Silvercorp raises $31m, eyes potential China acquisitions

Having closed a $31 million private placement, Silvercorp Metals (SVM-T, SVM-X), a silver miner focused on China, is sufficiently cashed up to enable it to consider new acquisitions, even though it has suspended production on two of its mines owing to low commodity prices. And having developed a unique approach to moving projects forward quickly, it is in the midst of permitting a project which it anticipates will be producing in 2012.

Silvercorp says it does not have definitive acquisition plans. However, China presents an opportunity for consolidation, arising from the fragmented nature of its silver mining industry. At the same time, small mines may not always be good consolidation candidates, since they do not offer economies of scale for a larger operator such as Silvercorp, so the company will have to be judicious about the acquisition targets that it picks.

It is somewhat surprising to realize that China is the number 3 silver miner, with a 2007 production of 86.5 million oz., playing a third violin only to Peru and Mexico. So there are certainly some suitable Chinese acquisition candidates out there.

“Silvercorp has become the largest primary silver producer in China today,” says Shirley Zhou, Silvercorp’s corporate communications manager. According to Zhou, in the year to March 2008, the company sold 4 million oz. silver, just under 50 million lbs. lead, and just under 13 million lbs. zinc, for revenues of US$108 million, and net earnings of US$60 million.

“What makes us also extremely profitable is that we work in China,” says Zhou. “And there are tremendous advantages to working in China, including very low labour costs and very low capital costs.”

As an example, Zhou says that 30-tonne trucks cost US$30,000, and a new 2,000 tonne-per-day mill in the Ying mining district cost US$12 million to build. These costs are at a significant discount to North American prices.

Because mine development costs in China are low, Silvercorp has adopted an aggressive growth strategy which is quite different from that used by most other explorers. When juniors find deposits, they typically spend years and millions of dollars to drill the discovery, increase the resource and move it to the measured and indicated categories, often defining reserves before developing a mine.

While this method is workable, it also forces juniors to raise capital while shares are cheap, causing shareholder dilution. Instead, Silvercorp takes advantage of the low labour and capital costs in China, preferring to fast-track projects. It goes ahead and develops a mine soon after discovery, and then expands resources and operations using cash flow from the mine.

Evidently this project development methodology works well for Silvercorp, but the downside is that the company does not report reserves, and so far most of the resources are in the inferred category.

Not every mining company can make it in China, where working closely with government, and knowing who to work with in government, could mean the difference between success and failure. It seems that Silvercorp has mastered this art.

“We have demonstrated to the government that we have an excellent safety record and an excellent environmental responsibility,” Zhou says.

To realize how the combination of low costs and high grades manifests itself on the bottom line, it is instructive to consider the company’s results last year. For the nine months ending December, Silvercorp produced 3.14 million oz. silver at a cash cost of a negative $1.02 per oz. In other words, zinc and lead byproduct credits alone exceeded all mining costs, so silver revenues went straight to the bottom line. However, in view of the collapse in commodity prices, it is unlikely that numbers will be that good in the first quarter of this year.

Silvercorp owns two producing mines, another two mines that have been placed on care-and-maintenance owing to low commodity prices, a development project and an exploration project. Silvercorp’s ownership stakes in each property vary between 70% and 95%.

Measured and indicated resources on all properties amount to an aggregate of 8.6 million tonnes grading on average 292 grams silver per tonne, 4.5% lead and 2% zinc, equivalent to 80.8 million oz. silver, 387,000 tonnes lead and 168,000 tonnes zinc. Aggregate inferred resources stand at 13.6 million tonnes grading 268 grams silver per tonne, 4.6% lead and 2.5% zinc, equivalent to 117.4 million oz. silver, 620,000 tonnes lead and 339,000 tonnes zinc.

A large part of the resource is in the Ying mine in Henan province. Measured and indicated resources at Ying are 2.05 million tonnes, containing 50 million oz. silver, 248,000 tonnes lead and 111,000 tonnes zinc. Inferred resources stand at 2.8 million tonnes containing 66 million oz. silver, 350,000 tonnes lead and 122,000 tonnes zinc. Average grades at Ying are 720-1,130 grams silver per tonne, 11.2-19% lead and 5.5-8.6% zinc. An updated resource estimate for Ying is due in midyear.

“What has made Silvercorp also extremely successful is, we have an amazing mine, the Ying mine, one of the richest silver-lead-zinc deposits in the world,” says Zhou. “Right now, in our mining operation, we are seeing head grades of 420 grams silver per tonne, 8% lead and 3% zinc, and that’s including dilution, because these are very narrow veins that we are working in.”

There is an advantage to mining lead in China, Zhou points out, since lead prices on the Shanghai Metals Exchange carry a premium over London prices.

In the year to March 2008, the company mined 3.96 million oz. silver. It anticipates similar production the financial years ending March 2009 and March 2010, mostly coming from the Ying mining camp, and in particular from the flagship operation, the high-grade Ying mine.

For the year to March 2010, the company anticipates 260,000 tonnes in production from Ying mine, with an average head grade of 480 grams silver per tonne, 9% lead and 3% zinc. Anticipated recoveries are 91% for silver, 95% for lead and 72% for zinc, with production of 3.65 million oz. silver, 49 million lbs. lead and 12 million lbs. zinc.

A further 400,000 oz. silver would be produced from ore from the LM mine, as well as ore from mine development at the HPG and TLP mines, for a 4.05 million oz. silver production for the year. Assuming a silver price of US$11 per oz., Silvercorp projects cash flow from operations at US$30-35 million for the year. Capital expenditure for the year is projected at US$20 million for all projects.

Silvercorp owns a 77.5% stake in Ying mine. It is milling 700-750 tonnes per day there, with pre-dilution grades of 1,250 grams silver per tonne, 21% lead and 8% zinc. The mine has a mill rated at 1,000 tonne per day, with another 2,000 tonne-per-day mill just completed.

The Ying mine is a part of the Ying mining camp, which also includes the HPG mine (70% owned), the TLP mine (77.5% owned) and the LM mine (70% owned). The TLP and HPG mines are on care-and-maintenance because of low commodity prices, so only the Ying and LM mines are producing. Silvercorp is using the downtime at TLP and HPG to develop mine infrastructure there, and also on the LM mine.

TLP mine has measured and indicated resources of 18.6 million oz. silver, and inferred resources of 12.4 million oz. HPG and LM mine together have about 10 million oz. silver in measured, indicated and inferred resources.

The company is applying for a mining permit for its development project named GC in Guangdong province, which it anticipates will produce more than 2 million oz. silver per year starting in 2012. If a permit is granted, Silvercorp plans to develop a mine and construct a 1,500 tonne-per-day mill in 2010-11 at a budget of US$30 million.

Measured and indicated resources at GC are 1.8 million tonnes containing 7.6 million oz. silver, 27,000 tonnes lead, 51,000 tonnes zinc and 2,500 tonnes tin. Inferred resources stand at 7.3 million tonnes containing 29.4 million oz. silver, 101,000 tonnes lead, 219,000 tonnes zinc and 9,200 tonnes tin. Average grades at GC are 125-129 grams silver per tonne, 1.4% lead, 2.8-3% zinc and 0.13-0.14% tin. An updated resource estimate is expected in June.

Silvercorp projects that the company will produce around 4 million oz. silver per year for the three financial years to March 2009, March 2010 and March 2011. Assuming the GC project starts producing in the year to March 2012, production is forecast to jump to about 6.7 million oz. silver that year.

While Silvercorp had all four mines in operation, its work force numbered 2,000. Present head count is 1,000.

Silvercorp holds an 82% stake in the Na Bao exploration project in Qinghai province. The project is dormant pending a rebound in commodity prices. Silvercorp also owns a 23.8% stake in New Pacific Metals (NUX-V), with gold, nickel, copper and platinum group metals projects in China.

Silvercorp has had a two-year tax holiday in China. Currently, it is on a three-year half-tax-holiday, paying Chinese corporate income tax of 12.5%, half the full rate. Following that, the full corporate tax of 25% will apply.

For the nine months ending December, Silvercorp lost US$20.6 million on sales of US$66 million. The loss was caused by a non-cash impairment charge of US$47.8 million. Working capital on December 31 was US$33.9 million, including inventories. Net future income tax liabilities stood at US$17.8 million.

After closing the $31 million financing, the company has 161.6 million shares outstanding, or 165.5 million shares fully diluted. With the $31 million, the company is estimated to have about US$67 million in the treasury. The shares currently pay a quarterly dividend of 2¢.

The private placement included 10 million shares at $3.10. The underwriters have an over-allotment option of 1.5 million shares until April 9. Silvercorp says that it intends using the money for potential acquisitions, development, working capital and general corporate purposes.

In a report issued before the latest private placement, which did not take the private placement into account, Haytham Hodaly, analyst at Salman Partners, rated Silvercorp shares a buy, with a $4.80 target. At presstime, Silvercorp shares were trading at $2.84. The shares have been trading between $1.19-$9.65 over the last 12 months.