Karmin Exploration fka KAR

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Good Summary

Fri May 20, 2011
Bottom-Fish Comment: Recommendation Strategy for Karmin Exploration Inc
Publisher: Kaiser Research Online
Author: Copyright 2011 John A Kaiser

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Karmin Exploration Inc (KAR-V: $0.25)
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Bottom-Fish Comment - May 20, 2011: Recommendation Strategy for Karmin Exploration Inc

Karmin Exploration Inc was initially recommended as a medium priority bottom-fish buy in the $0.30-$0.49 range on April 18, 2006 based on its 30% carried interest in a significant polymetallic VMS deposit in Brazil. The bottom-fish priority was upgraded to top on November 1, 2006 based on evidence that the Brazilian conglomerate Votorantim was stepping up exploration activity on the Aripuana project. Karmin had optioned Aripuana to Anglo American in 2000 but in 2004 the option was transferred to Votorantim which was interested in the zinc-copper sulphides in the Ambrex and Arex deposits. Under the amended deal Karmin retained 100% of the oxide mineralization which has a modest non-43-101 compliant gold-silver resource (the base metals are depleted) and a 30% interest in the sulphides which is carried until Votorantim delivers a bankable feasibility study. Votorantim did indeed step up activity, spending $19.2 million during 2006-2008, but has spent only $1.2 million annually since the crash for a total investment of $27.1 million since taking on the project. With the collapse of metal prices in late 2008 Karmin's stock slid below $0.20 and on December 24, 2008 I downgraded the priority to low while keeping the existing bottom-fish buy recommendation in the $0.30-$0.49 range open on the assumption that bottom-fishers would accumulate the stock at the much lower prices than the initial buy range. The hope in 2006 was that Votorantim would make a buyout offer for Karmin in the $1-$2 range when it was ready to develop Aripuana, but this prospect dimmed after zinc prices fell below $1/lb. In October 2007 Votorantim published an indicated and inferred resource estimate of 33,475,000 tonnes of 3.54% zinc, 1.34% lead, 0.26% copper, 0.29 g/t gold and 34.95 g/t silver for the two deposits. At spot prices as of May 20, 2011 the Aripuana resource has a rock value of $184 per tonne, of which zinc represents 41% while silver now represents 22%. The in situ value is $6.1 billion. Votorantim envisions a 3,000-4,000 tpd flotation and milling operation which would mine 1.2 million tonnes annually over a 15 year mine life. Preliminary metallurgical studies indicate no deleterious minerals, but a comprehensive study now underway remains an important milestone for the project. At the current spending rate Votorantim has Aripuana in a holding pattern, but it may step up activity after the 261 megawatt hydro-electric power plant located 13 km from the project is completed in 2011. Road access to the area has been improved as part of the construction of the $700 million plant which has the potential to supply the critical power needed for Aripuana. My reasoning that it was only a matter of time before Karmin gets bought out looked like a bad mistake when Karmin announced on March 19, 2010 that it planned to conduct a reverse takeover of Australian coal assets from a group that included Karmin insiders. The plan was to knock back Karmin's 38.5 million shares to 6.4 million shares through a 6:1 rollback, issue 168 million shares for the coal assets, and conduct a post-rollback $30 million financing. This transaction would have obliterated any upside bottom-fishers were hoping to get from the Aripuana asset, and the new coal asset would at best have represented fair value. Shareholder approval was secured but on October 1, 2010 the RTO was cancelled because Ignite Energy could not complete the financing, which tells us something about how negative this RTO would have been for the interests of existing Karmin shareholders. Trading resumed on October 4, 2010 and bottom-fishers were back in action with the original story intact. However, as of January 31, 2011 Karmin has a working capital deficit of $1.6 million that has been funded by the company's main shareholder, Robert Ciccarelli, who owns 13.9 million shares. As a group directors own 45% of Karmin's 38,453,591 issued stock, with associates likely owning additional stock. Karmin is almost a private company and there is a risk that management will conduct a debt settlement at cheap prices which takes some of the upside potential from the Aripuana asset away from minority shareholders, or worse, it may push the company into bankruptcy and privatize it. Given that bottom-fishers have hung in this long and survived a near catastrophe through the Ignite RTO, that metal prices, in particular silver, are so much better today than in 2008 when Votorantim spent heavily on the project, and that the critical power source needed to justify development is almost ready, I think it is prudent to maintain the open bottom-fish buy recommendation. Assuming Ciccarelli does not want the bad publicity of a bankruptcy and either figures out a reasonable way to convert the debt to equity or simply restructures it as long term for repayment when a buyout offer is received, the main risk to bottom-fishers at this stage is the possibility that another RTO is undertaken which eliminates meaningful upside but does provide the liquidity needed to get one's bottom-fish bet back.