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New Earth Mining Case Study:
New Earth Mining, Inc.
Company Background It was the beginning of 2013. After gold prices experienced an unprecedented boom from $300 per ounce to $1,700 per ounce in the previous decade, Denver-based New Earth Mining, one of the largest U.S. precious-metal producers, was enjoying rapid growth in earnings. With the continued improvement of its operating margins, New Earth had accumulated a large amount of cash on its balance sheet (Exhibit 1). It had a simple debt structure and a reasonable leverage ratio with no significant risk of liquidity.
Most of the company’s mines were located in the U.S. and Canada, but like many other firms in the precious-metals industry, New Earth had made substantial investments in gold exploration projects in other countries such as Australia and Chile. However, like many industry participants, New Earth executives worried about the sustainability of gold prices at their current levels. With its strong financial condition and the desire to diversify its business through new capital investments rather than acquisition, New Earth felt it was necessary to implement a diversification program that would reduce its dependence on precious metals. The company started investigating the possibility of diversification in base metals and other minerals.
New Investment Opportunity in South Africa A new investment opportunity appeared in early 2012. New Earth was informed of the existence
of a major body of iron ore close to the massive Kalahari manganese field in the Northern Cape of South Africa by an independent exploration consulting company. New Earth felt an investment in iron ore provided a strategic fit for its diversification objective.
Since steel represented almost 95% of the metal that was used in the world, iron ore was arguably more integral to the global economy than any other mineral. The price of iron appreciated more than five-fold from 2002 to 2012 (see Exhibit 2). Unlike the price of gold, for which there was considerable
speculation, the price of iron ore was not expected to fall dramatically given the strong global demand for the commodity. According to a 2012 report by the U.S. Geological Survey, the world iron ore market would continue to be tight, with demand exceeding supply until at least 2016. This was due to the long lead times required to bring mines into production, a world shortage of skilled labor, and growing natural resource nationalism, which reduced exports from some nations. Given that the price of iron ore had appreciated dramatically after 2007 and was expected to stay above $80 per metric ton, New Earth decided to evaluate the feasibility and profitability of developing the Kalahari mine.
New Earth hired Drexel Corporation, an engineering and construction firm, to analyze the extent of the deposit and to determine the cost and feasibility of establishing a mine site close to Kalahari. The engineering firm found that the field contained 30 million tons of ore with an average iron content of 60%. At the projected extraction rate of 2 million tons per year, it would take 15 years to deplete the ore body.
Drawing in part on its earlier evaluation of an iron ore project in Sishen, South Africa, Drexel estimated in October 2012 that the proposed venture in South Africa could be operational by the beginning of 2015. Drexel reported that there was limited need for infrastructure investment to support the development of the mine, and the total investment cost was estimated to be $200 million with 40% of the investment required at the beginning of 2013 and the rest required at the beginning of 2014. This investment amount would include construction costs and related insurance, operational costs, and $20 million in working capital. Ore would be trucked to Durban and railed to Port Elizabeth in the Eastern Cape for export. Given the high quantity of iron contained in ore mines in South Africa and the easy access to ports from the mine location, the venture was expected to have low production costs.
By November 2012, New Earth was able to produce pro forma analysis on the profitability of this new investment (Exhibit 3). The analysis revealed that the investment opportunity had attractive potential. At an assumed price of $80 per ton, the investment opportunity promised strong cash flows. The project would produce even stronger cash flows given an optimistic price forecast of iron ore at $100 per ton. New Earth also performed a sensitivity analysis to analyze the impact of various discount rates and iron ore prices on the net present value of the project’s cash flows (Exhibit 4). Despite its initial attractiveness, the project carried some substantial risks that New Earth needed to consider.
