Geologix Explorations: Another Mexican Monster Miner?

Excerpts from Trey Wasser's initial report on Geologix Explorations (GXEFX.PK), written on September 4, 2008:

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Geologix Explorations [GIX] is exploring and developing large precious metal deposits in the Americas. Their current flagship project is the San Agustin deposit in Durango State, Mexico. GIX is also active in Peru where they are partnered with Newmont Mining and have several additional optioned properties. They have an excellent business plan that focuses a large percentage of their human and financial resources on their flagship project.

GIX optioned the San Agustin property from Silver Standard (SSRI) in August 2006 and drilled 15,000 meters under the purchase agreement. In June 2008, they released their first resource report showing over 5MM indicated and inferred gold equivalent ounces. Their Phase III drill program is currently over 14,000 meters and they continue to expand and improve the deposit. While advancing the deposit, the Company is addressing all the infrastructure issues necessary for project development. San Agustin is shaping up to be a large poly-metallic deposit similar to Goldcorp’s (GG) Penasquito and Silver Standard’s Pitarrilla project...

The Finances

Geologix currently has about $12MM in cash and a burn rate of approximately $1MM/month. The Company raised $18MM in February of this year. They issued a total of 8,000,000 units at a price of $2.25 per unit. Each Unit consisted of one common share and one-quarter of one share $3.20 purchase warrant.

The Company has re-evaluated all their properties to better focus their human and financial resources. In North America, they are joint venturing or dropping their Nevada properties while adding more properties in Mexico. The Peruvian assets have been structured to use other people’s money. The Newmont (NEM) Alliance is a 50/50 cost arrangement and GIX remains the operator. Amera Resources [AMV.V] is paying 100% of the exploration expense to earn 51% in three Peruvian projects. Amera is the operator and will spend $3.7MM over five years.

The greatest financial challenge facing the Company, at this time, is their purchase agreement with Silver Standard. The agreement is a fairly complicated formula based on the resource derived from the Phase II drill results and metal prices. We don’t believe the formula is worth focusing on in this report. The resource has essentially been defined and will be very close to the June report. The cost to Geologix will be somewhere between $50MM to $60MM and the payment will be due in the first quarter of 2009. At this time, there is little or no flexibility with this payment. It is an “all or none” agreement and the Company risks losing the entire property if the payment is not made.

The options available to the Company at this time appear to be:

1. Finance the entire payment internally. This would require a very dilutive equity financing in the current market environment. GIX currently has 51MM shares outstanding. At current prices, this would likely result in over 100% dilution to current shareholders.

2. Renegotiate with Silver Standard and make them a partner. Normally this would seem like a very viable alternative and would fit SSRI’s business model. But SSRI is currently developing their large Pirquitas Mine [PDF file] in Argentina. They also have two feasibility staged projects, Pitarrillo in Durango State Mexico and San Luis in Peru. They may need the cash from GIX more than they need an interest in another development stage project that is only 30% silver.

3. Negotiate an extension with Silver Standard. This is our favorite option. The Company has the cash to drill for another 12 months and more fully define the deposit. They could develop a more complete scoping study and maximize shareholder value in a partnership transaction. This could be a lucrative option for both companies if SSRI can be enticed to wait for their cash payment.

4. Sell a base metal production interest or “silver stream”. This would seem unlikely without a full feasibility study and project financing in place. But, GIX’s strong management team and Board may be able to secure a creative financing to a third party. However, while selling production forward might solve the problem of the SSRI payment, it could also impact the final economics of mine feasibility.

5. Find a major company willing to partner on the purchase payment and the development of San Agustin. We feel this is the most likely outcome and the Company is currently entertaining several potential partners.

Concerns

We are obviously most concerned with the status of the purchase agreement with Silver Standard. The drill program, dictated by the agreement, has stymied the overall development of the deposit. While the Company has been very successful, they have yet to truly define the boundaries, depth and grade of the mineralization. The results of the current drill program will go a long way towards upgrading the resource. But, it will take another 12 months of drilling to more fully define the deposit at San Agustin and the potential for satellite deposits that could significantly enhance the economics of mine development. We believe that the cap-ex requirements for a 50,000TPD mine will easily exceed $500MM. Even if grades improve in the resource update, it might take a 300-400MM ton deposit to insure the project is economical. The current scoping study will be somewhat premature and will be based on certain assumptions made by the Company. Therefore, it will only be used internally to guide the Board in their purchase decision.

We are also going to watch the progress being made with the long term surface and water rights. As we discussed in our recent report on Nayarit Gold [NYG.V] [PDF file], we are in the “sooner rather than later” camp on both these issues. Hopefully, GIX can secure firm agreements to help the Board make a purchase decision. One only needs to look at the problems facing Minefinders [MFN.ASE] or Oremex [ORM.V] to see why we like to see the long term agreements in place as soon as a viable resource has been identified. Water rights are needed to drill wells in Mexico and they are getting harder to secure, especially for a large combined milling and heap leach operation.

Conclusions

We are very impressed with the management of Geologix. They are very focused on the development of San Agustin and are aggressively perusing their options for financing the purchase of the property. They have a good relationship with SSRI and the lines of communication are open.

We were also impressed with the deposit itself. It is becoming apparent that the gold equivalent mineralization should easily exceed 10MM ounces in the current resource update. While the drilling is not complete, the “blue sky” is very evident. A 300-400MM ton deposit is clearly possible. The economics compare favorably with Goldcorp’s Penasquito Mine. Mexico is a politically stable and mining friendly country where many companies are looking to expand their operations. The majority of the deposit is gold and silver. The grade is improving at depth and the deposit appears to be sufficient to drive a positive feasibility study for mine development. We believe management will be successful in attracting the attention of a major mining company or arranging an alternative with SSRI.

The current valuation of the Company could provide a very attractive entry point for a potential partner. If we use a minimum price of $2.25 per share from the most recent (and highest) equity offering and a $60MM SSRI payout, the entry point for a partner would be about $175MM. A “carried interest” or other partnership could lower that cost. We note that Glamis paid $1.2 billion for Western Silver, in 2006, when the Penasquito deposit was about 400MM tons and metals prices were significantly lower.

There is little doubt that a project of this size will require GIX to partner on its development. We believe that a 12 month extension from Silver Standard would allow the Company time to truly define the economics of San Agustin and significantly enhance shareholder value in any such partnership.

Their alliance with Newmont Mining in Peru is gaining traction focusing on grassroots exploration. They have identified high grade gold/silver mineralization at their Liscay project where drilling will begin this fall.

Hopefully any deal involving San Agustin will leave Geologix Explorations intact. This is a group of proven prospectors searching for large mineral deposits in mining friendly countries. They are employing a rifle approach to project development. They identify a flagship project and commit the majority of their resources to its development. They are a conservative bunch that tends to under-promise and over-deliver. This is exactly the kind of expertise and focus we are looking for in junior exploration companies in the current market environment.