A Speculator’s Digest reader recently asked me about Cornerstone Capital. I don’t own the stock, but it was once a winning trade in my past work, and the story makes for an interesting quick case study. For more in-depth guidance on what I’m actually buying, please subscribe to the Independent Speculator.
(CGP.V, C$0.26, 632.5M shares, C$159M estimated enterprise value)
Cornerstone was for a long time a fairly typical prospect generator, with multiple projects in Ecuador. A dozen years ago, when the world-class Fruta del Norte (FDN) gold mega-discovery was being made, several Ecuador plays had their day in the sun. Then newly elected president Rafael Correa slapped a nationwide moratorium on all mining and exploration in the country, obliterating market valuations and sending investors fleeing.
It didn’t take long for Correa to realize his mistake, but investors were once bitten, twice shy. Now, more than a decade later, there are high-profile mining projects (including FDN) advancing, as well as major mining companies investing in Ecuador again, but many investors remain wary.
At some point during this mini Dark Age for Ecuador, Cornerstone joint-ventured its Cascabel project to dual-listed SolGold Plc. (SOLG.L, SOLG.TO). Solid exploration work, all paid for by SolGold, resulted in the discovery of a huge copper-gold porphyry, now called Alpala. SolGold pays the bills and so gets 85% of the project, but Cornerstone owns about 10% of SolGold, so it retains an effective 23% or so ownership of Cascabel.
The current billion-tonne resource model includes:
The interesting thing about this story is that both partners struggled to get any sustained respect from Mr. Market when the Cascabel discovery was made, even after initial drilling began giving investors an idea of the large size of the deposit. The stocks did well, however, when copper rebounded sharply in early 2017. Cornerstone shares, which traded as low as C$0.02 in early 2016, hit C$0.51 by May of 2017—a 24-fold increase in share price.
The stock has struggled since then, driven by lower copper prices and shareholder dilution driven by every exploration company’s constant need for money. Even a proposed spin-out of Cornerstone’s non-Cascabel assets into a new company didn’t stop the slide all the way back down to C$0.14 last month. A recent upturn in copper prices, possibly helped by cancellation of the spin-out, has driven shares back up again, though still a good 50% below recent highs.
Key Analytical Points
+ Cascabel is big. Billion-tonne deposits at good grades like this are rare. For deposits of this scale, Cascabel is actually relatively high grade. There are smaller open-pit deposits that are higher grade, of course, and underground deposits that are much higher grade, but few like Cascabel.
– Cascabel is deep. Unfortunately, Cascabel is under a mountain. Many of the kilometer-long intercepts of potentially economic mineralization start a good 700 meters below surface. A lot of the best grades are over a kilometer below surface. It would take large scale bulk underground mining methods (block-cave) and a 5-kilometer long access tunnel to mine Alpala. That would likely cost at least US$1 billion and require the know-how of a larger company with experience with this sort of mining. Even with that, it’s not certain that the deposit is worth mining at current copper and gold prices. Efforts to find more mineralization closer to surface have turned up some interesting results, but the main asset here remains the deep core of Alpala.
+ Other People’s Money. Management has done a great job of getting partners to pay for most of the work over two decades. This has been a huge help, especially during the worst of the recent downturn, when it was on SolGold to keep raising and spending money to advance Cascabel. SolGold remains on the hook for the project’s bills, by the way, until they turn in a bankable feasibility study.
– Cornerstone has diluted shareholders anyway. The years have taken their toll, and the company now has such a bloated share structure, it looks like an Australian company, with almost 750 million shares, fully diluted. (Even new Aussie companies often have hundreds of millions of shares issued and outstanding.) Management proposed 10-1 and 100-1 rollback components as part of their plan to spin non-Alpala assets out into a new company. That was likely necessary, but I’m sure it alarmed many shareholders. The bloat now blunts the impact of value added on the ground per share.
+ Other projects have discovery potential. Some of the non-Alpala projects are quite interesting, but they get no love in the shadow of Alpala. None are “bird in the hand” type projects, with known if historical resources, but free shares in a spin-out would have been nice. Cornerstone raised over C$8 million earlier this year. If it gets lucky spending that on some of these other projects, it would help the company a lot. Hard to say what the odds of this are, however.
– Ecuador remains a question mark. Ecuador does seem to have come to its senses. Lundin Gold (LUG.TO) managed to negotiate a deal that, at least in theory allows them to profit from building FDN. Legendary mining mogul Ross Beaty is investing in Ecuador as well, recently attracting major miner Anglo American to partner with his Luminex Resources (LR.V). That said, there’s plenty of well-funded opposition to mining in the country. FDM is likely to be the true test of the government’s currently pro-mining stance. We won’t really know how that plays out until 2020.
History: Back in my Casey Research days, I recommended shares in Cornerstone twice. The first time was based on their generative work in Ecuador, and if I recall correctly, we exited at a loss when the Correa fiasco hit all Ecuador mining stocks. The second time was based on the Alpala discovery, which I could see becoming a huge deposit. I was right about that, but disappointed that the better hits were always deeper down. Between that and Cornerstone only having a 15% stake in the project, I didn’t expect the stock to take off the way it did last year. I was happy to get out with a modest win earlier in the game.
I have a great deal of respect for key members of Cornerstone’s management, whom I’ve known for years. The geological work that led to the Alpala discovery was excellent. I’d love to see these guys deliver a big win for shareholders who’ve been doggedly holding on.
And I’m not really worried about Ecuador these days—I do think the new government understands that the country needs mining.
That said, until I see good economic numbers on Alpala or another discovery taking shape (as when I got back onboard early in the exploration of Alpala), I’m content to watch from the sidelines.
My current take: It’s an interesting speculation, but I’m not a buyer.
As always, please remember that I am not making any recommendations in this service. I’m simply saying what I think.
Wednesday, September 26, 7:19pm, EDT, 2018