Time is not on Baja Mining’s side

There is “substantial doubt” that Baja Mining (BAJ-T, BAJFF-O) will be able to continue as a going concern, the company declared on May 16 in its first-quarter earnings analysis under a section entitled Risk Factors.

Design changes that included a larger port facility along with higher steel and fuel costs have pushed up projected capital costs at the company’s Boleo copper-cobalt-zinc project in Mexico by $246 million and earlier this month Baja said it would need a cash injection before mid-June to keep the lights on at the project.

The funding shortfall of $246 million was estimated after considering existing cost overrun facilities of $100 million and approximate additional cost contingencies of $54 million, suggesting a total estimated cost overrun of about $400 million, Baja explained in a sixteen-page management discussion and analysis of the company’s financial results for the three months ended Mar. 31.

Keith Stephens, a spokesman for Fluor Corporation, declined to comment on the cost overrun at Boleo, stating instead “that’s purely for them [Baja Mining] to comment on, we don’t have any information to share outside of our contractual obligations with the company.”

On Monday Baja’s president and chief executive officer John Greenslade resigned and was replaced by director Tom Ogryzlo, who will serve as interim CEO while the company conducts a search for a permanent replacement. Greenslade did not respond to an emailed request for comment following news he was stepping down.   

In its statements on May 16, the company explained that “its ability to continue as a going concern is dependent upon” its ability to obtain financing to satisfy short-term liquidity requirements; obtain further financing to fund the funding shortfall; complete the development of Boleo; obtain all necessary permits as stipulated in senior debt agreements and establish profitable operations.

Baja’s monthly expenditures at the project are about $60 million and the company is seeking to implement an aggressive cash flow management scheme. “Management believes that, based on the underlying value of Boleo, it will be able to obtain the necessary financing to meet the company’s requirements on an ongoing basis,” it noted, “and while the company has been successful in obtaining its required funding in the past, there is no assurance that such financing will be available in the near term, or be available on favourable terms, or at all.”

On a more positive note, institutional shareholder Mount Kellett Capital Management, which holds about 19.8% of Baja’s common shares, has withdrawn its petition to the British Columbia Supreme Court to appoint an independent inspector to determine when the company’s management first knew of the cost overruns and is now among the parties who have entered into confidentiality agreements with Baja that will allow the New York-based private investment firm to conduct due diligence on the project. 

“With the finger-pointing out of the way, the new team can focus on the problem at hand — financing the cost overruns … and maintaining its construction schedule,” Matthew O’Keefe, a mining analyst at Mackie Research writes in a May 14 research note to clients. “With Greenslade removed, the onus falls on the new team to come up with a solution — and fast. We suspect that they are capable and, now, focused.”

O’Keefe added that he continues to like the Boleo project for its high grades, strong by-product credits and short-term timeline to production (it remains on track for first production in 2013) and has a twelve-month price target on Baja of 75¢ per share. (At presstime Baja was trading at 28¢ per share, below a 52-week range of 32.5¢-$1.28.)

The Toronto-based analyst notes that the stock should move up following a financing solution, but admitted that “challenging financial markets and the potential for project delay add increased completion risk to the story meriting our current Speculative Buy rating.”

O’Keefe also points out that while Baja has delivered confidentiality agreements to several third parties for possible participation in the project and initiated preliminary discussions with members of the brokerage community, the difficult equity markets could open the door to opportunistic takeovers.

 “At current prices, Baja stock offers the chance to add over 80 million pounds of attributable production 12-months out for about $300 million in cash and stock (Baja equity value plus cash shortfall of about $172.5 million),” O’Keefe reasons. “In our view this would be a very good fit for companies like First Quantum (FM-T) or Inmet Mining (IN-T) that could acquire with paper and fund the shortfall out of cash and/or debt.”

Raymond James mining analyst Adam Low wrote in a research note on May 16 that the departure of Greenslade did not come as a surprise, but could complicate Baja’s efforts to raise incremental funding. “In our view, Mr. Greenslade had been the company representative with the closest relationship to the debt lending group and the minority 30% Korean partners for the Boleo project,” he reasoned. “His resignation may make negotiations with either the lenders and/or the Korean consortium more complicated and lengthy.” Low has maintained his Market Perform rating on the stock with a 6-12 month share price target of 70¢.

In an earlier research note dated May 8, Low argued that a plausible method for Baja to obtain the additional financing it needs would be to sell a stake in the project. Baja currently owns 70% of Boleo with a consortium of Korean companies owning the remainder. (The consortium consists of Korea Resources Corp. (KORES), LS-Nikko Copper Inc., Hyundai Hysco Co. Ltd., SK Networks Co. Ltd., and Iljin Copper Foil Co. Ltd.)

“We believe that the most logical buyer of a stake is the Korean consortium,” he said. “Arguably, for a transaction to proceed we anticipate that Baja will need to give up control of the project. We estimate that selling a 21% stake in Boleo, at a valuation of 50% of the project’s discounted cash flow … could generate proceeds of $161 million. This would result in an ownership structure for Boleo of 51% for the Korean consortium, and 49% for Baja.”

“Conceivably, a larger stake could be sold for a larger amount,” he added, “however we note that Baja’s bargaining power will diminish as it approaches the mid-June deadline, which may mean downward pressure on the valuation that it could receive for a partial sale of the project.”

Following the company’s initial announcement of the $246 million cost overrun on April 24, Haywood Securities mining analyst Stefan Ioannou cut his twelve-month target price on Baja shares to 85¢ from $1.75, but maintained his Sector Outperform rating, “acknowledging that specific high-quality advanced-stage development projects, such as El Boleo, offer a compelling opportunity for investors with patience and risk tolerance.”

Ioannou noted that annual output during the first six years of full production at Boleo is expected to average 125 million pounds of copper, 3.7 million pounds of cobalt, and 25,400 tonnes of zinc sulphate monohydrate on a 100% basis. “Development at El Boleo includes a 3.1 million-tonne-per-annum hydrometallurgical plant to produce LME Grade-A copper cathode, high-purity cobalt cathode, and zinc sulphate monohydrate. Our model includes a life-of-mine average total copper cash cost of US$0.55 per pound net of cobalt and zinc credits, which places the project within the lower half of the global copper cost curve.”

He also pointed out that Boleo is the world’s sixth largest manganese deposit, which provides potential for an additional revenue stream at the operation, while “proximity to key infrastructure within an established (historical) mining region enhances project value.”

In the meantime, as Baja scrambles to come up with a near-term financing plan and cut costs, it is considering deferring the cobalt and zinc circuits in order to ease pressure on the copper circuit construction schedule. And it says that if the project continues to progress as anticipated, the company will meet the development schedule of mechanical completion and commissioning of the copper circuits in late 2012 and early 2013 to allow for first copper production during the first half of next year.

Based on present reserves and the current mine plan, Boleo will have a lifespan of 23 years and is being developed as a series of underground mines using a room-and-pillar mining method, along with small open-cut mines. The ore will be fed to a processing plant, which will utilize a two-stage leaching circuit, followed by solid/liquid separation and solvent extraction/electro-winning to produce copper and cobalt as metal, zinc as zinc sulfate monohydrate, and likely at some point, manganese, probably as manganese carbonate.