Lion Selection 28 Oct 09

Seeking Alpha -- after a year awash with red ink.

Members will recall that in June of this year, Lion Selection announced a proposed merger of gold assets with Catalpa Resources (ASX: CAH). The purpose of the merger has overwhelming support from both boards. The idea is to create a new mid-size gold miner producing around 130,000oz per annum. It is highly unlikely that shareholders will vote against the deal.

The principal assets of the new Catalpa Resources are 30% of the Cracow Gold Mine in QLD, and 100% interest in the Edna May Operation in WA.

Under the terms of the merger, Lion will contribute $A1.5m in cash and Catalpa will acquire the pre-emptive right over the 70% of the Cracow Gold Mine owned by Newcrest Mining Limited.

The shareholders of both companies have to vote on the merger.

Shareholders are encouraged to vote for the merger of assets.

Lion shareholders will meet on Tuesday 17 November 2009, at 10.00am, at Rendezvous Hotel Melbourne, 328 Flinders Street, Melbourne, Victoria. The Scheme Meeting follows straight after at 10.15am.

Shareholders that intend to vote by Proxy must lodge the General Meeting Proxy Form for the General Meeting before 10am on 15 November 2009.

Shareholders that intend to vote by Proxy must lodge the Scheme Meeting Proxy Form for the Scheme Meeting before 10.15am on 15 November 2009.

The market has already voted for the merger evidenced by the increases in the share prices of both Lion and Catalpa.

Since the announcement for the proposed merger of mining assets the share price of Catalpa has risen from $A0.09 to $A0.16, and the price of Lion has risen from $A1.02 to $A1.82.

Fat Prophets gained exposure to LST via the merger between Auselect and Lion Selection Group. Our effective initial entry price is $0.81. Our last review of this stock was in July (Fat Mining 181).

Since our last review in July, Lion Selection has been a standout performer. As evident on the daily chart, prices have lifted from the $1.30 region, to a high of $1.905 this month. This represents a gain of around 45% over 3 months.

Given the pace of the recent rally, we believe there is now an increased risk of a correction, or pause in the trend over the coming weeks. Nevertheless, any such weakness should be limited, ahead of additional gains.

From a broader perspective, the rally through 2009 has returned prices back towards all time highs. With little chart resistance above current levels, we are encouraged by the stocks longer term potential.



Let’s recap some key information about the Edna May Gold Project. The total resource exceeds 1.5m ounces which contains an open pit reserve of 817,000oz. First gold production is targeted for June 2010 at a cash cost of around $636/oz plus royalties. When ongoing capital expenditure is added to cash costs the total cost will exceed $A700/oz. Production will start at 2.8mtpa and ramp-up to 3.2mtpa.

The feasibility study for Edna May estimated a capital cost of around $A92m. This amount is covered by arranging debt facilities of $A106m, and equity of $A38.9m, to advance the project to production in June 2010. Gold production has been partially hedged with 352,317oz sold at a fixed flat gold price of $A1,557.50/oz. This looks like an excellent move with recent strength in the AUD eliminating the benefits of a higher USD gold price.

At current prices (USD/AUD = 0.924, gold = US$1,041/oz) the AUD gold price is $A1,127/oz. It is a good thing that Catalpa has put protection in place, and better still when its 38% above the current spot price.

The Cracow mine produces around 100,000oz of gold per year. Ore grade and thus cost is variable from one period to another. Total costs including ongoing capital expenditure are in the range of $A475/oz to $A730/oz. Cracow has total resources of 2.8mt grading 7.8g/t gold. Exploration potential is very high and the mine life should exceed 8 years.

A recent success was a new high grade gold zone found south of Kilkenny with one hole intersecting true width of 19.8m grading 6.0g/t. Drilling is continuing and it looks as though a new ore shoot is being defined. Cracow exploration is shown in the next figure.

We are no going to turn our attention to Lion’s results for the Fiscal Year ending 31 July 2009. The company ended the year in a strong position with $A19.1m in cash and no debt. Lion competed a return $A160m to shareholders after selling out of Platmin, Allegiance Mining, and most of its holding in Indophil Resources, at the top of the last cycle – this was excellent timing.

However, the company reported a loss of $A23m on its remaining holding in Iodophil Resources NL. Unfortunately two takeover offers for Indophil failed. The global financial crisis cost Lion dearly and the total write down on investments was $A40.5m. After tax the company lost $A41.5m. The cash flow from operating activities was stronger than last year, $A16.1m versus $A14.2m.

Lion increased its exposure to Catalpa Resources by investing another $A19m in that company. Not surprisingly, the focus of late has been the merger with Catalpa. Assuming that the merger will proceed, as it should do, Lion shareholders will receive a 10 cents per share cash distribution.

The company’s major investments include Exco Resources (ASX: EXS, 9.3%), Indophil Resources (ASX: IRN, 6.8%) and Havilah Resources (ASX: HAV, 18.6%). The share prices of these three companies are in recovery mode. Since the start of August 2009, the price of IRN has risen from $A0.54 to $A0.94.

The company owns 32% of the African Lion Fund. Unfortunately there was a decrease in value of $A27.4m because of the fall in value of the underlying investments. This fund suffered badly when Albidon was placed in administration.

At the end of the financial year Lion had investments in many other miners.

Lion has a small holding in unlisted XDM Resources. This company is exploring in the Solomon Islands looking for intrusive or epithermal gold deposits. Exploration is in its early stages and encouraging indications have been recorded at four prospects.

XDM is perhaps typical of the sort of investment that Lion seeks to make. That is a company with tremendous upside if the exploration efforts are successful. The risks are high with all explorers but so to are the rewards.

Going forward, following the de-merger we would expect that Lion will trade at a 10-15% discount to net asset value (NAV). This is a normal discount for an investment house. It is only on rare occasions that such a company trades at a premium to NAV.

The proposed merger of gold assets has already unlocked value. Luck plays an important part in exploration and the spread of assets held collectively by the companies that Lion has invested in offer excellent upside.

Accordingly, we accept the risk and we will continue to Hold Lion Selection in the Australian Mining and Resources Portfolio.


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