new val at $2.43, page-48

SDL’s Mbalam project in Cameroon and Congo is on track to ramp up to 35Mtpa from 2014, which will make it a top ten global iron ore exporter. There are few iron ore opportunities of this scale so close to FID.

The successful ratification of a mining convention, and
financing and offtake solutions early in 2011, should
drive a re-rating. We initiate coverage with a Buy rating and a $0.77 target

Large, low cost, long life

The Mbalam project has resources to support a 35Mtpa high grade hematite (62.5%) direct ship operation for 10+ years at low opex of c.US$22/t. The capex is substantial at c.US$3.8bn, but competitive against the majors at US$110/t. Stage 2 will involve beneficiation of a lower grade hematite to produce 35Mtpa of high grade (66%) concentrate for 20+ years, giving a total life of 30+ years. There are several stranded iron ore deposits in the region, an opportunity for SDL to consolidate, or provide infrastructure services.

Several irons in the fire for partners

SDL is looking for an offtake partner who is capable of taking equity in the project, and helping to arrange project financing. Such an attractive project has significant interest, and an agreement next year should lead to construction soon thereafter. The Cameroon and Congo governments are supportive of the project, having already issued the mining permit and environmental approvals. The principles of fiscal terms are being negotiated and should be ratified early next year. Our valuation of SDL with its current share in the project is $1.09, however following financing and re-structuring, our diluted 12 month valuation is $0.77, which rises to $2.43 at spot prices.

Large, long life, low cost

Large: The Mbalam project, straddling the Cameroon/Congo border has a resource base capable of positioning SDL in the top ten iron ore exporters globally. At the 35Mtpa production rate it will be one of the biggest independent producers behind the “big four” Vale, Rio Tinto, BHP Billiton and FMG.

High grade: Direct ship hematite material is expected to be 62.5% Fe. That will make it one of the highest grade new hematite mines coming to market.

Long life: Under the hematite resource lies lower grade itabirite at 38% Fe which can be beneficiated into hematite concentrate. The use of this material after the hematite is exhausted should extend the life of the project beyond 30 years.

The project is due to begin construction in 2011, begin shipping in 2014, and be at the full production rate of 35Mtpa in 2015. The fast track to a sizable production level, makes SDL the fastest growing Australian listed iron ore producer.

Low cost: With strip ratios c.0.2:1, the project is expected to be in the lowest cost quartile of iron ore producers.

Integrated infrastructure solution: A 500km rail corridor and deepwater port site have been chosen, and MOUs signed with chinese construction companies to do final designs, costings and then construction. Infrastructure is the strategic advantage in bulk commodities, and SDL has the opportunity to consolidate, or provide haulage for, other stranded deposits in the region. In total the project could be managing up to 100Mtpa of exports.

Corporate Appeal

There are few independents with iron ore projects of this size and quality, so close to production. SDL is looking for an offtake partner and we expect there to be competitive tension for this opportunity. Miners looking to establish a larger Iron ore business, or steelmakers looking for greater supply certainty could also see the business as an attractive target. The Talbot Group is the largest shareholder at 16%. Although a committed long term investor, the group has sold large stakes to offtake partners in the past, MCC and RIV.

SDL is on a fast track to a final investment decision in 2011. That should see first production in 2014 and the full 35Mtpa rate by 2015.

The key achievements in 2010 have been:

• Environmental approvals received – from Cameroon Ministry of Environment and Nature Protection in June 2010.

• Port and Rail MOUs signed – with 3rd party infrastructure providers from China which can provide fixed price, fixed time contracts.

• Declaration of Public Utility (DUP) – received for port and waiting for rail. Appropriation of land by the government will follow.

• Reserve definition drilling in final stages. SDL currently have four drill rigs working around the clock to upgrade part of the resource to reserve status to underpin the feasibility study.

The key steps to be completed in the next few months are:

• DFS completion. Most studies have been completed, but awaiting final drill results.

• Signing Mbalam Convention and ratification by parliament. The convention covers the fiscal terms of the project with the Cameroon government. The convention has been submitted, but the final details are being negotiated. A similar convention is required with the Congo government which will follow. We assume the terms will be similar.

• Finalise offtake contracts. Steel mills from Asia and Europe are reportedly interested. An offtake contract may also involve an equity stake in the project.

• Secure project financing terms. The offtake partner is likely to be required to arrange debt financing.

• Final investment decision. This should occur in mid 2011.

• Construction: Late 2011.

The port and rail are expected to take 2.5 years to build. SDL is expecting first production in 2014, and full production from 2015. We have modelled a 1 year delay, assuming full production from 2016.

West Africa – emerging iron ore province

This world class iron ore project, close to commencement, would likely be valued higher if it was in an existing production province like the Pilbara or Brazil. Of the risks associated with a new iron ore project, we believe the resource, infrastructure and financing risk is relatively low for the Mbalam project. Political risk is what concerns most investors, so we explore the emerging iron ore province of West Africa.

Majors prepared to invest in West Africa

Most recently Xstrata has acquired Sphere Minerals for $3/s or $514m, which has a 6Mpta iron ore project in Mauritania, but which Xstrata hopes to grow much bigger. Xstrata has another project in Congo and is looking to grow its African business.

Further south, the majors Vale, RIO and BHP all have interests in Guinea and/or neighbouring Liberia. Rio Tinto has had issues with the Guinean government threatening to rescind its Simandou project. Rio is now fast tracking the project and has brought in partner Chinalco. The lesson has been not to stall developments and move as quickly as possible.

Other investors close to SDL in Cameroon and Congo are Xstrata, Severstal, Equatorial Resources, Cape Lambert, and China’s CMEC which has received approval for a project across the border in Gabon.

As well as iron ore, there is significant investment in oil and gold in West Africa.

Cameroon and Congo attracting investment

The Republic of Cameroon enjoys relative political and social stability. It is a unitary republic of central West Africa with a population of about 18m people, with a government that has held power since 1982. The currency is pegged to the Euro and has been revalued only twice in the last 60 years. Agriculture, transport, mineral processing and hydrocarbon industries are the principal economic activities in Cameroon.

The Republic of Congo (Congo-Brazzaville) is celebrating its 50 years of independence this year. The President was re-elected in 2009 for a further 7 year term. The sparse population of about 4m is concentrated in the southwestern portion of the country, leaving the vast areas of tropical jungle in the north near SDL’s tenements virtually uninhabited.

FOREIGN INVESTMENT FOR OVER 30 YEARS

Both Cameroon and Congo are former French colonies with a French based legal system. Both have recently enacted modern mining codes to attract mining investment. Governments take a 10% stake in projects and royalties are c.2.5%.

Tax rates in Cameroon and Congo are 38.5% and 38% respectively, but tax incentives, including tax holidays are available for new projects.

Several international companies are already operating in Cameroon, including:

• Rio Tinto – Owns 47% of Alucam (ex Alcan), an aluminium smelter.

• AES Corp – US based power company with a US$12b market cap, owns 12 plants in Cameroon with almost 1000MW generation capacity.

• Exxon Mobil/Texaco - The Chad–Cameroon oil pipeline which pumps around 150kbpd.

• Total, ENI, Chevron - have operated in Congo for c.30 years.

• Xstrata - has an option to acquire 50% of the Zanaga iron ore project after funding a DFS.

• Severstal – has acquired an interest in Core Mining which owns the Avima iron ore deposit close to the Mbalam project.

• MagIndustries - A Canadian company with several resource interests in Congo including a Potash project.

THE MBALAM CONVENTION – GLOBALLY COMPETITIVE

The convention covers agreements with the government with respect to land access, and tax and royalty regimes. It is designed to be globally competitive, offer security of tenure, and be internationally competitive. We expect the key elements to be a 5 year tax holiday, 25% corporate tax and 5% withholding tax, and a 2.5% mine gate royalty. The convention has been submitted and is in its final stages of negotiation.

The Mbalam project is the first mining project of scale in Cameroon and we believe it has the full support of key stakeholders including the government and local communities. The direct financial benefit is expected to be US$5bn over the life of the project and it will provide employment for over 1000 people and many direct and indirect business opportunities. 0.5% of project profits will be directed to an environmental and social fund.

Environmental approvals have already been received. Impact is reduced by the chosen rail corridor avoiding national parks and passing no villages. The area is heavily forested, but has been subject to previous logging. The Belinga iron ore project had environmental concerns due to the requirement for a new hydro facility. This is not a concern for Mbalam as there is existing hydro power near-by.

Mbalam Iron Ore Project

Establishing a large footprint in an emerging province
The project is located in an area that straddles the border of both Cameroon and Congo in Central West Africa approximately 500km due east of the coast. The province was discovered in the 1980s by le Bureau de Recherches Geologiques et Minieres, a French geological survey organisation.

CamIron was incorporated in April 2005 to explore and develop hematite iron ore prospects in the Mbalam region of Cameroon, and SDL acquired its interest in CamIron in 2006 based on its commitment to provide the financing and development expertise required to implement the project. SDL holds 90% of CamIron, with the original investors the balance, and the government has the right to a 10% interest which would dilute existing shareholders.

In 2008 SDL bought into CongoIron which holds the rights to the Nabeba deposit in Congo, 42km to the south of Mbalam. The option to transport Congo material to the Cameroon site improved the economics of the project, but additional ongoing drilling at Nabeba has delayed the project beyond an initial 2012 start-up estimate. SDL holds 85% of CongoIron, with local investors the balance, and again the Congo government has the right to 10% which would dilute SDL to 76.5%.

The Mbalam iron ore project comprises the Mbarga deposit in EP92 in Cameroon; and the Nabeba deposit in MRP262 and the Letioukbala deposit in MRP363, both in Congo. SDL now holds rights to over 1,742 square kilometres of this iron ore province.

World-scale resource with upside potential

HIGH GRADE DSO MATERIAL UNDER MINIMAL COVER

The total hematite resource of 415Mt @ 62% Fe is sufficient to support a 35Mtpa operation for at least 10 years. The grade is at the high end for new mines. The Nabeba ore is of high quality with 63% Fe and low silica. Blending with the Mbarga ore will produce a premium quality product with 62.5% Fe, <5.5% silica, and <2.5% alumina. The resource at Nabeba in the south is in the inferred category, but further drilling should bring this into the indicated category for use in the mine plans and DFS.

There is minimal cover over the high grade hematite cap which will result in a low strip ratio, <0.2:1 for Mbarga. The material is soft and will only require simple crushing and screening, before railing and shipping.

UNDERLYING ITABIRITE SUITABLE FOR HEMATITE CONCENTRATE

The high grade hematite is overlying lower grade itabirite at both Mbarga and Nabeba. Itabirite is the name given to a particular lower grade hematite enriched BIF (Banded Iron Formation) found in the Itabira region of Brazil. It requires processing through grinding and flotation, and concentrates and pellets are produced commonly in Brazil. Further drilling will follow to give an itabirite resource at Nabeba.

The intention is to beneficiate the itabirite into a high grade hematite concentrate (66%) once the DSO material is exhausted. The material is capable of producing direct reduction (DR grade) and blast furnace (BF grade) concentrates. DR grade pellets could be produced at a pellet plant at a site near the port where there is natural gas available. The strip ratio of the itabirite resource is also very low at 0.51:1, but beneficiation requirements will result in higher costs at c.US$40/t.

Long life production plan

MINE PLAN

There will be two distinct stages for the project, Stage 1 is 35Mtpa of DSO hematite for 10+ years, followed by 35Mtpa of concentrate production for 20+ years. Ore will be transported from Nabeba across the border to the project site in Cameroon for processing and blending. The pre-feasibility cost estimates were upfront capex of US$3.36bn and opex of US$20/t. This was conducted before the concept of adding the Congo production, and we have modelled capex of US$3.8bn which covers mine, rail and port, and opex of US$22/t pre-royalties. The ore is suitable for a lump product, but we have assumed 100% fines. Stage 2 will require a later investment decision for a beneficiation facility. Additional capex is expected to be US$2.4bn, and operating costs for Stage 2 should be c. US$40/t.

DEEPWATER PORT

A deepwater port site has been chosen at Lolabe, 50km south of Kribi, almost directly east from the project site. Scoping studies of a single berth with a capacity of 35Mtpa accommodating 200,000 DWT Capesize or 300,000 DWT “Chinamax” size vessels was completed by Sogreah (France). An offshore geotech drilling program was completed as part of the DFS studies. China Harbour Engineering Company (CHEC) is now finalising the scope and cost of the project. A Declaration of Public Utility (DUP) has been awarded as part of the Kribi multi user port facility. The Cameroon to China freight rate is lower than that from Brazil to China, so the product is relatively attractive to Asian customers.

RAIL TRANSPORT

Route optimisation modelling has been completed and has confirmed the Mid- Northern corridor as the preferred, least cost alignment, of several routes surveyed. The route is across undulating ground with no major river crossings.

The jungle is thick, but the corridor does not pass through any villages and bypasses game reserves and national parks. China Rail completed the initial scoping work, and is now doing detailed design for the track and rolling stock