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A gold and litigation stock play

Flickr. Romania has a rich mining history — and the Roșia Montană project could be the jewel in its crown.

The Roman Emperor Trajan, near the start of the second century AD, invaded and subdued what was then known as Dacia — current-day Romania — and seized its gold. Such was his jubilation at this martial and natural-resources coup that he ordered a solid four months of celebrations. Since then, Romania has become better-known for vampires Transylvanian and Soviet than for its world-class mining assets. So it may not be surprising, therefore, that Gabriel Resources (TSX: GBU) has faced difficulties in trying to develop such an asset there that would frustrate even Sisyphus. The London-based junior miner is focused on progressing with the Roșia Montană project, currently Europe’s largest undeveloped gold mine, of which Gabriel owns 80.7 percent through its local subsidiary.

The deposit is absolutely massive and of exceptional grade. If and when Roșia Montană (“red mountain”, so named for the color of mining pollution) comes online, it has a predicted 16-year life with a predicted annual production rate of 500,000 oz Au at a 1.46 g/t grade. Roșia Montană is also in physical and economic terms ideally situated as a gold mine. (The political terrain is another matter entirely, but more on that below.) It is located in the Western Transylvania region, which has a mining history stretching back centuries into the country’s Roman past. This long involvement with the mining industry has created a large and deep pool of skilled local labor that has been hungering for work for almost a decade. As part of its E.U. accession process, Romania closed the vast majority of its state-run mining enterprise in 2007, leading to unemployment rates in the Roșia Montană region that are around 80 percent. With regard to infrastructure, the project looks solid: it has easy access to water and power and a functional road and rail system. Romania enjoys a corporate tax rate well towards the lower end of the scale in E.U. countries at 16 percent — and it also has one of the lowest GDP per capita figures in the E.U., a mix which would in theory seem perfect for spurring the adoption of pro-growth policies by the government. Giving Roșia Montană the green light would seem to be just such a policy: it is estimated that it will add as much as $24 billion to the Romanian economy.

The trouble is that this green light does not, so far, seem to be happening. There are a number of structural-historical reasons. First, mining in Romania comes with a very tainted past: the Russians saw Romania as a resource bonanza, and when the country fell under Soviet dominion they began a campaign of aggressive and highly pollutive mining. The mine shutdown that preceded Romania’s E.U. accession was meant to wipe the slate clean there, but a cloud still lingers — and national feelings against such pollution were stirred up once more by the 2000 cyanide spill by another gold-mining firm into the Someș river near Baia Mare. This disaster proved to have international ramifications: the Someș flows into the Tisza, Hungary’s second-largest river, which in turn flows into the Danube, its biggest. The cyanide pollution spread with the currents, giving a significant piece of ammunition to Hungarian opposition to Roșia Montană (which in turn revives a long-held Hungarian complaint about the division of land after World War II, where it lost precisely the resource-rich region of Transylvania where Roșia Montană is located).

There is also the question of Gabriel’s founder, Frank Timiș, a colorful character with a couple of convictions for heroin possession, at least one serious fine from a London stock market levied against a company he was associated with, and a healthy slate of unproven allegations made against him about his business dealings — including about how he got the Roșia Montană project started. He’s no longer associated with Gabriel, but his presence seems to hover.

It’s no shock, then, that Roșia Montană has long been a focus of highly visible protests from NGOs — one funded by billionaire philanthropist George Soros — and ordinary citizens citing concerns about the environmental and cultural damage the mine might do. These have attracted a cadre of celebrity supporters as well, including Woody Harrelson and Romanian TV star Gianina Corondan. It should be noted here that rumors have long circulated that Russia helps the protest movement from behind the scenes. No firm evidence of this has yet emerged, but it would accord with the strategy practiced by Putin (as outlined in our September issue by Zvi Magen) in attempting to bring former Soviet bloc countries back into Russian auspices. Russian involvement or no, as a result of the protests the project has seen sporadic if significant progress in approvals stretched over almost two decades. It is currently advanced in the permitting process, needing only to receive the OK of Romania’s environmental agency — but that missing permit has been a key stumbling block for them, as the anti-mine activists have seized on its being granted as a be-all-and-end-all issue. Their protests were deemed a powerful enough issue that the current Romanian administration under Prime Minister Victor Ponta (now under investigation for corruption) and President Klaus Iohannis used them as a campaign issue in 2012 — and successfully.

The mine does have some political support: former Romanian president Traian Basescu has proved to be a consistent backer. But Ponta and Iohannis’s campaigning against the project and their eventual victory sent the company’s stock price plummeting from its early 2011 highs of C$8.40 to $2.28 by the end of 2012. This despite the fact that the Romanian government through its Minvest subsidiary owns a 19.3 percent stake in the Roșia Montană mine. After Ponta was safely installed as Prime Minister (his rival Iohannis ended up taking the presidency Ponta had aimed at), he switched gears on the Roșia Montană question and drafted a law that would have removed the obstacles to getting the mine into operation. Whatever Ponta’s motive for moving the issue to the legislature was, the law died there, in the face of those very loud, very sustained protests, leaving the project in limbo. This has driven the price down to between $.24 and $.47 where it has been trading since April of this year, putting the company’s market cap just a hair above $94 million.

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.