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The Leverage of Warrants

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December 31, 2006 – Comments (0)

My last blog is on Northern Orion, and so is this one, and it is on the how the leverage of warrants can work to maximize profits.

Northern Orion has a market cap of $558 million, plus dilution by the warrants. The dilution isn't necessarily a bad thing. At today's share price of $3.68, the dilute market cap would be $815 million. In that is $180 in cash holdings, and the warrants if exercised will bring another $160 million in cash, for $340 million, or about $1.54 per share.

This cash is a good thing because Northern Orion has a mine to build, and current cash, cash flow and warrants will pay for about 1/4 of the construction.

The value of the economically feasible and recoverable portion of Northern Orions' resource is about $33 billion in today's dollars, or about $149/ diluted share. At conservative prices of $2 for copper, $400 for gold and $12 for moly you get $98/diluted share. The mine construction is about $9/share, and over the life of the mine, the production costs are about $23/share, leaving $66/share for profits over the life of the mine.

My last blog gave a price estimate for Northern Orion of about $19/share once the new mine is built.

Northern Orion has two kinds of warrants, the regular ones, and the A warrants. The regular warrants should all be exercised as the exercise price is $2 CAD or $1.72 US. These warrants give a wonderful leverage of earnings right now. Currently trading for $2.45 CAN on the TSX or $2.11 US (I didn't find a US version of them). They expire in just over a year, May 29, 2008.

It is hard to say what the developments for Northern Orion will be at that time. It should be well into its mine construction, as building is expected to start around next summer. It is very hard to say what will happen to the price of Northern Orion with earnings not increase, but there should be a jump in price when the permits and the financing plan is arranged.

Currently the premiums for the warrants is tiny, about 15c US, or 4%. Consider target prices of $4, $5, $6, $7, and $8 by the time the warrants expire.

Increases for the shares would be 8% 35%, 63%, 90% and 117% respectively.

The increases for the warrants would be leveraged to give:

8%, 55%, 102%, 150% and 197% should share price go up to $4, $5, $6,$7,$8 respectively. In this case, it is hard to lose going for the warrants.

The A warrants expire Feb 17, 2010. They have an exercise price of $5.17 US, or $6 CAN. They will be generating cash for Northern Orion right about when the mill is in the last stages of construction.

This is the year that cash flow increases by about a billion dollars with copper priced at $2, gold at $400 and Molybdenum at $12. The mine construction has to be paid for. The share price should reach $15-20 once the mine is producing cash flow.

In US dollars the A warrants currently cost about $1.26. So, where will the price be right about when the mill is in start-up and there is anticipation of an increase in cash flow of $1 billion? $8, $10, $12, $14, $16?

At those prices the shares would go up by:

117%, 171%, 226%, 289% and 335%respectively.

The A warrants would go up by:

124%, 289%, 442%, 600% and 759%.

The market is bearish on copper, and many things copper have declined. My last blog showed the profitablity of Northern Orion at bearish prices of $2 for copper, $400 for gold and $12 for Molybdenum.

Northern Orion with its cash credits from the gold and molybdenum would be one the lowest cost copper producers in the world. Their figures are -$0.02 with cash credits of gold at $400 and molybdenum at $6.

For comparison, cash costs for some other producers according to the link below are:

$0.81 for anglo amerian,

$0.57 for bhp,

$0.50 for phelps dodge,

$0.36 for grupe mexico,

$0.116 for codelco,

$0.06 for Rio Tinto.

If you further look of the valuation of the copper in the ground from the Phelp Dodge take-over, it is giving a valuation for the metals in the ground of about $.70 per pound.

With those kinds of costs for other producers, new copper production is unlikely if copper goes below $2 for many producers.

Northern Orion will win big time because they got the property rights at a very good time, and the by-products make them an exceptionally low cost producer.

http://www.c...df/Oct06.pdf

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