More rumbles from the DRC

Tough times for companies across the mineral sector are being amplified for those in the Democratic Republic of the Congo (DRC).

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

Justin Reid, an analyst with Cormark Securities, says while miners relying on debt financing are being hit hard the world over — the cost of capital in some recent deals has hit as high as 20-40% — such expensive capital is especially toxic for firms in the DRC. That’s because it comes at a time of escalating political discount rates.

Analysts have upped discount rates in their valuation models to the 12-15% range from 7-10%, meaning projects have to generate greater cash flows to keep the internal rate 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 within it, (one analyst commented that the company has the strongest lobbyist in its corner in the form of the American government), others are not so lucky.

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

Despite its Kamoto project generating solid cash flows (aided by the fact that it has negative cash costs 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, Switzerlandbased Glencore International 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 2007, they recently traded in Toronto at just $1.29.

That precipitous drop has occurred even though Katanga has a memorandum of understanding (MOU) with the government — something neither Freeport nor First Quantum Minerals (FM-T, FQVLF-o) can boast.

Those two companies have been trying to hammer out a new deal with state-run mining firm Gcamines that would replace prior agreements.

A government edict issued late last year 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 is talking with, Freeport and First Quantum are 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 free-carried, meaning that Freeport and 25% owner Lundin Mining (LUN-T, LMC-n) must wholly finance development.

But with the crash of commodity markets resounding all around, analysts likeCormark’sReid believe that both Gcamines and the government are coming to their senses.

In the present market, an increased stake in the projects would have to be off the table for Katanga and First Quantum, and if they were to walk away from their respective projects, it would effectively kill foreign direct investment in the country, and cut off the flow of revenue to the government.

Given such an environment, Reid believes that increased royalties and taxes are more likely.

The wildcard in the region, however, is the Chinese. China is investing upwards of US$9 billion in the country and rumours occasionally surface that the government may scare away Western companies and then flip the projects to the Chinese.

But such a scenario would bring heavy consequences from the likes of the World Bank and international courts.

An industry source familiar with inner workings of the Tenke deal who preferred not to be named, said he expected negotiations with the 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.

As for the violence some 1,000 km north of Katanga, in North Kivu province, Reid says it could have consequences in Katanga.

“Historically, it’s been shown that it can blow up and an escalation of violence in the east would undoubtedly impact Katanga province,” he says.

Much of the 1998-2003 Congolese civil war that saw some 5 million people killed was concentrated in the region — thrown off kilter when Hutu militia fled Rwanda after the genocide there, pursued by the Rwandan military.

And while so much of the government in Kinshasa’s revenue comes from Katanga — giving it extra incentive to ensure the stability of the region — in the event of an all-out war, the government’s ability to protect it could be called into question.

Closer to the violence, around the city of Goma in North Kivu, is Banro (BAA-T, BAA-x).

The company’s four key projects are still some 200 km away from where the fighting is taking place and company spokesperson Martin Jones says there has been no impact on its operations.

But like many of its counterparts in the region, Banro’s share price has taken a serious hit. Despite holding some of the more prospective gold properties on the continent, it’s had to watch its shares fall from the $11-range at the beginning of the year to their current price of around $1.19.

And the neighbouring unrest isn’t the only thing fuelling market skepticism. Banro, like First Quantum and Freeport, has been caught up in the renegotiation mess.

Earlier this year, the country’s minister of mines said the non-payment of surface taxes on Banro’s four key exploitation claims was a concern.

But Jones explains that the exemption was included in the mining convention signed between the government and Banro in 2003.

“We think it is unlikely they would want to change the convention,” Jones says. “We’ve been successful in demonstrating the benefits we’ve brought to the area.”

He added that the renegotiation of mining contracts was mandated to focus on deals between state-owned and private mining firms.

“We don’t have contracts with state-owned companies. We have a convention directly with the government,” he says.

As for the conflict itself, while at presstime a ceasefire was said to be holding between Tutsi rebel leader Laurent Nkunda and Hutu rebels — who Nkunda accuses of being aligned with the Congolese national army — onlookers say more United Nations troops are urgently needed.

The UN already has its largest mission in place in the country, with a force of 17,000, but only 850 are in Goma, the centre of the violence. UN officials say they are open to the idea of sending in more troops, but at presstime no official announcement had been made.