Bond deal lets Inca One ramp up in Peru

VANCOUVER – A creative debt package is giving Inca One Resources (TSXV: IO) the $5.5 million it needs to expand Chala, the gold mill in Peru where the company processes ore from artisanal miners.

Inca One and its Chala mill are at the forefront of a shift within Peru’s small-scale gold scene. Artisanal miners have long mined gold in Peru’s hills but the precious metal trade was highly informal. Trucks and backpacks full of gold-bearing dirt would leave the country for processing elsewhere; of the ore processed domestically much went to small, inefficient and unofficial mills. The system deprived Peru of major royalty and tax revenues and limited miners’ returns.

To address this the Peruvian government is working to formalize its gold sector. Small-scale miners are now required to register and take their ores to permitted mill facilities.

That’s where Vancouver-based Inca One fits into the picture. Many of Peru’s small-scale mill operators cannot navigate the formalization process, because of environmental non-compliance or lack of funds to complete necessary upgrades or operational inefficiencies that mean a tax burden would render them uneconomic.

But Peru’s small-scale miners keep digging up gold and now, as registered operators, they have to take their ore to permitted facilities. And there simply are not that many.

“If you have the cash to buy it there’s an unlimited amount of ore,” said Edward Kelly, president and CEO of Inca One. “Nobody really knows how many tonnes are being produced a year … If you just go with the government numbers, they figure it’s been about 1.6 million oz. of gold per year that’s been leaving the country with no taxes paid on it.

“How many tonnes is that? If you use half an ounce gold per tonne as an average grade — that’s sort of the minimum that the artisanal miners will mine — that’s 3.2 million tonnes per year. It’s a lot.”

Inca One is not the only international player in Peru’s ore processing space. Dynacor Gold Mines (TSX: DNG) led the way and now operates a 250-tonne-per-day ore processing facility in southern Peru. Others, such as Anthem United (TSXV: AFY) and Standard Tolling (TSXV: TON), are on the hunt for facilities to purchase.

Inca One is also hunting, for additional facilities to increase its capacity down the road. Kelly says the company has several such mills in its sights.

“The sweet spot for these kinds of plants is 250 tonnes per day — that’s been proven by Dynacor,” said Kelly. “We plan to have four plants in strategic locations up and down the coast of Peru, each doing 250 tonnes per day.”

That’s the plan, but before Inca One acquires another operation it wants to get Chala up to snuff.

Chala is in southern Peru’s Chala region. The mill has been churning through 25 tonnes per day since Inca One bought it in mid-2013, but from day one the company had bigger plans in mind.

As a first step Inca One plans to expand Chala to 100 tonnes per day. With nearly a year of test milling and metallurgical tinkering under their belts, Kelly and his team are ready to expand the operation. The only hitch was money.

“Now that we have the capital, it’s just a matter of putting the money to work to build the plant out,” he said.

The money is coming from a $5-million private bond placement. The bonds will bear interest at 10% per annum and the lender will also receive a 3.5% fee on part of the net revenues from Chala. Inca One plans to start repaying the debt after one year and have it paid back in full by the end of the third year.

“We worked long and hard on this deal and right now you have to be creative with financing,” Kelly said. “You definitely don’t want to be doing equity financings in these kinds of markets and if you’re going to be taking on debt you better have a way to pay for it – you have to be in cash flow. So that’s what we set out to achieve just over a year and a half ago now.”

Inca One started out along a more conventional path: by acquiring an old mine. As the company grew to understand Peru’s gold scene, it became clear that milling was a more profitable avenue.

“We started out with a mine then we bought a plant, and we quickly realized that best return on investment right now is definitely within the plant,” said Kelly. “It’s a phenomenal cash flow machine.”

Importantly, Inca One is not a toll miller. As the name implies, toll millers process ore for miners for a fee. Inca One, by contrast, is an ore processor. Miners bring their ores to Chala, where the golden dirt is assayed. Within 24 hours, with a gold grade estimate in hand, Inca One buys the ore and the miners walk away cash in hand.

“Then it’s our risk — we take on the risk for the metallurgy,” Kelly said. “That’s what we’ve been focused on in the last six months — test milling and figuring out how the metallurgy works and the economics behind it. There are a lot of little things you have to figure out to be able to have your gold sell and put money in your bank account at the end of the day.”

In exchange for taking on the metallurgy risk, miners sell their ores to Inca One for a discount. The better Chala can do at recovering gold, the larger the spread that is Inca One’s return.

“Peruvians have gone with toll milling for a long time for two reasons,” Kelly said. “One, the millers don’t have the cash to buy ore inventories, because they’re just small, illegal operations.”

That’s where Inca One’s bond deal comes into play. The company plans to spend more than half the money expanding Chala into a 100-tonne-per-day facility, but $2 million of the $5.5 million raised will be spent buying ore.

“Two, the small millers don’t want to take on the metallurgy risk,” Kelly continued. “They just put ore through their mill and if 50% of the gold goes into the tailings pond, that’s that — the miller gets his fee. It means the miller has no incentive to improve recoveries. So we’re bringing a whole new level of professionalism to the ore processing market in Peru.”

There is certainly a lot of gold in the artisanal ores showing up at Chala. In two months near the start of 2014 Chala recovered 172.4 oz. gold and 78.6 oz. silver from 365 tonnes of ore carrying an average grade of 18.17 grams gold per tonne.

Inca One’s share price remained steady near 16¢ on news of the bond deal, after having climbed from the 13¢ level in recent weeks. The company has a 52-week share price range of 6¢ to 17.5¢ and has 63.6 million shares outstanding.