Description

Orvana Minerals operates a Bolivian copper/gold mine and is developing a gold/copper mine in Spain. The current share price does not reflect very favorable developments at each project.

• Orvana approved an extension of its Bolivian mine last May based on an assumed gold price of $650, copper price of $2.00 and silver price of $10. Current prices (as of 12/4) are $1161, $3.17, and $18.47.

   

• Orvana approved an extension of its Bolivian mine that would not recover copper from oxide ore. Since then Orvana has designed a circuit for oxide copper recovery (using a simple and well-known process). This will add 80mm lbs of copper output (potentially $252mm of revenues) with the only significant additional operating expense being the cost of sulphuric acid.

   

• Orvana acquired Kinbauri Gold in August for C$49mm in cash. Kinbauri's Spanish gold mine will produce approximately 900,000 ounces of gold and 81 million pounds of copper over 9 years. The increase in metal prices since Orvana launched its bid represents an increase of $254mm in life of mine revenues while the appreciation of the euro implies $20mm higher expenses.

BASIC FACTS

Symbol	TSE:ORV OTCBB:ORVMF
Basic Shares Outstanding	115.2 million
Options	3.2mm at average strike price of C$0.88
Warrants	None
Market Cap	US$109mm = C$121mm
Average Daily Volume	140,318 shares (last 3 months)
Net Cash	US$53mm
Enterprise Value	US$56mm
Major Shareholders	52.5% Fabulosa Mines (Glencore) 11.5% Sprott AM
Website	http://www.orvana.com/index.html
Investor Contacts	Investor Relations - Jane Watson 647-221-9505   CFO - Malcolm King 416-368-1629 [email protected]   Corporate Development - Bill Williams 480-522-7925 [email protected]

BOLIVIA - DON MARIO MINE

Orvana has operated the Don Mario underground gold mine Bolivia since 2003. Underground exploitation of the Lower Mineralized Zone was consistently profitable generating cumulative cash flow of C$138mm. The underground resource was depleted in 2009, but Orvana spent several years planning a shift to open-pit mining of the somewhat lower grade surface extension of the same deposit. The company will need some new equipment, but the ore will be processed within the existing mill by existing employees so the development expense and risk are low.

Orvana released economic projection in May 2009 with an estimated cumulative after-tax cash flow of US$62.5mm and I estimate that implied an NPV of US$23mm (using a 10% discount rate). On 11/20 Orvana announced:

Production from the UMZ will follow the depletion of the Las Tojas deposit in fiscal 2010 and is expected to enable Orvana to extend mine life at Don Mario to approximately 2019.

Prestripping of the UMZ is scheduled to begin during the second quarter of fiscal 2010 and production is expected to start at the onset of fiscal 2011 [beginning 10/1/10]. Orvana currently estimates UMZ pre-production capital costs at approximately US$20 million, compared with the US$26.5 million estimated in a financial summary disclosed in a news release dated May 15, 2009. The project plan announced in May 2009 did not include the production of the copper in the oxide zone and planned the flotation of the oxide ore at the end of the mine life to recover only gold and silver. Orvana will now install the necessary infrastructure to apply a Leach-Precipitation-Flotation process, which will beneficiate the copper from all ore types. As previously disclosed, UMZ life-of-mine metal production was estimated to be 70.5 million pounds of copper, 176,000 ounces of gold and 6.1 million ounces of silver, but the revised mine plan will now add an additional 80 million pounds of copper to the forecast production.

Placing this updated information into the economic model from May 2009 shows a huge increase in value (amounts in US$ unless noted):

The Upper Mineralized Zone will be a very valuable asset for Orvana, however investors will always be cautious because of concerns about Bolivian country risk. A majority of the open pit revenues will be from copper (the underground mine had a higher gold grades) so the project will not receive a generous gold mine valuation multiple. The market never rewarded Orvana for the earnings form the underground mine, however the company was able to accumulate nearly $100mm and finance an acquisition that is likely to be seen more favorably.

SPAIN - EL VALLE MINE

Orvana acquired El Valle in 2009 through the acquisition of Kinbauri Gold. Rio Narcea Gold operated an open pit mine at the site from 1997 to 2004 and then briefly mined underground ore until 2006. The underground mine was unprofitable due to lower than expected ore grades and use of inexperienced and high cost contractors. Analysts were happy when the company shut the mine to concentrate on the Tasiast gold mine (now owned by Redback Mining) and the Aguablanca copper/nickel mine (now owned by Lundin Mining).

An extra degree of caution should normally be applied to mine restarts because over time it often becomes apparent that a mine closed for good reasons. I believe Orvana has multiple advantages at El Valle that are likely to make it successful:

• Fully operational mill. Orvana only needs to spend a modest amount on refurbishment and parts replacement.

   

• The El Valle site contains multiple ore bodies of which Rio Narcea had only a limited understanding. Extensive work since then has revealed a larger and better defined resource:

Drilling has continued through 2009 and Orvana will release an updated resource calculation in 2010. Better definition should enable better mine planning. The Boinas East area being mined by Rio Narcea in 2006 turned out to be relatively unattractive with a grade of only 3.2 g/t, well below the property average of 5.1 g/t.

• Orvana has experienced managers and an excellent track record operating an underground gold mine. The company's CEO is an engineer with 35 years experience. The lead engineer at El Valle managed the underground Don Mario operation for the past 3 years. Internal expertise increases the chances of success while also allowing Orvana to avoid the risk and expense of relying on outside contractors.

Orvana's recent announcement had this news about El Valle:

Orvana started development of El Valle-Boinas/Carles in November 2009 and plans to begin production from the mine in fiscal 2011 [beginning October 2010]. Once a mine plan is submitted to Spanish authorities and the applicable environmental permits are reactivated, development will focus on improving the existing underground accesses and sinking of a shaft. Based on a revised production schedule, Orvana estimates pre-production capital costs to be approximately US$50 million compared to Scott Wilson Ltd.'s cost estimate of US$122 million. Key infrastructure, including a fully-equipped mill that requires some refurbishment, is already in place. Underground drilling at El Valle-Boinás and Carlés is ongoing. The principal purpose of this drilling is to upgrade inferred resources to measured and/or indicated resources. An updated resource estimate is planned to be released during the second quarter of fiscal 2010 [ending March 2010].

Most of Orvana's plans are consistent with studies released by Kinbauri and Scott Wilson in 2009. The large reduction in pre-production capital expenditure results from

1. Expanding an existing ventilation shaft to accommodate the hoist rather than drilling a new shaft or ramp.

2. Deferring some capital expenditures to future years when they can be financed from mine cash flow

3. Eliminating outside contractors because of Orvana's internal engineering and management experience.

Updating the economic analysis performed by Kinbauri and Scott Wilson in April 2009 for the new information from Orvana and current metal prices generates the following valuation (amounts in US$ unless noted):

An investor willing to apply typical gold stock valuation metrics will see much more value. My favorite metric is "Total Cost of Acquisition". A good benchmark for feasibility stage projects is an acquisition cost equal to 70% of the spot price of gold. Operating mines are valued around an average of 90% of the spot price.

One of the attractive aspects of this mine is that the current plan produces only 894,000 ounces out of a current resource of 2.2mm ounces. And the resource is still being expanded through new drilling. In time El Valle could support either a higher production rate or an extended operating life.

BOLIVIA RISK

Orvana shares are cheap because until this year all of its business has been in Bolivia. In recent years the company often traded for less than its net cash value. In spite of the perceived risk, Orvana's experience in Bolivia has been excellent. 100% of its staff in the country (including the CEO) are Bolivian and the company has earned $138mm in cash flow from the Don Mario mine over the past 7 years. The mine is located in Santa Cruz province, the eastern part of the country which has been less supportive of Evo Morales socialist policies. To date, the only significant impact of Morales policies on Orvana has been a rise in the tax rate from 25% to 37.5%. Morales' intervention in the mining sector has concentrated on former assets of the Bolivian state mining company that he believes were privatized too cheaply and perhaps corruptly. The Don Mario property was never under state control, Orvana acquired it from a private Bolivian venture in 1996.

While the current Bolivian government is anti-capitalist, Bolivian culture is very pro-mining. Morales moderated his rhetoric in the recent election in order to broaden his appeal, but it's possible that taxes and royalties could increase. In the worst case expropriation is not inconceivable. But there is no risk of closure due to permitting problems or opposition from local communities or environmentalists.

MANAGEMENT & CORPORATE GOVERNANCE COMMENTS

Orvana has been remarkably conservative in preservation of value for shareholders. The company has not sold any shares since January 2002 and grants only small amounts of options.

I have found management easy to contact and comfortable answering questions about the company's activities.

Orvana has two strong shareholders (Glencore and Sprott).

Orvana's senior management is dominated by engineers. The company provides shareholders with plenty of technical information on its website and regulatory filings, but does not explain the financial value of the company's assets.

The company did not repurchase shares in the market even when they traded below the company's net cash value. The company chose to accumulate as much cash as possible in order to make a significant acquisition and in the end it appears that they were successful with the Kinbauri merger.

LIQUIDITY

Orvana has about US$53mm in cash, but will spend about $50mm in Spain and $20mm in Bolivia over the next year. The company's preference is to fund the shortfall with debt and several options are available including a smelter loan (hello Glencore ?) Given the company's conservative approach, I suspect they would also issue equity if they felt the terms were fair. This would bring modest dilution, but it could also bring an investment opportunity to readers for whom the exchange volume is too low to support a meaningful investment in the shares.

VALUATION SUMMARY

Combining the elements presented above (US$ unless noted)

OUTLOOK

2010 will be a transition year for Orvana as the Don Mario underground mine has closed and the company's major new developments will not enter production until 2011. The value of the company's assets is likely to gradually become apparent through disclosure of resource updates, mine plans, and financing the 2010 capex requirement. Fair value is unlikely to be realized until steady production is achieved in 2011 so I think $2.50/share is a realistic target price within two years.

Catalyst

- updated resource calculations in 2010

- updated mine plans in 2010

- financing of 2010 capex

- successful production startups in 2011