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TABLE OF CONTENTS Oct 7 - 13, 2013 Volume 99 Number 34 - 0 comments

Centerra's compromise on Kumtor lifts political overhang

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Facing penalties of US$467 million for alleged environmental damages at its Kumtor mine in Kyrgyzstan and a state commission report issued last year that concluded Centerra Gold (TSX: CG; US-OTC: CAGDF) should pay more to operate the mine, the Canadian gold producer has signed a memorandum of understanding (MOU) that gives the Kyrgyzstani government a 50% direct stake in the project.

In exchange, a $500-million, Kyrgyzstan-held equity stake in Centerra will be converted, and the gold producer will be given another $100 million in future cash payments. Under the non-binding MOU, all claims for environmental damages would be dismissed, and Centerra would implement environmental changes outlined in a report by an independent third party earlier this year.

Alec Kodatsky and Terry Tsui of CIBC say in a research note that the deal “offers a road map to remove the political overhang on Centerra,” and that “between the alleviation of the political concerns and strong expected fourth-quarter production, the shares can move higher.” The analysts also note that the market “appears to have already priced in a worse deal than what has been proposed.”

Andrew Breichmanas of BMO Capital Markets argues that the MOU’s impact is “potentially positive,” and that “while the new structure would negatively impact estimates, the shares still appear to trade at a significant discount to peers.”

Breichmanas added that “if the transaction is finalized and the support of the Kyrgyzstani government demonstrated, the joint venture could better align the parties to realize value from the world-class Kumtor mine.”

David West of Salman Partners reasons that while the deal is not complete, it “appears imminent” and “doesn’t look bad.”

“We would view the deal as fair to Centerra,” the mining analyst  says, pointing out that a clause in the MOU gives the Kyrgstani government 6 million warrants at $10, exercisable in two years.

He adds that “a small proportion of the deal [the warrants] are important in that they keep the interests of Kyrgyzstan the same as the interests of shareholders. Although not at the same level as currently, this is an important aspect that should not be overlooked.”

Last year the Kumtor mine — located 350 km southeast of the capital city of Bishkek and 60 km north of the Chinese border —  produced 315,238 oz. gold.

In November 2012, Centerra altered the mine plan to expand the open pit while maintaining the option for underground exploration. Under the new plan, the open-pit mine life was extended by five years to 2023 and milling operations to 2026, and proven and probable reserves grew by 58% to 93.1 million tonnes grading 3.3 grams gold per tonne for 9.7 million contained oz. gold (an increase of 3.6 million contained oz. gold).

When the decision was announced, Centerra estimated that the increase in reserves and mine life would provide life-of-mine tax revenues of US$1.5 billion, based on US$1,350 per oz. gold.

The company says nearly 1.9 million contained oz. gold in the inferred category remains underground and below the expanded pit, and management will assess opportunities for underground mining once open-pit mining is complete.

In the meantime, most of the underground development work on two separate declines was folded into the expanded open pit, and Centerra recorded a US$190-million charge in the fourth quarter of 2012, which included money spent on underground infrastructure and equipment.

At press time Centerra was trading at $6.47 per share within a 52-week range of $2.99 to $13.28.

Kodatsky and Tsui of CIBC have an $8 target price on the stock for 12 to 18 months, while Salman Partners’ West have $9.10, and BMO Capital Markets’ Breichmanas $10 per share.

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Inside the processing facilities at Centerra's Kuptor mine in Kyrgyzstan. Source: Centerra
Inside the processing facilities at Centerra's Kuptor m...
Centerra Gold's Kumtor gold mine in Kyrgyzstan, 350 km southeast of Bishkek. Source: Centerra
Centerra Gold's Kumtor gold mine in Kyrgyzstan, 350 km ...

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