back of the envelope musings, page-2

Page 13 of the March investor presentation on the left bottom section lists the "Operating Cash Cost". The thing is if you look at the list of the specific items, these are extraction costs, not operating costs. Basically these are the costs of mining and direct costs for selling. This leaves unsaid what are their operating costs.

Operating costs would be the unrelated expenses, like the lease costs for their main offices, G&A, R&D, Finance, etc. I'm assuming those costs are nominal, but I cannot find them anywhere.

Your annual revenue looks right (although I'm backing out about 10% just for margin of safety, and on assumption that only 90% of a proven reserve is usually extracted). Once I know operating costs (as I redefine them above) we can get at EBITDA.

I have been trying to derive free cash flow, so I extract out of that the financing cash flows (interest and principal), and capex. I have been using 15% of sales as my capex number so far, because Rio seems to base their capex on something similar like 12.5%, and I figure no one is going to be more efficient on capex than Rio. My assumption is that the more profit they make, the more they invest to capex, so there might be some linearity there in using 15% as a flat percentage multiplier to sales.

You touch on the issue of "GBG share 50%". I have been trying to understand this as well. Some of their presentations say things of the Chinese partner like "their 50%". That makes it sound like the iron ore is owned by a partnership, and GBG is a part owner of that partnership. But in other presentations it sounds more like the Chinese partner took their ownership just in the form of equity of GBG, and that GBG owns the asset directly. Maybe someone could clarify this issue? As you know, that little detail could end up doubling the EBITDA per share.

Assuming the Chinese are just equity owners in GBG, and not direct co-owners of the asset in partnership with GBG, I did some present value calculations on free cash flow, and at $82/ton I get a fair value around 62 cent Australian. At $123/ton, I get a fair value around AUD $3.50.

At this point I don't rely on any of those numbers; they are very much "beta version" calculations. Some variables to ponder:

- Do we really want to count on iron ore selling for $120+ for 12 years? That's probably not a safe number to rely on, even though it might go to $150+ for three years, that is little consolation if China collapses in five years and the price goes to $30/ton.

- The financing rate is LIBOR + 3%. If inflation starts up in five years and financing costs go to 9%, that greatly affects the free cash flow.

- I'm not calculating value for GBG for 30 Mtpa. I'm going to do that a different way by projecting my model for Rio or BHP as buyers of the project. I think they get taken out at some point as a more likely conclusion than that they develop the resource on their own for 12 years.