even bother to try. This is the typical “short and distort” approach these kind of hedge funds adopt. (For a funny video on this, go here)
“We believe that Northern Dynasty is on its own. It will never develop the Pebble deposit and has no other source of potential value; it’s worthless. “
They are entitled to their opinion. There is no way of knowing the future with absolute certainty. Hindsight may prove them right, but investing is not about being right or wrong. It’s about how much money you make when you are right and how much you lose when you are wrong. A statement like this has no place in an investment thesis. The real question to ask is: Given that Pebble has a chance to get back to a normal permitting process, at this stage of the exploration cycle, what is it worth? This is how venture capitalists think. The shares have optionality value, until it is proven indisputably that the project is forever uneconomic. Can Kerrisdale Capital prove that? Investors are paying up for this optionality – the share price movement reflects this.
Cost and time over runs are so common in the mining industry that it is hard to find a mine that was completed on-time and on-budget. There are several reasons projects get shelved/abandoned, mainly due to the turning of the commodity cycle. At the peak, investors are more willing to finance a long-lead time investment. This is when companies which want to drill moose pasture find themselves flush with funds. This is when projects which require a higher commodity price assumption get funded anyway, since investors think prices will head higher forever.
At the trough, no one wants to hear the name of that commodity. They will tell you they ‘lost their shirt’ on that one. Or that oil prices will be $20 in 2017. Or gold will soon go to $800 as it is useless. That’s when the smart money gets into the sector, and buys the babies thrown out with the bathwater. That’s when a Keith Neumeyer assembles a set of properties in Mexico nobody wants and proceeds to make money as the silver bull market ignites. That’s when a spin-off company starts assembling a portfolio of streaming agreements on the silver by-product of base metal mines for a small upfront payment and an on-going payment of $4 per ounce of silver delivered.
“One newsletter writer, Doug Casey, even claimed (falsely) that “on Friday, Jan. 20, Presidentelect (sic) Trump’s first executive order will roll back one of President Obama’s biggest mistakes” – namely the EPA veto of the Pebble mine.” (emphasis mine)
An EPA under Trump will be vastly different from one under the nihilistic Obama. I say nihilistic because that was his attitude towards the extractive industries. Trump is an empire builder, he knows the importance of steel and copper to civilization and life itself. It is not a lone newsletter writer who thinks Trump will be good for Pebble, it is a whole class of investors who know and have followed this story. It is a whole class of investors familiar with the commodity cycle and the exploration cycle. It is a whole class of investors whose livelihood depends on pricing risk.
“As Northern Dynasty itself discloses, “there are currently no known reserves or body of commercially viable ore [in the Pebble deposit] and the Pebble Project must be considered an exploration prospect only.…Mineralized material which is not mineral reserves does not have demonstrated economic viability.”11 In short, Northern Dynasty itself is unsure whether the deposit is worth mining.” (emphasis mine)
This is the kind of ‘research’ they put out. Northern Dynasty is by law forced to include such cautionary statements when it talks about mineral resources that are not mineral reserves. The short report twists such disclosures the way the BLS tortures employment data or the USSR tortured potato production statistics. There is only one word to describe their conclusion: bullshit.
“If Pebble were really the bonanza that Northern Dynasty claims it is, why would Teck – a company with extensive North American mining experience – put such little value on it?”
Why would Barrick Gold, a gold miner, acquire Equinox Minerals for $7.3 billion in 2011 and take a $4.2 billion impairment charge on it less than two years later? Companies make mistakes. So do analysts. When Apple came out with its iPod, tech analysts predicted that it will fail. Who would buy an Apple iPod when they could buy a Microsoft Zune instead, they said. Michael Porter of Harvard Business School and Paul Krugman of Nobel-prize fame both predicted the death of the internet. They got those call wrong, although it didn’t hurt their careers. A major miner like Teck will have dozens of such properties in its exploration portfolio. It will keep adding and divesting as per the corporate priorities. A major miner discarding a project is as common as a major miner acquiring one. The question is an interesting one to ask, but it neither adds nor detracts from the main investment thesis.
“With the regulatory process still, at that time, so uncertain, and with many options for legal action open to Northern Dynasty in the event of an adverse decision – in addition to the option of just waiting for a more laissez-faire EPA administrator to step in – why would Rio Tinto choose to walk away? Why not hang on? We believe the only rational inference is that Rio Tinto came to doubt the profitability of any future Pebble mine.” (emphasis mine)
A major miner walking away from an early stage exploration company during a commodity bust? It would be uncommon if there was no such news. It happens literally all the time. The rational inference is, “it’s the commodity cycle, stupid!”
I have a question to as Kerrisdale Capital: If the Pebble project is truly worthless, why has the Hunter-Dickinson group not walked away from it? They support other companies as well, ones which aren’t sitting on truly worthless undeveloped deposits.
Maybe then they can make a rational inference that the Hunter-Dickinson group continues to believe in the profitability of a future Pebble mine.
“Overall, the work of Anglo and third-party engineers indicated that the likely upfront capital cost of the Pebble project would be roughly $11 to $13 billion – more than double the $4.7 billion figure used in the Northern Dynasty–commissioned 2011 preliminary assessment. While Northern Dynasty’s estimated operating costs were, in Anglo’s view, more realistic, they were still roughly 20% too low.”
Let’s work with these numbers. As I stated earlier, the turn of the commodity cycle can render unprofitable mines profitable. Using measured and indicated resources, if gold prices regained their 2011 peak, the company will add roughly 47 billion dollars to its bottom line. If copper prices doubled, add another 156 billion dollars to the bottom line for a combined $203 billion. What’s a $13 or even $20 billion in capex on that scale? Where you think we are in the commodity cycle factors greatly in terms of assessing such a project. Northern Dynasty bulls simply have a different view of the future where such concerns become minor compared to the potential upside.
“Consider again the history of Pebble. Teck, Mitsubishi, Rio Tinto, Anglo American: all walked away from it. Northern Dynasty itself tried to divest its then 50% stake but found no interested buyers.”
From this, we are expected to infer that Northern Dynasty itself finds the project to be no good. The answer is very different. Since the release of the PEA on Feb 23rd, the share price is down 88%. Had the Pebble interest been sold back then, that loss would have hit the buyer and the management (Hunter-Dickinson) would have been lauded for pulling off such a coup. They would have been the geniuses who saw the turn in the commodity cycle and headed for the exit.
“While some Alaskans did resent what they perceived as high-handed action on the part of the EPA, many of those same people – and many others besides – still oppose the development of the Pebble deposit; they just believe it’s up to Alaska, not the federal government, to stop it.”
Natives opposed to mining? Big surprise. If that’s all it took to stop mining, the world would have run out of metals and energy by now. It is only the most vocal dissenters who take the effort of speaking out; the silent majority which doesn’t mind one way or the other doesn’t get its opinion reported by the press. Cherry picking dissenters’ comments adds no value to the investment thesis.
The one opinion the short sellers choose to quote at length prove the point.
“Alaskans and hundreds of thousands of others across the country are united in the fact that the Pebble mine is too risky because it trades lasting American jobs for temporary ones backed by a foreign mining conglomerate.…” (emphasis mine)
This is supposed to represent a consensus. Such a statement could easily come out of the mouth of an Occupy Wall Street protestor or a Bernie Sanders fan. This kind of fluff piece is ignored by serious investors, who like to concern themselves with the fundamentals.
“Northern Dynasty, however, has had more than a decade to win over the public, and it has definitively failed; there’s no reason to believe it will suddenly start succeeding. Even if the EPA allows Pebble to proceed, we believe the Alaskan legislature will block it.”
And finally, towards the end of the report, there’s a real argument to support a short thesis. That’s the only point in their favour so far.
“The Threat of an EPA Veto Will Never Go Away.”
That’s the kind of uncertainty every investor in every mine in every country lives and copes with on a daily basis. Everyone knows the risks involved with regard to the changing political landscape. Not just mines, the SEC or IRS can effectively shut down Kerrisdale Capital in a heartbeat if they choose to. All this proves is that the US government is a behemoth with a giant club and arbitrary powers.
“For a project with enough upside at a low enough price, this staggering political risk might be worth taking; for Pebble, which several of the world’s largest mining companies have already abandoned, it obviously isn’t.”
I’m long the stock because I disagree with precisely this. This is a project with enough upside at a low enough price.
The only valid point in the short sellers’ entire report comes down to this: Alaskans and the EPA will not allow Pebble to be built. I’ve already discredited their second point on mine economics. But at current share prices, the company has a lot of optionality value! If things truly change under a Trump administration, and we get onto the second leg of the secular commodity bull market (indications are that it is already underway), the mine will just be too lucrative for the enviro-fascists to have their way. Will native Alaskans or migrant workers turn down a $100,000 starting salary offer to work for the Pebble mine in order to show solidarity with the hunters and fishermen? I think not. Will the Trump administration actually enable Pebble to become a mine? I don’t know. I do know that at these prices, it is a great speculation. I have some skin in the game.
“It’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong.”
– George Soros