Howard Mark’s latest (brilliant as usual)…

Via Bloomberg

For more on Burry and another great read check out Tariq Ali’s (of the fantastic Street Capitalist) latest post on the interview.

Daniel Loeb’s latest…

Another formerly written up opportunity that we find particularly attractive at the moment is KHDHF.PK. An updated analysis can be found below.

Deep Value + Special Situations = A Favorable, High Probability Outcome

The Opportunity

An investment in KHD Humboldt Wedag International (KHDHF.PK) at or around the current price (~TBV), offers bargain hunting investors the chance to purchase a Fisher-esque growth stock, at a Ben Graham cigar butt price.

Notably, KHDHF.PK possesses nearly all of the qualities we look for in a great investment. In particular (1) an unsustainably low absolute and relative valuation (2) a good, fully incentivized management team (3) near to medium-term operating momentum (4) a promising long-term business model (5) a significant amount of recent non-economic selling pressure and (6) a variety of internal and external catalyst’s to bring about the convergence between price and value.

Given the company’s recent spin-off from TTT on March 31, 2010 (and the unique underlying dynamic/implications of this transition), and the fact that it’s in a cyclical business that is in all likelihood operating at a cyclical trough, we think it is reasonable to believe that KHDHF.PK’s underlying operating performance has stabilized and is poised to improve going forward. The bottom line here is that as the post-spin selling pressure abates and the company’s backlog begins to materially grow again, the market will eventually come to its senses and award this high quality company with a more appropriate multiple on much higher profits at some point in the coming months and years – driving returns of potentially 100%+ over the next 2-3 years with limited downside risk.

Spin-offs – A Secret Hiding Place of Stock Market Profits

Always cognizant of the typical post-spin trading dynamics that accompany the first few months of newly spun-out public company (i.e., the shareholder churn and significant noneconomic/short-term downward selling pressure that typically lasts for the first few weeks/months after the separation), we wrote that “investors interested in owning KHD pre-split may want to keep a little cash on the sidelines, as their will likely be a fair amount of non-economic selling in KID shares immediately following the spin (due to its German listing, its small size, etc.), which will likely create an even more attractive entry point. Our hope is it gets crushed so we get the chance to load up at an even better price.” Luckily, almost six months after our initial write-up, we are thankful to say that our hopes have been realized.

So with that in mind, we would like to reintroduce investors to the idea and remind them that they will likely have a relatively short window of time to earn both low-risk and outsized returns relatively quickly (a year or so), assuming they are more than willing to (1) to take advantage of one of the market’s most exploitable inefficiency’s and (2) are comfortable investing in a relatively obscure German domiciled cement and engineering company that only reports twice a year, and with what seems like purposefully complex/confusing financials (which fwiw, is a classic hallmark of KHDHF.PK’s chairman, the enigmatic, value creating extraordinaire Michael Smith).

Business Description:

KHD Humboldt Wedag International Ltd. is a world leader in supplying proprietary technologies, equipment and engineering/design services for cement and minerals processing. The company was founded in 1856, and designs and builds plants that produce and/or process cement, beneficiated coal, clinker, base metals and precious minerals. The Company has more than 900 employees worldwide, and has operations in India, China, Russia, the Middle East, Australia, Africa and the United States.

KHD through its subsidiaries offers their clients all over the world engineering services, machinery, plant and processes as well as process automation, installation and commissioning. The services include staff training as well as pre- and after-sales services through to feasibility studies and financing concepts. This array of supplies and services includes, in particular, the modernization of existing facilities for capacity increases and, for reducing the specific energy demand and the burden on the environment.

Revenue Driver’s

Going forward, KHD’s fortunes are largely tied towards the success of their operations in India and Russia/Eastern Europe (given the two countries currently make up the majority of the company’s existing backlog). In the near-term the company’s order intake will be driven primarily by strength in the Indian market, where demand for the company’s services remains robust (and fwiw should remain so for a long, long time).

With that said, a recent thesis we came across on the Distressed Debt Investors Club (hat tip to the author cparyse) framed the various issues and opportunities within the Indian and Russian markets perfectly (it is included in italics below).


India represents the second fastest growing market in cement only to China, and KHD has a growing presence with over $140mm of orders coming from India in 2009. Generally speaking, cement consumption in developing countries grows above the rate of GDP (historically this has been at a ratio of 1.7x). At current GDP growth rates in India, one would expect cement consumption to be growing at about 15% per year. Current cement capacity is around 230 metric tons; therefore, you would need about 30 metric tons of new capacity each year. This is equivalent to about 10-15 new plants. The following is a breakdown of the annual KHD market opportunity in India:

The average customized 2mm ton per year cement facility costs $425mm. The breakdown of the cost is:

KHD supplied equipment – $165mm
Pass-Through equipment – $130mm
Civil Construction – $100mm
Land Cost – $30mm

If 15 plants are built in India every year, that represents a $2.5B market opportunity. If KHD can capture 10% of that market that represents about a $250mm annual revenue opportunity. India is a structural growth story that in many ways could be analogous to China. While India currently has 230m metric tons of capacity, China has 1.4B. If India was ever to grow on the same plane as China, India would need another 800mm tons of capacity which would represent a $66B market opportunity over the long term”.

So, given that cement consumption/demand is considerably higher in developing nations in the process of undergoing industrialization than it is in mature or developed nations (as they are still in the process of building out the necessary infrastructure to support future growth) as well as that countries like India (and other developing nations) will likely continue on this path (i.e., that they will continue to grow in the future), then one must by implication believe that the demand for cement (and hence KHD’s services) will remain strong over the medium to long-term.

We want to quickly note that unlike China, where the requisite infrastructure that is needed to support the county’s near to medium-term economic growth prospects is already in place (and then some to be honest); the situation in India is radically different. Currently India’s national infrastructure is not only not overbuilt, but woefully inadequate – so much so that it essentially acts as a heavy tax and drag on economic growth (ironically the same is true in China but for the opposite reasons). Whether we are talking about power, transportation, ports, you name it – their infrastructure situation is dire, which is why the government is directing an increasingly huge amount of spending (along with courting foreign direct investments) towards remedying the problem. Keep in mind that given India’s above average GDP growth, the gap between the infrastructure they need vs. what they currently have continues to grow. Equally as noteworthy from an investment perspective is that given India’s positive labor force trends, significantly lower levels of national debt, immense foreign currency reserves, and a consumer sector that is still in its infancy, they can actually afford it. Our point is that given India’s above average growth and the governments continued spending on national infrastructure, cement consumption is poised to grow in the double digits for the foreseeable future almost regardless of the economic health of the world at large.

With the above in mind, is it any surprise that the Indian government can and will spend hundreds of Billions of dollars over the next 10 years or so to alleviate the current bottleneck? Or for that matter that KHD will continue to benefit from this spending/emerging megatrend for a long, long time to come? A prime example of the above mentioned investments is the Indian governments plan to invest almost $400B in road infrastructure projects by 2012 (notably the use of concrete in road building in India is a nascent trend). Initiatives such as this are not only not really discretionary at this point, they are actually fundamental to India’s continued economic growth and prosperity. The bottom line here is that with a large and growing need for more roads, housing, and various other forms of essential national infrastructure, cement consumption should continue to accelerate in the short, medium, and long-term. Again, investors should keep firmly in mind that the industrialization/urbanization of India is just beginning and that this fact is tremendously bullish for KHD’s long-term prospects.

On Russia/Eastern Europe (from the same write-up)…

Russia/Eastern Europe

As previously mentioned, the opportunity in Russia/Eastern Europe is now more medium term in nature due to financing issues in the country emanating from the credit crisis. In this region of the world, there is a significant need for new cement kiln technology. Eighty percent of production capacity here is wet kiln capacity which is 50% less efficient that dry kiln. There is two year payback by switching technologies. Based on discussions with management, I believe that there is about 52mm tons of capacity that needs to be replaced. Assuming $165mm in equipment per 2mm ton plant, this could represent a $4.3B market opportunity. If KHD can capture 20% share (old market share when Russia was strong), that could represent $858mm of backlog.

As the above makes clear, KHD’s order intake within the Russian market may continue to remain subdued in the near term due to the lingering effects of the credit crisis – although management recently stated that they are seeing tentative signs of improvement there (which is certainly a positive data point all things considered).

The way we see it is that regardless of the company’s immediate prospects, looking out a couple of years their Russian operations offer significant potential given KHDHF.PK’s dominant competitive position and the countries significant need for new (i.e., much more modern and efficient) cement kiln technology.


Note, we are using a USD/Euro value of 1.27 for all calculations below

Valuation wise, not too much has changed since our last write-up. An examination of the business indicates that KHD should still be able to conservatively earn 400m in revenues and generate at least $22m in free cash in a normal year going forward.

According to the August 17th mid-year update, the company currently has a backlog of $397.57m (E 313m). Per management, we can expect to recognize roughly 80% of that as revenues over the next 12 months, or roughly $318m. Add in the $75 to $100m in service revenue the company expects to earn this year and the company’s total revenue’s should fall somewhere between the $393and $418m range (or roughly $400m). Assuming $400m in sales and EBIT margins of 8% this business would generate roughly $32m in pre-tax profit. If we assume a 33% tax rate we are left with roughly $22m in net after-tax profit. With $32.9m shares outstanding that equates to .68 cents per share.

Given the qualitative and quantitative characteristics of this business I think one could make a good case this business deserves a market multiple (15x) at an absolute minimum, but let’s keep it conservative and assign a multiple of 10x. That gives us a value on the operating business of $6.8/share. So after we add in the value of the company’s net working capital (an approximation of the company’s excess cash) of roughly ~$7/share, we get an intrinsic value of ~$13.8/share or well over a 100% upside from today’s prices.

We think the above multiple is almost absurdly conservative considering this is a competitively entrenched, high return business with (1) an incredibly strong balance sheet (2) predictable, high margin cash flows and (3) above average longer-term growth prospects. Granted, this is a cyclical business facing a relatively difficult near-term operating environment, and it may be a few years before things return to normal. But with that said, we believe that it’s important to note that it’s a matter of when business conditions normalize, not if – as cement companies, can’t put off their cap-ex needs indefinitely and it doesn’t necessarily take a genius to figure out that demand for their services (1) should be strong going forward as India continues to industrialize and Russia/Eastern Europe goes about modernizing their existing production capacity and/or (2) isn’t going away anytime soon – after all, this is a business that’s been around for 100+ years.

Another important point to keep in mind here is that the valuation above assumes 0 growth going forward in KHD’s backlog, which seems almost impossible given their focus on (and competitive position in) growing emerging economies with large and growing infrastructure needs. Notably, in the company’s August 17 interim report, management stated that they have seen a significant improvement of late order intake wise, and that in their opinion the 2nd quarter of 2009 was almost certainly the bottom of the current business cycle (from an order intake perspective). So given KHD (1) appears to have reached an operational inflection point, where results are almost certainly poised to improve going forward and (2) possesses a strong competitive position in various growing emerging economies that desperately need to expand/modernize their existing infrastructure, one could argue that the 0 growth assumptions made above are indefensibly conservative over the long-term.

It’s hard to say exactly what KHDHF.PK is worth at the moment, but with its current TBV marginally below the current price it’s pretty easy to conclude “a lot more than the current price!” Paraphrasing Buffett, you don’t have to know a man’s exact weight to know he’s fat! Anyhow, we want investors to ask themselves how often they get an opportunity to pay essentially nothing to own a durable, capital light/high ROIC business generating cash flows of over $20m today, and what amounts to essentially a growing royalty stream on the continued growth of the developing world tomorrow. Again, potential cyclical headwinds aside, this is a great business that continues to have a huge secular tailwind at its back as most of its business is derived from emerging markets (particularly India, Russia, The Middle East, and Eastern Europe), where cement consumption is likely grow at an above average rate for a very long time – the current price implies the opposite.

The bottom line here is that the current valuation simply makes no sense unless one believes the company is likely to burn cash for the foreseeable future – considering the company’s variable cost structure and growing backlog, such an outcome seems highly unlikely at this point (at least for any material amount of time). Note: Revenues would have to drop beneath $300m before KHDHF.PK would come close to burning any cash, so taking into account the current valuation and given the top-line should remain comfortably above that number we believe such concerns are wildly overblown all things considered.

Downside Protection (Margin of Safety)

Considering today’s environment and the myriad of risks/headwinds that still face both the public and private sectors of our economy, we think it makes sense to look for investments with significant downside protection as well as certain defensive characteristics that will likely ensure the business in question will do well under any reasonable future outcome we can imagine. With that in mind, we feel that KHDHF.PK fits this bill beautifully, as it possesses numerous attractive qualities that taken together go a long way towards ensuring a positive outcome regardless of what the future has in store for the general equity market as whole. Again, the combination of (1) an attractive absolute and relative valuation, (2) a fortress balance sheet (3) a durable, high return, capital light operating business with above average long-term growth prospects (4) numerous internal and external catalysts that should help bring about the realization of value and (5) a proven, high quality management team that is absolutely committed to increasing shareholder value by maximizing return on capital and growing the business at an appropriate rate.

The long and short of it is that given the current valuation, the quality of the business/the management team and the secular tailwinds that underlie their long-term growth outlook it truly is difficult to figure out how one could lose money looking out 2-3 years and beyond, as there simply isn’t much that could upset the applecart so to speak. There are no BS/financing risks to worry about given how the company continues to maintain a strong balance sheet with significant liquidity and financial flexibility, nor any exogenous type risks – think political and/or legislative risk. Management is candid, fully incentivized, with a history of capital discipline and remaining focused on all the right things. Also, given Chairman Smith’s long paper trail of savvy acquisitions and building shareholder value through buying, improving, and spinning off businesses, the risk of the company doing anything stupid with their excess cash is very low, at least over the long-term. Granted, it’s entirely possible that short-term cyclical headwinds put pressure on KHD’s near-term results, but as long as (1) developing countries don’t stop industrializing (2) cement remains humanity’s building material of choice and/or (3) companies and governments don’t stop wanting to make their plants more environmentally friendly and efficient – any near-term operating weakness will almost certainly be a temporary issue…so there isn’t a lot of business risk in the short or long-term. There is certainly market risk in the near term, but given (1) the presence of multiple catalysts and (2) the fact that we are being incredibly well compensated for taking it, not only do we not think this is an issue, we are thankful for it.

Another way to analyze and slice the data when evaluating the probability of permanent capital loss regarding KHD is to drill down on the qualitative characteristics of the business. Attractive qualitative characteristics that should help safeguard KHD’s current intrinsic business value both in the short-term and over time include (1) significant earnings visibility – again, KHD’s backlog has not only stabilized, but order intake has actually improved significantly over the first half of the year (up 86% over the prior period). The takeaway is that business should be at least decent for the next few years at minimum as they continue to work through their existing backlog (2) low capital intensity (i.e., asset light business model) – With an asset heavy a business, an owner needs to continually re-invest considerably more money into his company to keep earning a profit than an owner of an asset light business. In KHDHF.PK’s case, most of the FCF generated from their operations simply piles up on the balance sheet (i.e., not much of its book value is needed to generate the company’s profits) (3) a variable cost structure – KHD’s primary cost is people, which gives them the ability to more quickly/effectively react to any significant deterioration within the company’s fundamental outlook, and hence to preserve profitability much more easily than your average business over the full cycle and (4) a strong competitive position in a consolidated market – essentially four players control roughly 90% of the worldwide market due to intellectual property. KHD holds roughly 500 patents and is currently the fourth largest player with a roughly 6% share. Keep in mind that their % share was 20% a very short time ago, and their current share is temporarily depressed due to the significant drop off in activity within their core markets (in particular Russia, Eastern Europe, and the middle east). In time we think KHD’s market share will return to a more normalized level as they win new business and activity in their bread and butter markets returns.

Also, in light of the large amount of credit creation, quantitative easing, and dollar printing that has been taking place in the U.S. and around the developed world, it is reasonable to be concerned about the future buying power of the dollar, the prospect of higher interest rates, etc. Luckily the effects of these negative outcomes on the cement engineering business should be minimal, as this business (1) earns most its profits globally (over 90% of its earnings are foreign sourced) and (2) due to both its market position and asset-light business model, it should have the pricing power to be able to preserve its real earnings power in both an inflationary and/or deflationary world.

The bottom line here is that KHDHF.PK at or around $5.76 is a classic low-risk, high-return fat pitch – offering investors who get in around the current price the chance to make a considerable amount of money under any reasonable future outcome/scenario we can imagine.


Value – current valuation is simply way too cheap given the quantitative and qualitative characteristics of this business.

Improving Operating Performance – given the myriad of macro concerns currently haunting the market and the lack of a standalone operating history, our guess is that it the company will need to have a few quarters of decent results under its belt before the market begins to realize (1) the company isn’t likely to burn any cash going forward due to the strength in the company’s order intake and their growing stream of service revenues (and that the company may in fact be entering into a cyclical upturn) and (2) to fully understand the standalone company’s permanently improved economics (as operating margins post-spin should be permanently augmented relative to what a historical examination of their results would suggest). This is due to a variety of factors, including a higher % of revenues being generated from the companies higher margin service division, the sale of the lower margin coal and mineral division and various other restructuring initiatives the company has taken on in the recent past (like their switch to a 100% outsourced model, etc.). As these changes begin to show themselves in KHDHF.PK’s results, the valuation should normalize.

Improving disclosure/general investor understanding – Post-spin, KHDHF.PK was a near complete “black box,” and the myriad of post-spin information that was released was incredibly confusing (for example, some of the reported revenue numbers didn’t include any of the company’s newly added divisions nor any of the servicing revenue as part of its projections). In fact, it was so confusing that in all honesty it was a significant factor (fwiw, the primary reason had to do with worries on the TTT side of the spin) that ended up causing us to sell out of our original position not long after our original write-up. We were convinced that we had either (1) seriously messed up our work, i.e., we flat out didn’t understand the business in the first place and (2) that management had lied to and/or had intentionally mislead us. Turns out the latter wasn’t the case (and to an extent, neither was the former), and that we had actually been “generally correct” about most of our key assumptions. In retrospect, we simply ended up being “shaken out” so to speak by the classic shenanigans that Michael Smith is so well known for (another lesson learned). Anyhow, the recently released (August 17) interim report and improving disclosure in general from the company over the next year or so will likely lead to better general investor understanding and hence a more appropriate valuation in time.

The Bonding line is renewed (November 10, 2010) – the second the company’s bonding line is renewed, management will likely begin putting the company’s excess cash to work for the benefit of shareholders. We feel this is a near certainty given the company’s present financial strength. Given management’s capital allocation savvy and the current stock price, our guess is that most of the company’s free cash will go towards what would be massively accretive stock repurchases (but they could always go towards acquisitions and/or a dividend of course).

Analyst Coverage – the company has been doing road shoes and attempting to get some decent analyst coverage.


More of the company’s stock should be spun out at the end of the month (8/30/2010), which as always could put some additional short-term downward selling pressure on the stock. Although the longer-term upside to this is that it will also make the stock more liquid. Regardless, both issues are temporary concerns that shouldn’t worry the long-term investor.

The August 17 interim report can be found here



Ackman’s Latest

Going forward we have decided to periodically post updates regarding some of our older write-up’s/positions when for whatever reason we feel they are particularly attractive and actionable. Below is a quick update for Premier Exhibitions – as always feel free to comment/email us with any relevant thoughts and/or questions. Our original thesis can be found here

Update August 24, 2010:

We would argue that at today’s price of $1.67 PRXI is more attractive than its ever been and would advise our readers to read the recently released court opinion/letter to shareholders for some further color. Fwiw we think that Sellers and his turnaround team deserve a standing ovation for their efforts here. Anyhow, the quick and dirty “pitch” is below.

“We have to say this is the first time we have ever witnessed the intrinsic value of a company roughly triple overnight, at least where the market greeted the news with nothing more than a yawn. Sure, the stock closed up some 40% on the news and clearly there is some uncertainty regarding the monetization of the Titanic assets, but given the federal court ruling granted the company an award equal to almost three times its EV at the time of the announcement – one would think at least a double would be in order. God knows the market isn’t efficient, but still…this is ridiculous. Regardless, its clear from experience that Mr. Market can be a little slow but typically he comes to his senses given time and for this I am thankful – especially in this case as its providing investors with an absolutely incredible opportunity in our opinion to generate spectacular returns over the next year or so with very little risk.

Let’s do a quick and dirty valuation for PRXI:

Value of the Assets:

Value of original Titanic artifacts = $35m
Value of newly awarded Titanic artifacts = $110m
Value of Digital archives, etc. = $44m

Note the values above where computed on a liquidation basis by a variety of independent, company, and court appointed appraisers.

Total Value of Titanic Assets = $189m

Its important to keep in mind that the NAV above is for the first time in PRXI’s history completely solid. The Federal court has ruled, meaning their will be no appeal. It’s over, case closed. The only issue at the moment is wether the court will pay PRXI cash of $110m by next August or the company will receive the in specie award. Sure, their remains uncertainty regarding what these assets will ultimately garner when sold (or what happens to the rest of the company if they get the cash award) but with the current EV of the whole company standing at roughly $60m that’s a pretty steep haircut, no? I mean we are as skeptical as the rest, but given all of the new information that has come to light since the ruling we just can’t imagine how this company isn’t worth north of $3 (or double the current price) at an absolute minimum.

Value of the operating business (exhibitions/merchandise):

Looking out over the next couple of years, the question is how much is PRXI’s core business worth? Well, if we assume last quarters revenue run rate of roughly $45m and a 20% EBIT Margin (in line with what history would suggest is achievable post turnaround) the core business would generate roughly $8m in EBIT. At a reasonable multiple of 6x, the business is worth roughly $54m (or right around the company’s current EV). Granted it will likely be another year or two before this company’s turnaround is complete but as of today their is still no compelling reason Im aware of that would lead me to think that this business won’t be able to generate similar revenues and/or a similar level of profitability that it had pre-blow up (in fact, a significant amount of progress turnaround wise has already been made but due to various restructuring charges it remains masked). Notably with the significant costs associated with the court battle now finally behind them, our guess is that progress will only accelerate from here.

Anyhow, add the $8m in excess cash on the balance sheet that is not needed to run the business and we have everything that we need….

Value of Titanic Assets = $189m
Value of PRXI’s operating business = $54m
Value of PRXI’s excess cash = $8m

Note that the above valuation does not assign any value to any future potential recoveries (which could be sizable) nor to any improved performance ticket sales wise from the upcoming 100th anniversary of the sinking (which could certainly increase public interest and hence sales as it draws near).

Total Value = $251m or roughly $5/share vs. the current price of roughly $60m or $1.60/share.

In sum, we’re not sure exactly what PRXI is worth at the moment, although we think its pretty safe to say its worth a lot more than its current price (paraphrasing Buffett, you don’t need a scale to tell a man’s fat!). Seems like an easy lay-up that will likely generate an outsized return over the next six months with very little risk (and better yet regardless of what the general market does as a whole). That said, its possible an investment today may require some patience but given Sellers commitment to monetizing his stake in the near-term, the significant and undisputed embedded value in the titanic assets and the progress to-date regarding the company’s turnaround efforts, our guess is that good things will happen sooner rather than later.”

Below is a great question we received earlier today, so we figured we would go ahead and post it along with our answer if anyone else would like to chime in with their own thoughts:

Q – Thanks for the update. Will the company have to pay taxes on the reward from the court ruling? If yes then the NAV should be adjusted. Also, suppose they get the artifacts (not the cash). They may be “worth” $110M, but how do they get monetized or generate any cash flow for shareholders?

A – great point. We don’t know for sure, although for conservatism’s sake we should probably expect that they would (considering that any sale would likely include all of the assets, one could apply a 36% tax rate to the $189m number above, which would in turn reduce the total value by roughly $68m – not chump change, but not enough to materially change our thesis – even with the reduction Premier remains bafflingly cheap). As to how they get monetized, we wouldn’t think it would be two difficult to sell the collection (all things considered) given their archaeological, historical and cultural significance. Granted, we don’t have any unique insights into this but according to the court appointed appraiser there would be multiple bidders for the assets (at 110m) if they were to go to auction today (Fwiw this has been echoed by management and Sellers). This gives us some comfort given his independence and expertise.

Outside of an outright sale (and given they now have full rights to the assets) we could see how the ruling could also result in additional revenue streams through film expeditions, artifact retrieval, TV royalty’s from Discovery or National Geographic, etc., but thats just us thinking out loud here. We would imagine they might be able to pull some sort of sale leaseback transaction as well.

Again, any thoughts on all of the above by our readers would be greatly appreciated.

PRXI Letter to Shareholders

Jim Grant’s latest

The investment analysis below is our sixth in our ongoing series of guest write-ups, and is brought to you by friend of the blog Jared Levin of A R Schmeidler & Co. We came across Jared’s outstanding recent write-up about a month ago, and frankly had to rub our eyes a little bit after our first read through (its not very often we come across asymmetrical risk/reward opportunities like Yukon).  As Jared said, “after my first meeting with management I must have had a look on my face like I was stealing candy from a baby.” Indeed! After doing our own dd we felt the same way (and have been buying ever since).

Anyhow, for those of you out there scouring the markets for 1) an incredibly attractive “bottom up” bargain, and 2) an ideal macro hedge, then taking a deeper dive into Yukon Nevada will certainly be worthwhile.



Yukon-Nevada Gold Corp:
(YNG.TO; NG6 (Frankfurt); YNGFF): $0.25
12-Month Target Price: $1.00 (+300% / 4x)
24-36-Month Target Price: $2.50 (+900 % / ~10x)

Company Web Site: http://www.yukon-nevadagold.com/s/Home.asp
Company Power-Point: http://www.yukon-nevadagold.com/i/pdf/YNG_10_05_17.pdf
Sell-Side Research Coverage: None


  • Yukon-Nevada (“YNG”) is a deeply under-valued US-based small-cap gold miner with operations in Nevada, USA and British Columbia, Canada
  • YNG is in the later phases of a turnaround:
  • Company was previously mismanaged, leading to loss of environmental permits and a liquidity crises
  • Today, company is newly-recapitalized and under the leadership of a proven turnaround CEO:
  • In 2009, a Swiss group along with Eric Sprott put $60 million into YNG and installed new management
  • Company is now debt-free
  • Most operating permits have been re-instituted and YNG is executing on a court-supervised consent decree that spells out all of the remaining steps that YNG must take to become fully-compliant; YNG currently permitted to run at 75% of capacity, with remaining permits expected soon; note that future environmental liability is capped and constrained by the limits specified in the consent decree
  • YNG re-commenced operations in October 2009 and recently achieved 150k oz/year operating rate
  • Under low-risk expansion plan (based on the re-starting of existing mines and the milling of stockpiled ore), YNG’s production will grow from 150k oz per year over the next 12 months to ~400k oz in 2012 at a cost of ~$450 per oz
  • No new equity issuance will be required to finance growth
  • Company is currently finalizing $40mm loan and forward gold sale to finance re-opening of existing mines
  • Free Cash Flow is expected to be over $75 million over the next 12 months at current metals prices, rising to $250-300 million-plus by the end of 2012 at current metal prices
  • This is against an adjusted market cap of approximately $145mm
  • Market does not yet appear to be aware of the progress of YNG’s turnaround:
  • Company is currently net-debt-free trading at an adjusted market cap of $145 million—or 2x NTM free cash flow, and <1x expected 2012 FCF
  • Mid-cap gold miners typically trade for 10-15x operating cash flow
  • YNG is also trading at a market cap per resource oz of gold of approximately $35 per oz compared to a peer average of $150-200 per oz (peer group comprised of Alamos Gold, Aurizon Mines, Centamin Egypt, Kingsgate, Kirkland Lake, Mineral Deposits, Capital Gold and Semafo)
  • There are multiple upcoming positive catalysts for YNG (see below) that will unfold over 2H 2010 that should quickly lift YNG closer to fair value
  • Near-term price target of $1.00, or 6x NTM FCF should be realized fairly quickly as market becomes aware of the progress of YNG’s turnaround

Note: If YNG were re-valued to simply trade on a market cap/resource oz in-line with its peer group, YNG would currently be valued at $1.25-1.50/share

  • Longer-term price target of $2.50 represents <10x 2012E FCF at current metals prices

Upcoming Catalysts:

The following catalysts will all be material positives for YNG and we believe have a very high likelihood of materializing when and as described:

  • July 2010—Announcement confirming achievement of operational steady-state production of 150k oz per year at a cost of approximately $450/oz
  • 3Q 2010—Completion of $40mm debt issuance/forward gold sale to finance expansion of Jerritt Canyon operations with the re-starting of the SSX/Steer underground mine (operations to re-commence in early 2011)
  • 2H 2010—Announcement of multi-year contract/JV with Newmont Mining (NEM) and/or Barrick Gold (ABX) and/or other regional producers for purchase and processing of stockpiled medium-grade ore through YNG milling and roasting facilities
  • 2H 2010—Announcement of drilling results as YNG executes on its planned $5 million 2010 exploration program on its Jerritt Canyon property
  • 2H 2010—Announcement of settlement of 2 lawsuits brought by former employees and outsourced engineering firm, both of which were terminated by current CEO (note that bid/ask for the two settlements currently at a combined total well under $10mm; initial hearings have all been going in YNG’s favor)
  • Q4 2010—Announcement of updated 43-101 resource estimate which should substantially increase YNG’s resource base, while converting a large portion of existing resources into reserves
  • Last resource update by the Company was based on drill results through 2007 using an assumed gold price of $520/oz
  • Updated 43-101 will be run using a 3-year average gold price of $1,000 (making a much larger portion of their mines economic, and thus expanding recoverable resources and reserves) and will also include drilling results from the last 3 years plus results from YNG’s current $5 million drill program
  • Note that YNG has historically converted resources into reserves at a 120% rate
  • 2H 2010 / 1H 2011—Potential re-initiation of sell-side research coverage. Note that several analysts used to cover YNG prior to the management turnover and permit suspension in 2008/2009. Current management believes that some former analysts would consider picking up coverage again after YNG announces that they have returned to 150k oz production (note that there is significantly less visibility on this specific catalyst and it is beyond management’s control)


YNG’s Jerritt Canyon property based in Nevada, USA has produced 8 million oz of gold since 1981. Prior senior management was weak and in 2008, production was suspended as a result of environmental violations and a lack of liquidity. As just one example of prior management’s incompetence, the Jerritt Canyon property at the time of shut-down was operating with over 500 employees while current management is running nearly the same throughput was fewer than 150 employees.

In early 2009, a Swiss shareholder group saved YNG from declaring bankruptcy by injecting an emergency overnight financing. Over the next several months, this same Swiss Group along with Eric Sprott of Sprott Asset Management put nearly $60 million into YNG, fired the old management team and engineering firm that was assisting with operations and brought in a new CEO named Robert Baldock who has a 30-year track record of overseeing turnarounds in the mining sector. Since taking over, new management has paid down the Company’s debt, made key maintenance investments to update machinery and equipment and come to a court-overseen consent decree with the Nevada Division of Environmental Protection (NDEP) that allowed the re-start of its facilities in October 2009.

Jerritt Canyon is located just Northeast of the prolific Carlin Trend in Nevada. One of its key assets is its roasting capacity used to process sulfide ore. Currently there are only 3 roasting facilities in Nevada, owned by YNG, Barrick Gold and Newmont. There will likely never be another roasting facility permitted in Nevada due to their lack of popularity with environmentalists. With roasting capacity limited, producers tend to process only their highest-grade ore, while stockpiling their low and medium-grade ore. In NEM and ABX’s case, they have over 100mm tons of ore combined sitting in Nevada that may never get processed that is listed on their balance sheets as assets. Eventually they will be forced to write-down that ore as liabilities if they cannot demonstrate to their auditors that there is any chance of processing it in the foreseeable future (there are also environmental clean up costs associated with it). Although under prior management YNG often processed ore on a tolling-fee basis for Newmont, current management is focused on securing a long-term profit-sharing ore-purchase contract to acquire additional mill feed stock.


YNG’s wholly-owned Jerritt Canyon property is 120 square miles with 3 current / former operating gold mines—the Smith mine, SSX/Steer and Starvation Canyon. The Jerritt mill is engineered to produce 6k tons of ore per day. Currently permits are in place for ~4.3k tons per day of ore throughput. YNG is currently completing stacking tests that should soon allow permitted throughput of 6k oz/day, which is the current engineering-rated capacity. Over the next 12 months, YNG plans to process 3k tons per day (at an average grade of 0.15-0.20 oz/ton, translating to >150k oz/year), with roughly half of the ore coming from YNG’s Smith mine and the other half coming from a stockpile of ore on YNG’s property. Over the next few years, as YNG’s SSX/Steer and Starvation Canyon properties come online, YNG would like to be supplying 50% of production from its own mines, or roughly 3k tons per day, which would still leave capacity of at least another 3k tons per day for entering into JV/purchase transactions to process and roast and sell the low-to-medium grade stockpiles of neighboring mines such as for Newmont and Barrick. Management is confident of being able to sign such an agreement by year-end 2010.

Over the next 12 months, if YNG is successful at producing in excess of 150k oz at their targeted cost of under $450 per ounce, cash from operations would exceed $105mm and FCF would approximate $75mm. Over the next 24-36 months, if YNG successfully re-opens its SSX/Steer and Starvation Canyon mines along with an ore-processing arrangement with one or more of its neighbors, then daily throughput should average 6k tons at average grades of 0.20 oz/ton, which would result in annual production of close to 400k oz (including regularly scheduled maintenance stops). (Note that YNG is considering restarting its wet mill for the processing of oxide ore, which would add additional mill throughput capacity of 5k tons per day—this would be upside to the assumptions described immediately above).

YNG also owns a mine at Ketza River in the Yukon Territory of British Columbia. Ketza River is a former producer with much of its infrastructure in-place that was closed down in 1990 when it became un-economic to mine (at ~$300 gold prices). In May 2010, YNG raised $10mm of flow-through financing for Ketza River and plans to commit another $11mm out of FCF to have a 60k oz/year mine up and running by sometime in 2012 (note that Ketza River was producing 100k oz/year when it was closed down in 1990). The mine would have a cost profile of less than $300 per ton and would be capable of generating approximately $50mm of annual FCF. This would bring 2013 production for YNG to 400-450k oz, assuming no contribution from incremental oxide processing capacity, acquisitions or contributions from further successful drilling and mining on YNG properties.


Yukon-Nevada is substantially under-valued but no one is yet paying attention. Many investors were burned by prior management and are still stewing. In addition, the market cap is small and with large insider ownership (greater than 60%), there is limited float. There is also no sell-side research coverage. Because of these factors, there is a window of time for opportunistic investors to perform their research and come to a view on YNG. This window is likely to begin to close in July when the company announces it has achieved steady-state production of 150k oz. The reward for moving in early on YNG could be substantial, as a non-demanding multiple of under 10x 2012/2013 FCF would suggest a 10-fold return for the stock over three years.


July 24, 2010

Some recent news on YNG, all generally supportive of thesis:

July 22: Company announces hiring of new Chief Geologist and outlines 50k foot drilling program for 2010, designed to extend the run-rate of 150k ounces of production (fed by their own mines, as opposed to purchased-ore from neighboring mines) from 4 years to 7-8 years (http://www.yukon-nevadagold.com/s/NewsReleases.asp?ReportID=410285&_Type=&_Title=Yukon-Nevada-Gold-Corp.-Announces-The-Recommencement-Of-Exploration-Drillin&#8230; ) (Note: I believe their is still a second press release expected in July confirming they have achieved 150k oz of run-rate production in their mills)

July 20: Boutique firm Byron Capital Markets launches on YNG with a Strong Buy and $0.50 price target

July 13: YNG announces $25mm forward gold sale financing to Eric Sprott’s Sprott Asset Management (http://www.yukon-nevadagold.com/s/NewsReleases.asp?ReportID=408905&_Type=News-Releases&_Title=Yukon-Nevada-Gold-Corp.-Negotiates-US25-Million-Note-Financing )

July 6: Boutique firm Hallgarten & Co initiates coverage of YNG with a $1.50 price target

Variant View:

As described above, the market has not revisited YNG since its difficulties under prior management. It is only due to the fact that we meet so many small-cap gold mining management teams each year that we were fortunate enough to be introduced to YNG’s new management, otherwise we would be in the dark as well as to the progress they are making

Note however, that upside case requires successful execution by management that at times may face set backs and not progress in a straight line.

The gold price is near an all-time high in US$ terms and could easily face a 10-20% correction beginning at any time. Note that despite having a substantial margin-of-safety, it is not uncommon for small-cap gold mining stocks to sell off, sometimes significantly, on any pull-back in the price of gold.

We just came across this complete set of the Buffett Partnership Letter’s and figured we would pass the PDF along (not to mention the timeless investing wisdom found within its pages). Enjoy!

H/T to jcv2010 for putting it all together in one PDF

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