hartleys price tgt - $2.30 ( valuation $3.05 )

ATLAS IRON LIMITED
Atlas Expands Pilbara Footprint via Warwick Merger
Atlas Iron Limited (“Atlas”, “AGO”, “Company”) is acquiring Warwick Resources Limited (“Warwick”, “WRK”) via a Scheme of Arrangement. Warwick is an iron ore focussed explorer with 5,000km2 of tenements within ~120km of Newman and ~400km south of Port Hedland. The combined tenement holding of the merged entity will be over 15,000km2.
We see the acquisition of this ground as key to the long term growth prospects of the Company, helping to move Atlas beyond the current market perception of a niche iron ore miner to a substantial +20Mtpa DSO producer.
Merger Details
The $64m deal involves Atlas issuing 1 AGO share for every 3 Warwick shares. This is a 20% premium to WRK’s closing price the day before the announcement. Atlas already has a 22.2% stake in WRK. Other substantial shareholders include Hannans Reward Limited with ~18% and the Warwick board with ~15%. The Warwick board has unanimously recommended the offer.
The Scheme is subject to a number of conditions including the approval of Warwick shareholders, court and regulatory approvals, and a favourable finding by an Independent Expert. The Warwick shareholder meeting is expected to be held in November 2009.
154Mt Resource Base with Large Growth Potential
Warwick has current JORC compliant resources of 26.4Mt. However, we understand that WRK plans to issue a resource upgrade before the end of the year. Based on the current respective resource inventories, the Company would have a combined direct shipping ore (“DSO”) hematite resource base of 154Mt at an average grade of 56.5% Fe. This is in addition to Atlas’s Ridley magnetite resource of 2Bt.
Following the acquisition, Atlas will have an exploration target of 319 - 492Mt of DSO hematite (180 - 245Mt from AGO’s tenements, 139 - 247Mt from WRK’s tenements). Atlas has a history of aggressive exploration and resource expansion and we expect this to continue on the Warwick tenement package.
Whilst the Warwick tenements are likely to contain a similar range of ore types to Atlas, we understand that the package also includes some high grade, premium quality ore. This premium quality ore is currently lacking in Atlas’s portfolio. The addition of any premium quality ore may enable blending to upgrade some of its other ores, or be sold by itself as a premium product.

Source: Atlas Iron Limited
Aggressive Production Target
Atlas is calling the Warwick tenements the “Southeast Pilbara Projects”. AGO has stated targeted production from these projects of 14Mtpa by 2014. Management has advised us that Atlas will ramp up exploration on the new projects, aiming to delineate far greater resources than the current 26Mt to enable 14Mtpa of DSO production over a number of years.
We expect that the Company will build a substantial resource base for this area before committing to development. This process is different to which the Company followed at Pardoo, Abydos and Wodgina, which had development studies running in conjunction with the resource drill outs. This more traditional approach is due to the larger scale and higher capital expenditure likely to be required when compared to the very low capex of Pardoo and Wodgina.
However, we would not expect the overall capital expenditure for the new projects to be onerous due to Atlas’s low development capital philosophy. We would expect that any development to be in the region of $20 - $40 per annualised tonne of production. This is at the lower end of the scale for DSO hematite projects. This range would imply an overall approximate capital expenditure for 14Mtpa of production of $280m to $560m.
Potential Development Contingent on Port and Rail
Commercial development of any DSO deposits on the Southeast Pilbara ground will be conditional on both port and rail access. The ore is likely to be shipped via the planned North West Iron Ore Alliance berths in Port Hedland, which are scheduled for completion in late 2013. The berths are to have a capacity of 50Mt, of which Atlas has been allocated ~18Mt.
For the rail, we see three options for access: BHP’s Newman rail, FMG’s rail; or the construction of a new rail line.
BHP Option - The Warwick tenements are located close to Newman, which is a major centre for BHP’s iron ore operations and is supported by extensive rail infrastructure. BHP has historically been reluctant to allow third party access to this rail. However, Fortescue Metals Limited (“FMG”) made an application to the National Competition Council (“NCC”) in mid 2004 that it should be
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granted access to the Mt Newman rail line. The full bench of the Federal Court found in FMG’s favour. A subsequent appeal by BHP to the High Court was unanimously dismissed in September 2008. Fortescue now has the ability to argue in the Australia Competition Tribunal that it should be granted access to the Mt Newman rail. The Tribunal hearing into the matter is set to commence on 28 September 2009.
Even if the tribunal confirms the allowance of third party access, we see it as unlikely that BHP will allow AGO to utilise this rail system in the near term. However, a decision in favour of allowing third party access has the potential over the long term to open the Pilbara to numerous junior miners, as well as Atlas, enabling the development of a number of stranded ore bodies.
Fig. 3: Pilbara Rail and NWIOA Projects
Source: North West Iron Ore Alliance
FMG Option - The FMG railway line to Cloudbreak is located approximately 300km to the north of the WRK ground. This will be reduced by 50 – 100km if the planned expansions to both the Christmas Creek and Serenity projects go ahead. Given FMG’s open access rail policy; we see the FMG rail as the more likely transport to port option.
New Rail Option – A third possibility is the construction of a new railway line to Port Hedland, possibly partly or fully funded by Chinese interests. Whilst we do not see this as likely in the short term due to the relatively fractured ownership of the non BHP, RIO and FMG deposits, we would not rule out the development of such infrastructure. If there were to be consolidation amongst these junior iron ore companies, it may enable the economies of scale and mine life required for such a large infrastructure project.
Pilbara M & A on the Rise
Over the last few weeks there have been a number of corporate transactions undertaken by junior iron ore explorer/developers with Chinese firms with a view to enabling the development of the juniors currently stranded deposits. The recent transactions between FerrAus Limited and China Railway Materials Commercial Corporation (“CRM”), as well as United Minerals Corporation and CRM, are aimed at progressing the development of each company’s’ deposit, and may lead to the development of other third party rail infrastructure. Other deals include Aquila Resources Limited with Baosteel Group Corporation, as well as FMG’s agreement with BC Iron Limited.
We note that Atlas is one of the few companies that has not required the backing of a major infrastructure partner for the development of any of its deposits.
We expect to see this trend of Chinese infrastructure partnerships in the Pilbara region continue. In addition, we believe that there is the potential for some of the juniors to
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start consolidating to enable the development of these stranded ore bodies.
Deal Slightly Dilutionary, Medium Term Value Accretive
Based on the 1:3 ratio as per the scheme of arrangement, we estimate that Atlas will issue ~41m new AGO shares to the WRK shareholders. This will give WRK shareholders just over 9% of the combined entity.
However, as Warwick is still at an exploration stage, the addition of the WRK tenements will not increase our valuation of Atlas by 9%, as exploration of the area is still at a relatively early stage, not all of the current resources are likely to be economic and the project is reliant on future exploration success.
We believe that the merger is likely to go ahead in its current form due to the large portion of shares controlled by Atlas, the Warwick board and Hannans (totalling ~55%). However, we are being conservative and will not officially incorporate the merger into our Atlas valuation until the shareholder’s meeting.
Our current Atlas valuation is $3.05/share. By way of comparison, if we were to incorporate the additional 41m shares, and assume $50m in value for the Southeast Pilbara tenements (equivalent to just under $2 per resource tonne), our valuation drops to $2.89/share. If we assume zero value for the Southeast Pilbara tenements our valuation drops to $2.78/share.
If Atlas is able to deliver on its targeted 14Mtpa production from the Southeast Pilbara projects, the Company should more than double operating cashflow, assuming similar operating costs to Pardoo, Wodgina and Abydos. As an example of the potential value of the new tenements, if we assume an operating margin of A$20/t and a 14Mtpa production rate, the new tenements could generate annual operating cashflow of A$280m.
Summary – Merger Gives Large Growth Potential
Atlas is paying $65m in scrip to acquire a large ground holding in the east Pilbara – an area where it has little current landholding.
We see the addition of this land package as key to the long term growth prospects of the Company. We believe that the 12Mtpa targeted production rate from Pardoo, Wodgina and Abydos projects is the natural DSO production peak from these assets. Consequently, to expand beyond these levels, the Company needed to acquire other assets with production potential, which is the rationale behind the Warwick merger.
We believe that over time, as additional resources are defined on the Southeast Pilbara ground, and the rail infrastructure issues are overcome, our valuation for the Company will significantly increase. We also expect the market to reward Atlas if it is able to achieve its targeted production rates. This will move the Company away from the current perception of a niche iron ore producer to a substantial +20Mtpa DSO producer.
We see this deal as a relatively cost effective expansion into a new area for Atlas, though the expansion is a departure from its traditional philosophy of low capex start-ups close to port. We see the biggest impediment to development as railway access, though this is not insurmountable and we await developments on this front in the future. We believe that this acquisition will become key to the Company becoming a significant DSO hematite producer and maintain our Buy recommendation.

Hartleys Limited ABN 33 104 195 057 (AFSL 230052) 141 St Georges Terrace, Perth, Western Australia, 6000 Hartleys does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.