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Sandspring (SSP.P.V): A new company, a bought deal, DD and ‘cui bono’

Here follows a little walk-thru on a company about to go public named Sandspring Resources. The idea is to show you what to look for when considering a new entrant and how you can decide whether the play can benefit you. On Tuesday 28^th, Sandspring published a PR (8) that piqued my interest. Here’s the first paragraph of the presser:

TORONTO, ONTARIO–(Marketwire – July 28, 2009) – Sandspring Resources Ltd. (TSX VENTURE:SSP.P) (the “Corporation” or “Sandspring”) today announced that it has entered into an agreement with a syndicate of underwriters led by Research Capital Corporation (the “Underwriter”), whereby the Underwriter will purchase, on a bought deal basis, 14,285,800 subscription receipts of the Corporation (each a “Subscription Receipt”) at a price of $0.35 per Subscription Receipt, for aggregate gross proceeds to the Corporation of $5,000,030 (the “Offering”).……….”

It then continues (please check link). So why did this offering grab my attention and why is it a good case-study in DD? The answer is a combination of several factors that should always interest the investor when looking for an investment in the sector, including, company structure, management, resource size, resource quality etc. First a little about the company.

Share structure. The first place I went was, of course, the regulatory filings. According to the last quarterly, SSP is a shell company with has 5.7 million shares out, 600,000 options at $0.10 and no warrants. So my quick math added the offering and then presumed full takeup of the overallotment (Research Capital can place another 2,857,200 units) and got the share structure as

Shares out: 22,843,000
Options: 600,000 (at 10c)
Warrants: 10m approx (at 50c)

This looked perfectly acceptable at face value for a start-up. So it was now time to find out what the company has by way of assets.

Company asset and valuation metrics. The SSP main asset is the ‘Toroparu’ gold project in Guyana. It is envisaged as an open pit mining operation. In the 43-101 compliant report that was signed off in January 2009 (I can send you a copy, but it’s 11 mega), the Toroparu resource was given an indicated and inferred estimate of around 2.3m oz Au, breaking down as follows:

Indicated: 1,369,400oz Au (at 0.93g/t)
Inferred: 973,400oz Au (at 0.82g/t)

It also has copper in the mineral. In fact the resource (low grade gold, copper credit, open pit possible) strongly resembles the Gold Reserve (GRZ) ‘Brisas’ property in neighbouring southern Venezuela. Contained copper is estimated at 265.5 M Lbs, breaking down as follows

Indicated: 45.574MMT at 0.16% Cu = 160m Lbs Cu
Inferred: 36.8MMT at 0.13% Cu = 105.5M Lbs Cu

From these numbers, the company claims a gold equivalent resource of over 3.3m oz Au, which is debatable. Personally I would use gold at $900/oz, copper at $2/lb to give a 1:450 ratio. This would put Au Eq at 2.89m oz Au..but that’s just me. Most of this mineral is in fresh rock, with a little in saprolite rock. As fresh rock is more expensive to process the 43-101 report estimates that mining and processing costs total U$10 per metric tonne. If we assume U$900/oz gold, 0.88g/t gold in the mineral and a 90% recovery rate, this mean the contained gold per tonne of rock is worth $22.92. If we assume $2 for copper and 80% recovery that adds $2.55 to the rock worth. Therefore theoretically (and at the low end of current prices) the mine has a good operating margin.

So after about five minutes of checking out the apparent share structure and the asset I’m interested. This is because if we assume 2.3m oz gold and 23m S/O, it’s approx 10 shares per ounce of gold. So from there the approximate in situ gold calculation is easy:

PPS $0.35 = gold is valued at $3.50/oz
PPS $0.50 = gold is valued at $5/oz
PPS $0.70 = gold is valued at $7/oz
PPS $1.00 = gold is valued at $10/oz

And of course these metrics become even more interesting if we add the possible copper credit and calculate using the 2.89m oz Au Eq number (or even 3.2m oz Au Eq). I am assuming CAD$1 = U$1 for convenience in these simple in situ valuations.

These are interesting numbers, especially when you consider that the current $0.35 placement offer comes with a half warrant priced at 50c. In baseball parlance, this company has got to first base in my DD and I’m thinking about just how cheap it seems to be. At this point on Tuesday I even made contact with somebody I sometimes bounce ideas off and said “hey, have a look at this”. However, as you’re about to see, you should never rush into these things on half-baked due diligence.

Share structure revisited. So now that my greed glands had been opened and I was thinking about all that cheap gold about to plop into my lap, it was time to do the careful checking. The first thing was to check all press releases and filings, not just the ones that suited my initial DD pattern. And sure enough the Utopia-like scenario I’d imagined of $3.50/oz in situ gold soon faded away. In a May 20^th press release (9) the terms of the acquisition of the Toroparu property are laid out. Feel free to read the whole thing, but in effect the owner of the property gets 38,156,288 shares of SSP for handing over his gold project. The debt of the middleman company arranging the transfer of Toroparu from the current private owner to SSP (that’s also run by one of the directors of SSP) is also paid off by issuing 3,282,740 shares and 1,804,747 units (presumably share+1/2 warrant) of SSP in lieu of debt accrued. Then $850,000 of the initial placement capital raised by selling shares of SSP also goes to the vendor of the Toroparu property to pay off the capital he placed in the middleman company.

Or in other words, assuming the bought deal placement run by Research Capital goes to plan and the full overallotment is also taken up, the company will have…

Shares out: 66,086,775
Options: 600,000 (at 10c)
Warrants: 15m approx (at 50c and 75c)

…and the owner of the private property will have 57% of the new company and gets all the money back that he put up to get the deal running. All this, of course, makes a big difference to the in situ valuations of the Toroparu gold made earlier. Again assuming 2.3m oz Au here are the revised figures:

PPS $0.35 = gold is valued at $10/oz
PPS $0.50 = gold is valued at $14.36/oz
PPS $0.70 = gold is valued at $20/oz
PPS $1.00 = gold is valued at $28.72/oz

These numbers aren’t half as attractive any longer (for example, market hotpot Keegan is valued at $21/oz right now). However they still look possibly cheap and worth further investigation, so at this point the DD turns to asset quality and to the management team behind the deal.

Management. Firstly the management and there are three directors at the moment. The CEO is Mark Maier, whose main job is working for The Aurum Group. This sounded to me like a mining-related company, but it turns out to be a dental supply company. Maier has a background in finances, holds a CFA qualification and used to work for Merrill Lynch in London. He also plans to step down as CEO and hand the baton to a certain Richard Munson, who is the abovementioned director of the company selling Toroparu to SSP, so if this transaction is claimed to be arms’ length we’re talking about very short arms indeed. The two other named directors at present are the above mentioned Richard Munson and Charles Gryba, an experienced mining executive who knows his job but (and trying to avoid character assassination after getting some off-record opinions from contacts) doesn’t seem to be the greatest of team players.

The role of Maier perplexed me the most, however. Why should a CEO who is also experienced and knowledgeable in finances step down at the precise moment the company goes public? Then on swapping mails with A.N. Other, a possible answer to that mystery came to light. As mentioned Maier works for the Aurum Group, a dentistry/dental supplies company. Here’s what my correspondent said on this angle

“The Dental-connection is very interesting. I’ve seen a number of what I call Dental-deals over the years and they tend to be unmitigated disasters. A very close childhood friend is a dentist in (removed from blog post) and was several years ago President of the dental Assoc of (removed from blog post); He says dentists are the dumbest investors on the planet (he admits he is but at least recognizes it and refrains from all investments…has kids to consume his $). My dream company would be one with a lot of Dentist and Hockey players as major investors!”

So I hope there are no dentists or hockey players in my audience that are now about to unsubscribe from the Weekly :-). But the reason for Maier’s presence may be explained by this; his job may be to sell the seed capital placement to an established circle of investors he knows through his sector. This may also explain the confidence Research Capital has in making the placement offering a bought deal. You may have noted in the first PR excerpt that the offering is a bought deal, i.e. is being underwritten by the brokerage itself and any units left unsold are taken up by Research Capital. A bought deal scenario usually means that the brokerage is extremely confident of a full take-up in the offering, as it doesn’t want to be left holding any excess baggage; it just wants its commission (which in this case is a juicy 8% cash and one warrant for every 10 units placed).

Downsides to the property
The main problem with the SSP asset is that it’s located in the middle of nowhere in the jungle area of Guyana. Water supply is easy enough. It’s one day by road in the dry season and unpassable in the wet seasons. River transport is possible. There is an airstrip for light craft with a one hour flight time to the capital, Georgetown. During the main wet season from November to February it rains like you cannot possibly imagine unless you’ve witnessed it previously (it’s not called the rain forest for nothing) and holes in the ground, such as the open pit mine envisaged here, quickly become lakes unless continually and efficiently pumped. There is a second minor rainy season from May to June. Finally there is no power supply anywhere near the place (which shouldn’t be a surprise after the previous descriptions).

The other main downside is the relatively small deposit size and low grade. Brisas (the GRZ project) is over 10m oz Au and this is not, but 2m oz or 10m oz still needs a lot of capex spent at the site. Combined with the remote location, this may well turn out to be a project killer. Even in the best of circumstances, a 0.8g/t property needs a lot of work to turn it into a viable proposition for a mine, even if benefitting from viable roads, energy supplies, on-hand labour, clement weather conditions, etc. The $4m or so that SSP will have in the bank once the placement is closed is enough, according to the 43-101, to fund exploration operations in year one. After that there will surely be more financing rounds to come and the mine will still be a long way off.

The bottom line to all this has a practical trading suggestion. I think you’d be stone mad to go for this offer and lock up money in this placement, however there may well be a trading opportunity on the horizon. If you can get shares at the 35c level on the open market when the stock comes out of shell status and starts trading as a ‘dot V’ there is every chance that the promotional aspect will send the share higher while the placement cash is still under escrow. The short-term trade envisaged is to buy early and then sell during the initial promotional push while initial interest is high (that will surely involve mention of 3.3m oz gold controlled by a company with a tiny $25m (or so) market cap). However anyone considering this tactic must make sure s/he is sold and long gone before the dentists’ (and more importantly the owners’) shares move out of lock-up.