Bolivia to take Malku Khota

The Bolivian government plans to expropriate South American Silver’s 100% owned Malku Khota silver-indium-gallium project, the Vancouver-based company announced in a press release after markets closed on July 10.

The Bolivian government plans to expropriate South American Silver’s 100% owned Malku Khota silver-indium-gallium project, the Vancouver-based company announced in a press release after markets closed on July 10.

South American Silver said it has not received any formal notice from the Bolivian government about the cancellation of its concession and is still seeking clarification about its intentions, but confirmed that the government has made statements that it intends to nationalize the project.

The news comes in the wake of Bolivia’s nationalization of Glencore International’s Colquiri lead-tin mine earlier this month and its expropriation of Spanish energy firm Red Electra’s local grid in May.

“Bolivia stated publically after the Glencore nationalization and that of Red Electra that these were ‘renationalizations’ of previously state owned assets and that private investment would be respected under the constitution,” Greg Johnson, South American Silver’s president and chief executive, told The Northern Miner.

“For us it was particularly surprising in that only a little more than a month ago an accord was signed with the government in supporting the [Malku Khota] project and supporting the community and expressing the desire of the local community to have this work,” he added. “We’ve been here since 2007 and have been particularly focused on working with the indigenous community. Areas of social responsibility and community relations have been a real focus for the company; we take this whole area as a really important part of our business approach to mining.”

South American Silver has invested more than $16 million in the development stage project over the last seven years and says it continues to receive support from 43 of the 46 indigenous communities in the project area.

Johnson added that while it was a setback for the company, it continues development work at its Escalones copper-gold project in Chile and has over $38 million in cash as of the end of the first quarter.

Calling the nationalization of Malku Khota “a perverse move” Paolo Lostritto, a mining analyst at National Bank Financial in Toronto, said the decision “is likely to cause the country to suffer from a decrease in foreign direct investment and likely will have a negative impact on the nation’s ability to attract investors to its recently announced bond auction.”

“While there is still a small chance that there could be some consideration received for the asset expropriation, we have taken a draconian view at this time,” he wrote in a research note. “We now value SAC based on the remaining cash on hand (about $0.27 per share) and the in situ value for the preliminary resource at Escalones (about $0.46 per share) in Chile.”

Tom Hayes, a mining analyst at Edison Investment Research in London, said in an email response to questions that if the statements made by the Bolivian government turn out to be true, it would mean that the country is going against its own policy of only “recovering” previously state owned assets, and “sets an unwanted precedent for further potential appropriations of private foreign investments in the country—something that Finance Minister Luis Alberto Arce once said his country had never, and would never, do.” (The finance minister made the comment in a guest blog published on the Financial Times website on May 10, 2012.)

“Previously, projects in the oil and gas industry that have been nationalized, in certain cases, were once state controlled anyhow and the government just took back what they considered was once theirs,” he continued. “Malku Khota is a little different in this respect as it is a new project being developed, and the recent comments of nationalization by Evo Morales seem to have been made to try and quell a minority group, that seems to have little support from the wider community, rather than take the project for any strategic means. The reasons for nationalization of the oil and gas industry at least can be viewed from a strategic resource stand point.”

Bolivia’s nationalization comments come after a violent minority opposition to the project detained members of South American Silver’s Bolivian subsidiary and a local policeman. The final three captives were released on July 9 after the national government stepped in to help negotiate their release. Local opponents to the project wanted the government to cancel the mining concession.

Mike Niehuser, the founder of Beacon Rock Research in Oregon, describes the management of South American Silver as being “in the top 1% of mining companies today in working with governments at all levels not just to develop projects but also leaving a positive legacy on the communities they operate,” and says until it receives a formal notice of nationalization from the government, the statements “could be miscommunication or could be positioning to reposition the government relative to the company.” He also points out that it could be a case of something getting lost in the translation. “Not only do you have issues with word choice and translation from Spanish into English but you have words spoken to one audience in Bolivia, namely voters, and another audience footing the bill elsewhere, namely investors, listening intently.”

But he says that if Bolivia does take the course of expropriation not only will it put investors in the company at risk but also “the citizens of Bolivia who will continue to live without foreign investment.”

“Bolivia is a wonderful country,” he says, “and the project is world-class, and management could not be better suited to the challenge, but integrity and trustworthiness is a universal trait, and we will see whether the Bolivian government fits in the world or not.”

In the meantime Lostritto of National Bank Financial has slashed his target price on South American Silver’s stock price to 60¢ from $2.85 and changed his rating from Sector Outperform to Sector Perform.

The analyst said he arrived at his new target price by applying a 0.75x multiple to his in situ valuation of the company’s early stage copper-gold porphyry target in Chile.

“We believe that Escalones has excellent exploration potential, but the market is likely to require some time to digest the negative events that transpired in Bolivia.”

Lostritto noted that South American Silver completed an initial resource estimate for Escalones in December 2011 and upcoming catalysts include drill results over the coming months, additional drilling from October to April, and the release of an updated resource estimate and a preliminary economic assessment in the next 12 months.

Escalones has an inferred resource of 420 million tonnes containing 3.8 billion lb of copper, 56.9 million lb of molybdenum, 610,000 oz of gold and 16.8 million oz of silver using a 0.2% copper equivalent cut-off grade representing a copper price of about US$2.50 per lb. On a copper-equivalent basis Escalones contains 4.5 billion lb of copper grading 0.49% based on approximate three-year average metal prices in late 2011 of US$3.00 per lb copper, US$1,200 per oz gold, US$22 per oz silver and US$16 per lb molybdenum.

Jon Hykawy of Bryon Capital Markets in Toronto has cut his price target from $2.75 per share to $1.40 and in a research note reasoned that the next best steps for the company would be to “somehow negotiate an involvement for SAC in Malku Khota on some reduced set of terms. By involving the Bolivian state in the form, perhaps, of Comibol (the Bolivian national mining entity), it may be possible for SAC to regain some value from the project.”

“We should perhaps be grateful that the move to nationalize the project occurred at a time when minimal investment had been made by SAC,” he continued. “We have previously noted that our valuation of Malku Khota, based on a historical level of silver, indium and gallium pricing and using a 17% discount rate and 10x terminal multiple was $196 million. To date, nothing like this value has been spent on the project. If Comibol was to take a stake in Malku Khota, and ‘control’ the social aspects of the project, even with SAC carrying the full weight of development and capital expenditures, there is good value in pursuing Malku Khota.”

If that isn’t possible, Hykawy adds, than the wisest course is just to “abandon the claims and the country.”

“It is very likely that it would not be alone in doing so,” he says. “Litigation is likely to prove fruitless, and to our mind would likely be a case of throwing good money after bad.”

South American Silver’s shares closed at 37¢ apiece, down 12¢ or 24.5%.

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