DRC miners hardest hit

While these are tough times for companies across the mineral sector miners in the Democratic Republic Congo (DRC) are getting hit twice as hard as their peers.

Mounting fears of war in the east, continued delays in the renegotiation of some key contracts in the copper rich Katanga region in the south, combined with the tightness of credit across the globe has slashed the share prices of miners in the country by two to three times that of the industry average.

Justin Reid, an analyst with Cormark Securties, says miners relying on debt financing are being hit hard the world over, with cost of capital in some recent deals rising to as high as 20 to 40%. But such expensive capital is especially toxic for firms in the DRC as it is coming at a time of rising political discount rates associated with the troubled country.

Analysts have upped their discounts from the 7 to 10% range to the 12 to 15% range, meaning that projects in the region would have to generate considerably greater cashflows to keep their internal rates of return (IRR) above the discount rates used to bring those cash flows back to their present values.

And while companies such as Freeport McMoRan Copper & Gold (FCX-N) are well diversified outside the DRC and well connected, (one analyst commented that they have the strongest lobbyist in their corner in the form of the American government), others are not so lucky.

Katanga Mining (KAT-T), a company that takes its name from the province in the DRC which hosts massive quantities of copper and cobalt, has been one of the hardest hit.

Despite its Kamoto project generating incredible cash flows (helped along by the fact that it has negative cash cost due to other mineral credits) the company has had to suspend construction of the second phase of the project.

Katanga recently announced that it is unable to raise new capital in the current market and owes privately owned Zug-based Glencore, some $150 million, which must be paid by next November. The situation has had a disastrous effect on its share price. While its shares had closed as high as $26 in July of 2007, they are currently trading in Toronto for just $1.29.

And Katanga has an memorandum of understanding (MOU) with the government in hand, something that neither Freeport nor First Quantum (FM-T) have.

Those two companies have been trying to hammer out a deal with state-run Gcamines despite the fact that they already have another agreement in hand.

The problem stems from a government edict issued late last year that ordered a review of all mining contracts in the country. From that review it was announced that a renegotiation of some 60 already signed contracts would begin.

And while Gcamines says it has concluded renegotiations with 28 of the 30 companies it was involved with, Freeport and First Quantum were not among them.

Rumours are swirling that Gcamines is looking to greatly increase its stake in the projects without buying-in. In the case of Freeport’s massive Tenke Fungurume copper deposit, Gcamines already has roughly a 17% stake which is a free -carry, meaning that Freeport and part owner Lundin Mining (LUN-T) must wholly finance development.

But with the crashing sound of commodity markets resounding all around, analysts like Cormark’s Reid believes that both Gecamines and the government are coming to their senses.

An increased stake is off the table for Katanga and First Quantum, and if they were to walk away from the projects it would effectively kill foreign direct investment in the country. That would simply mean too much lost revenue for the government. Reid believes that increased royalties and taxes are more likely.

An unnamed industry source familiar with inner workings of the Tenke deal, said he expected negotiations with government to wrap up by the end of the year. An important point because the project is slated to go into production late next year.

Freeport says development of the project is proceeding in a business as usual manner.