If you did not subscribe to Ultimate Value Finder yet, I don’t know what you are waiting for. There are so many investment opportunities out there that it is mind-boggling. To download your sample issue, click here.

Adams Golf (ADGF)

Adams Golf designs, assembles, markets and distributes golf clubs for all skill levels. I have done a lot of research on this company previously, but ended up passing, which didn’t turn out to be such a great idea. If you talk to anyone who knows anything about golf and you mention the name, Adams Golf, they will automatically know the company, which is good because this means that the company benefits from brand recognition. It is very difficult for an unknown company to just start making golf clubs and selling them profitably. At one point, Adams Golf was an unknown company but it was able to break into this business. The founder, Barney Adams, wrote a book, The Wow Factor, which details the company’s history and its struggles in the golf equipment industry.

The problem with the companies that provide golf equipment is that the golf industry is in decline domestically. However, the bright spot is that internationally the industry is growing. The companies that will be able to gain sales internationally should do fine.

The stock of Adams Golf experienced a nice jump in price this month because the company announced a decision to explore strategic alternatives, which could possibly lead to the sale of the company. Currently, the market cap is $60 million or $7.77 per share. There is a chance that if the company sold, it will sell for a price higher than the market cap.

Helix Energy Solutions Group (HLX)

Helix Energy Solutions Group is an oil and gas services company focused on deepwater and subsea markets. It also has oil and gas producing properties.  I learned about this company because it spun off Cal Dive International, which focuses on shallow water markets.

The reason why Helix looks appealing is because the sum of the parts appears to be greater than the market cap of the company. It has been documented that Helix was trying to spin off the oil and gas producing properties from the oil and gas services company, but this did not materialize after the BP oil spill in the Gulf of Mexico.

Cal Dive International (DVR)

Cal Dive International is an oil and gas services company that was spun off from Helix Energy Solutions. Cal Dive focuses mainly on shallow water markets. Ever since the spinoff, the stock has been a nightmare investment for its shareholders. In 2009, it traded at over $10 per share and in October 2011, it traded as low as $1.60 per share. Ouch! Some high profile investors such as Joel Greenblatt were invested in Cal Dive but sold out after unprofitable quarters.

The management is claiming that Cal Dive will return to profitability in 2012 after various cost-cutting initiatives are implemented. If the management is successful, the stock could be a big winner in the future. I would like to get more details on the cost-cutting measures, but it is hard to get the management on the phone.

Blyth Inc (BTH)

Blyth is a multi-channel operating primarily in the home fragrance and decorative accessories industry. It designs, markets and distributes an array of decorative and functional household products, including candles, accessories, seasonal decorations, household convenience items and personalized gifts. It also markets chafing fuel and other products for the food service trade, and for coffee and tea, nutritional supplements and weight management products.

At first glance, it doesn’t appear that there is anything interesting with Blyth but after you notice that the chairman and CEO bought $20 million worth of stock in July 2011, you can’t help but pay attention.  I did not get a chance to speak with the company’s management, but it appears that there is value in the hidden businesses outside of the home fragrance and decorative accessories segments.

Perion Networks (PERI)

Perion Network an Internet content and media company that builds downloadable consumer applications that make the everyday life of its users simpler and more enjoyable. It was founded in 2000 with a single product, IncrediMail, which is an e-mail product sold in more than 100 countries.

When I first looked at this company, I passed because it only had one product. However, the company is growing its product mix as shown in the following chart:

Currently, the company has a market cap of $47 million. The guidance for 2011 EBITDA and net income is $10 million and $8 million, respectively. This valuation looks extremely cheap, especially since the company is growing. I will definitely look into this company in more detail.

Disclosure: The author has no positions in any of the mentioned stocks.

Why Am I Releasing the January Issue a Week Early?

I was going to wait to release the January issue until the first week of January 2012, but approximately one to two hours before the market closed on Friday, significant news was released on one of the companies covered in the first issue. The number of shares that traded on this stock was over 800k, while the average volume is 55k. However, the stock price barely moved. This means that while there was huge buying activity taking place, there was a big seller on the other side. If the seller was unloading this much stock without the frenzied buying, the price would have been crushed. Because the news was extremely positive, there is no question why people were buying. The only logical explanation for such heavy selling was the presence of a forced seller taking advantage of the buying frenzy. There are rumors that a fund is closing its doors and is liquidating this particular position. If this is true, the selling will be done soon, and the overwhelming interest from the buyers will push the stock price higher. I am not a fortune teller, and please don’t hold me to it, but I suspect that the stock price could make a move next week.

Consequently, I faced a dilemma – wait to release the newsletter during the first week of January 2012 and have you miss out on the investment opportunity or release it a week earlier and let you benefit from this idea if you choose to participate.

Normally, I will be releasing each monthly issue within the first two weeks of a particular month, unless I encounter another unusual situation.

In one of my previous posts, I asked whether you would be interested in subscribing to a paid newsletter. Because I received such a warm welcome to this idea, I decided to proceed with the project. However, I have to apologize because I initially said that I was going to charge $100 per year. After looking at various costs, I can’t make it work for this amount. Therefore, I changed the price to $199 per year or $149 per half a year. If you are a Classic Value Investors client, you can receive the newsletter free of charge, but you have to e-mail me to let me know you are interested. I truly apologize for the price change but I guarantee you that you will not be disappointed with the product. I simply cannot produce poor quality work. If I do something, it has to be high quality – this is just me.

I put together a sample issue, which includes my old analyses. This should give you an idea of what each issue will look like. You can download your sample issue here. Then, if you like what you see, I encourage you to subscribe to Ultimate Value Finder for the entire year or half a year.

I am looking forward to sharing various investment ideas with you, and hopefully, we can profit from them together.

Sincerely,

Mariusz Skonieczny

I was very unhappy to see the management’s announcement that they intended to acquire the Mengapur project by issuing lots of shares. Therefore, I decided to write a public letter to the company’s management discussing my reservations towards the project. While some investors thought that the management was simply going to ignore my letter, I received a phone call from Bob Baldock, Monument Mining CEO, within 24 hours. I brought up many points that bothered me about the deal, and in this article, I want to share with everyone what I learned. After you finish reading it, you can then decide on your own whether you want to vote “yes” or “no” for the deal.

Baldock’s mission for Monument Mining is to build a company that has a sustainable production profile comprising various projects in order to support sustainable dividend payments. The reason for this is to attract institutional investors who are going to be long-term shareholders and who are going to price the stock of the company with a proper multiple over earnings or cash flows.

To accomplish this goal, they discovered and pursued the Mengapur project. Aside from various press releases, the only other source of information about this project is an outdated NI 43-101, which is based on the results of the Mengapur Project Feasibility Study of 1993. This was almost 20 years ago. The price of gold was approximately $350 per ounce. Today, it is approximately $1,600 per ounce. The price of copper was less than $1 per pound. Today, it is more than $3 per pound. The price of silver was $5 per ounce. Today, it is approximately $30 per ounce. These are some major differences.

Based on this outdated NI 43-101, the Mengapur project is estimated to bring revenues of $100 million with cash flows of approximately $40 million over the next two decades. To bring this project into production, it will cost approximately $179 million. When I substituted the old commodity prices with the most recent prices, I estimated revenues of more than $300 million. This would probably translate into cash flows of about $85 million.

Most investors, including myself, are comfortable with the project but not with the way the company is financing its acquisition. I am not opposed to dilution if it is done for the right reason. Until I spoke with Baldock, I was completely opposed to it. I am not 100 percent convinced yet, but at least I have a better understanding of what it is that we are getting by purchasing the Mengapur project.

First, it appears that even after I arrive at $300 million of top line revenues, I am way too conservative. The Mengapur project was owned by the Malaysian government with the intention of mainly producing sulphur, which is used to make fertilizer. The 43-101 was prepared for this reason. However, we are almost in 2012, and since 1993, the world has changed and the prices of commodities have increased significantly. Consequently, the management has much bigger plans for the Mengapur project than simply producing sulphur. It still plans to produce sulphur but it will not be as significant of a contribution to total revenue anymore. With that being said, the Malaysian government is still interested in seeing Monument Mining produce sulphur for its fertilizer industry, and as an incentive, it will provide the company with a 10-to 20-year tax break, which is pretty significant. It appears to me that what all of this means to us is that the Mengapur project has the potential to generate revenues that will be much higher than $300 million per year. It could even be $500 or $600 million per year (I am purely guessing here). All I know is that it will likely be higher than $300 million. You can make your own estimates.

Second, the sellers of the Mengapur project are in default with their bank. It is the bank that is in control of the disposition process. When the management approached the bank with the offer to buy the Mengapur project, the bank put certain restrictions on them. Because of the small size of Monument in relation to the Mengapur project, the bank will not allow the company to close the deal by taking on debt. The company also has a limited time frame to come up with the money. Consequently, the management sees raising money by issuing shares as the best way to come up with money for the transaction. The price tag for the project is $60 million. If Monument does not come up with the money, the Mengapur project will go into receivership. I get the sense that it could sell for as much as $270 million. Of course, we will never know until someone else buys it for that price.

Many investors including myself are puzzled why the company would not pay for the acquisition with cash in the bank. The company should have enough to close the deal. Baldock’s response was, “Because we would be totally broke.” With the ongoing expansion of the Selinsing project, drilling activities on other properties, the company needs money to continue to grow its resource base. In the mining business, you never want to get rid of all of your cash and find yourself forced to rely on capital markets should you need help.

Some investors believe, and I was one of them, that if Monument acquires the Mengapur project, it will take a long time to put it into production. I was surprised to learn that the management believes that the first cash flows can be generated by the end of 2012. Currently, there is a plant designed for production of iron ore. It was commissioned in November 2010 and operated until July 2011. It was shut down because of a lack of capital. The management believes that they can restart the production of iron ore by the end of 2012 after some modifications and modernizations to the plant. At this point, I have no idea how much it will cost but I was told that it is within Monument’s capacity. Then, the cash flows from iron ore, gold production from Selinsing, and warrant exercises should be enough to build out the rest of the Mengapur project.

Another point that I brought up in the conversation is the way the proposed private placement is being structured. The company announced that it would conduct a non-brokered private placement of up to 140,000,000 units at a price of $0.50 per unit resulting in gross proceeds of up to $70,000,000. The company expects that Tulum Corporation will subscribe to purchase all of the units under the private placement. What angers many investors is the fact that Tulum Corporation is run by Francois Marland who is a director of Yukon-Nevada Gold Corp, another company run by Baldock. Immediately, this deal looks fishy and investors question why Baldock is giving a deal to his buddy Marland while some current shareholders wanted in on the deal but were rejected.

Instead of jumping the gun and accusing Baldock of being unethical, I chose to ask him directly and give him a chance to explain himself. Because Monument currently has approximately $70 million in the bank and generates another $70 million in cash flow per year while trading for a market cap approximately $70 million, it is a prime candidate for a takeover. Wouldn’t you want to gain control over a company with $70 million in the bank and $70 million in yearly cash flow, for $70 million? It is like paying $70 million, getting it back right away, and keeping $70 million in cash flow per year. Just show me where to sign.

By allowing Marland to buy all the shares from the secondary offering helps the company stay independent and not be bought out for a song. While Baldock did not specifically tell me that there are entities trying to acquire Monument on the cheap, I am connecting all the dots and I don’t believe that they would be structuring the deal this way if there wasn’t a threat of a takeover.

Now that I laid out the major points that I wanted to cover, you as an investor have some choices. You can disagree with the management and vote “no” for the Mengapur project or sell your shares. Or you can stay invested in the company for the long haul, let the management go ahead with its plans and vote “yes” for the Mengapur project. I can’t solve this problem for you. All I can do is to try to clear up some misunderstandings and confusions by allowing Baldock explain himself. Now, you have more information to make your voting decision.

What are your thoughts? I encourage you to leave a comment below.

To rectify this, I was thinking about starting a monthly newsletter (by subscription for $100 per year), where I would write about these other deals. I am not sure exactly how many companies I would cover in each monthly newsletter, but at this point, I am thinking that it would be around three to four.

I am trying to gauge interest to see whether this is something that people would like. I love looking for deals and sharing them with people. Please let me know if you are interested.

Yukon-Nevada Gold Corporation has broken a lot of hearts lately. Many individual and professional investors have thrown in the towel and sold at a loss. The remaining shareholders are completely exhausted. New potential investors are afraid to buy it. This is exactly the kind of pessimism that creates great prices.

Many investors learned about Yukon-Nevada in the middle of 2010 and during that time, the stock price was at $0.25 per share (today it is at $0.30 per share or a market cap of $300 million). Within six months, the stock reached $0.90 per share, and some of the shareholders felt like geniuses tripling their money in such a short period of time. Everything was great – the management was successful in turning the company around, operations showed profitability, and future growth productions targets were stunning. The stock price was on its way to reaching $10 per share.

Then, at the beginning of 2011, investors were shocked to learn that Yukon-Nevada lost money on production during the fourth quarter of 2010, after the third quarter of 2010 had showed promising profitability. This is when the stock price started to decline. It became clear that something was seriously wrong with the production process and that the processing plant was in immediate need of winterization and refurbishment. Until major capital improvements are made to the plant, the company will never reach its full potential. The new CEO took over in 2009, he told the board of directors that the plant was in need of more than $100 million in capital expenditures, which would result in more dilution. However, at that time, the controlling shareholders strongly opposed the issuance of more shares. Without additional money, the management restarted production with the hope of producing enough cash to pay for the capital expenditures. Soon, it became obvious that this was a terrible mistake which could have been avoided from the beginning. Only when it became clear that the company’s existence was in question did the board of directors give the management the green light to raise enough money to fix the malfunctioning plant.

The management went on to explore options to raise enough money to winterize and refurbish the plant so that it would produce gold without breaking and shutting down constantly. The first option was to offer a discount to option holders for early exercise. Unfortunately, some of the major holders (same people that originally rejected dilution) backed out at the last moment, and the company was stuck in a liquidity crisis. Consequently, they went with a different plan to engage Deutsche Bank to provide the company with a total of $179 million from private placement, warrant exercises, and pre-paid gold forward facility.

Before Deutsche Bank went ahead with the deal, it hired SRK Consulting, a world class mining consulting firm, to examine Yukon-Nevada’s plant to determine if its production problems were solvable. After receiving approval from SRK, Deutsche Bank proceeded with the deal. While Yukon-Nevada’s management and Deutsche Bank were negotiating all the details, the existing shareholders were doing what they are best at – screaming, yelling and panicking, making it more and more difficult for the financing agreement to be reached. During the worst of the panic on May 4, 2011, the stock of Yukon-Nevada closed at $0.39 per share.

After twenty days, which at that time seemed like an unending nightmare, on May 24, 2011, Yukon-Nevada reported that it had raised $59 million. However, this was only part of the $179 million in financing. The day after the announcement, the stock price increased to $0.56 per share which represented a 40 percent jump in one day. The optimism was short lived because the stock price started to decline the next day. Within two weeks, the stock price was pretty much back at the same level it was at before the announcement. Now, the worry shifted toward closing the second part of the financing.

Finally, on August 15, 2011, Yukon-Nevada and Deutsche Bank closed the second part of the financing, which was for $120 million in the form of pre-paid gold forward facility. Now, the company had enough funds to winterize and refurbish the plant. You might think that after all the panicking and doubting about whether Yukon-Nevada was going to get the necessary financing, this would have been good news that would have sent the stock price higher, like it was when the first part of financing was closed. But no, the market completely ignored it. Actually, it was even worse because by October 3, 2011, the stock was trading at $0.28 per share. Yes, you read that correctly. When shareholders were panicking because Yukon-Nevada was struggling to survive due to a lack of financing, the market was pricing it at $380 million, or $0.38 per share. However, after the company raised $179 million, the market was valuing the equity portion of the company for $280 million, or $0.28 per share.

How is this possible? When you are dealing with the following shareholders or potential shareholders, anything is possible.

Before I get into why shareholders are acting so pessimistically, let me list exactly what it is that you get for the current price tag of $300 million or $0.30 per share. Yukon-Nevada has no debt, $120 million pre-paid gold forward facility and three main assets: Jerritt Canyon, a roaster facility, and Ketza River.

Jerritt Canyon

Jerritt Canyon consists of open-pit and underground mines that have been exploited over the last 30 years. Since 1981, it produced 8 million ounces of gold. As shown in the following illustration, the property produced 300k ounces of gold per year until 2002.

Jerritt Canyon has about 3.5 million ounces of gold when totaling what is in measured, indicated, inferred, and stockpiled as shown below.

What is Jerritt Canyon worth in terms of gold in the ground?

If we ignore the fact that Yukon-Nevada is a gold producer and value the ounces as if it was an exploration company, we could probably get $30 per ounce.

Value = 3.5 million ounces x $30 per ounce = $105 million or about $0.11 per share

Roasting Facility

The management claims that the roasting facility is what gives Yukon-Nevada its value. They estimate that the roasting facility has a replacement cost of $1 billion or $1 per share. For now, let’s just assume that this is what it is worth.

Ketza River

Ketza River is a property in Yukon, Canada, which historically produced 98,000 ounces of gold and by-product silver between 1988 and 1990. Currently, it has 485,000 ounces in 43-101 between measured, indicated, and inferred.

At one point, the management was going to spin off Ketza River when it was looking for options to raise money for the winterization and refurbishment project. Christopher Ecclestone of Hallgarten & Company, who covers Yukon-Nevada, believes that if Ketza River was marketed properly and spun off as a separate company, it could bring a value of $100 million or $0.10 per share. To read his report, see the following link:

http://classicvalueinvestors.com/i/2011/10/yukon-nevada-gold-coverage-update/

At this point, because the company raised money from Deutsche Bank, there are no plans to spin it off. Instead, the company will put it back into production at a rate of 70,000 of gold per year. However, this will be after Jerritt Canyon in Nevada is generating lots of cash. For now, we will just ignore the future plans and value it only at $100 million as Christopher Ecclestone advised.

Value Summary

Jerritt Canyon = $105 million or $0.11 per share

Roasting Facility = $1 billion or $1 per share

Ketza River = $100 million or $0.10 per share

Total = $1.2 billion or $1.2 per share

Considering that the market cap of Yukon-Nevada is $300 million and enterprise value of $420 million ($300 + $120 gold forward facility), the market is not valuing the company even close to $1.2 billion. If we assume that the market is pricing Jerritt Canyon’s gold in the ground at $105 million and Ketza River at $100 million, it is leaving only $215 million ($420 – $105 – $100 = $215) for the roaster facility. This means that after the management raised $179 million to winterize and refurbish the plant, the market is telling us that the plant is worth only slightly more than the money that they raised to fix it. This is ludicrous. It is equivalent to spending $10,000 to redo an entire kitchen in a single-family house while the market prices the entire house at $12,000.

Because there is such disconnect, it would be useful to understand how the plant could possibly be worth $1 billion. There are many way of looking at it. One way it is to figure out how much it would cost to build it. This is exactly how the management came up with their replacement cost. However, you couldn’t build a roaster like this in the region because you couldn’t get it permitted, and even if you could, it would take you 8 to 10 years to complete the construction.

Yukon-Nevada’s roaster is one of only three roasters in Nevada and the surrounding region. The other two roasters are owned by Newmont and Barrick and both are running at full capacity. Roasting is currently the only economic method of processing refractory sulfide ore, which is prolific in the region. Obtaining a permit for new roaster capacity in Nevada and the surrounding region is extremely difficult and time-consuming due to environmental concerns. No new roasters have been permitted in the past 12 years, and none are currently proposed or in the feasibility stage.

One can argue that it doesn’t matter what it costs to build the roaster. What matters is whether there is a buyer for it and how much such a buyer could afford to pay for it. The two most logical buyers are Newmont and Barrick.

Newmont and Barrick may be interested in the facility because of the reasons that I listed before – Yukon-Nevada’s roaster is one of only three roasters in Nevada with spare capacity. Because the permitting of new roaster capacity in Nevada and the surrounding region is extremely difficult and time-consuming, both of these companies are using their roasters to process only the highest quality ore (0.40 to 0.50 ounces per ton) and are stockpiling the lower quality ore.  For example, Newmont has 53 million tons of ore with a grade of less than 0.10 ounces per ton sitting idle. This is equivalent to about 5 million ounces of gold. At the current price of gold, this translates into more than $8 billion. If Newmont acquired Yukon-Nevada’s roaster, they could probably process their 53 million tons for $40 per ton or $2 billion, pocketing the remaining $6 billion. This would be spread over many years.

Could Newmont afford to pay $1 billion for Yukon-Nevada? I think even if they paid $2 billion, they would make out like bandits. Not only would they be able to process their 53 million tons of ore and pocket $6 billion over many years, they would also get access to 3.5 million ounces of Yukon-Nevada’s gold in the ground. In the hands of a producer like Newmont, these ounces would probably be worth $700 million, or $200 per ounce, instead of my estimate of $105 million, or $30 per ounce. Then, they would put Ketza River into production much more quickly because they have big pockets. At a production rate of 70,000 ounces of gold per year, they could get Ketza River cash flowing at nearly $90 million per year (70,000 x ($1,650 gold price – $400 cash cost) = $88 million). To them, Ketza River, producing at this rate, would be worth about $500 million. Likewise, when Yukon-Nevada puts Ketza River into production, it will be worth almost twice as the current market cap.

If the value of Yukon-Nevada’s roaster is so great, why won’t they try to do a hostile takeover since the company is selling for a song?

That’s a good question, and both the management and Christopher Ecclestone were surprised that they didn’t try. Because the board of directors foresaw the potential threat of a hostile takeover, on October 4, 2011 they approved a poison pill to prevent it from happening. As a result, it would now be difficult for Newmont or Barrick to attempt a hostile takeover. Christopher Ecclestone said that it is not unusual for the big mining companies to miss on incredible deals. He comically states – “Why buy now if you can pay more later?”

Considering that Newmont and Barrick already missed the chance for a hostile takeover, why don’t they just try to offer a reasonable price for Yukon-Nevada now?

They would probably not be able to convince Yukon-Nevada to sell for $500 million or less, especially now that Deutsche Bank funded the company with $179 million. Maybe before the financing, they would have had a chance of getting it for such a steal. My speculation is that they would probably need to offer $1.5 billion or $1.50 per share to be taken seriously. But, this is unlikely because how in the world would they explain to their shareholders that they are buying an unknown publicly traded company for five times the price of the stock when the roasting facility is not even working properly? They are more likely to wait for Yukon-Nevada to complete the winterization and refurbishment project. Of course, they will have to pay much more for it after it is working properly but as Christopher Ecclestone put it – “Why buy now if you can pay more later?” As silly as this may sound, if the stock price of Yukon-Nevada were at $2.50 per share, they would be more interested because it is much easier to explain to shareholders why they are buying something for $3 per share when it is trading for $2.5 per share than buying something for $1.50 per share when it is trading for $0.30 per share.

Now that you know how and why Yukon-Nevada’s roaster could be worth $1 billion, the only question that remains is whether the company will be able to fix the plant so that it operates properly and doesn’t shut down all the time, thus reaching its full value. Obviously, the market does not believe that Yukon-Nevada will fix the plant even after raising $179 million from Deutsche Bank to accomplish this exact task. In other words, the market believes that after throwing serious money at the plant, nothing good is going to come out of it.

It appears that some insiders are not agreeing with the market and are taking advantage of the situation by buying shares on the cheap. Between November 21, 2011 and November 23, 2011, the following transactions took place.

For some investors, Reichert’s purchase of 100,000 shares, Heinrichs’ of 30,000, and de Trentinian’s purchase of 260,000 may not be enough. Some investors are not one hundred percent convinced until they see the insiders mortgaging their homes and borrowing against their kids’ college funds to buy shares. For me, seeing insiders’ buys is good, but not a requirement.

Why is the stock price as low as it is?

Investors are exhausted from the roller coaster and a constant flow of disappointments. In the middle of 2010, there was not supposed to be any financing. The funds necessary for the winterization and refurbishment of the plant were supposed to come from already restarted operations. After Yukon-Nevada reached a steady state of production at a rate of 150,000 ounces of gold per year, production was supposed to increase. Also, after the third quarter of 2010 was profitable, everyone expected profitability to continue and to increase.

Well, the plant breakdowns created all sort of problems. Profitability disappeared. The hope for increased production was crushed. Liquidity problems arose. Then, the lack of cash was going to be solved by enticing warrant holders to exercise early. This fell through. When Deutsche Bank came into the picture, new hope was born, but as the lawyers on both sides were dragging their feet, investors kept getting more impatient, sending the stock price lower by the day. Deutsche Bank, seeing the stock price plunge, renegotiated the price on the private placement to milk a better deal out of desperate Yukon-Nevada. By the time the deal actually closed, everyone was so exhausted that the stock price didn’t even react. Plus, recently there were rumors that a hedge fund faced redemptions needing to get out quickly.

Once the financing closed, the management made another promise – to complete the winterization and refurbishment of the plant in September 2011. By looking at the date of when the second part of the financing closed (August 15, 2011), it doesn’t take much imagination to see that such a huge capex would probably take more than six weeks to complete even though they had already started some work right after the first part of the financing for $59 million closed on May 31, 2011. My attitude is that things always take three times as long as originally anticipated.

Here we are today on November 27, 2011, and the work is still not complete. However, when you listen to the conference call http://podcast.newswire.ca/media/yukonnevadagold20111116.mp3

that took place on November 16, 2011, you will learn that the work is pretty much done. What was slowing everything down was a delay in the manufacturing of the dryer, which is a very important component. The dryer was shipped in two parts. One part already arrived and is being installed as I am writing, and the second part is in transit. Because it is coming from Mexico, it could be held up at the border, but it will arrive very soon if it has not already arrived. Once it finally gets there, the management will shut down the mill for 10 days to install it, and the winterization and refurbishment will be pretty much complete.

The revised completion date is scheduled for mid-December 2011. Whether they will hit the new deadline exactly on time is hard to say. It is always possible that something else can go wrong. It is construction – what do you expect? If you ever remodeled a house, you know that something always goes wrong. I can totally see more investors sitting in warm offices staring at their computer screens having a fit if it is not completed by December and saying how incompetent the management is.

What happens after the mill is working properly?

Shortly before the company encountered all the recent problems with the plant malfunctioning, it reached a point where it was operating at a run rate of 150,000 ounces of gold. After the winterization and refurbishment is complete, this is the number that the management is shooting for, right out of the gate. Then, for 2012, they are anticipating a total production level of 175,000 ounces of gold. Assuming the price of gold is $1,650 per ounce and the cash cost is $789 (I will address how I came up with this number later), this translates into cash flows from mining operations of $150 million. After all the other expenses, you are looking at $108 million in operating income.

How are they going to get to 150,000 ounces of gold?

The Smith Mine is currently contributing 1,000 tons per day to the mill at an average grade of 0.235 ounces per ton. The SSX/Steer Mine Complex was restarted recently per a press release on October 3, 2011.

http://www.yukon-nevadagold.com/s/NewsReleases.asp?ReportID=483004&_Type=News-Releases&_Title=Yukon-Nevada-Gold-Corp.-Starts-Mining-at-SSX-Steer-Mine-Complex

At the beginning, SSX/Steer Mine Complex is only contributing 300 tons per day and will ramp up to 800 tons per day by the end of 2011 when additional equipment is delivered to the site. By the end of the first quarter of 2012, it will be contributing 1,200 tons per day. The grade is 0.189 ounces per ton.

Smith                    1,000 tpd x 0.235 = 235 ounces per day x 365 days = 85,775 ounces per year

SSX/Steer            800 tpd x 0.189 = 151 ounces per day x 365 days = 55,188 ounces per year

Total                      85,775 + 55,188 = 140,963 ounces per year

Between the Smith and SSX/Steer mines, the company can produce approximately 141,000 ounces of gold. However, as of January 2011, the company stockpiled 902,000 tons of ore at an average grade of 0.073 ounces per ton which equates to 65,900 ounces of gold. Adding this to the ounces produced from the Smith and SSX/Steer Mines, I arrive at 206,863 (140,963 + 65,900 = 206,863). You can easily how they can reach 150,000 ounces of gold right after the mill is completely fixed or 175,000 ounces of gold for the entire year in 2012. The management’s projection of 175,000 for 2012 might be on the conservative side.

By 2013, the company is planning to produce at a run rate of 300,000 ounces of gold per year. This is not some unrealistic number pulled out of thin air. The production rate of 300,000 ounces of gold per year was achieved before, from 1987 to 2002. There is no reason why they cannot achieve it again with the renovated roaster and 3.5 million ounces of gold in the ground. Plus, they are currently updating their 43-101 and believe that they will have an additional 1 million ounces.

To arrive at the run rate of 300,000 ounces of gold per year, the company will need to open more mines to in addition to the Smith and SSX/Steer mines. Starvation Canyon, the third underground mine, will be opened, contributing 600 tons per day at an average grade per ton of 0.22 ounces. The company will also reopen Burn Basin (open pit operation) in the fourth quarter of 2012, contributing 2,000 tons per day at an average grade of 0.104. SSX/Steer, instead of contributing 800 tons per day, will contribute 1,200 tons per day.

Smith                    1,000 tpd x 0.235 = 235 x 365 = 85,775

SSX/Steer            1,200 tpd x 0.189 = 227 x 365 = 82,782

Starvation           600 tpd x 0.220 = 132 x 365 = 48,180

Burn Basin           2,000 tpd x 0.104 = 208 x 365 = 75,920

Total                      85,775 + 82,782 + 48,180 + 75,920 = 292,657 ounces per year (this is close to the management’s estimate of 300,000)

To sustain this kind of production profile for many years, the company will need to reopen additional mines and/or explore more at Starvation Canyon and Burn Basin because these two only have about two to three more years of gold in the ground before they will be depleted. Smith and SSX/Steer mines have enough in the ground to last for more than 10 years of production.

Costs to Produce Gold

Yukon-Nevada’s profitability or any miner’s profitability is the function of the price of gold, the cash costs of mining and processing, and the costs of running the entire company. During the last seven quarters, Yukon-Nevada generated a positive gross profit only once, and some investors are confused why the company is not able to generate profit when the price of gold is as high as it is today. The following is the summary of the last seven quarters:

As you can see, the only positive quarter in terms of gross profit was achieved in the third quarter of 2010. In order to understand why the company has been losing money and is about to turn the corner, it is useful to break the cost of sales into two components – the cost of mining and the cost of processing as shown below. The cost of mining is what it costs the company to get ore from the Smith and SSX/Steer Mines or from other sources such as buying ore from a third party. The cost of processing ore is the cost of running it through the roaster.

The following is the same chart but displayed in costs per ounce sold.

I calculated this breakdown by using partial information provided by the company. It is by no means totally accurate, but it is better than nothing. For example, during the first quarter of 2010, 18,786 tons or 4,200 ounces were delivered from Smith Mine, which indicates that the grade was 0.22357 ounces per ton. The cost per ton was approximately $95 which translates into $425 per ounce ($95/0.22357). This is where the $425 cost of mining per ounce comes from. Because the total cost of sales was $13,743,000 and the number of ounces sold was 9,105, the total cost per ounce was $1,480 ($13,743,000/9,105). We can conclude that the difference between $1,480 and $425 or $1,055 was the cost of processing ore.

As you can see, the cost of mining per ounce was the same $425 for the first, second, and third quarters of 2010. The cost of processing per ounce declined over the same three quarters. This happened because the company increased production over these three quarters. This makes sense because as you run more ore through the roaster, the cost per ounce declines because the majority of the processing costs are fixed. Therefore, by the third quarter, the company was able to achieve a total cost of $1,161 per ounce which was lower than the average price per ounce of $1,252. This is why the company achieved a positive gross profit.

Unfortunately, during the fourth quarter 2010, both the cost of mining and the cost of processing per ounce increased to $733 and $1,018 respectively. This drove the total cost per ounce to $1,751 which was higher than the average price of gold of $1,366 per ounce. In order to understand why the cost of mining increased from $425 to $733 (a 72 percent increase) from the prior quarter, it is useful to investigate where the ore to feed the plant came from. The total of 71,173 tons or 14,919 ounces (grade 0.20962 ounces per ton) came from the Smith Mine. By using the cost of $95 per ton, this is equivalent to $453 per ounce ($95/0.20962). Because the cost of mining for fourth quarter of 2010 was $733 per ounce, and we just calculated that it cost the company $453 per ounce to get the ore from the Smith Mine, there had to be some other source of ore that was more expensive to drive the cost higher. The company bought ore from Newmont for $198.53 per ton. Because the grade was 0.19598, this is equivalent to $1,013 per ounce. For simplicity’s sake, if we just average the two numbers, $453 and $1,013, we arrive at $733 per ounce, which is the combined cost of mining per ounce.

From this calculation, we learn that buying ore from Newmont increases the cost of mining per ounce. Because the company continued to buy ore from Newmont in 2011, the cost of mining per ounce continued to be high at $671 in the first quarter of 2011, $821 in the second quarter of 2011, and $857 in the third quarter of 2011. The reason why these costs trended higher from quarter to quarter is because Newmont charges Yukon-Nevada more per ounce as the price of gold continues to increase. What a terrible deal!

This situation is about to change. Starting in January of 2012, Yukon-Nevada will no longer be buying ore from Newmont. Instead, it will be getting its own ore from the Smith Mine, the recently opened SSX/Steer Mine Complex, and stockpiles. In the most recent investor presentation, the management stated that the cost of bringing ore from Smith Mine is currently around $140 per ton (this will come down to $80 to $90 per ton after Yukon-Nevada stops utilizing a third party mining company – the contract expires in the middle of 2012). For now, I will keep using $140 per ton, which translates into $596 per ounce. The cost of brining ore from SSX/Steer Mine Complex is approximately $85 per ton, which translates into $450 per ounce. Based on this information, I estimate that after the Newmont ore-buying deal is eliminated and more ore is brought from the SSX/Steer Mine Complex, the cost of mining per ounce will decline to $523 per ounce.

If buying ore from Newmont is such a bad deal for Yukon-Nevada, why do it in the first place? The management always treated it as a temporary solution until the company’s own ore could replace it. In the short term, they were hoping that the increase in production would lower the processing cost per ounce because as mentioned before, the more ore that is run through roaster, the cheaper it is to process per ounce. Let’s see how successful this strategy was.

In the fourth quarter of 2010, after getting additional ore from Newmont, the processing costs per ounce increased to $1,018. Then, by the first quarter of 2011, they shot up to $1,739, sending the entire cost per ounce to $2,410. You can’t possibly make money when it costs you $2,410 to produce an ounce of gold while the price of gold is below $2,000 per ounce. Obviously, the strategy to get more ore to decrease the processing costs per ounce failed. Actually, both the processing cost per ounce and mining cost per ounce increased, which is the worst situation you can be in.

The reason why the processing costs were up was because the current roaster is old, breaks down all the time, and eats up tremendous amounts of energy. The only way to address this is to fix it which is exactly what the company has been working on after raising $179 million from Deutsche Bank.

Now, let’s look at my estimate of the processing costs per ounce after all the work is complete. During the fourth quarter of 2010, when the mill was operating at a rate of 1,000 tons per day and wasn’t breaking down as much, the processing costs per ounce were $736. If I was totally ridiculous and assumed that the newly refurbished roaster will not improve efficiency at all from this level, and I use the $736 per ounce as the processing cost per ounce, Yukon-Nevada will be profitable. After adding my previously calculated mining costs of $523 per ounce to the processing costs of $736 per ounce, we get a total cost per ounce of $1,259. Considering that the price of gold is $1,650 per ounce, Yukon-Nevada will be making $391 per ounce. At a production rate of 150,000 ounces of gold, this translates into $58 million in gross profit.

However, the roaster will be running at a rate of 4,000 tons per day, not 1,000 tons per day, which means that the processing costs will be lower than $736 per ounce. Also, after spending money to improve the plant, its performance is sure to improve. I was told that the roaster will be able to process ore for $40 per ton. If we use a grade of 0.15 ounces per ton, this translates into $266 per ounce, which is much cheaper than $736 per ounce.

Based on my estimates, the combination of mining and processing costs per ounce will equal $789 per ounce ($523 + $266). The management estimates $785 per ounce, so I am close. How will this all translate into earnings?

Considering the current market capitalization is $300 million, you are buying Yukon-Nevada for three times the projected 2012 earnings. Bringing production to 175,000 ounces of gold per year is just the first step. By the end of 2012, the management is planning to increase the production to 300,000 ounces of gold, which is what it historically produced between 1987 and 2002. I used the cost of $789 per ounce even though by 2013, the management is planning to lower these costs even further by opening more mines and taking the mining at Smith Mine in-house. If and when they lower the costs, it will be a nice bonus. For now, I will stick with $789.

Conclusion

Assuming that Yukon-Nevada achieves a production goal of 300,000 ounces of gold by the beginning of 2013, it will be set to generate more than $216 million in opearing income. Applying a conservative multiple of 7 gets you to $1.50 per share, which is a five bagger from now.

Risks

I believe that the majority of risk has been lifted after the company raised $179 million from Deutsche Bank for the winterization and refurbishment of the facility. Obviously, there still remains more execution risk. However, Yukon-Nevada’s problems came from the malfunctioning plant, not from metallurgy or a lack of resources in the ground. Malfunctioning plant is fixable with money. There also is a risk that the money raised will not be enough. Considering that they are almost done, I doubt that they will need to raise more money for the winterization and refurbishment of the plant. But if they do, it shouldn’t be much.

Also, another risk is the price of gold. I can’t really help you here. If you think that the price of gold is about to crash, then you should obviously stay away from this company.

I think that the biggest risk of all  is other investors. So far, they have acted impatiently and as if they know very little about the company. There is nothing that will stop them from continuing to act foolishly. Therefore, if you choose to invest in this company, just know that you will need to buckle up or you will be thrown off the horse by the insane volatility created by other investors.

Video with the CEO

Disclosure: I, or persons whose accounts I manage, own shares of Yukon-Nevada Gold Corporation (YNGFF). This report is not a solicitation to buy or sell securities. Neither Mariusz Skonieczny nor Classic Value Investors, LLC, is responsible for any losses resulting from purchasing or disposing shares of Yukon-Nevada Gold Corporation (YNGFF). You are advised to consult your financial advisor or conduct the due diligence yourself.

“A substantial disconnect has developed between the price of gold and the mining companies,” Einhorn said today in a conference call discussing results at Greenlight Capital Re Ltd. (GLRE), the reinsurer where he is chairman.

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