High River Gold’s Hardships

After preparing the markets for some sort of deal, a deal has indeed been done: High River Gold Mines (HRG-T, HRIVF-o) has announced a massive private placement with Russian steel giant Severstal that will see the Russian firm take a controlling interest in the Toronto-based gold producer.

High River, which has three operating mines in Russia and a fourth in Burkina Faso, found itself in financial straits as continuing production problems at two of its key mines restricted cash flows at a time when credit markets were beginning to dry up.

The situation left the company vulnerable to lenders and its failure to meet two covenants attached to loans it took out for its Taparko mine left its survival in question.

The chief covenant breached was one with Denver-based Royal Gold (RGL-T, RGLD-q) that required High River to meet project completion requirements at Taparko by Oct. 1. It didn’t.

It was also forbidden to rack up debt from operations of more than US$1 million before the project was completed. It did.

Unfortunately for High River, its debt from operations had reached $8.2 million so Royal Gold took a 90% equity interest in Somita — the subsidiary that controls Taparko — to secure the loan.

And the company’s balance sheet for the third quarter pointed to more troubles. Current liabilities show short-term debt and the current portion of its long-term debt at US$104 million.

With credit tight, it would have had to increase cash flows to meet such payments. But while the company came back out of the negative in terms of cash flow from operations in the third quarter, at just $2.4 million, the sum was not enough.

In addition, increased capital spending associated with mine repairs hammered investing cash flow, coming in at a negative $71.2 million.

Relief, it was clear, had to come from outside and it arrived in the form of Severstal. The company is taking a 50.1% controlling stake in High River via a $56.4-million stock purchase.

“The money they inject will alleviate short-term cash requirements and with four new mines in production, that will generate the cash flows needed to take us forward,” says High River’s head of investor relations, Dan Hrushewsky.

Severstal may be remembered by some Canadian investors for its last-minute bid for the former Stelco last year — a bid that ultimately lost out to U. S. Steel.

But in buying 282.3 million new High River shares at 20 apiece and 40.7 million warrants with a strike price of 64, it is not letting High River slip out of its grasp.

And while there may be some speculation about a large Russian firm taking over a foreign company with gold and silver assets within Russia’s borders — given the country’s recent history of quasi-nationalizing deals — Hrushewsky says nothing of the sort was at play in this case.

“They would have been familiar with us as there are not a lot of North American producers of gold in Russia with reasonably successful operations,” he says. “But their active interest only began when we announced we were looking at strategic alternatives.”

Severstal Resources, a division of Severstal, got into the gold mining business in 2007 when it acquired Celtic Resources Holdings, a gold miner with assets in Kazakhstan. Soon after its acquisition, Celtic was delisted from London’s AIM exchange.

The arrival of Severstal as a controlling shareholder — it formerly held close to 10% of High River stock — will also usher in a change at the company’s head.

High River’s chief executive David Mosher will step down and be replaced by Nikolay Zelenskiy, currently the head of Severstal’s gold division.

At presstime, High River shares were trading for just 7 — a long way off from their 52-week high of $3.50.

The challenge for new ownership will be to ensure operational problems that have plagued High River at both Taparko-Bouroum in West Africa and its Berezitovy mine in Russia, are a thing of the past.

The mill at Taparko was shut down for the entire third quarter while a new $200,000 gear box was installed, and Hrushewsky says the company is confident that it has a handle on vibration issues that had hampered production over the course of the last year.

The mine is currently running at a throughput of 2,500 tonnes per day, just shy of its designed capacity of 2,700 tonnes per day.

Gold production at Taparko in November is forecast at 5,000 oz., increasing to 7,000 oz. in December. That production will come from a stockpile of 200,000 tonnes of ore. So far this year, the mine has produced just 22,967 oz. of gold — and will not be able to reach the 91,000 oz. that was given as guidance back in early March.

About 200 km northeast of Ouagadougou, Taparko was initially slated to go into production in the fourth quarter of 2005.

Its first gold pour came in July 2007 and it went into commercial production two months later. At that time, High River said it expected to produce 100,000 oz. gold at the mine in 2008 and 140,000 oz. in 2009.

As for the Berezitovy gold mine, 900 km northwest of the city of Blagoveshchensk, its first gold pour came in August 2007. While commercial production was originally slated for the end of 2007, a filter cloth problem meant the facility was only producing at 29% of its designed capacity, pushing that target to May 2008.

Missing that target date, the project finally reached commercial production on Oct. 1. Gold production for the first three quarters at Berezitovy came in at 28,202 oz. Guidance from early March put total production for the year at 77,000 oz.

The company expects to approach its targeted total production from all operations of 300,000 oz. gold for 2009.

The lone bright spots for High River on the operational side are its two smaller projects, the Zun-Holba and Irokinda underground mines in Russia’s Buryatia Republic. The mines produced 109,592 oz. gold as of the end of the third quarter and were on track to meet production targets.

And yet even that good news was tempered by questions about financial reports from OJSC Buryatzoloto — High River’s 85% controlled subsidiary that has a 100% stake in the two mines.

On Nov. 16,High River announced it was delaying the release of its financial statements because of concerns over financial reporting from Buryatzoloto. Hrushewsky says the problems are related to technical accounting matters and not to any major revelations.

“In light of what was going on (in terms of looking at alternative strategies) the board wanted to make sure there were no issues,” he says of the decision to withhold releasing financial statements. “It’s just to be safe.”

The combination of High River’s delayed financial reporting and its agreement to give Severstal a majority interest in the company without shareholder approval — High River used a financial hardship exemption that allowed it to bypass its shareholders — has the TSX reviewing the company’s listing status.

But Hrushewsky says the company will file financial results in due course, and will meet the necessary financial requirements by June to show that it is out of financial hardship, thus maintaining its good standing.

Whether Severstal decides to keep High River on the TSX, regardless, is anyone’s guess.