ocean equities broker report on fmg deal

http://iohpublic.powercreations.com.au/images/5-120214_oel_ioh___deal_with_fmg_for_iron_valley__update.pdf

Highlights:

1) Will FMG exercise

Reiterate again their expectation that FMG will exercise the option. In terms of the 13month exclusivity period, " The 13 month exclusivity period to obtain a licence to mine the Iron Valley and the adjacent Welli Wolli tenements coincides with when we expect the project to be potentially production ready with all statutory approvals in place and feasibility studies completed.”

2) Near term mining potential and potential contractual safeguards against warehousing.

“In our view Iron Valley provides FMG a potentially attractive near term, low cost trucking
operation exploiting outcropping high grade mineralisation which is expected to provide
excellent blending material with existing operations at Cloudbreak and Christmas Creek.”

Indeed, Ocean Equities point out that FMG have stated that work is progressing on an “early ore project based on trucking up to 5Mtpa of direct ship Nyidinghu material to utilise available port capacity”. IV would the logical option here to support this.

“We believe the commercial logic for FMG developing Iron Valley before Nyidinghu relates to: permitting; reducing the lead time to, and improving the ability to ramp up, initial production; and, reducing upfront capex with initial mining at Iron Valley effectively being
the pre-strip for Nyidinghu (which lies ~40m undercover at the tenement border) and being above the water table. We would expect that the agreement between IOH and FMG
in effect reflects a ‘take-or-pay’ structure, with minimum production levels and a fixed starting date, which safeguards IOH shareholders to ensure that the deposit is not ‘warehoused’. However, given FMG’s publically stated plans to integrate Nyidinghu with the Chichester Hub and potentially support a 40Mtpa operation we expect the Central and Northern zones of Iron Valley to be relatively quickly, and fully, depleted”

3) Valuing the deal

“Assuming a realised price of A$100/t and 3.5% royalty, would generate total undiscounted cash flow to IOH of A$675m or over A$50m pa in steady state production (refer to Exhibits 1 & 5). We estimate that the Net Present Value (‘NPV’) under this scenario is worth ~A$264m (or A$1.59/sh) assuming production commences in 2017 with a 10% discount rate and believe there is upside risk to the expected commencement date of operations (we believe FMG is currently investigating a near term 5Mtpa trucking operation) and iron ore price assumption.

4)Bottom line

“As the summary valuation table in Exhibit 2 illustrates, IOH’s current capitalisation ascribes little or no value
for the announced deal with FMG or its remaining assets in the Western Pilbara (total resource 573Mt),
including Bungaroo South that has a 241.6Mt resource. The Company has cash reserves of A$130m2 (or
A$0.79/sh) and an implied EV of only A$124m. We estimate the deal announced with FMG to have an
NPV10% of ~A$264m (or A$1.59/sh) with risk to the upside from our conservative assumptions.”

What we’ve been saying on these forums- at these prices downside risk is minimal, market cant ignore this forever.