Silver Standard, a different company

 

 

By : Sean Rakhimov

Editor,  www.SilverStrategies.com/

 

 

 

 

 

 

 

Introduction

Silver Standard (NASDAQ: SSRI, TSX: SSO) is a company that needs no introduction to silver bugs.  Or does it?  It has long been regarded as a premier silver play and its President, Bob Quartermain virtually single-handedly popularized the "land bank" aka "ounces in the ground" concept of valuing a company based on the defined undeveloped resources it has.  And it has been wildly successful.  So successful in fact, that today we lament that (in our opinion) it has largely removed the analytical work from the daily chores of many mining analysts at investment houses and diminished it to plugging in numbers into a resource-centric model of valuation of exploration companies and small producers.  This, of course, is not the fault of Silver Standard, but rather a testament to their marketing prowess.

 

To that end, SSRI has amassed some 2.5 Billion ounces of silver equivalent (with gold and base metal, more on that later) and grew to gain its place among the best of the best of exploration companies.  That, you know.

 

More importantly, over half of those resources – spread over a host of projects from Canada to Chile and Australia – are concentrated in the company's four development stage projects: Pirquitas, Pitarrilla, Snowfield, Diablillos with the high grade San Luis project being the fifth to sweeten the mix.

 

Production

 

You probably also know that most recently the company has put its first silver mine into production at the Pirquitas project in Argentina.  That is a transition few companies have navigated without hiccups, at least in the beginning and it would be naive to expect it in this case.  The plan is to produce silver at the rate of:

 

1.    1 Million oz in 2009

2.    9 Million oz in 2010

3.    10 Million oz annual average for the life of mine of 15 years

4.    $2/oz cash cost average for the life of mine

 

At current metal prices that should generate some hefty cash flow to the tune of $150 - 200 MM annually.  These numbers are made possible because of expected significant credits from production of tin and zinc.  In our opinion, there is a good chance that cash cost net of credits could turn negative at some point in the future due to rise in base metal prices.  Like for most industrial metals, the tin price has moved to higher levels in recent years and there is no reason that we know why it would not continue to participate in the general commodities bull market which should last at least another decade.  Incidentally, the case for future zinc prices could be even more compelling.  You can find the long term charts for zinc and tin at Infomine.com.

 

The first shipment of concentrate from the Pirquitas mine took place at the end of July of 2009, and there were a few more since then, with ramp up towards commercial silver production scheduled toward the end of this year.  The tin circuit construction is under way and plans for subsequent commissioning of the zinc circuit are in place.

 

 

If Silver Standard to cashflow $150+ MM or more free and clear starting 2010, that could mean we may have seen the last equity offering by the company earlier this year.  This is a rather important point, emphasized by Frank Holmes in this interview.  Shareholder dilution has been the Achilles heel of the industry and SSRI stresses per share value in its development strategy.  That is not to suggest the company should not take advantage of growth opportunities in the future which may involve share issuance so long as per share value remains a priority.

 

At $17 silver, a 10 Million ounce/year producer, depending on different variables, can be valued anywhere between $500 MM to $1 B in market cap.  For our calculations, we'll use a number in the middle of that range, say $650 Million.

 

In the development pipeline for production are two more projects: San Luis in Peru and Pitarrilla in Mexico.  San Luis is a joint-venture with Esperanza Silver (TSX.V: EPZ, a company we have long favored and discussed in the past) where SSRI has 55% interest, which can be taken to 70% by delivering a feasibility study (currently underway, expected to be completed in Q1, 2010), and to 80% by funding it through production. While the current resource at this project may appear small (350,000 oz Au), particularly with respect to ballpark mine construction cost of $100 MM, this high grade gold mine would produce some 80,000 oz of gold annually at $300/oz (our guesstimate) cash cost.  At $1000 gold price, SSRI's 80% interest would add in round numbers another $45-50 Million annually to the bottom line for 4 years (projected mine life).  Since production at San Luis is not likely to start until 2011-2012, one could theorize that the actual upside could be much greater given recent action in the gold market.  (Personally, we believe most of these numbers, especially ones 5-6 years from now, let alone 10-15 years, will be blown out of the water based on our expectations for metal prices, but we have to use some numbers, and think current prices will resonate with most readers.)

 

Although Pitarrilla is in development stage and is slated for production within 4-5 years, we can't resist the temptation to use a recent market transaction to arrive at a hypothetical price tag for this project.

 

Digging for more value

 

To simplify the math and valuation on the Pitarrilla, which is somewhat of a monster project, we will use the recent acquisition of Aquiline for $626 MM as a basis.  That transaction included the Navidad project in Argentina with 750 Million oz of silver and 3.5 Billion lbs of lead (in all categories) along with about 1.5 M oz of gold at two other projects.  A portion of that silver was sold to Silverstone (now Silver Wheaton).  Pitarrilla sports 726 Million oz of silver (in all categories) with minor base metal resources.  To make an "apples to apples" comparison and be conservative at that, we'll round down the theoretical market value of Pitarrilla to $550 MM.  One could argue that number up or down, but in the current context with admittedly liberal assumptions, it is close enough for us.  That is what the market paid for a comparable asset just last month.

 

A similar calculation can be made for the Snowfield project in British Columbia, Canada.  This project essentially occupies a part of the same ridge and is an extension of the KSM project of Seabridge Gold (TSX: SEA).  On its web site Seabridge reports the following: "The KSM project is one of the five largest undeveloped gold projects in the world. Measured and indicated resources now total 34.5 million ounces of gold and 8.5 billion pounds of copper."  Since KSM is further in development than Snowfield, for valuation we'll use resources in all categories, which stack up at 46.6 M oz Au and 18.8 M oz Au for KSM and Snowfield respectively.  Silver Standard also reports silver values, while Seabridge shows significant copper resource.  SSRI did more drilling since then and we should expect better numbers in the next resource calculation, perhaps before year end.  The new resource should move a chunk of the inferred resources into measured and indicated as well as increase the total number of ounces.  Again for a quick and dirty calculation erring on the conservative side we'll assume that Snowfield can be valued at 1/3 of the KSM project valuation.  Based on that, at current prices, the rough guesstimate price tag for the Snowfield project is about $300 MM.  Put all of the above together and we get a classic situation where a sum of parts is greater than the whole (all numbers in CA$).

 

Total Market Cap

$1,500,000,000

Pirquitas

$650,000,000

Pitarrilla

$550,000,000

Snowfield

$300,000,000

Rest of SSRI approx. 1B+ oz Ag eq

$0

 

As of day close of November 13, 2009, the market values the rest of Silver Standard's roughly 1 Billion oz of silver (eq.) ounces at $0.00, with a big Z.  That includes the San Luis project discussed above, the San Agustin which we visited last year and believe it has the potential to be another monster deposit, the entire team, another dozen projects scattered through the Americas, and so on. To be fair, a case like this can probably be made for many other companies, but that only confirms our point that stocks will play catch-up to metal prices in the next few years.

 

The Team

 

In the case of Silver Standard, we think the "management" or "team" factor should be given specific consideration.  You may not know that in the early days SSRI had acted as an exploration arm for western Canada for Teck (TSX: TCK).  Teck itself started as an exploration company and grew into – quote from their web site – "Canada's largest diversified mining, mineral processing and metallurgical company".

 

In addition to Bob Quartermain (geo), Kenny McNaughton (geo) and Joseph Ovsenek (eng), who have been building the company forever (something like 50+ years between them), Silver Standard has beefed up its upper and middle management in the last three years with people who have done it before on the operations side.  Here are some of the recent additions to the management team.

 

Year Joined

Name and Title

Background

2007

George N. Paspalas, B.E. (Chem.)
Senior Vice President, Operations

ex Senior VP Projects
Placer Dome

 

Tony Horton
VP Safety & Risk Management

ex Senior VP Safety,
SNC Lavalin/Placer Dome

 

Tom S.Q. Yip, C.A.
VP Finance, CFO

ex VP Finance/CFO
Asarco/Echo Bay

2008

Emilio Roca
General Manager, Pirquitas

ex Senior Engineer
Barrick/Xstrata

 

Monty Reed
General Manager, Pitarrilla

ex Mine Superintendent
IAMGold/Placer Dome/Newmont

 

Kevin Torpy
Mine Engineer 

ex Chief Mine Engineer
Coeur/Teck

 

Douglas Kim
Manager Technical Services

ex Project Manager/Chief Geologist
Sabina Silver/North American Palladium

2009

W.J. (Jim) Mallory
VP Finance, Sustainability

ex GM Operations/Mine Manager
NovaGold/Placer Dome

 

W. John DeCooman Jr.
VP, Business Development

ex Mining Project Finance
Deutsche/Standard Bank

 

David Sinitsin

ex Project Director
Freeport McMoRan

 

You can find more info on some of these gentlemen here or inquire with the company (while you're at it, also check out the Board members).  As you can see, there are no lame ducks there and Silver Standard has been proactive and judicious in assembling an experienced and accomplished team of professionals to facilitate the transition to an operating company and has the necessary expertise to grow as a producer.  We also think that some of these hires are intended to further advance development of projects in the production pipeline.  If there are any staffing gaps still, they certainly have the resources and ability to attract additional talent. 

 

Where to from here

 

So how is Silver Standard planning to add shareholder value going forward? – A question we asked when we met with the company.  They outlined three directions:

a)  Grow production - as discussed above;

b)  Continue exploration, particularly on the gold side (Snowfield) for which the company does not

     yet get due credit;
c)  Monetize non-core assets - we have seen some of this already. 
     Incidentally, through this avenue, SSRI has some $10+ M worth of shares of juniors, mainly
     Silvermex, Aurcana, Esperanza Silver and Canplats.

 

The company has $138 M in long term convertible (at $42) debt at 4.5% interest and $23 M still tied up in the ABCP instruments.  The former does not worry us as the actual inflation rate is probably higher and the anticipated cashflow should be sufficient to cover it or pay it off.  We think that chances of conversion of this debt into equity are better than 50%.  As for ABCP issues, it certainly must have been an unpleasant experience, but what's done is done and the management is likely to be ultra conservative with their cash in the future.  To that end, we don't recall anyone giving the same management a pat on the back for their very profitable silver bullion holdings that were bought at an average cost of $5.85/oz and cashed in above $20.

 

More importantly, we expect the management team to continue to make good decisions and steer the company to new heights.  If that does not seem like a valid argument, consider this: 80% of wealth in most sectors is created by 5% of the people.  People who have been successful in the past have a tendency to do it again; whereas those who haven't managed to break through are less likely to do so in the future.  This is a very important point, particularly in the resource sector.

 

The stock may track the silver price for a few more months, while the production ramp up at Pirquitas is under way and the new reality of Silver Standard as an operating company sinks in with the investment public.  New investment funds are entering the precious metals space at a steady pace and this trend should both broaden and accelerate.  We also expect the money flow into this sector to do the same, as money managers increase their percentage allocation to metals.  Lastly, as a producer, Silver Standard is likely to be added to various indexes, which in turn will make it more attractive to still new investors.

 

 

 

Sean Rakhimov

Editor,  www.silverstrategies.com/

 

Also by Sean Rakhimov

 

 

 

 

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