Romanian Rhapsody: A Gold-Plated Litigation Play

Gabriel does not only have a giant interest in a world-class asset, its majors shareholders are all boldface names. Commodities guru Thomas Kaplan holds, via his Electrum Group, a 16 percent stake in the company. Beny Steinmetz, a titan in the mining space, holds via BSG Capital Markets a 16 percent share. Legendary investor Seth Klarman’s Baupost Capital holds a 13 percent stake. Newmont Mining, one of the world’s largest gold-mining firms, holds another 13 percent, and Paulson & Co holds 9.9 percent. And with more than half a billion poured into the project over the past 15 years, Gabriel -- as even the current Romanian FM has admitted -- had little choice but to file for arbitration with Romanian government under the World Bank’s ICSID convention. (The amount they seek could run as high as $5.34 billion.) That process is underway, with Romania having yet to respond to Gabriel’s filing of the arbitration request. Their slowness to respond highlights what is the main enemy here for Gabriel: time. ICSID arbitration averages about 3.6 years; more complex cases, which this qualifies as, can take far longer -- the upper end of the scale being a full decade. Assuming a mid-case scenario between the average and the extreme puts arbitration time at almost seven years. Gabriel has as of June 2015 $32.1 million cash and cash equivalents on hand. It has no revenue from the Roșia Montană asset, and until that project is up and running it seems unlikely that Gabriel will be able to find other sources of income. Gabriel has an average monthly expenditure of $1.8 million over 2015 so far. That gives it on the current numbers just under 18 months -- not long enough for it to survive without more cash. Its dwindling cash pool was refilled somewhat by a fully subscribed private placement with significant existing shareholders in 2014, which took the form of a convertible note with an eight percent coupon to be converted at $1.25 (a five-bagger at current prices), common share purchase warrants, and arbitration value rights, each entitling the holders to a pro-rata portion of up to five percent of whatever Gabriel might win (capped at $130 million).

Yet it seems that major shareholders in the company are keeping the faith, at least for the moment. Possibly because there will be another general election in 2016, and a presidential election in 2019, which might mean a change in government to one less committed to opposing Roșia Montană. This might also mean the opposite, however, especially as the on-the-ground protests do not appear to be losing steam. But these stakeholders might also be confident in the eventual arbitration outcome -- while Romania can stall the permitting process on Roșia Montană as long as it likes, defying the verdict of arbitrators backed by the World Bank would be much more dangerous, especially given the very grim economic numbers the country has been putting up in recent years and the fact that it already had to be bailed out by the IMF in 2009.

So what’s the nitty gritty? Like NovaGold -- with which it has three major shareholders in common, Baupost, Paulson & Co, and Electrum -- Gabriel offers in theory strong leverage to the gold price via a potentially game-changing asset. True, there’s a high capex to get the project online: $1.87 billion. But at $1,200 gold and a 10 percent discount rate, Roșia Montană has according to our proprietary models an NPV of $1.2 billion; Gabriel’s 81 percent stake in that being worth $963 million, which yields a NAV of $3.25 per share. At $1,400 gold, that jumps to $5.24, at $2,000 it hits $11.44. Using a five percent discount rate, at $1,200 gold NAV per share hits $5.32; at $1,400 it hits $8.00; at $2,000 it hits $16.37. And at a zero discount rate, $1,200 gold yields a per-share NAV of $9.10, while $1,400 gets us to $13.00 and $2,000 to $25.08. And keep in mind that during boom times gold stocks can trade at premiums to per-share NAV.

There are two ways to look at Gabriel. The first is as -- the numbers above show -- a great way to buy part of a great asset, and far cheaper than other companies in the space holding similar assets. This is a case of an amazing deposit not glittering. The other, less obvious way is as a litigation play: if Gabriel wins, they will win big. As noted, the amount they could be awarded might go as high as $5.34 billion; net of leakage to the AVR holders and estimated taxes, that would be worth as much as $4.17 billion, or $10.12 per Gabriel share. An arbitration win therefore could be a more high-powered driver of value here than a rising gold price.

The most likely outcome of this struggle, as we see it, is an arbitration settlement with Romania and the Roșia Montană project going forward possibly with the state improving their deal. Either way, the stock goes up big -- but the real risk here is dilution from another equity raise to keep the company solvent. There is real time pressure here for Gabriel to get this settled sooner, not later. So it’s a cheap buy -- a fire-sale price, in fact -- but it only makes sense if you’re a committed gold bull blessed with extraordinary grit. Whether they do so by convincing the Romanian government that opening Roșia Montană is in the country’s best interest or by winning their arbitration, Gabriel needs to get its political issues sorted out before investors see real value from it. The risks here are clear, but the potential upside is many multiples -- what they call on Wall Street an intriguing risk-reward.

So this one is not for the fearful. Then again, it takes what the Emperor Trajan would have called serious fortitudo to conquer Dacia.