New Earth Mining Case

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Introduction

New Earth Mining (NEM) is a fast-growing Denver-based precious metal producer that is looking for ways to diversify from its core business; gold production. The Company reaped the benefits of the boom in gold prices, constantly increasing their top line (CAGR 2002-2011: 35.53%) and maintaining a good profitability (EBIT margin: 31.38%).  Based on our current data, the overall financial condition of NEM seems to be very good. The company has a strong cash buffer of $1.73m in 2011 and the short-term borrowings of only $0.28m: this gives a Current Ratio of 6.25, meaning that NHM had a strong liquidity and could easily meet its short-term obligations with its liquid assets.

Why investing in iron ore? Why South Africa?  

New Earth Mining is actually evaluating a project in the Kalahari manganese field in the Northern Cape of South Africa. The field is expected to contain ca. 30 millions of tons of ore with an average iron content of 60%. The company is mainly looking at this opportunity because it would represent a diversification from gold. Theoretically this statement makes sense because gold is usually considered a “safe haven asset” by the financial markets and therefore its price is negatively correlated to the economic development. On the other hand, iron ore should be positively correlated to the economic development and therefore represents a good diversification opportunity. However, looking at Exhibit 1, apart for some periods, the negative correlation between gold and iron ore prices seems to be weak or lacking. Moreover, iron ore seems to have higher volatility than gold.

Exhibit 1.

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Correlation coefficient: 0.219320

Source: Indexmund, 5-year Gold / Iron Ore price comparison – From: 

Nevertheless, the strong expected demand for Iron Ore and the essential part it played in the economic growth of several emerging and developed countries (e.g., China, Japan, South Korea etc.), increase the attractiveness of the investment.

The company mainly considered South Africa because of the low production costs, the high quality of the iron and the easy access to ports and facilities in order to export the product that reduced the need for infrastructure investments to support the development of the mine.

How does the financial structure of the project help in mitigating risks? And what are the risks not mitigated?

In order to carry out the project, New Earth Mining formed a new subsidiary, New Earth South Africa (NESA) that would ring fence the parent company assets, protecting it against potential liabilities. Therefore, in case of financial distress, the debt-holders will have no claim on the assets held by the parent company, significantly decreasing the risk for NEM.

The Company had contracts with steel producers in China, Japan and South Korea, to obligatory sell them all the future production of the mine, therefore completely securing itself from inventory risk. Moreover, NEM was able to secure against country risk thanks to insurance by National Assurance Corp. (a U.S. insurance company). This coverage guarantees against potential losses from the South African risk of civil war and government nationalization of natural resource assets.