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Sunken Treasure: A Mining Stock for the Bold

Flickr. Nautilus Minerals hopes to mine high-grade gold from beneath the Bismarck Sea, pictured here.

Jules Verne’s famous submariner Captain Nemo piloted his opulent vessel the Nautilus to the sites of shipwrecks around the world to harvest their gold in the classic adventure story 20,000 Leagues Under the Sea. Nautilus Minerals (TSE: NUS), a Toronto-based mining company with shares currently trading hands at C$0.46, is trying to replicate Nemo’s feat. Their targets, however, are not the holds of richly-loaded sunken frigates, but massive deposits of gold and other metals on the ocean floor. And they won’t be using a 19th-century Frenchman’s fanciful idea of a submarine to grab the gold, either: their proposed tools are state-of-the-art seafloor mining machines and a first-of-its-kind seafloor mining support ship — one that travels on the waves, not beneath them.

As Verne’s preoccupation shows, harvesting the mineral wealth at the bottom of the sea is not a new idea. Offshore oil and gas projects have been a mainstay of the fuel sector since the early 1890s. But getting at the valuable metals lying on the seafloor is another question entirely. The 1960s and 70s saw multinational mining consortia harvesting manganese nodules from the ocean bottom for the nickel and iron they contained. This laid the groundwork for future seafloor mining developments by building up the industry’s collective technical expertise, but the project itself was derailed by a glut of nickel in the world market.

Nautilus, which began life as a Canadian oil and gas exploration outfit, is playing a different and potentially much higher-stakes game: it specializes in locating and targeting seafloor massive sulfides (SMS), deposits rich in gold, copper, silver, and zinc that form around hydrothermal vents. They are essentially undersea volcanoes located in tectonically active zones, vomiting forth plumes of superheated chemicals. These precipitate metals as they find equilibrium in the frigid, basic ocean water they erupt into. The unique environment allows communities of exotic bacteria and sea life (the fearsome-sounding giant tube worm among them) to flourish under seemingly hostile conditions. That’s not mere color: environmental concerns could be key for Nautilus. But more on that in a bit.

Nautilus has been in the undersea exploration business since 1997, when it began sniffing around SMS in the Bismarck Sea off Papua New Guinea. These exotically formed deposits have a number of advantages over traditional mining targets.

First, seafloor projects are generally very high in grade: the Solwara-1 project, located about 19 miles off the coast of Papua New Guinea and which Nautilus envisions as its first real commercial prospect, has indicated resources of 1 million tonnes and five grams per tonne of gold and inferred resources of 1.5 million tonnes and 6.4 grams per tonne of gold. The current average grades of terrestrially mined gold — around one gram per tonne and headed downwards — make Solwara-1 look extraordinary even if the price of gold doesn’t see any significant upward action.

Second, Nautilus is first to the party. There has been no real demand for the kind of leases they’ve acquired, so they’ve acquired and acquired and acquired them, to the tune of a massive 500,000-plus square kilometers. And if the Solwara-1 project pans out, it means that Nautilus will have gotten into a whole new field of the mining industry before anyone else, with the advantage of years of technical preparation, and will own a huge swath of key real estate.

Third, the method proposed is revolutionary. A massive ship outfitted with a huge pump would position itself over three enormous pieces of equipment operating on the seafloor, cutting, grinding, and slurrying the mineral-rich rocks around the vent before pumping the slurry skyward into the ship’s cargo hold, to be readied for transport to shore. This means, in effect, that Nautilus would be operating a mobile mine, one not constrained by the physical location of a deposit — the ship and the seafloor equipment could exhaust Solwara-1 and move on to the next tenement without incurring additional capital costs. They don’t have to dig, in other words — their mine moves to where the gold is.

The company is now helmed by Michael Johnston, an industry vet with knowledge of the complex issues in mining across East Asia. Its largest shareholders are Mawarid Mining, a subsidiary of the Omani exploration giant MB Holding, Uzbek mining titan Alisher Usmanov’s Metalloinvest, and mining major Anglo American. Nautilus listed in Toronto in 2006. It peaked early, at C$5.20 that same year, and its stock has looked wobbly ever since. It hit an especially bad patch in recent years, however. After making something of a recovery towards the start of 2011, it’s been stuck in a seemingly unstoppable slide downward.

The problems that caused this slide arose not from technological setbacks, but from issues all too familiar to miners of every type: the difficulties of doing business with a small government that holds all the cards when it comes to the undersea territories Nautilus wants to mine for their gold and copper. In January of 2011 Nautilus was granted the world’s first deep-sea mining lease by Papua New Guinea; its government soon afterwards closed an agreement with Nautilus under which the island nation would purchase a 30 percent stake in the Solwara-1 project, then slated to begin production in 2013. This development prompted a rise in stock price to as high as C$3.48. But then, in what seemed to be a possible deathblow to the world’s first seafloor mine, in June 2012 Nautilus suddenly announced that it was in dispute with the PNG government, accusing it of having reneged on what Nautilus declared its contractual obligations to make significant payments for development costs already incurred in the construction of equipment to mine Solwara-1 as well as capital contributions going forward.

On the day of the announcement, the stock dropped almost 40 percent, from C$2.01, already significantly off the high, to C$1.23, and continued to slide, reaching a low of C$0.20. This occurred against an ugly backdrop for the broader gold space as even the large-cap gold miners were in the start of what has been a vicious bear market. Small wonder that the news of the fight with Papua New Guinea absolutely hammered Nautilus, a comparatively tiny company proposing to use unproven technology to mine a single commercial prospect.

To get some breathing space after this potential Doomsday event, Nautilus closed a private placement in September 2012 of C$34 million at C$0.90 per share, with its biggest shareholder Mawarid upping its stake in the company and gaining the right to appoint a member to the board — in this case the founder and chairman of Mawarid’s parent company, Dr. Mohammed Ali al Barwani. But the breathing space turned out to be insufficient as the project remained frozen, and Nautilus terminated the building of its seafloor production system and laid off around 60 people in November of 2012. To further fund care and maintenance, Nautilus resorted in June 2013 to a C$36 million rights offering at C$0.18 and slashed its research and development spending and executive compensation. Its largest shareholder, MB Holdings, remained steadfast in its support, acting as the standby purchaser for the offering. In August 2013, Nautilus and the Papua New Guinea government entered arbitration in a Sydney court. In October of the same year, Nautilus emerged victorious with a decision ordering the PNG government to pay what Nautilus deemed them to owe. But even this failed to get the PNG government back on board: they missed a court-mandated deadline to pay the US$120 million they had themselves initially agreed to. Undaunted, Nautilus nonetheless continued to work with PNG toward a commercial resolution of the dispute.

Then, in April 2014, after Nautilus’s price had hit a bottom amid a continuing disastrous environment for even gold stocks without issues, the company made the dramatic announcement that it had come to a mutually acceptable resolution with Papua New Guinea, ending the years-long dispute and in effect wiping their contractual slate clean to start afresh. In return for the restart, they secured for the government third-party participation rights in the considerable intellectual property generated through the building of all the seafloor mining technology the Solwara project would require. With things now looking up, the markets reacted positively, and Nautilus climbed to C$0.67, the biggest gain since its October 2013 arbitration victory. PNG made an immediate US$7 million down payment on their $120 million share of the project. Importantly, Johnston’s confidence that the PNG would, indeed, live up to their new bargain was validated in mid-December of 2014, when the remaining $113 million flowed out of escrow and into Nautilus’s hands. The payment entitles the island nation to a 15 percent stake of Solwara-1 with the option to purchase another 15 percent in 12 months. This suggests a valuation of the Solwara-1 project at $753 million and change, or C$1.43 per share.

Things are now starting to move forward again. Nautilus has formed a joint venture with Eda Kopa (Solwara), a wholly owned subsidiary of Petromin PNG Holdings Limited (the vehicle Papua New Guinea uses to acquire state ownership of stakes in mining and fuel company assets), and has chartered the “world’s first bespoke underwater deep sea mining support vessel,” as the maritime newspaper Lloyd’s puts it, from the UAE’s Marine Assets Corporation, which is having the ship specially built in China. It’s gotten two of the three pieces of equipment necessary to actually conduct mining operations on the seafloor built by Britain’s Soil Machine Dynamics, which specializes in building vehicles and support machinery for undersea work. The slurrying systems and the risers and lifts are under construction. Nautilus expects to take delivery of the specialized equipment over the course of the next 18 months and delivery of the vessel itself in 2017. With the ship and the seafloor equipment in its hands, it plans actual production at Solwara in 2018.

Now that Solwara looks much closer to reality than it has at any time since 2011, any potential investor needs to consider the question of its cost: Nautilus has projected that US$450 million will be needed to build the project, but that does not include the cost of the ship that will hover above the SMS deposit and suck up the slurried ores. On that, Nautilus made a US$10 million prepayment against a US$18 million, five-year charter agreement (with an option to purchase) with Marine Assets Corporation. All in all, that’s a total expenditure of $458 million, a significant amount for a company with a market capitalization of $205 million to finance. Once Solwara goes online, however, it is expected to produce approximately 1.3 million tonnes of material per year — at an $80 per tonne operating cost — which would indicate expected annual gold production of 170,500 ounces.

And then there’s the fact that the project generated local opposition on environmental grounds before it suffered its contractual setbacks. Ecologists in general worry that deepsea mining could harm the unique life forms that congregate around the vents producing the mineral-laden plumes that leave behind SMS deposits. In Papua New Guinea specifically, a leader of the 1.2-million-member Evangelical Lutheran Church of PNG, Giegere Wenge, has been vocal in his opposition to the project on ecological and theological grounds (seabed mining apparently violates their church’s understanding of Biblical
doctrine) — and in a country of 7.3 million people, a denomination that size can carry some weight.

Despite the drama and the hefty capex bill in a tough financing environment for junior miners, all in all, at its current price of C$0.46, Nautilus looks extremely cheap to us. Our proprietary model suggests that at a 12 percent discount rate — high but perhaps merited, considering that Nautilus is a risky proposition — and including all its cash, Nautilus has an NAV of US$4.30 at $1,200 gold. At $1,400 gold, that rises to $4.64; at $1,600 NAV hits $4.99, and at $1,800 $5.34. If Nautilus gets going and shows that it can in fact do what it has promised to without any more significant hiccups, and assuming a discount rate of six percent, at $1,200 gold NAV is eight bucks even; at $1,400 $8.61, at $1,600 $9.22, and at $1,800 $9.83. That’s solid leverage. This does not take into account any increase in value coming from the enormous seafloor land positions Nautilus holds, which will start to look attractive if Solwara-1 proves viable.

Call it deserved skepticism. Call it an imaginative failure. But markets do not yet seem to have taken a full account of the fact that Nautilus has weathered the sociopolitical storm that killed its stock price. Yes, the company is still in the embryonic stages of its project, so it’s hard to make analytical statements about its performance. That said, it has shown grit and resourcefulness in the face of adversity, and it has not lost the confidence of its major shareholders. And don’t forget that a success at Solwara-1 is a success that opens the door to a brave new (undersea) world. For those willing to take a risk on a bloodied-but-unbowed innovator, Nautilus looks attractive. We suspect that Jules Verne’s Nemo, a proud champion of underdogs, would approve.