Khan’s troubles in Mongolia (June 07, 2010)

VANCOUVER — The past few months have been a bit of a rollercoaster for Khan Resources (KRI-T) as it tries to reopen the historic Dornod uranium mine in northeastern Mongolia.

The company has had to deal with two failed takeovers, having its mining licenses invalidated and its proposed joint venture with the Mongolian government being deemed illegal by the head of that country’s nuclear agency. The recent events can be traced in the company’s mercurial stock chart.

Khan’s stock price first jumped from around 25¢ to 60¢ in late November when Atomredmetzoloto (ARMZ), a Russian state-owned nuclear energy corporation, made an unsolicited takeover offer. The board of Khan recommended that shareholders reject the offer of 65¢ per share as far too low.

Then in late January, the company’s stock jumped from roughly 65¢ to around 95¢ on news that the company had signed a memorand

um of understanding with MonAtom, the Mongolian state-owned uranium development company. The deal neatly resolved the issue of the hostile takeover as well as the requirement in Mongolia’s recently passed Nuclear Energy Law that the state is to have a 51% ownership in uranium projects. The head of the Nuclear Energy Agency (NEA) of Mongolia, however, stated that the memorandum violated Mongolian law. The company’s stock dropped to around 80¢.

Only days later, Khan announced a takeover deal by China National Nuclear Corp. (CNNC), and Khan’s stock price shot up again, to just over a dollar. The terms of the Chinese deal were much richer than that of the Russians, with an offer of 96¢ a share in cash, a roughly 118% premium on the closing share price before the ARMZ bid. The board of Khan unanimously recommended that shareholders accept the offer. The deal, however, was dependent on CNNC obtaining regulatory approval from the Chinese National Development Reform Commission.

Near the end of February, a working group established by the Mongolian parliament recommended that a number of uranium exploration and mining licenses in the Dornod province, where Khan’s project is located, to be invalidated because of certain law violations. While Khan’s license was not specifically mentioned and no notification was received, ARMZ withdrew its takeover offer citing the announcement. Khan’s stock price dropped from about $1.05 to 65¢.

The CNNC deal, however, still seemed to be going forward, and Khan’s stock recovered somewhat after the initial shock; by early April, Khan’s stock was near 90¢. At that point, the government formally told the company that the licenses held by its 58%-owned joint-venture subsidiary, Central Asian Uranium Co., and its 100%-owned subsidiary Khan Resources LLC, had been invalidated. The company’s stock price plunged to 45¢.

Yet there still was hope that the CNNC deal would go through, and Khan’s stock price hovered at a little above 50¢ for over a month. On May 21, CNNC informed Khan that it did not receive regulatory approval for the takeover, and Khan’s stock price fell to 23¢, slightly lower than it was back in November when the rollercoaster began.

Martin Quick, Khan’s president and CEO, said in a phone interview that the whole affair is unlawful and unjust, and the company is looking at various means of recourse. The Mongolian government, however, has been less-than-forthcoming with information and has not been open to dialogue, said Quick.

For instance, the company has not received an explanation as to why its licenses are invalid.

“We’ve never really been told specifically what we have violated, when we violated it and what measures we need to do to fix up whatever problems they allege,” said Quick. “So it’s a really difficult situation in that we really don’t know what we’ve contravened.”

Quick wrote a letter to Mongolia’s prime minister, formally protesting actions taken by the NEA, but did not receive an acknowledgment that it was received.

“We’d love to talk to the Mongolian government but they won’t even respond to our correspondence. They won’t really answer the questions that are put to them by the staff at the Canadian embassy in Mongolia. It’s a standoff,” said Quick.

Quick believes the Russian government is using its vast political and economic sway over Mongolia to gain control over the Dornod project so the Russians and the Mongolians can form a joint venture and exclude Khan.

“This is highly politicized, and the Russians are employing their bully tactics as they’re oh so very good at,” said Quick. “The Russians have decided to go the political route, and work with the Mongolians on this expropriation and try and kick Khan out of Mongolia without any recompense. So that’s their game. Trying to do business with the Russians is like trying to do business with the devil.”

The CNNC did not give a reason why regulatory approval was rejected, but Quick suspects it is in part because the Chinese knew the Russians were making a play for the project.

For now, Khan must pursue the matter in Mongolian courts, but Quick puts little faith in the system.

“Unfortunately, the rule of law in Mongolia is very weak, and the courts are so highly politicized that even logic and a solid case do not necessarily prevail there, but we have to go through that process and see if the courts indeed order the NEA to reissue our license,” said Quick.

If the Mongolian courts fail, Quick said the company could pursue the matter through a Netherlandsbased subsidiary of Khan. The country, unlike Canada, has a trade protection agreement with Mongolia. If that fails, the company will possibly pursue the matter through the United Nations international trade body.

“Hopefully we’ll give the Mongolians a sense that we’re for real and were not going to go away, and that we will take them to international arbitration and cause them a huge amount of embarrassment,” said Quick.

As to the Dornod project itself, Quick said the project was ready to go, with the next stages being dewatering and rehabilitation of the mine. The company released a feasibility study in early 2009 that outlined a probable reserve of 18 million tonnes grading 0.133% U3O₈ within an indicated resource of 25.3 million tonnes grading 0.116% U₃O₈.

At a milling rate of 3,500 tonnes per day the combined open-pit and underground mine could produce 3 million lbs. of U₃O₈ over a 15-year life. Through its two subsidiaries, Khan has an overall 69% interest of the uranium, which is contained within two deposits.

The study, using a price of US$65 per lb. U₃O₈, put the internal rate of return after tax at 29.1% and the net present value, using a 10% discount rate at, US$276 million. Capital costs were pegged at US$333 million.

Khan Resources, however, is unable to proceed with development until the current court battles and other outstanding issues are resolved.

Quick said the company is in limbo with the licensing, unsure how things will proceed.

“We’re not quite sure what they’re up to and we’re pretty sure that what they’ve done is completely illegal, even in Mongolia,” said Quick. “We’re entangled in international intrigue in a country where the rule of law is very very weak.”