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Morningstar | Potential Acquisition of Mod Resources Could Add Much Needed Reserve Life to Sandfire

Sandfire Resources has approached small-cap ASX-listed Mod Resources, or Mod, to explore a potential acquisition. Prospective copper miner Mod hopes to develop its T3 deposit in Botswana. A prefeasibility study completed in early 2018 outlined aims to produce about 25,000 to 30,000 tonnes of copper a year for about 10 years from a 590,000 tonne copper resource.

Mod has so far rebuffed Sandfire’s advances and is instead reportedly looking to raise capital to complete its feasibility study, which is due in March 2019. We have reviewed Mod’s plans and operations and can understand the firm’s desire to continue to stand alone. The company has extensive copper exploration leases in Botswana and the potential to find more resources in an historically underexplored area. Mod is led by longtime ex-Western Areas managing director Julian Hanna. He presided over the successful exploration and development of Western Areas’ Forrestania assets. His leadership adds credibility to Mod’s growth and capital raising plans, important if the Sandfire approach is to be defended.

Sandfire’s approach looks opportunistic with Mod’s share price at Friday’s close down about 75% from its March 2017 high, selling off with the lower spot copper price and potentially the coming cash call to develop the mine. We can see the logic of a combination as Sandfire is cash-rich but limited by a relatively short reserve life of less than five years. However, we make no change to our Sandfire AUD 6.10 per share fair value estimate given the approach is at an early stage, Mod’s size and the likely relative value. The chance of a transaction at this stage seems low with Sandfire yet to make a formal offer. Sandfire’s mooted offer price of AUD 0.38 per share for Mod, would translate to a fully diluted acquisition price of about AUD 110 million. This would see Mod make up about 10% of the combined group.

Mod’s T3 prefeasibility study estimated a net present value of AUD 370 million pretax based on USD 3.00 per pound copper, an 8% real discount rate and an AUD/USD exchange rate of 0.76. We think it is likely the pending feasibility study will mine a greater proportion of the resource. So, despite our lower midcycle copper price forecast of USD 2.30 per pound, we could still see potential for Sandfire not to destroy value by acquiring Mod. There could even be upside longer term given the extensive exploration acreage around T3.

With a market cap at Friday’s close of just AUD 65 million on a fully diluted basis, or about AUD 57 million net of cash, Mod would represent a relatively easily digestible acquisition for Sandfire. We forecast Sandfire to end fiscal 2019 with approximately AUD 250 million net cash. With net cash and forecast free cash flow of about AUD 400 million in fiscal 2020 and fiscal 2021, Sandfire is well placed to fund Mod’s capital cost, estimated in early 2018 at USD 155 million to 192 million. We estimate Mod’s cash at end December was less than AUD 10 million and financing is required to build the mine.

Part of the motivation for Sandfire is that its sole development asset, Black Butte in Montana, may not secure approvals. The acquisition of Mod Resources, and its T3 deposit, would extend life and provide Sandfire with a second source of production, albeit at much lower rates than Sandfire’s existing operation at DeGrussa in Western Australia. We estimate DeGrussa will produce an average of about 75,000 tonnes of copper a year for the next four years. Mod’s potential development potentially weakens Sandfire’s competitive position somewhat, given DeGrussa has particularly low cash costs. Cash costs at Mod’s T3 deposit are forecast to be higher at about USD 1.20 to USD 1.30 per pound versus our forecast of USD 0.90 to USD 1.00 per pound for DeGrussa.