IKN

Fortuna Silver (FSM) (FVI.to) is wide open to a class action suit

But oh brother, has this story ever spiralled quickly! The news release out Friday from Fortuna Silver (FSM) (FVI.to) was the first official comment from the company regarding the unholy permitting mess that has blown up around its San José mine in Mexico. The company spent last week on the airwaves trying to limit damage to the share price but the NR, when it finally arrived, shone light on just how bad the company’s predicament has become. As a result, FSM was featured on the blog Friday afternoon (11) and, while the house comment was “bloggy” (let’s say) instead of The IKN Weekly’s style, there’s no hiding how bad things are at San José any longer.

Why so? In one word, Roxgold. Earlier this year, FVI started and completed the buyout of ROXG but at no point in the proceedings, except perhaps buried in contractual legalese, were shareholders of ROXG made aware of the continued denial of permit to FVI’s San José mine, despite the transaction opening in April 2021 and closing on July 2nd. For a bit of numerical history, the all-paper deal was announced just after FSM had run to $8, but by the time it had closed FSM was down at $5.50, with both ROXG and long-standing FVI holders already somewhat hamstrung and unhappy with the outcome. From that point in early July, the share price of the new larger Fortuna Silver Mines more or less trod water until two Fridays ago, dissent had tampered down and was limited to a few grumbles and gripes, but not any longer; with the new revelations out of Mexico, ROXG has seen its original stake cut in half. Here we go with some numbers and sums, starting with a quote from the original NR announcing the deal (12):

“The exchange ratio implies a consideration of approximately C$2.73 per Roxgold common share based on the closing price of the Fortuna common shares on the Toronto Stock Exchange (“TSX”) on April 23, 2021, representing a 42.1% premium to the closing price of Roxgold on the TSX on the same date. Based on the 20-day volume weighted average price of the Fortuna shares and the Roxgold shares on the TSX for the period ending April 23, 2021, the exchange ratio implies a premium of 40.4% to Roxgold shareholders. The implied fully diluted in the-money equity value of the Transaction is estimated at approximately C$1.1 billion.”

Applying details to that, on April 23rd FVI closed at $9.64 and ROXG closed at C$1.92. After the announcement of the deal, the next trading day Monday April 26th saw ROXG close at $2.21. Cut to this weekend and at FVI.to new and badly whacked price of C$4.85, ex-ROXG holders have $1.37 worth of shares for their money. Or if you prefer, in July 2021 Roxgold’s last trade before the fusion completed was at C$1.90, so even that is a 27.9% haircut to today’s price. All a long way from what ROXG holders were promised and a lot due to FVI management keeping quiet about the risks inherent at San José.

Summing up, Fortuna Silver got approval from Roxgold shareholders by offering than C$2.73 worth of value for their shares. This evening the equivalent ROXG fraction is worth C$1.37, an almost exact 50% haircut from the offer and largely due to a permitting process that would normally be straightforward, but turned out to be anything but that. Under these circumstances, ROXG shareholders are allowed to wonder where approximately $500m of the deal has gone and let’s recall, ex-ROXG shareholders make up around 35.7% of post-merger Fortuna Silver (13). The potential for a class action suit against FSM for this permitting mess was already high, weaponized (ugh, that word again) by the fact that the company trades on the NYSE, a more litigious market toward companies than Canadian-only listed stocks. However, once you delve into the weeds of this story it gets worse. A lot worse.

First up, last week’s Conference Call and in order to head off criticisms, FVI addressed the issue this way in its prepared notes (14):

“This renewal process is something we started on May of this year. Semarnat is citing two main reasons for the denial: one, not receiving requested information from us; and second, that we have an open evaluation for the regularization of 73 ancillary facilities not declared in the original 2009 Environmental Impact Statement.”

With respect to the first point, we have already provided proof dating back to 2019, we have been submitting and complied with the share information. And second, we are of a strong view that the regularization of ancillary infrastructure, which is a process that we initiated in 2019 and is currently in the hands of Semarnat and evaluates the mitigation of impacts for a greenhouse, a soccer field, a weather station, a core check and drill core storage facilities, an office, a 40,000-liter fuel truck, a power transformer and other infrastructure of similar nature cannot provide grounds for a denial. Additionally, our legal team is also of a strong view that the regularization of 73 works does not form part of the request for the extension. The deadline for Semarnat to provide a response to our 10-year extension application expired on Saturday, October 23.

IKN back and we note that FVI glosses over point one, but even then decides to paint a false picture as FVI started the renewal process for the permit in September 2020, not May 2021. Then they go into detail on point two whereas in point of fact, the second issue is the minor of the two and the devil is in the details of point 1, the fact that SEMARNAT is demanding a prior consultancy process and social license from the company. Here’s what SEMARNAT says about that process (translated):

“This consultancy will allow the indigenous communities to decide, in a democratic and legitimate manner, about their territory without underestimating environmental protection and the region’s natural resources, protecting human and environmental health.”

So not only does the prospect of a prior consultancy sound bad for FVI, but the wording used by SEMARNAT now seems biased in favour of the local opposition. And who is this opposition, people that have always been portrayed by FVI as tiny in number? For that, we refer to this article (15) which lists the groups and organizations that come under the main opposition front, named “El Frente No a la Minería por un Futuro de Todas y Todos” (“The No to Mining for a Future for All Front”, a bit of a mouthful in English and in Spanish). Translating the list, the front comprises of municipal and community agrarian authorities from Magdalena Ocotlán, San Matías Chilazoa, Monte del Toro, San Martín de los Cansecos, Los Ocotes, El Vergel, Santa Catarina Minas, San Nicolás Yaxe, San Dionisio Ocotepec and la Noria de Ortiz. Also, the United People’s coordinators of the Ocotlán Valley, The Oaxaca Collective in Defense of Territorios, The Services for Alternative Education AC, The Services of the Mixe Ser People SA, and the Union of Organizers of Sierra Juarez of Oaxaca UNOSJO S.C.

That doesn’t sound like a tiny minority to me. Perhaps those inside the company knew that a while ago, for example the FSM VP Exploration for LatAm who “resigned voluntarily” in September (16). It may be mere coincidence of course but in hindsight, that timing now looks odd at best. Then there’s this (17), a Globe&Mail article from May 14^th when the Roxgold merger was getting criticism from Fortuna shareholders. At that point, FSM went on the marketing trail to make its case and was clearly successful as the deal went through as planned. After featuring a quote from a shareholder named Buckley, the report continued:

Finding more believers like Mr. Buckley is key for Fortuna, because half of its shareholders are retail. Part of the company’s current strategy is engaging with newsletter writers, in the hope of favourable coverage. Just as institutional investors turn to sell-side analysts for their thoughts on a deal, retail investors likewise listen to the opinions of newsletter writers. Fortuna lately has presented to several writers in the business, including Dave Kranzler of Investment Research Dynamics, Trevor Hall with Mining Stock Daily, and Garrett Goggin with Stansberry Research. In an e-mail to the Globe, Fortuna spokesperson Carlos Baca stressed the independence of the views of the newsletter writers, saying the company doesn’t remunerate them for coverage and hasn’t paid any of them to write about the transaction.

Reading that note this week and hearing how the company doesn’t pay for coverage made me laugh loudly. The aforementioned Carlos Baca knows why, I will simply remind readers that I dropped coverage of Fortuna a long time ago and will never go back. In any case, we do know that the aforementioned newsletter writers mentioned zero zip nada about the issues around San José at the time, probably due to a lack of DD. Then there’s the abrupt change in attitude shown by Fortuna Silver to a public consultancy, as last year under a different head SEMARNAT tried to organize what opponents called a “Consulta Expres” (no need to translate that) they feared would ram through findings that didn’t represent local opinion. This fast-track approach was eventually abandoned, but at the time (18) Mexico’s national daily “El Universo” asked “la Compañía Minera Cuzcatlán” (i.e. Fortuna Silver’s wholly owned subsidiary), who said the proposed fast-track consultancy “had carefully followed all indications established by the law for this type of procedure” and that the company “fully trusts in the determinations of the corresponding authority.” My, how they’ve changed their tune since the old boss left SEMARNAT and the new one arrived! And you don’t need to ask the Ganoza family or even Carlos Baca in IR for the new company opinion, either. Let’s take for example this report (19) that quotes one Saúl Molina Jiménez, General Secretary of the workers’ union at the mine, who is leading the current protest marches and sit-in outside of ministry buildings in Mexico, all with the purpose of getting Fortuna’s permit signed off. He said last week that the workforce was waiting on word of negotiations in order to resolve the issue. He also stated that the protests would continue until they could return to Oaxaca with their permits and would intensify the protests if their demands were not met.

That’s strong support from the workforce, but it’s not the whole story because IKN has another angle that Fortuna doesn’t want you to know about. The protests happening in Mexico’s capital city are not new, as this October 26th 2021 (20) news report testifies. Here’s a quote from that report:

“During the protest, Saul Molina, General Secretary of the union of the STCSCEO CTM union (workers at the mine) openly threatened physical violence. During an interview with Oaxaca Central News TV, Molina warned, “We’re not going to let the closure happen…even if blood has to be spilled, we will defend it”, referring to the FSM mine at San José de Progreso.”

Perhaps Señor Molina regrets being as strident as that nowadays. Summing up, FVI started a permit renewal process in September 2020, but when it went off their planned track in 2021 (the change of boss at SEMARNAT was clearly a big negative moment for the process), decided not to tell anyone and the merger process with Roxgold (ex-ROXG) went ahead, with the aid of “newsletter writers” to convince retail shareholders, closing in July. Things were clearly getting worse and the writing was on the wall in October, as why else would union leaders who want the mine to stay open threaten blood in the streets if the permits were not granted? At the conference call on November 10th FVI glossed over the main issues, failing to explain that “not giving them requested information” is in fact the prior consultancy that hasn’t happened since 2011, not the 2019 date mentioned by them. And the tiny local opposition is anything but that.

Fortuna Silver Mines (FVI.to) (FSM) is in a lot of trouble.