South Boulder Mines and Eritrean Potash

South Boulder Mines (STB.AX / SMBSF) owns half of a potash project in Eritrea.  We can start off by noting that Eritrea ranks 160 out of 175 on Transparency International's corruption index and 173 out of 177 on the Heritage Foundation Index of Economic Freedom.  Good luck trusting the authorities in that country to safeguard an investment.  Oh yeah, it's also ranked 147 out of 155 on the World Bank's Logistics Performance Index.  The have a photo of the Massawa deep water port on the company website but I'd like to see photos of the road network from the project to that port.

Check out the management team.  The CEO is from a major mining company but he's not a geologist by training.  Their country manager is a geologist but they need people who've actually mined potash.

The Eritrea project was under development two years ago and is still under development.  They have MII resources but no 2P reserves.  The IRR and mine life are extremely impressive.  I just don't know how to interpret their published statements.  They have quarterly reports that look more like press releases than an audited financial statement, and their most recent one for October 31 says they have over A$13M in cash on hand.  That's nice to know but without seeing their net income (or loss) I can't figure their burn rate.

I first noted this company back in 2011 and I said nothing at the time because I wanted to see what they would do.  We can all see what they've done.  The stock has steadily declined for the past two years and is now in penny territory.  I had a feeling that would happen.  The world needs potash.  I won't be buying any potash from this project, or any stock of this company.

Full disclosure:  No position in South Boulder Mines, ever.

The Haiku of Finance for 12/26/12

Phosphate and potash
Agribusiness needs inputs
Fertilizing crops

South Boulder Mines (SBMSY) And Eritrean Exploration For Potash

South Boulder Mines trades as STB in Australia, and SBMSY here in U.S. markets.  The company does have other mining projects in Australia but one newer project is worth a discussion.  They think they've found a bunch of potash in Eritrea and want to try their luck bringing it into production.  How hard can it be?

The good news is that potash deposits have fairly uniform geology, unlike metal deposits that form in veins and require more precise estimations of grade and depth.  That makes for a straightforward estimate of the mine's layout and required capex.  They have considered requirements for new roads and port facilities in advance and have budgeted to build them from scratch.  The potash site is below sea level, so pumping water to the site from the coast is feasible in energy terms.  I am curious as to whether the seawater would have to be desalinated or otherwise treated prior to use in a potash mine; there is precedence for using treated waste water.  Saltwater from oil drilling is apparently also useful in the hunt for potash, so maybe seawater isn't a worry at all.

The bad news is all about Eritrea.  The U.S. State Department has a good summary of Eritrea's political situation.  Eritrea's willingness to defray the company's capex costs is nice but the government's requirements for free carry, an option to buy a 30% stake after the bankable feasibility study, a 3.5% royalty, and a corporate tax rate of 38% all add up to a serious bite before the common shareholder will see a penny of net earnings.  The government completely controls the economy, prohibits civil liberties, and has not held free elections.  That should give foreign investors pause in considering how safe their investments will be.  Transparency International rated Eritrea as 2.5 in its Corruption Perceptions Index in 2011 (that's pretty bad).  The Heritage Foundations' Index of Economic Freedom ranks Eritrea's economy in 2011 as one of the least free in the world.  The U.S. government is also sufficiently concerned about Eritrea's support for Al Shabaab, an Al Qaeda-inspired radical Islamist terrorist group, that it advocated international sanctions against Eritrea earlier this year.  The UN enacted those sanctions and recently made them stronger.

Read that State Department political summary again for an interesting fact.  Eritrea's GDP was only $1.87B in 2009.  South Boulder Mines estimates revenue from this project of $6B over 17 years, or roughly $353M/yr.  That's almost 19% of Eritrea's total GDP, from a single project.  A country as corrupt and poor as Eritrea would be sorely tempted to nationalize a lucrative mining project.  I have no idea whether the Eritreans would actually do such a thing, but they don't seem to have much respect for the law or international norms of behavior.

The company owns a legacy nickel property and plans to spin it off. Why not sell it to raise the money they'll need for capex at the potash site?  That would make the rest of the raise easier.  It would also be easier to raise capital with working interests rather than share issuance, as the Eritrean government's potential equity stake could massively dilute shareholders.  Working interests, if creatively structured, can let revenue flow to strategic investors before the Eritrean government collects its onerous taxes.

In any Western country, a potash play this large and shallow would be a more straightforward financial decision.  Its location in a country with a questionable political structure should make investors think carefully.

Full disclosure:  No position in STB / SBMSY at this time.