analysis of the cuo mxx merger

I posted this lengthy analysis elsewhere and thought it may be of interest to those on this board also.

Analysts have recently upgraded their expectations for copper prices. Mineral Securities (L.MXX and ASX:MXX) is merging with its investee CopperCo (ASX:CUO). CUO offers very cheap and profitable copper production, MXX offers a very cheap set of listed investments and development projects including one of the most promising new platinum plays (Platmin, T.PPN and L.PPN) and an unlisted 25% stake in a very high grade zince/lead/silver deposit (Xstrata own the rest). Private shareholders in CUO and MXX were both upset with the merger proposal, which to me just confirms that it is a fair deal. Certainly the new company, which so far is being termed New CopperCo, will be very attractive indeed.

Here is the breakdown (all these figures in A$):

761.7m shares (after having taken out MXX's 97m holding in CUO)
$388.47m Mcap at $0.51 (current CUO price)
$207.37m liquid assets (setting aside CUO cash/debt; this figure does however take into account MXX's $51m cash and $72m debt, so $21m net debt)
$181.09m enterprise value (ignore CUO cash/debt)

$82.60m (post-tax profit at current 19kt production)
$112.23m (post-tax profit at 25kt production [mid 2008])
$136.93m (post-tax profit at aimed for 30kt production [end of the year])

This assumes copper is at US$3.73/lb. The company has hedged 27.5kt over three years at US$3.02/lb equivalent (the hedge is in A$, hence the equivalent bit) but the rest of production will be unhedged.

Of the $207.37m net liquid assets, $151.27m is the investment in PPN, which will be a very serious producer from Q1 2009 (shallow, low-chrome platinum ounces - a very attractive company indeed).

At 30kt copper the ratio of enterprise value to earnings is 1.322. Just going on MCap, the P/E is 2.84. All post-tax. Mine life is not terribly long at present (7yrs), but there is a great deal of potential to expand this, especially since the merger with MXX brings together a lot of land in Nthern Queensland, which is where the copper operation is.

None of the above takes any account of the unlisted assets that MXX brings to the table. They include Vostok (a copper property into which Vale is earning an 85% interest - by funding a feasibility study), Sappes (an 800koz gold property in Greece; feasibility completed in 2006, awaiting permitting [a tricky business in Greece] before production), and the jewel in the crown, Lady Loretta, in which they have a 25% interest (Xstrata holding the rest). Here is the analysis for Loretta:

13.7mt at 17% Zn, 5.8% Pb, and 96g/t Ag. Assuming 90% recoveries, each ton contains 336.6 lb/t Zn, 114.8 lb/t Pb, and 2.8 oz/t Ag. At $0.75/lb Zn this is $252.45/t for the zinc, at $0.50/lb Pb, $57.42/t fot the lead and at $12/oz Ag, $33.45/t for silver. Add it up and you have $343.32/t - at conservative metal prices. Assume $50/t opex and you have $293.32/t margin. Outstanding by any measure. Further assume:

2kt/day (19.6yr mine life)
700kt/annum (350 days)

$205.32m operating profit
$51.33m (New CopperCo [pre-tax] share)

I haven't estimated capex for a 2kt/day operation. There was a technical report from April last year which set out some alternatives (one of which was toll milling through Xstrata's nearby Mt Isa operation: higher opex [although my $50/t was a high stipulation] but much lower capex). I wouldn't think it would exceed $200m, of which the company's share would be $50m, so pay-back in less than one year.

Increase the production rate (which is very possible) or up the metal prices and the annual profit leaps accordingly. Very latest metal prices: $1.04 zn, $1.24 pb, $17.79 ag. The value per ton (at 90% recovery, as above) is $542 and the margin $492. MXX's pre-tax annual profit would be $86m. Or increase production to 3kt/day or 4kt/day - pre-tax profit leaps to $77m and then $102.6m.

A very nice kicker for the New CopperCo.

I think this is screamingly good value.

And it gets better.

Since the merger plan was announced CUO and MXX have traded in lock step, but they have diverged slightly since then (the deal is 2.2 CUO shares for each MXX share). The last close for CUO was A$0.51. The merger equivalent is $1.122 or 51.83p. MXX closed at A$0.99 (45.73p equivalent) and 43.5p in London. This gives a nice value gap, into an already startlingly cheap proposal. Invest £1 into MXX now and it buys £1.19 in the New CopperCo (this is just 51.83/43.5). If you buy on the ASX your A$1 buys $1.133, so not quite as cheap, although getting an instant 13% uptick into an already absurdly cheap company should appeal. Or buy in London and get an instant 19% free. All this assumes the merger closes, which I expect it will. If it doesn't, and you bought MXX direct, then you just own an astoundingly cheap mining house.

I have an interest - I own a lot of this (for a small investor like myself) - because I think the numbers are compelling. This is, in my view, worth a serious look for any copper enthusiast or value investor (especially one who wants to buy a copper producer on a forward P/E of under 3, which effectively comes with platinum production, zinc development and a gold landbank for free).

The company websites are quite useful:

http://www.copperco.com.au/
http://www.mineralsecurities.com.au/default.asp

And the following article may be of interest (although it does contain errors):

http://www.proactiveinvestors.co.uk/articles/art.php?MXX2

This crowd have written on MXX before. The comments on management experience and the quality of the team being assembled are worth noting. They also wrote up Platmin (PPN) a few days later:

http://www.proactiveinvestors.co.uk/articles/art.php?PPN2