Hudbay sells Back Forty stake, Constancia’s gold

With seven projects in the Great Lakes area, Aquila Resources (TSX: AQA; US-OTC: AQARF) is carving out something of a reputation as a junior explorer to watch in this region of North America. That reputation grew two sizes in early November, with news that Aquila is acquiring 51% of the shares in the Back Forty project that it doesn’t already own from joint-venture partner Hudbay Minerals (TSX: HBM; NYSE: HBM).

The high-grade polymetallic deposit in Michigan’s Penokean volcanic belt contains 1 million oz. gold and 1 billion lb. zinc in the measured and indicated categories, and news of the proposed acquisition brought Aquila’s shares 21% higher to close at 11.5¢ apiece.   

On the same day, Aquila unveiled plans to merge with REBgold (TSXV: RBG; US-OTC: RBGCF), a junior that has stakes in two exploration projects in Finland and brings strong institutional backing, plus an investment pledge in the combined entity of $4.5 million.

REBgold’s largest shareholder, Baker Steel Capital Managers, says it will invest the money to advance the Back Forty project. Baker Steel oversees assets worth $540 million on behalf of financial institutions, wealth managers and professional investors.

Under the merger’s terms, Aquila can acquire all of the outstanding shares of REBgold in exchange for Aquila shares on a one-for-one basis. And in Aquila’s deal with Hudbay, it will buy the miner’s controlling interest in the Back Forty project for an initial consideration of up to $2.5 million in Aquila shares, and as much as $9 million in milestone payments tied to the project’s development. Under the agreement, Hudbay will also receive a 1% net smelter return royalty on production (capped at $7 million) from certain land parcels on the property.

If Hudbay does not receive any milestone payments or at least $2.5 million in proceeds from selling Aquila shares within a decade, it has the right to repurchase a 51% interest in the project in exchange for its initial consideration shares, or $2.5 million in cash.

Hudbay suspended development at the Back Forty project and ended its strategic alliance last year due to capital commitments at its key development projects in Peru and Canada, as well as deteriorating global economic conditions.

“The reality is that Hudbay was suspending funding in July 2012, so Aquila was looking at different strategies to restructure its relationship with Back Forty and the joint venture, so it could recapitalize and ramp-up the development again,” Aquila CEO Barry Hildred explains in an interview. “I was brought in to find a resolution to that, which would include financing. And in this market, as you know, you need to get creative — and that’s what we did. We found a company that had several strong institutional shareholders, one of which wanted to fund this project going forward. Obviously we like the fact that they have capital and some good early stage assets in Finland, and a good management team that will help us develop this project.”

Mark Burridge, chairman of REB-gold, adds that the company had been looking for assets for a year to move the company to the next level, and when it came across Back Forty, it thought it held potential.

“In evaluating the project it seemed clear to us that the previous preliminary economic assessment was not optimized, and there was significant scope to look at different options for project development that would bring more value,” Burridge says.

The next steps would be to start optimization and trade-off studies to evaluate the project with new drill data and methods, and move forward into a prefeasibility study and continue permitting, the partners say. There are five months of studies left to go before finalizing the permitting process.

Burridge noted that the funding REBgold brings to advance the project “gives Hudbay confidence that they are vending the project to a viable company.” That’s important to them, he continued, “because they’re going to end up being a major shareholder following this transaction, and they want to make sure the company has funds to advance the project. It has also given Aquila confidence that it’s doing a deal with a partner that has financial means — and that’s pretty critical in today’s environment.”

Once the merger is complete, Hudbay will own 17.4% of the combined entity’s shares, and Baker Steel will own 23.6%.

According to a February resource update, Back Forty has an open-pittable resource of 4.72 million tonnes grading 2.24 grams gold per tonne, 26.77 grams silver per tonne, 0.55% copper, 3.49% zinc and 0.13% lead in the measured category, and 4.93 million tonnes grading 1.90 grams gold, 18.30 grams silver, 0.14% copper, 1.49% zinc and 0.21% lead in the indicated category. Inferred resources add 152,000 tonnes averaging 2.76 grams gold, 34.56 grams silver, 0.19% copper, 2.86% zinc and 0.39% lead.

Back Forty’s underground resource stands at 1.98 million tonnes grading 1.97 grams gold, 28.56 grams silver, 0.29% copper, 5.04% zinc and 0.31% lead in the measured category, and 3.50 million tonnes grading 1.96 grams gold, 27.78 grams silver, 0.33% copper, 3.57% zinc and 0.32% lead in the indicated category. Inferred resources add 2.18 million tonnes averaging 2.03 grams gold, 25.96 grams silver, 0.37% copper, 2.15% zinc and 0.33% lead.

Constancia

Meanwhile in southern Peru, Silver Wheaton (TSX: SLW; NYSE: SLW) has inked a second off-take agreement on Hudbay Minerals’ Constancia polymetallic project, but this time for its gold output.

The Vancouver-based streaming company — which in 2012 agreed to buy the mine’s total silver production — is now buying 50% of Constancia’s life-of-mine gold production for an initial payment of US$135 million. As a result, it has combined the gold and silver streams under one revised agreement.

Silver Wheaton’s president and CEO Randy Smallwood described the gold-stream deal, announced after markets closed on Nov. 4, as a win-win for both companies. It adds to Silver Wheaton’s growth profile, and gives the Toronto-based miner a little extra cash to finish building Constancia. 

Construction at Constancia is more than 40% complete, and it’s slated to start production in late 2014, before reaching full production in mid-2015. Silver Wheaton’s annual share of gold should average 35,000 oz. over Constancia’s first five years, and 18,000 oz. over the mine’s 16-year life.

Salman Partners analyst David West, who covers Silver Wheaton, said he finds the deal attractive because the streaming firm is already familiar with the Constancia project and can make the upfront US$135-million payment in either shares or cash. If Silver Wheaton pays in shares it could maintain the liquidity level on its balance sheet, he notes.

Under the agreement, Silver Wheaton would make the initial payment after Hudbay spends US$1.35 billion developing the estimated US$1.78-billion copper-molybdenum-gold-silver mine at Constancia. Silver Wheaton will then buy each gold ounce produced for the lesser of US$400, plus an inflationary adjustment, or the prevailing market price.

Gold recoveries have been set at 55% for the Constancia deposit and 70% for the recently delineated, higher-grade Pampacancha deposit. “Should actual recoveries not hit those targets, HBM could end up delivering more than 50% of payable gold produced,” cautions Raymond James analyst Al
ex Terentiew, who has a $9 target and “market perform 3” rating on Hudbay. 

Silver Wheaton says that the gold stream needs to meet the completion test from the 2012 agreement. This means that if the Constancia processing plant is not 90% finished expected throughput and recoveries by the end of 2016, Silver Wheaton would receive 100% of the gold produced from Hudbay’s 777 mine in northern Manitoba. Moreover, if the completion test is not fulfilled by the end of 2020, Hudbay would have to return part of Silver Wheaton’s investment. The streaming company may also be entitled to compensation if there’s a delay in achieving completion or mining at the Pampacancha deposit after 2018.

Despite all the terms to safeguard Silver Wheaton’s investment at Constancia, not all analysts believe the recent deal was the best move for Silver Wheaton.

“From our perspective, Constancia is not an especially attractive project and remains subject to significant development risk, especially in light of some early challenges in its construction,” said TD analyst Daniel Earle in a note. He writes that he dislikes the idea of streaming or royalty companies acting as a “safety net” for their partners whenever they need cash, as it leads to “over-concentration in single assets,” and lowers diversification.

Earle says the market would have preferred that Silver Wheaton strengthened its balance sheet after signing the US$1.9-billion gold-streaming deal with Vale (NYSE: VALE) in February. But he adds that the Constancia deal is relatively small and could be easily funded, and might include the high-grade Pampacancha deposit.

Salman Partners’ West says that in his view, the only drawback is that the recent deal doesn’t increase Silver Wheaton’s exposure to silver. Given that there are few pure-silver plays out there, he believes the company “going forward will be better served to concentrate more on the silver side than the gold side.”

West has a $35 target and a “buy” on Silver Wheaton.

Silver Wheaton is guiding production of more than 33.5 million equivalent oz. silver in 2013, and has lowered its 2017 target by 13% to 42.5 million equivalent oz. silver. The decrease mainly owes to Barrick Gold’s (TSX: ABX; NYSE: ABX) move to stop construction at its Pascua-Lama gold-silver mine, where Silver Wheaton has agreed to buy 25% of the mine’s total silver output.