We are short AKG because we believe it is highly likely to end up a Zero.
- On the back of flawed geology, AKG made investments in Nkran, its satellite pits, and Esaase that we believe will never be recovered.
- Nkran is already experiencing a serious collapse of its west wall that we believe is a sign of AKG’s desperation. We estimate AKG needs to spend $75 – $115 million soon to keep mining Nkran, or the mine will “pinch out”. Spending the money likely means AKG will run out of liquidity in 2018; not spending the money leaves the company without the cash flow to develop its largest deposit, Esaase.
- AKG’s “satellite deposits” are unlikely to yield significant cash flow, due to likely flawed geology. In a December 2016 upgrade to their resources, AKG used a record gold price – $2,000/Oz – to boost their estimated value. This is only one of the serious flaws we see.
- There are indicia that some of AKG’s resources models have been “smeared”, which would cause estimates of their ore contents to be inflated.
- Management is outwardly assured and confident, but their behavior reeks of desperation and short-termism.
Introduction: AKG is Highly Likely to End Up a Zero
We are short Asanko Gold Inc. (“AKG”) because it is highly likely to end up a Zero. Flawed geology led to investments in Nkran, Esaase, and various satellite deposits that in our view are unrecoverable. We see the company as trying to stave off the inevitable, and unsustainably mining Nkran in a desperate search for cash flow. The company is looking to Nkran’s satellite deposits to bridge the gap, but we see little chance that the satellite deposits save the company. We expect AKG to run out of cash in 2018 while trying to service $165 million of debt. The best-case medium-term scenario seems to be an extremely dilutive equity raise, possibly approximating half of AKG’s market cap. The worst case scenario – and not a remote one in our view – is bankruptcy. Regardless, we think that eventually AKG is highly likely to become a Zero.
Nkran could be on the verge of two discrete, but related, calamities: Major wall collapse or “pinching out”. Significant portions of Nkran have already collapsed. There has been a failure in the west wall that management has described as “little” and “tiny”.1 However, satellite and drone imagery shows the wall failure and impact on the ramp is likely quite serious. The collapse is approximately 250 meters long, and has caused an approximately 175 meter to 200- meter section of the ramp to begin sliding into the pit. The same imagery shows there are mine wall failures in almost every direction, making it quite possible that additional major failures of the mine’s upper and mid-levels are just a matter of time. Over the next five months, Ghana will go through its two rainy seasons (May – July and August – October).2 Even without a collapse, AKG will highly likely need a significant pushback of the west or east wall to continue accessing ore from the pit through 2018. We estimate that a pushback that allows AKG to access new ore bodies would cost $75 to $115 million.
With the S&P 500 falling a double-digit percentage in the first half, most equity hedge fund managers struggled to keep their heads above water. The performance of the equity hedge fund sector stands in stark contrast to macro hedge funds, which are enjoying one of the best runs of good performance since the financial crisis. Read More
Nkran might be about to “pinch out”, in which case its remaining LoM could be less than six months, or just 25% of the original plan. “Pinching out” is when the costs of additional mining exceed its expected revenue – i.e., it is not profitable to mine further. If Nkran pinches out, we do not see how AKG could fund Esaase or any other development that might move the cash flow needle. AKG has found significantly less gold in Nkran than expected. The original plan called for it to “slow-mine” Nkran,3 which would have entailed regular wall pushbacks to make the wall slopes more gradual. After the initial mining turned out to yield less gold, AKG responded by aggressively mining into the “guts” of the ore body.4 In doing so, it abandoned plans for ongoing wall pushbacks. Nkran has now been mined into a steep “V” shape. The lowest level of its pit floor is a skinny, irregular shape, only ~65 meters at its widest point and narrowing to about half that at either end. AKG might have as few as two benches of depth (at 18 meters per bench) in Nkran that it is able to mine.
With uncertainty hanging over the quantity and quality of ore below, the company faces a dilemma: should it risk running out of money by pushing back the walls, or admit defeat and move on from Nkran, but likely without the liquidity needed to generate meaningful cash flow from its other resources? As of the end of FY16, Nkran has significantly underperformed the original 2015 mine plan despite mining so aggressively as to have removed 19% more ore than planned. There was an -11% short fall in total gold production.5 Recent disclosures cause us to think the company will deem Nkran as pinched out, and it will therefore abandon the project. In that case, if the 2.7 million tons of ore and 166,000 ounces recently reported as being accessible with minimal additional cost is all the mining management intends to complete at Nkran, then Nkran’s remaining LoM could even be less than half a year (which would reduce Nkran’s LoM to one-fifth or less of its original plan).6
The satellite deposits will not save AKG in our view. Nkran’s poor performance has meant that AKG lacks the cash flow to Esaase. This has seemingly caused AKG to focus on small low grade “satellite deposits” to plug the hole. Over the last year, AKG has repeatedly shuffled its satellite mine development plans, fast-tracking mines with near surface ores apparently to generate some cash flow. Since Q2 2016 the satellite plan has changed on an almost bi-monthly basis. The demotions of once promising deposits imply expected economics that are much worse than stated in AKG’s Mineral Resource Estimates (MREs). These frequent changes also signal the company is desperate. We believe these deposits will follow Nkran in disappointing due to flawed geology.
We see AKG root problem as flawed geology. The most recent evidence of the poor geology is the newest Nkran pit model, which significantly decreased the reserve estimates.7,8 An expert report we reviewed on the history of AKG’s MREs and other technical reports was highly critical. The experts found significant flaws and omissions in the assumptions and methodologies, including possible “smearing” of the mineral resource model. The report strongly suggests that critical flaws remain in the pit models for Nkran, Esaase, and the original satellite deposits including Dynamite Hill, which until May 23, 2017 was the satellite first in-line to be developed.9 In February 2016, AKG hired Philip Bentley as its Executive for Geology and Resources. Mr. Bentley was the VP of Geology and Exploration of the spectacularly collapsed Great Basin Gold (GBG). He was named as a defendant in a lawsuit over that collapse. We wonder why out of all the potential geologists AKG could have hired, it settled on Mr. Bentley.
AKG is significant risk of a liquidity crisis in 2018. The company’s liquidity is limited to only $48 million of cash on hand, and it has zero availability on its $150 million revolver, which has accrued interest.10 If the company pushes back the collapsed wall at Nkran, we estimate it would consume $75 million to $115 million. Using company-favorable assumptions, we believe the company will have a 2018 cash short fall ranging from -$43 million to -$129 million in 2018.
If investors are surprised by the foregoing conclusions, they can be forgiven. Management has often painted a “puppies and rainbows” picture of its operations, putting positive spins on news that should be unambiguously bad for the company. This includes having made the spurious claim that no material change to its “global” MRE was justified.11 One of AKG’s most brazen deceptions has been trying to convince the market it is “conservative” and its planning is “bullet proof.”12While management outwardly exudes a sense of calm, we see a management that is desperately flailing around in search of cash flow.
AKG investors appear to have been comforted by the backgrounds of chairman Collin Steyn and CEO Peter Breese. The pair previously sold LionOre Mining International Ltd. and Mantra Resources Limited for significant gains in 2007 and 2010, respectively.13 However, a soberer assessment of their track record is that the buyers in each case were undisciplined, and it was in the midst or tail end of a bull market for the underlying commodity.14 There have since been a series of write downs and failures at Lion Ore, and Mantra has never gone into production. The pair’s investments in Coalspur and Mirabella Nickel have been greatly disappointing.
We doubt the company can avoid an expensive debt restructuring in the next 12 – 18 months. Management contends its cash flow and liquidity are sufficient to cover its near-term obligations and capital expenditure plans, and hopes to renegotiate an already onerous 7% interest rate.15,16 However, it appears far from capable of generating enough cash to make repayment of the
already once extended loan (currently at $165 million).
Article by Muddy Waters
See the full PDF below.