Winspear Diamonds Inc -
Winspear working on a sparkling response to De Beers
Winspear Diamonds Inc WSP
Shares issued 51,634,088 2000-07-07 close $4.5
Monday Jul 10 2000
by Will Purcell
The clock is now ticking on the offer by De Beers Canada Holdings Ltd. to purchase all of the outstanding shares of Winspear Diamonds Inc., with the formal offer being made on July 6. Winspear now has until July 17 to formally respond to the offer, and the market anxiously awaits the company's response to the hostile takeover bid by De Beers. Winspear officials, led by president Randy Turner, provided a few clues as to what form that response might take, during a scripted conference call with analysts and shareholders, held last Wednesday afternoon.
A key element of Winspear's response will be the unveiling of an updated scoping study, to be prepared by the company and MRDI Canada Ltd. The scoping study is expected to provide an updated picture of what is known about the Snap Lake diamond deposit, and it is likely to present a far more optimistic picture than the conservative prefeasibility study that was completed earlier this year. The new scoping study will undoubtedly identify a greater global tonnage, and may even consider greater mining rates than the 3,000 tonnes per day contained in the current plan. Increases in these figures would serve to enhance Winspear's share of the project's net present value, which most analysts have calculated to be in the $6 to $7 range, on a per-share basis, based on parameters contained in the prefeasibility report.
The key ingredient to an increased net present value for Winspear is an increased rate of production, and the key to increasing production is increasing the available kimberlite tonnage. Adding to the global tonnage has been an easy matter for Winspear in recent years, and the current figure seems certain to be revised, as a result of recent drilling programs. In mid-May, Winspear announced that 24 drill holes had been completed, several in the region included in the mine plan, but new ground was also hit on the north shore, on the dikes near the southeast arm of Snap Lake and under the southeastern part of the lake itself. On Wednesday, Winspear vice-president, John McConnell, revealed that 35 holes have now been completed, and most of the 11 additional holes are likely land-based, due to the lateness of the season.
Most of the increased global tonnage will come from the north shore of Snap Lake, where the winter and spring drilling program has identified an additional area of about 1.2 square kilometres with continuous kimberlite intersections. Although the drilling has been widely spaced, much of this region could be incorporated into the global tonnage estimates. So too could a portion of the southeast dike system, although this is less likely at this time.
A year ago, MRDI calculated the total tonnage at 21.9 million tonnes, with about 18 million tonnes of kimberlite present in portions of the dike with a thickness greater than two metres. It seems quite likely that these figures could grow closer to 30 million tonnes, with about 21 million tonnes of kimberlite in the thicker portions. Even these figures could be understated, should portions of the southeast dikes also be included, or if some of the most recent 11 drill holes have expanded the known dimensions of the dikes further to the north and east. If future infill drilling indeed proves the dikes are continuous and of sufficient thickness, the total tonnage may be close to 40 million tonnes, with the deposit still open to the north, east, and southeast.
It is highly unlikely that the updated scoping study will incorporate anything close to that inflated number, at least at this stage, although it will undoubtedly point out that a substantial amount of kimberlite remains to be outlined by additional drilling. The benefit of an increase in the global tonnage could be to extend the proposed mine life, but of far more importance, a greater amount of ore would sustain an increased production rate over the life of the mine.
The benefit of an increased rate of production is significant and can even outweigh falling ore value and rising operating costs, as evidenced by the results of earlier studies of the Snap Lake project. Late in 1998, Winspear released the original scoping study, based on a resource of 3.5 million tonnes, which proposed a mining rate of 1,000 tonnes per day for 10 years. That study assumed an ore value of $380 per tonne, and operating costs of $87 per tonne, arriving at an after-tax average cash flow of $57-million per year. That plan carried a net present value at the time of about $3.50 per Winspear share, assuming a discount rate of 5-per-cent, a figure used by most analysts, and using the number of shares now outstanding on a fully diluted basis.
That study was updated a year later, after bulk sample testing and an aggressive drill program had been completed. Based on a resource of 8.2 million tonnes, the plan called for the rate of production to escalate to 3,000 tonnes per day a few years after startup. Although the ore value was now reduced to just $251 per tonne, with operating costs of $72 per tonne, the after-tax average cash flow had escalated to $74-million per year, although Winspear's net present value remained fairly constant, near the $3.50 mark.
The prefeasibility report, released this spring, incorporated the results of additional drilling, updated diamond valuations and engineering work. The report increased the minable resource to 12.6 million tonnes, sufficient to sustain a mining rate of 3,000 tonnes per day for 12 years. Based on the increase in diamond valuations, the ore value used was probably close to $275, while a more formal assessment of the proposed mining method resulted in an operating cost increase, to $94 per tonne. Nevertheless, the increased production resulted in the average after-tax cash flow rising to $102-million annually, and the increased resource extended the mine life to 12 years. As a result, the net present value increased to just over $6 per share.
The net present value of Snap Lake would receive an impressive boost should the rate of production be increased substantially, say to 5,000 tonnes per day. Much of the required ore is at greater depth than what was included in the prefeasibility report, and operating costs are likely to be somewhat higher, although this increase would be at least partially offset by efficiencies gained from the higher production rate. Capital costs would also escalate, but again, doubling the rate of production is unlikely to result in a doubling of the capital costs. A very rough calculation would suggest that increasing the production rate to 5,000 tonnes per day would result in an average annual after-tax cash flow of about $175-million, increasing the net present value of Winspear's share of the project to just under $11 per share.
A more realistic approach might be to proceed with the plan proposed in the prefeasibility study, but escalating production to 5,000 tonnes per day a few years after production commences, paying for the capital cost out of early cash flows. Such a plan would require about 19 million tonnes of ore to sustain a mine life of 12 years, and would incur an initial capital cost of about $300-million, with another $200-million likely required in the first two years after production commences, paid for from cash flows from operations. Such a plan would result in a net present value of just over $10 per share, again based on the 5-per-cent discount rate.
A more conservative approach would be to increase the rate of production by a more modest amount, perhaps to 4,000 tonnes per day in the third year of mining. Such a plan would require just over 15 million tonnes of kimberlite for a 12-year mine life, and might be expected to increase the project's net present value by about one-third, to just over $8 per share. In more routine circumstances, this might be the most likely approach, but Winspear seems likely to choose the most aggressive route available in order to enhance the public's perception of the value contained at Snap Lake.
Whatever the plan, after-tax cash flows to Winspear from a Snap Lake mine are likely to be impressive. The prefeasibility report projects an after-tax cash flow to Winspear of just under $70-million annually, and that figure could approach $120-million if the planned production rate were increased to 5,000 tonnes per day. The current plan projects cash flows in excess of $1 per fully diluted share, and that number would grow to just under $2 per share at a production rate of 5,000 tonnes per day. The updated scoping study is likely to arrive at a cash flow per share of about $1.50, and possibly higher, which might give current shareholders something extra to mull over, as they ponder the De Beers offer.
Mr. McConnell also said that an "aggressive drill program of step-out holes" would be commenced to further the company's value recognition program. These holes are likely to be completed in areas to the northeast, east and southeast of the current drill limits, but the results from this work are not likely to be available in time to be incorporated in any updated reports prior to the expiry of the offer, unless the affair becomes mired in sufficient wrangling to result in delays.
Winspear also appears to be actively courting potential white knights that might be lurking on the sidelines. The company announced last week that it was negotiating confidentiality agreements with an unspecified number of "interested third parties," and Winspear has set up a data room so that potential suitors can perform their due diligence, once the required agreements are in place. The company may be seeking a competing bid, but it is also possible that Winspear would consider taking on a new partner, if the terms were right.
Although time appears to be of the essence with the bid set to expire on July 28, the process may well wind up consuming a much longer period of time, thanks to the shareholder rights plan, which was approved by shareholders in the fall of 1997. The rights plan would create substantial dilution, and De Beers has effectively imposed the withdrawal of the plan as one of a number of conditions to its bid. Winspear is not likely to acquiesce to this demand, leaving De Beers to commence legal action to have the rights plan revoked. Presumably, De Beers would argue that their bid offers shareholders fair value, and Winspear's directors, by enforcing the rights plan, would be breaching their fiduciary duties to their shareholders. Such an argument might well succeed, but it would probably take a fair amount of time progressing through the court system.
With the deadline for the mailing of Winspear's circular set for next Monday, it seems quite possible that the updated scoping study will be released late this week, and certainly no later than Monday. Whatever its contents, it seems likely that Winspear management will attempt to incorporate as much as possible into the plan in order to maximize the project's current value, as there may be no tomorrow for the current management, whose primary task will be to convince shareholders that two birds in the bush are worth more than one in the hand. That could be a formidable task, with the stock now at a 52-week high and a recent history of trading at a fraction of the calculated net present value.
Winspear's shares had a good week, rising above the $4.25 offer price last Tuesday, and closing on Friday at $4.50, up 29 cents on the week, as a number of analysts have declared the De Beers offer too low. The surge was maintained through the week, perhaps due to an increasing expectation that there may be a competing bid, fuelled by Winspear's announcement that it was talking to interested third parties.
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