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The Darch Factor

Building towards a Pediment-like buy-out

· investors,gold,canada

Going forward, InProved via our blog, Afar Insights, will be including background stories regarding some of our clients, and why we consider them compelling opportunities.

The first in the series is Sonoro Metals Corp, a TSX.V listed junior gold company which is developing the Cerro Caliche in Mexico, a gold deposit in a prolific and intensely mined gold trend. Our relationship as advisor, is to assist Sonoro to structure a gold-backed bond which is to be repaid from pilot gold production that is planned for 2020. Sonoro’s technical team’s last company was Pediment Gold Corp which appreciated some 800% in the space of two years before it was acquired by Argonaut Gold. They are just getting started with Sonoro and we think readers would do well to keep an eye on it.

Sonoro Metals

Heap-leach-pioneer Chester Millar is not new to seasoned gold stock investors. Much of the original money to finance Glamis Gold came from overseas, so we know it well. Glamis, for more recent mining company investors, was a late ‘70s $0.15 per share ($600,000 market capitalisation) penny stock when Mr. Millar took the reins, which ultimately became his greatest triumph. Glamis experienced a 14,000 fold market-cap growth explosion before it was ultimately bought for $8.6 billion (by Goldcorp) in 2006.

Critically, Mr. Millar eschewed the high-risk game of exploration. Instead Glamis Gold’s success was borne of a more plodding strategy. It started small, produced cash flow and grew by acquiring and developing low-grade deposits that often surround former lode mines. Glamis Gold’s first mine was the Picacho. Its original reserve base totalled a mere 360,000 ounces and it produced roughly 2,000 ounces per month for two decades. The Picacho’s slow-motion production rate was intentional, as it was meant to be the cash cow which would fund Glamis’s acquisition of additional deposits as they were found, acquired and developed. The mine was profitable and low cost and it left enough money in the bank to set Glamis on the path to become a multi-billion dollar company.

Enter Sonoro Metals Corp.

Mr. Millar’s road is one that we rarely see travelled. And in the coming months and years we will chronicle the progress of a company that appears to be taking the same path. The company, Sonoro Metals Corp. has acquired two late 19th-century mining camps. The first is called Cerro Caliche and the second, the San Marcial. Each, the company says, has the potential to develop low grade million ounce gold deposits in their midst.

Gold production planned to fund development

Like Glamis Gold’s earliest days, they are planning a small pilot gold mining operation at an already defined area of the Caliche deposit. The pilot plant’s size is meant to produce enough gold to fund both projects’ and future developments. A gold loan, which is to be paid back from production, is currently being structured with InProved’s assistance. Production could begin in less than a year.

Central to Sonoro’s strategy is to first create a revenue stream. “We want to avoid diluting our shareholders which will happen if we keep having to finance the development our gold deposits. Therefore our focus is to go into production, so that we can fund exploration and development from cash flow” says Sonoro’s Chairman John Darch.

From our extensive research into the project we think bootstrapping a pilot operation should be near child’s play for Sonoro’s, as the company has the expertise already in place. Jorge Diaz, Sonoro’s operations manager, has worked as an engineer on the design and development of mines in Mexico for the past 25 years, including the multimillion ounce Mulatos Mine (owned by Chester Millar’s Alamos Gold) and Argonaut Gold’s La Colorada.

The Pediment–Colorada connection

But that is not Sonoro’s only connection to La Colorada. In 2005 Sonoro’s current VP of Exploration, Geologist Mel Herdrick, held the same position at a company called Pediment Gold. On his advice Pediment acquired La Colorada which at the time consisted principally of a former high grade gold mine. It was a well-known though defunct mine that had produced, since it was staked by Jesuit missionaries in 1740, right up until the start of the Mexican Revolution in 1914. Mel's plan was to develop a low-grade gold resource which he knew surrounded the mine. Mel ultimately outlined a 1.2 million ounce gold resource there. It was the La Colorada resource which prompted Argonaut Gold to acquire Pediment in a C$137 million plan of arrangement. Argonaut now owns and produces gold at the La Colorada, while Mel now hopes to develop million-ounce gold deposits at Sonoro’s Cerro Caliche and San Marcial.

Capital calculations

Pediment is a relevant model for Sonoro. Knowing this dollars for dollars comparison is a worthwhile exercise if we are to calculate just how much shareholder value Sonoro can grow. Using its recent $0.18 share price, Sonoro has a fully diluted market value of CAD $6 million. With its million ounce deposit in hand, Pediment’s value grew to $137 million – 22 times larger – so Sonoro’s potential is considerable. But how likely is a mid-tier willing to bid for the company?

There is a growing need by the area’s mid-tier miners for deposits of the size that we expect Sonoro to develop. Argonaut is one example. Cash-rich Agnico Eagle is another. Baring another discovery, Agnico Eagle will run out of ore at two of its Sonora State Mines within the next 5 years: La India by 2023 and Pinos Altus in 2024. Thus it is a risk, and a happy one, that Sonoro’s long-term plans might be cut short by a takeover bid by one of the area’s mid-tier gold miners as they move to replace their depleting gold reserves.

The Darch Factor

But Sonoro seems unlikely to stop with at Cerro Caliche. Its new Chairman, John Darch, has a multi-decade track record of finding and successfully developing big assets – a record he says he intends to continue. Take Crew Gold (formally Crew Development), Darch founded it in 1997 and similar to Sonoro, his strategy was to generate cash flow as quickly as practical. This was achieved by buying a 51% interest in a South African miner called Metorex. Crew subsequently joined a consortium to take private a high grade Zambian copper mine called the Chibuluma – the first privatisation in the country’s history. Crew’s portfolio soon grew to also include an operating diamond mine in South Africa and Greenland’s first gold mine.

In 1999, Crew merged with a then supposedly-friendly Norway-based Mindex but in reality, it marked the beginning of a creeping takeover. As Darch describes it, by the time he stepped down as Chairman in 2002.

Crew was already massively successful. We had projects on which the sun never set – they spanned the globe, while our African and Greenland assets continued to produce cash flow. - John Darch

Crew’s success, however did not stop the Norwegians from wanting to take control and when they did, one of their first acts was to sell Darch’s prize Metorex. Under Darch’s direction Crew paid just over US $25 million for its Metorex stake, and the new management sold it for about double the amount – a fraction of what Darch thought it was worth. He was ultimately proven correct when China’s Jinchuan Group acquired 100% of Metorex for US $1.2 billion.

Another Darch start-up, is closer to home and one of our skill sets given InProved’s role in the construction of the giant Al Jalamid Phosphate concentrate processing plant and Ras Al Khair chemical and fertilizer complex. John's Asia Pacific Resources, which John was one of the founders in 1992, was discovered and developed to pre-feasibility, and that was one of the world’s largest un-mined high-grade potash deposits. Asia Pacific was trading at C$0.15 when he started and as the deposit was outlined, its shares traded as high as C$11.00. The deposit is in Udon Thani in North Eastern Thailand and it is now owned by Italian-Thai Development Corporation, one of Thailand’s largest companies.

Between Crew and Asia Pacific, seeing Darch in action tells us there is a good probability that Sonoro’s growth may yet be fast-tracked by a surprise high-impact acquisition. If it isn’t, then there remains the reality that Sonoro should be an attractive takeover target for its gold-producing neighbours. And for these reasons, plus its approaching phase 1 gold production, InProved remains enthusiastic supporters.

Darch, Doi Chaang and the Akha

In our experience, the ethics and underlying motivation of a person plays a large role in his or her ultimate success. How John Darch chooses to spend a temporary period of retirement speaks volumes as to why we are happy to grow our relationship with him. - Neil Maedel

Darch’s Asia Pacific – Thai experience, was not limited to developing and selling a giant potash deposit. He had promised his wife Louise, that he would retire in 2006 – not that any one who knew him could believe it. Darch’s ‘retirement’ really amounted to a change in industries for the serial entrepreneur. This time however it was more of a ‘feel good enterprise’ with a massively positive social impact.

In Thailand, the Akha Hill tribes were originally refugees. Most migrated from Burma to escape being caught in the crossfire as various factions fought each other, following a military coupe in 1962. They lived in the dense forests of Northern Thailand - near Burma’s border. Opium was a key cash crop for the Akha, not only because it had a comparatively high value, but also because it was easy to store and transport.

The end of the Vietnam War and later the collapse of the Soviet Union meant that Thailand’s strategic importance had diminished. One consequence was that opium production by forces friendly to the West was no longer tolerated. This meant increasing efforts to eradicate opium production. For the Akha the loss of their principle source of income also coincided with the razing of the area’s forests by Thai Loggers. Isolated and surrounded by a denuded landscape, while at the mercy of unscrupulous traders, the Akha remained destitute despite numerous attempts to grow and sell substitute crops.

The Akha in Doi Chaang were no different. Wicha Promyong’s latest idea was to grow coffee in Doi Chaang. It was a business that, while promising, he had been struggling with since 2001. The coffee he produced was excellent but the scale was tiny and the cost of growing and then selling within Thailand often meant that almost no money was left over to reinvest. They needed capital or better prices. It was 2006 and Darch’s potash venture had just been sold to Italian-Thai. It was following the sale that while he was in Bangkok a mutual friend introduced him to Wicha.

After meeting Wicha and discovering how good the Doi Chaang coffee was, Darch’s idea was to create a premium brand and market it globally, beginning first in Canada. To do this he formed a separate Canadian company which would buy the beans from the Akha and he gave the Doi Chaang Akha 50% of its shares. He immediately began by paying the cooperative a premium that worked out to triple what they had previously been getting paid. It was also more than double the ‘Fair Trade’ stipulated price and Darch differentiated it by labelling their coffee as ‘Beyond Fair Trade’.

It was critical to ensure the growers made enough money to develop the business and reinvest in the community. - John Darch

It was also expensive, forcing him to plow millions of dollars into the Canadian business, until the brand caught on, and the company finally broke even. In the meantime, the effect on the Akha was transformational.

In 2006, only 200 acres of coffee was being grown, a tiny amount compared to the 6,000 plus acres of coffee currently being produced today. The community today has a school, medical clinic and coffee growing academy. Through Darch’s backing and over a decade of work, Doi Chaang has became a prosperous community while its coffee continues to be award-winning and recognised globally. Darch says his, and the company’s core goals, was always to eliminate the cycle of poverty, promote education, health care, equality and create a sustainable prosperity. With the Akha self sufficient and prosperous, his job was complete. Out of his so called-retirement, Darch’s next focus is to add Sonoro Metals to his stable of winners.

Our coverage begins

So the story begins and InProved looks forward to relaying the news of Sonoro’s progress. With Darch at the helm we have a moral visionary with all the drive, acumen and creativity to make Sonoro a success. He has carefully assembled a team of experts to execute, and two key assets are already being advanced. Combine this with Sonoro’s plan to produce cash flow – funded by a non-dilutive gold loan, and the risks, especially regarding share dilution and future funding needs, are set to be mitigated. Then there is the potential for capital appreciation where at minimum, a Pediment-like buy-out appears more than reasonable. Sonoro Metals trades on Canada’s TSX.V under the symbol SMO.

Disclaimer: The information contained on this email is for marketing purposes only. Nothing contained in this email is intended to be, nor shall it be construed as, investment advice by InProved or any of its affiliates, nor is it to be relied upon in making any investment or other decision. Neither the information nor any opinion expressed on this email constitutes and offer to buy or sell any security or instrument or participate in any particular trading strategy. The information on the site is not a complete description of the securities, markets or developments discussed. Prior to making any investment decision, you are advised to consult with your broker, investment advisor or other appropriate tax or financial professional to determine the suitability of any investment. Opinions and estimates expressed on this site constitute InProved judgment as of the date appearing on the opinion or estimate and are subject to change without notice. This information may not reflect events occurring after the date or time of publication. InProved is not obligated to continue to offer information or opinions regarding any security, instrument or service.

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