CHICAGO () -- Nevsun Resources [AMEX:NSU; TSX:NSU], one of the mining world's major laggards of late, shot up more than 20% today after the company announced that the government of Eritrea had finally signed a participation agreement at the company's massive Bisha project.
Bisha represents one of the larger undeveloped gold and base metal deposits known today, with 1 million ounces of gold, 9 million ounces of silver, 747 million pounds of copper and 1 billion pounds of zinc. But the mine's status has been the subject of debate over the past several years.
Nevsun was actually kicked out of the country by the Eritrean government in late 2004, and only allowed to resume exploration activity in early 2005 after agreeing to allow the government to purchase a 30% interest in the project (on top of its 10% free carried interest). While exploration and development work has proceeded since then, the ultimate fate of the project has remained up in the air as the Eritrean government has been slow to issue a formal mining permit.
The news that the Eritrean government has agreed to purchase 30% of the project makes it increasing likely that the company will shortly get a mining permit. After the unmitigated disaster known as Tabakoto - the Malian mine currently sits mothballed after running substantially over cost estimates - things were looking pretty grim for Nevsun.
This makes today's news that the Eritrean government has agreed to a participation agreement at Bisha that much sweeter. After many years of attempting to develop a world-class mine in Africa, Nevsun CEO John Clarke may finally be one step closer to that goal.
Agreement Hinted at by Curiously-Timed Financing
An inkling that an agreement might shortly pass first emerged when Nevsun announced a C$15 million private placement financing package on October 18th for $1.50 per share - suggesting that Nevsun was looking to get cash on hand shortly to continue its development work. While those institutional shareholders are likely still under lock-up agreement, they've already netted themselves paper gains in the range of 50%.
While the timing is likely little more than good fortune for the institutional buyers, the timing of the issuance does beg the question: Why was Nevsun in such a rush to issue shares?
If we assume that the company had some clue that the participation agreement was close to signing, simply waiting an additional two weeks for the expected pop would have significantly reduced the dilution to current shareholders.
At today's prices, for example, the company would have to issue 1/3 fewer shares to net the same C$15 million. Unless the company was truly that starved for cash, or truly had no sense of the impending deal, the financing can only be labelled as poor corporate governance.
Valuation
What is quite unclear, however, is Nevsun's valuation immediately following the agreement. Beyond the normal metal price and discount rate assumption, the biggest question that remains is what price will the Eritrean government pay for the 30% interest in the project?
Although the valuation will be determined by an 'independent' auditor, it's quite difficult to ascertain what inputs the auditor will use to determine the project's intrinsic value. Valuation estimates from Canaccord Adams that factored in fairly aggressive metals prices of $700 gold, $14 silver, $2.25 copper and $1 zinc and a 10% discount rate, the government's purchase price would come to $195 million - leaving the NAV for Nevsun at a quite healthy $4.30 per share.
However, if the government's valuation expert is less generous with its numbers - or we feel that the country risk warrants a higher discount rate - the net to Nevsun shareholders changes dramatically, as seen in the chart below.
(Using this methodology implicitly factors in the government's share of mine development costs, which it has agreed to spend, because the projects NPV is obviously net of capex.)
Nevsun's share of gold production at Bisha will account for 270,000 ounces per annum (60% of 450,000) for 2 years, followed by a net 81 million pounds of zinc and 54 million pounds of copper.
According to a valuation by John Doody, editor of Gold Stock Analyst (GSA), at current $785 Au, $3.58 Cu, $1.31 Zn, the base metal output comes to $299 million per year, or 381,000 ounces per annum gold equivalent.
The last issue of GSA put Nevsun's average market cap per ounce of production at $4,450/oz. If we give this a 50% discount for Eritrea since production is 2 years away, we get a $2,225/oz value.
Gold production of 270,000 per year equals $601 million. Divide that by 151 million fully diluted shares, this comes to $3.98. GSA's target price is $4.00.
"If Nevsun trades over $4.00, then sell," Doody said.
Conclusion
While the final numbers are certainly a significant question mark, it is looking more and more likely that Nevsun's Bisha project will eventually get built. Even using fairly conservative estimates, it does appear that there's more upside room for current shareholders - and that a decent floor has probably been set under the stock.
