Spec Value Hunter Comment - December 21, 2010: Amazon files a patent application for a process that could be a game changer
During the past six weeks Amazon Mining Holding plc has made a series of announcements which together put the "alternative potash" security of supply story into a much bigger league that could deliver tenfold gains from the current price during the next two years. Amazon was made a medium priority bottom-fish buy in the $0.10-$0.19 range on December 24, 2008, which was converted to a Spec Cycle Hold 100% recommendation at $0.80 on July 31, 2009. On December 18, 2009, after Amazon reported initial drill results which confirmed the existence of a large zone of homogenous, good K2O grade glauconite within the Cerrado Verde project, I issued a Good Absolute Spec Value Buy at $2.03 with a price target in the $3-$5 range for the second half of 2010 if a preliminary economic assessment (PEA) was favorable. On October 28, 2010 Amazon delivered a PEA which estimated an NPV of US $455.4 million for a 1.1 million tpy operation and $858.1 million for a 2.2 million tpy operation using a 10% discount rate and 40 year mine life. This translated into a stock price of $14.60 and $27.50 respectively using the then fully diluted capitalization of 31.2 million shares. The stock settled into the $4-$5 range where it appeared stuck as the market wondered when and how Amazon would raise the $20 million needed for a demonstration plant in 2011, whether the fertilizer blenders would accept the ThermoPotash prices assumed by the PEA, and if the commercial plant's reliance on coking petroleum and resulting cost sensitivity to oil prices would ultimately stymie raising the $200 million plus capital cost. With the bottom-fish recommendation up 2,400%, the spec value recommendation up 137% and at the upper end of the target range, and the story now at a highly technical engineering and product marketing stage which is beyond my technical expertise, I have been in a quandary over closing out the positions or investing additional time in the Amazon story at the expense of generating new cheap bottom-fish picks. Fortunately a series of very brief news releases during the past couple weeks have not only answered the demonstration plant financing question, but have also transformed the "security of supply" story into a "breakthrough" story that has profound implications for Amazon's upside potential and the possibility to mitigate future food shortage problems by making glauconite generally accessible as a source of traditional KCl fertilizer. Accordingly, I am maintaining the bottom-fish recommendation as a Spec Cycle 100% Hold, and issuing a new Good Absolute Spec Value Buy recommendation at $4.81, with a $20 plus price target by the end of 2011, and $50 plus during 2012 if Amazon does not disappear in a bidding war before then.
On December 15 and 16 Amazon issued several financing news releases which started off with a best efforts private placement offering of 960,000 shares at $4.17 by UK based Ocean Equities, whose analyst Natasha Liddell published an excellent research report on November 16. Ocean is placing 60% of its tranche with a private investor who is a stakeholder in the South American agribusiness giant Bunge, an investment that was apparently initiated on the basis of independent due diligence. The other 40% is being placed with UK institutions. Amazon issued a separate news release the same day where it announced that the Canadian brokerage firms GMP and Wellington West would conduct a private placement of 960,000 shares at $4.17 on a bought deal basis, with an over-allotment option for 480,000 shares. The next day Amazon announced that Salman Partners was now also part of the financing syndicate which would place an additional 960,000 shares on a best efforts basis. Some of the paper being placed by the Canadian brokers is going to strategic investors from the agribusiness sector. In total, if the over-allotment is exercised and the best efforts portion fully completed, Amazon will issue 3,360,000 shares to raise $14 million, and bring its fully diluted capitalization to 34,511,204 shares. Coupled with the existing $4 million working capital position, this financing, which is expected to close by January 11, 2011, would boost Amazon's working capital to about $17 million, enough to cover the $3 million cost of an extensive drilling campaign designed to quantify the glauconite resource within the entire 100 km verdete slate belt covered by Amazon's 165,069 hectare concession, and the $8.5 million cost of running a 60,000-100,000 tpy demonstration plant for 12 months which will form part of a feasibility study for the project.
When Amazon's CEO Cristiano Veloso told me in late November that the company planned to spend $3 million drilling shallow holes on 400 metre spacing along the entire Verdete Slate belt for which a conceptual estimate of 15 billion tonnes of glauconite was made by Coffey Mining last year, I questioned the need for this work in light of the operating scale proposed by the PEA. The PEA was based on an inferred resource of 105 million tonnes of 10.3% K2O within the Funchal Norte zone at a 7.5% cutoff, which represented 100 years of mine life at the 1.1 million tpy scale and 50 years at the 2.2 million tpy scale. Earlier in the year I was told that Amazon planned to do this sort of exploratory drilling in an effort to systematically identify the highest grade zone with the best location with regard to energy and transportation infrastructure. This time around I was told that Amazon needed to conduct assessment work to be in a position to convert the exploration license into a development license covering the entire resource. I supposed this was necessary to prevent somebody else from horning into Amazon's niche market and applying the ThermoPotash process, which was invented during the eighties and has no proprietary protection, to glauconite zones Amazon would otherwise have let come open. A week later on December 2 Amazon published a news release about filing a patent application for a process that produces "conventional potash products, muriate of potash and sulphate of potash" from verdete slate. Assuming this was another one of those tedious "chemistry" press releases Amazon periodically makes, I put it aside to read when I had nothing better to do and a couple cups of coffee in me, like, never. But when I followed Cris Veloso's suggestion to read it carefully, I instantly had a "holy mackerel" experience and understood why wealthy investors from the agribusiness sector were participating in last week's financings.
When I first discussed Amazon's story in a March 18, 2009 Bottom-Fish Comment I focused on the potential for the junior's huge "glauconite" resource in southern Brazil known as the "verdete slate" to reduce Brazil's dependency on imported potash. Glauconite is a silicate containing 5.5%-14% K2O compared to 18%-22% K2O for the salt called sylvite from which the fertilizer potassium chloride (KCl) is derived. Amazon's goal was to melt the glauconite in a rotary kiln in conjunction with limestone followed by quenching to create a "shattered glass" product called ThermoPotash which could be added to fertilizer blends used by Brazilian farmers. ThermoPotash, because it is a "whole rock" product, could not really replace KCl because it contained only 5.5%-14% K2O compared to 60% K2O for KCl, which implied a substantially higher application cost. (On the plus side, ThermoPotash would not run afoul of organic certification requirements as does potassium chloride.) However, the lower solubility of ThermoPotash made it an ideal supplement for fertilizer blends whose KCl content has a tendency to wash out quickly in Brazil's setting of acidic soils and torrential rains. Glauconite deposits exist throughout the world, but the location of the Verdete Slate in the heart of Brazil's agricultural district at surface combined with the region's climate and resulting high fertilizer consumption represented a special situation. All Amazon had to do was demonstrate ThermoPotash's agronomic efficacy and a cost structure that was competitive with the landed cost of imported KCl potash from Canada or Russia. The upside for Amazon bottom-fishers and spec value hunters lay in the strategic premium a large fertilizer company might pay to control Amazon's Cerrado Verde project and thus enjoy some protection against another episode of skyrocketing potash prices as the world witnessed in 2008 before the financial meltdown, and is likely to experience again as climate change impacts growing regions and the emerging market populations expand food demand. Argonomic studies were initiated during mid 2010, with no negative news so far, and the PEA published in late October 2010 suggested that the project was feasible if FOB Vancouver KCl prices did not drop below $400/t and the blenders accepted Amazon's ThermoPotash's pricing model. The timeline below shows that 2011 will be a critical year leading to big decisions in early 2012 with regard to this business plan. So, maybe somebody would eventually pay $200-$400 million to privatize Amazon, which would translate into a stock price in the $6-$12 range, a very nice accomplishment for bottom-fishers who bought at $0.19 but certainly not something to boast about on a "holy mackerel" scale.
This patent, however, has "holy mackerel" implications. The patent application for a simple process that cost effectively converts glauconite into conventional forms of potash such as potassium chloride or potassium sulphate is a game changer at many levels if the process works and the patent is granted. BHP Billiton spent $350 million on its failed bid to buy Canada's Potash Corp for $39 billion. It should double that bet, and set the stage for some future payback, by making a snap $10 per share takeover bid for Amazon before its competitor Vale does (the stock will be $20 before this idea hits their radar). One has to admire the broad-ranging vision of Cris Veloso, who in 2008, after Amazon staked the Verdete Slate belt over the objection of some Canadian board members and before certain predators sought to "rescue" the treasury, immediately began to look for a scientist with the capacity to develop a process for converting glauconite (K(Fe3+,Al,Mg)2(Si,Al)4O10(OH)2) into potassium chloride (KCl). His search led him to Dr Derek Fray, professor and director of research at the University of Cambridge in the UK. Amazon sponsored Dr Fray to invent a solution to this problem, and two years later he came up with a way of "reacting verdete slate with a simple mixture of salts to form water-soluble potash". The reaction involves temperatures of 800-1000 degrees C and allows for regeneration of most of the reagents. The next step will involve pilot plant studies to confirm the process and better quantify the cost structure. More details will be published in January 2011 after Amazon has filed related patent applications. This angle is above and beyond everything that I have talked about with regard to Amazon!
If the process works and the associated cost is reasonable, Amazon could be in a position to convert the 10-15 billion tonne glauconite resource within the Verdete Slate belt that grades 5.5% to 14% K2O into potash products that would not only eliminate Brazil's need to import potash from Canada, Russia and a handful of others who dominate potash supply, but it could enable Brazil to become a net exporter of potash. Furthermore, Amazon would be in a position to license the process to operators in other countries with accessible glauconite deposits. If Amazon has the potential to become a $10-$20 stock just on the basis of providing ThermoPotash as a 1-2 million tonne per year supplement to Brazil's existing fertilizer blenders, what would the stock be worth if Amazon turns out to have a process for converting glauconite into conventional potash products at a cost competitive with South American brine operations and the deep sylvite deposits in Saskatchewan? On December 21 Amazon announced that the Secretary of Finance from Minas Gerais has approved special tax treatment for the Cerrado Verde project which will also apply to to any conventional potash products (SOP and KCl) that might be produced if the new process works. Specifically, an 18% type of VAT is suspended for all raw materials and equipment that need to be imported, which apparently applies to most of the capital cost of the ThermoPotash project, and several key agricultural states which would be markets for ThermoPotash and any other potash products have agreed to reduce their "VAT" to 4% from existing rates that range 4.9% to 12%. Amazon Mining Holding Plc is a Good Absolute Spec Value Buy with doubling to tripling potential on the basis of its primary ThermoPotash business plan, and substantially higher if it can demonstrate that Dr Fray's process is feasible.