Time is not on Baja’s side

There is “substantial doubt” that Baja Mining (BAJ-T) will continue as a going concern, the company declared on May 16 in its first-quarter earnings analysis, under a section entitled “Risk Factors.”

Design changes that included a larger port facility — along with higher steel and fuel costs — have pushed up projected capital costs at the company’s Boleo coppercobalt- zinc project on Mexico’s Baja Peninsula by $246 million, and earlier this month Baja said it would need a cash injection before mid-June to keep the lights on at the project.

The funding shortfall of $246 million was estimated after considering existing cost overrun facilities of $100 million and approximate cost contingencies of $54 million, suggesting a total estimated cost overrun of $400 million, Baja explained in a 16-page management discussion and analysis of the company’s financial results for the three months ended March 31.

Keith Stephens, a spokesman for Fluor, the lead engineering firm at the Boleo project, declined to comment on the cost overrun at Boleo, stating instead it was “purely for [Baja Mining] to comment on,” and that “we don’t have any information to share outside of our contractual obligations with the company.”

Baja’s president and CEO John Greenslade resigned in early May and was replaced by director Tom Ogryzlo, who will serve as interim CEO while the company searches for a permanent replacement. Greenslade did not respond to an emailed request for comment following news he was stepping down.

On May 16 the company explained that continuing as a “going concern” would be “dependent upon” securing financing for short-term liquidity requirements, and further financing for the funding shortfall; Boleo development and permits, as stipulated in senior debt agreements; and establishing profitable operations.

Baja’s monthly expenditures at the project are $60 million, and the company is seeking an aggressive, cash-flow management scheme.

“Management believes that, based on the underlying value of Boleo, it will be able to obtain the necessary financing to meet the company’s requirements on an ongoing basis,” the company noted. “And while the company has obtained required funding in the past, there is no assurance that such financing will be available in the near-term, or be available on favourable terms or at all.”

On a more positive note, institutional shareholder Mount Kellett Capital Management, which holds 19.8% of Baja’s common shares, has withdrawn its petition to the B.C. Supreme Court to appoint an independent inspector to determine when the company’s management first knew of the cost overruns. It is now among the parties who have entered into confidentiality agreements with Baja that will allow the New York-based private investment firm to conduct due diligence on the project.

“With the finger-pointing out of the way, the new team can focus on the problem at hand — financing the cost overruns . . . and maintaining its construction schedule,” Matthew O’Keefe, a mining analyst at Mackie Research, wrote in a May 14 research note to clients. “With Greenslade removed, the onus falls on the new team to come up with a solution — and fast. We suspect that they are capable and, now, focused.”

O’Keefe added that he likes the Boleo project for its high grades, strong by-product credits and short-term timeline to production. It remains on track for first production in 2013 and has a 12-month price target on Baja of 75¢ per share. At presstime Baja traded at 28¢ per share, in a 52-week range of 28¢– $1.28.

The Toronto-based analyst noted that the stock should move up following a financing solution, but admitted that “challenging financial markets and the potential for project delay add increased completion risk to the story, meriting our current ‘speculative buy’ rating.”

O’Keefe also pointed out that while Baja has delivered confidentiality agreements to several third parties for possible participation in the project, and initiated preliminary discussions with members of the brokerage community, the difficult equity markets could open the door to opportunistic takeovers.

“At current prices, Baja stock offers the chance to add over 80 million lbs. attributable production 12 months out for about $300 million in cash and stock [Baja equity value, plus cash shortfall of $172.5 million],” O’Keefe reasoned. “In our view this would be a good fit for companies like First Quantum Minerals (FM-T) or Inmet Mining (IMN-T) that could acquire with paper, and fund the shortfall out of cash or debt.”

Raymond James mining analyst Adam Low writes in a research note that Greenslade’s departure did not come as a surprise, but could complicate Baja’s efforts to raise incremental funding. “In our view, Mr. Greenslade had been the company representative with the closest relationship to the debt-lending group and the minority 30% Korean partners for the Boleo project,” he reasons. “His resignation may make negotiations with either the lenders or the Korean consortium more complicated and lengthy.” Low has maintained his “market perform” rating on the stock with a six- to 12-month share price target of 70¢.

In an earlier research note dated May 8, Low argued that a plausible method for Baja to obtain the additional financing it needs would be to sell a stake in the project. Baja owns 70% of Boleo with a consortium of Korean companies owning the remainder. The consortium consists of Korea Resources, LSNikko Copper, Hyundai Hysco, SK Networks and Iljin Copper Foil.

“We believe that the most logical buyer of a stake is the Korean consortium,” he said. “Arguably, for a transaction to proceed we anticipate that Baja will need to give up control of the project. We estimate that selling a 21% stake in Boleo, at a valuation of 50% of the project’s discounted cash flow . . . could generate proceeds of $161 million. This would result in an ownership structure for Boleo of 51% for the Korean consortium, and 49% for Baja.

“Conceivably, a larger stake could be sold for a larger amount,” he said. “However, we note that Baja’s bargaining power will diminish as it approaches the mid- June deadline, which may mean downward pressure on the valuation that it could receive for a partial sale of the project.”

Following the company’s initial announcement of the $246-million cost overrun on April 24, Haywood Securities mining analyst Stefan Ioannou cut his 12-month target price on Baja shares to 85¢ from $1.75, but maintained his “sector outperform” rating, “acknowledging that specific highquality, advanced-stage development projects, such as El Boleo, offer a compelling opportunity for investors with patience and risk tolerance.”

Ioannou noted that annual output during the first six years of full production at Boleo is expected to average 125 million lbs. copper, 3.7 million lbs. cobalt and 25,400 tonnes of zinc sulphate monohydrate on a 100% basis. “Development at El Boleo includes an annual 3.1-million-tonne hydrometallurgical plant to produce London Metal Exchange grade-A copper cathode, and high-purity cobalt cathode and zinc sulphate monohydrate. Our model includes a lifeof- mine average copper cash cost of US$0.55 per lb. net of cobalt and zinc credits, which places the project within the lower half of the global copper cost curve.”

He also pointed out that Boleo is the world’s sixth-largest manganese deposit, which provides potential for another revenue stream at the operation, while “proximity to key infrastructure within an established [historical] mining region en
hances project value.”

In the meantime, as Baja scrambles to come up with a near-term financing plan and cut costs, it is considering deferring the cobalt and zinc circuits in order to ease pressure on the copper-circuit construction schedule. And it says that if the project progresses as anticipated, the company will meet the development schedule of mechanical completion and copper-circuit commissioning in late 2012 or early 2013, to allow for copper production during the first half of next year.

Based on its present reserves and mine plan, Boleo could have a lifespan of 23 years and is being developed as a series of underground mines using a room-andpillar mining method, along with small, open-pit mines. The ore would be fed to a processing plant, which would use a two-stage leaching circuit, followed by solid-liquid separation and solvent extraction-electrowinning to produce copper and cobalt as metal, zinc as zinc sulphate monohydrate and likely manganese as manganese carbonate.