A big bet by Buffet on tungsten…or a firm specific move to lock-up supply?

While tungsten promoters may want to spin an investment in a tungsten mine that connects back to Warren Buffet as a rousing endorsement for the metal, the main factor in the move is far more pragmatic.

Buffet’s Berkshire Hathaway (BRK.A-N, BRK.B-N) has an 80% stake in the privately held Iscar Metalworking (IMC) — a position it acquired back in 2006 for US$5 billion — and IMC has made a significant investment in a tungsten project in South Korea that is currently owned by Vancouver-based Woulfe Mining (WOF-V).

But extrapolating that the investment means Buffet believes tungsten prices are about to soar is a bit of a stretch.

The more prominent motive for the deal is that IMC operates a large-scale metal cutting tool manufacturing plant in South Korea, roughly 200-km south of Woulfe’s Sandong tungsten project.

IMC’s facility is the largest producer of metal cutting tools and the second largest consumer of tungsten. With the plant expected to double production, its little wonder that IMC would seek to make a move to lock-up a key supply source, especially when the location of the mine makes such logistical sense.

And while such maneuvers towards vertical integration can benefit if the price of the underlying commodity rises, they are seldom done as a play on the metal price.

Woulfe’s president and chief executive Brian Wesson also emphasizes the more practical aspects of the deal, as he explains that Woulfe has been in talks with IMC for years over a possible partnership at Sandong.  

“They were the first people we went to see when we acquired the project,” Wesson says of his initial contact with IMC, which was made shortly after Woulfe’s management team took over the project in January of 2010. “We knew they were connected with Berkshire Hathaway and so we knew they had money in the bank. We thought they were the logical guys to be a part of this.”

The structure of the deal breaks out into two distinct sections. 

First there is IMC’s investment in the Sandong mine itself. That amounts to a $35 million cash investment by IMC for a 25% stake in Sandong — a former mine that was the world’s leading producer of tungsten before it shuttered in 1992 after the Chinese flooded the market with their own cheaper metal.

The second part of the deal, however, is the key according to Wesson. It will see the two companies joint venture on the creation of an entirely new entity that will be responsible for upgrading concentrate produced at Sandong into an end-user quality product —ammonium paratungstate.

Generally tungsten mines ship concentrate grading roughly 67% tungsten to an upgrade facility which turns it into APT, but by creating their own JV Woulfe gains IMC’s branding and its guarantee of quality.

That is significant as a chief concern amongst providers of capital in the industry is often metal quality.

“What the deal really brings is that now the actual guy making the end product is a user of it, so there is no risk of quality control,” Wesson explains. “That’s why we gave them a 55% stake….so their brand is on the final product.”

Woulfe will have the remaining 45% stake in the new firm, which is to be called APT JV. The company will buy at least 90% of Sandong’s production but has the option to buy a full 100%. Wesson says the prices to be paid will be at a slight discount to market but that the terms were better than those being offered by other potential off-take partners.

As for capital for the new company, IMC will put in $19.25 million while Woulfe is required to put $15.75 million, but that amount will be made available to Woulfe via a loan from IMC.

IMC is also loaning the Sandong project $5 million in cash immediately so that the project can move into the development stage this spring. The mine is expected to reach production in the first half of 2013.

With IMC on board, Wesson is confident that the rest of the roughly $135 million in capex needed to construct the mine will be available via debt financing — which means there will be no dilution to current shareholders.

Thanks to the deal with IMC Woulfe can now go to the bankers with a guaranteed buyer as collateral and an end product that is guaranteed by IMC. Those two factors take a considerable amount of financing risk out of the project and with declining risk comes declining interest payments on debt.

While recent deals in the gold mining industry have priced debt financing for capex at roughly 10%, Wesson believes Woulfe will be able to get terms at less than 8%.

He expects to have the financing done by June, just after Woulfe completes its feasibility study on Sandong and IMC signs off on the deal for good.

The Sandong project is made up of three ore bodies that are held within a mountain rising 500 metres from a valley floor. Wesson says the ore bodies have a structure similar to coal seams, as they are roughly 10 metres high and run for 1.2 km along strike.  

Mining will be done as an underground operation using cut and saw techniques. The mine currently has an 11 year mine life, “because that’s all we’ve drilled so far,” Wesson says. “We know there’s a lot more ore as there’s been a good correlation between historic drilling and our drilling.”

The historic resource at Sandong stands at 106.5 million tonnes grading .35% tungsten.

 Woulfe has defined an indicated resource of 5.9 million tonnes grading 0.42% tungsten and 0.04% molybdenum.