DY CN ($1.42) <Dynatec Corp. > by hao777

**Value-Investing-Forum** Tue May 30, 2006 10:35 am

DY CN ($1.42) <Dynatec Corp. > by hao777
4/12/2006 3:51:00 PM DY CN ($1.42) <Dynatec Corp. > by hao777 (From Value Investor Club)
Description:

What if I gave you a small-ish Canadian metals and mining company as an investment
idea, trading at under C$2…would you be interested? What if I pitched the same
company, but also told you that you could buy the company's stock for nearly the value of
the cash on their balance sheet and their holdings of a much bigger and more liquid
publicly-traded mining company, in effect getting all of their operating assets for
almost nothing? Would you continue reading
then?

Dynatec's (ticker DY CN) last close of C$1.42 is merely C$0.03 above the C$1.39 of
value on DY's balance sheet that is in cash and its stake in FNX Mining (ticker FNX
CN in Canada). Said another way, you can purchase DY today and only pay C$14mm for
a set of assets which includes: an ongoing Mining Services and Metallurgical
Technologies operating business (amongst the best in the industry, which I value
conservatively at approximately C$41mm); a West Virginia coal-bed methane asset that contains
an estimated 65Bcf (at C$1.00/Mcf, say C$65mm); and, DY's interest, today at 75%, in
the Ambatovy Nickel Project located in Madagascar - a mine which has the potential
to become one of the world's largest and lowest unit operating cost nickel and
cobalt mines in the world (the real swing factor in terms of upside, but probably not
worth less than zero).

[Note, all $ amounts will represent C$ unless otherwise stated, from this point
forward.]

History of Ambatovy

In February 2005, DY acquired the interest in the Ambatovy project held by
subsidiaries of Phelps Dodge Corporation. Later the same month, DY released the results of
the feasibility study, which confirmed the potential for annual production capacity
of 60,000 tonnes of nickel, 5,600 tonnes of cobalt and 186,000 tonnes of ammonium
sulphate, at expected cash operating costs for nickel, after credits, of US$0.67 per
pound for the first 10 years after two years of ramp up. Proven and probable
reserves, and additional low-grade material, are believed sufficient to support a project
life of approximately 27 years, with the potential existing to extend the project life
through additional drilling. At the time of the first feasibility study, capital
costs for the project were estimated at US$2.25bn. The feasibility study resulted in
an estimated IRR of 11.1% and NPV (10%) of US$168mm in the financial base case (ie
US$3.50/lb nickel, US$10/lb cobalt), and IRR of 16.4% and NPV (10%) of US$1,038mm in
the average metal prices case (spanning 1980-2003, US$4.07/lb nickel, US$18.65/lb
cobalt). It also stated that due to the low operating costs, the Project had a positive
rate of return at nickel prices above US$1.70/lb. Nickel prices are currently in
the US$6-7/lb range and should remain in that range for the next couple of years per
Street consensus.

Implats of South Africa (world's #2 platinum producer) signed an agreement with DY
in May 2005, under which they would split ownership and development costs; these
ownership percentages dropped to 37.5% each when Sumitomo, one of Japan's largest
integrated and investment business enterprises, joined the project with a 25% interest
in August 2005. At the time, Sumitomo also provided DY with a sub loan facility and a
project completion cross guarantee with respect to a substantial portion of DY's
financing guarantee related to project debt for which DY was to pay Sumitomo 10.2mm
common shares (payable annually in arrears in four equal installments commencing on
December 31 of the year in which the project debt financing closes). Subsequent to
this, Implats formally withdrew from the project, as announced December 1. The company
cited rising costs for mine development and the smelter expansion as the reason for
the withdrawal. Expansion to Madagascar and nickel was in line with Implats'
strategy of diversifying away from platinum and South Africa, but it appears that they
were not prepared for the kind of financial commitment that Ambatovy would entail, and
furthermore, nickel-focused projects of this size (ie not platinum with nickel
by-product) may have been outside of their comfort zone. As a result of Implats'
withdrawal, DY's ownership has increased to 75% and Implats paid DY US$12.1mm (in January).
In any event, Sumitomo and DY have announced that they remain committed to the
project and will release a revised feasibility study, targeted for completion by the end
of this month. They also continue to work towards adding a third partner and
"discussions with interested parties are progressing"; it was also reported that the Japan
Bank of International Cooperation (JBIC) has expressed "strong interest" in the
proposed project debt financing.

My view on Ambatovy: worst-case scenario is that DY/Sumitomo do not find a third
partner, get expensive financing, and still go ahead with Ambatovy into a nickel
market which weakens substantially and with cost over-runs. Best-case (not incl a sale
of the asset) is that they find a third partner - I assume that they announce a deal
with a Chinese metals producer, eg MinMetals or similar, in the next 3-6 months -
the project comes in below the estimated capital costs which should be released at end
of April, and nickel stays at the upper end or above the prices assumed in their
feasibility study. The end result will likely be somewhere in the middle, though I
think there is a decent likelihood they do find a partner (most likely Chinese) and
that their feasibility study, while accounting for higher capital costs, has a new base
case using C$4.00/lb nickel and still shows positive NPVs and respectable
IRRs.

Other Assets

While the value ascribed to Ambatovy is critical in understanding the upside in DY
(though I'm content to own the stock as long as I can get comfortable that the
value is greater than zero, which I do believe), the other assets contain enough value
to justify the stock price DY trades at today and still make this interesting. (Note,
for the values below I am using a FD share count of 312.8mm which excludes the
10.2mm to be paid to Sumitomo over 4 years in exchange for the cross guarantee…including
these shares changes the values by
~$0.02/share.)

Cash - Cash on hand + marketable securities as of December 31 is $152mm or
$0.48/DY share.

FNX - DY acquired the stake in exchange for its 25% interest in the Sudbury Basin
Joint Venture and 50% interest in Aurora Platinum Corp. The two companies also
entered into a mining services agreement through which DY will continue to perform mine
development and operating work on the SBJV properties until at least the end of 2007
(work will be cost-plus and DY will also receive additional fees totaling $15mm to
be paid in two installments on December 31 2006 and 2007). I will not go into FNX in
much detail here as you could choose whether or not to short out the relevant stake
in DY to create the stub, but for more information on the SBJV, check DY's
site:

http://www.dynatec.ca/op_sudBasin.html

The FNX stake is worth $282mm or $0.90/DY share. I'd also mention that FNX was
pitched by Oscar Shafer in January's Barron's Roundtable and he specifically mentioned
two of the properties that DY sold to FNX (Levack, part of SBJV and Aurora). Again,
for the sake of this posting I'll reserve any opinions on FNX as one could choose
whether to keep it through DY or sell it.

Mining Services and Metallurgical Technologies - DY reports these as two separate
divisions but I will describe them together. Mining Services' activities include
contract mining, mine shaft sinking, lateral mine development, mine construction, and
others. Through this segment, DY has worked on mines for companies such as Inco,
Franco Nevada, Barrick, and Goldcorp. In fact, the segment's largest contract is to
operate Goldcorp's Red Lake Mine, one of the world's largest and lowest-cost gold
properties. Metallurgical Technologies Division was once part of Sherritt International
and joined DY in 1997. As DY describes, "it is retained by mining and refining project
owners to assist in the evaluation, design, implementation and operation of
proprietary processes for the treatment of metal-bearing materials." By most accounts, this
group of engineers and the company's proprietary technologies are behind the
company's status as a recognized world leader, especially in hydrometallurgy. Clients
include companies such as Stillwater, Outokumpu, and WMC (check the company website for
a 13-page list of clients/projects). Combined, these two divisions generated EBIT in
2005 of $19mm; for a more appropriate and conservative run-rate, I have deducted
all the corporate and other costs from these two segments' income ($3.9mm) as well as
the receipt of a license fee of $6.1mm, leaving you with $9.0mm. At 4.5x LTM EBIT
(not EBITDA; D&A adds another $3.6mm), the value of this business can be estimated at
$41mm or $0.13/DY share.

CBM - DY has leased CBM rights on 42k acres in West Virginia. The pilot program
for this asset continues and management has guided to all pilot well units getting to
production in Q2. This asset will either start production and generate cash flow or
be sold. At $1.00/Mcf applied to the 65Bcf gas-in-place (3P), this is worth $65mm
or $0.21/DY share. One could debate with the value of $1.00/Mcf (or US$0.87) for 3P
reserves but given where other unconventional gas resource deals are pricing these
days, giving fuller credit to probables and possibles, I feel comfortable with this
estimate.

Issues? Of course there are issues, the critical ones being Implats' withdrawal
from DY (covered above), DY's share issuance in November, and the shareholder rights
plan the company adopted in December. Taking the rights plan first - it is clear that
management has noted its vulnerable position and trading value relative to
intrinsic value. The plan is a standard Canadian protection and allows the company / Board
additional time to consider an unsolicited bid ("Permitted Bids" must remain open for
60 days, for example). This is not likely to prevent a motivated bidder. As for the
share issuance, DY raised $118.8mm in November at a $1.35 share price, in order to
have the necessary equity requirements to fund Ambatovy. While it is disappointing
that they'd sell shares at that level, the company did need the capital to ensure
that a) they'd have the required capital and b) their partners, potential lenders and
host country would see their commitment to the project. This all considered, the
value and optionality in DY allow me to overlook many problems. Either the market will
value DY's assets more appropriately or a bidder will correct the situation. The
latter is especially plausible given the fact that the valuation is accounted for mostly
in cash and publicly-traded shares, meaning that a bidder could finance a takeover
in a straightforward manner.

Catalyst:

Feasibility study for Ambatovy later this month
New Ambatovy partner
Commercialization of CBM
Bid on the company?