Upstart ASX Explorer Sandwiched Between Billion Dollar Giants: Takeover on the Menu?

Two of the largest minerals sands producers in the world have key operations in Western Australia – Iluka Resources, capped at $3.3BN, and US based Tronox, capped at $1.3BN.

These large incumbents currently deliver around 70% of global mineral sands production, and have been able to control prices for some time...

However one plucky ASX listed explorer has muscled in between both of them, and is now looking to shake up the mineral sands status quo by partnering with other companies and fast track its own production.

With deep pocketed partners behind it, our company is planning to produce 5-7% of one of the world’s key mineral sands: zircon.

Our ASX explorer has signed an MoU which would effectively cut into Iluka and Tronox’s production and force them to begrudgingly lower their prices...

The non-binding MoU involves $20M worth of infrastructure, plus a package of $20M to fund production start-up – combined, this is significantly more than the company’s current market cap of $14M.

By entering into production next door and cutting into market share, this could signal the end of the party for the billion dollar incumbents...

One consequence may be a takeover of our little company – and this is something that would likely come at a significant premium to today’s prices.

To date, this company has been largely overlooked by the market as well as its own much larger competitors. Given the rapid pace at which this explorer has gone about dotting all its I’s and crossing the T’s, we think it might be time for this company to make its move.

With one of the highest grade undeveloped mineral sands deposits in the world, its drilling now to expand its resources further...

Given this company’s projects are just a stone’s throw away from existing production infrastructure of the billion dollar global players, and our explorer’s more attractive cost base, there is certainly potential for a takeover here...

At the same time, this is a speculative stock, and not without risk.

Introducing:

Image Resources (ASX:IMA) is developing into a producer of a mineral largely overlooked by investors – zircon, a mineral sand.

Mineral sands are essentially old beach sands that contain concentrations of important minerals such as zircon, ilmenite, rutile, leucoxene, monazite. These minerals are dubbed the ‘Heavy Minerals’ (HM).

Zircon in particular has wide ranging applications; but is predominantly used in the nuclear power industry – an industry forecast grow along rapid increases in energy demand globally.

IMA has been working hard to finalise all of its exploration work and commercial agreements – with a view of going into production next year. Its BFS is just months away from completion and attractive production margins are already on the horizon.

Zircon currently sells for US$1,100/tonne, and our company’s estimated production cost is around $300-400/tonne. Let’s find out a bit more about why IMA are looking to mine zircon.

Zircon is a state-of-the-art mineral with wide applications...and long-term commercial viability

The mineral sand zircon and its derivative, zirconium are not as well known in the minerals exploration space compared to other minerals such as iron ore, graphite and coal.

But its applications reach so far and wide that demand for this specialised mineral is likely to remain high. IMA is front and centre to enter this market by planning to produce 5-7% of the world’s production of zircon.

Zirconium does not absorb neutrons which makes it a superb element for use in nuclear power stations. More than 90% of zirconium is used in this way with the other 10% being consumer applications such as ceramics, cosmetics and pharmaceuticals.

Modem nuclear reactors typically have more than 100,000 metres of zirconium alloy tubing and use zirconium in superconductive magnets.

Zirconium alloy tubing used in nuclear power station

According to independent research, zircon prices are expected to rise from current levels around US$1,100 per tonne up to US$1,200/t over the next 5 years. This is excellent news for IMA, whose cost to produce one tonne of zircon is estimated to be around $300-$400/t.

When we look at IMA’s total capacity, the potential is self-evident.

IMA is aiming to produce around 40,000-60,000 tonnes per year from a 3-4Mt operation. That equates to approximately $72M in annual revenue (assuming a sale price of US$1,200/tonne and a production rate of 60,000tpa from Zircon)...

Whilst the company is on the right track, there is no guarantee though the company will reach these revenue numbers – there are a number of hurdles to jump over before the company gets to production.

IMA’s current reserves stand at 24.1Mt at 8.2% Heavy Minerals – and include one of the highest grade undeveloped mineral sands deposits in the world boasting zircon grades as high as 24.5%.

With such reserves and healthy margins on the horizon, IMA is firing on all cylinders to get its project into production.

The most significant hurdle is to secure a direct off-take agreement which IMA has gone a long way to securing courtesy of a cornerstone non-binding Memorandum of Understanding (MoU) agreement that ensures at least 90% of all production will be gobbled up at market rates.

Arranging deals directly with offtake partners is a significant strategic move for IMA. It effectively cuts into Iluka’s and Tronox’s production line and could therefore force the two zircon giants to lower their prices. Given their overwhelming market dominance, with 70% of production, the two giants are likely to consider a takeover offer simply to maintain their existing market position.

A takeover is only just a possibility at this stage but given the disruptive threat that IMA poses to its larger rivals, the idea is not so far-fetched.

What these little and large zircon players are all gaming to supply into is the fastest growing source of zircon demand over the next 10 years: nuclear power stations.

The World turning to nuclear power could be a boon for all zircon producers

According to research from Barclays Capital, titled ‘ China Nuclear Reaching Criticality’ published in February 2015, China will be investing heavily in nuclear power to satiate its rapid growth cycle.

In the research note, the bank says, “nuclear power in China is just starting to ramp up, and is on the verge of doubling installed capacity in the next 3 years”. Going on to label China’s nuclear ambitions as “the fastest ramp up in the history of the nuclear industry” and adding...”China’s installed capacity of 13GW for nuclear power in 2013 has increased to 20GW in 2014 and is well on track to hit its 2020 target of 58GW.”

That’s a 446% increase in just 7 years...

Here’s China’s nuclear ambitions mapped out. The red dots indicating planned future power stations indicates how serious Chinese authorities are about ramping up energy production over the next 10 years.

With China busy expanding its nuclear power programme and nuclear energy here to stay the world over, it seems IMA’s zircon production will be going into a thriving market.

IMA’s tenements are located in the heart of WA’s mining community, with access to first-class infrastructure

IMA has several tenements being actively explored and best of all, this explorer is making good headway with a new drill programme launched last month. IMA’s 10 year mine life expected to be extended soon on the back of this results.

Mapped out below, you can see IMA’s two major projects, Atlas and the flagship Boonanarring. Atlas holds probable reserves of 9.7Mt @ 8.1% HM while Boonanarring holds 14.4Mt @ 8.3% HM. Combined, IMA has access to over 24Mt of Ore with grades of 8%-10% HM.

Company presentation, June 2015

The fact that Boonanarring has a higher total ore reserve, better HM grade, more contained HM and a higher zircon grade compared to Atlas, has encouraged IMA to focus on developing Boonanarring first and foremost. The Atlas reserve is expected to be the next focus after Boonanarring.

Company presentation, June 2015

As you can see from the map, IMA’s Boonanarring reserve is sandwiched between Tronox’s processing plant to the south and Tronox’s operational site to the north which produces around 700kt mineral sands concentrate per year – remember Tronox is the $1.2BN NYSE listed major we mentioned earlier.

The operational proximity to Tronox has opened up collaborative possibilities for IMA, so much so that the explorer is now working hard towards bringing the Boonanarring reserve into production in 2016. IMA’s strategy is to enter production as soon as possible, almost as if to send a message to the currently monopolised market, that competition has finally arrived.

To help it achieve this ambitious target, IMA has gone out and signed an MoU with existing zircon producer Murray Zircon (MZ) and its parent company, Guangdong Orient Zirconic Ind Sci & Tech Co. (OZC). The deal is designed to fast track the development of IMA’s fully-owned Boonanarring and Atlas deposits into production – we will go into the details further down, or you can read the ASX announcement here .

MZ produces zircon 150km east of Adelaide in the Murray Mallee region of South Australia. The producer supplies all of its product to its parent company OZC, headquartered in southeast China. OZC is a huge zircon processing and manufacturing company producing a full complement of zirconium products that are sold globally. OZC is an industry mammoth, employing more than 2,000 people and listed on the Shenzen Stock Exchange, capped at $1.8BN.

OZC owns 65% of MZ as part of OZC’s long-term vertical integration strategy to secure a supply of zircon and hedge market risk, thus strengthening its status in the industry as an integrated group of companies.

Needless to say, IMA’s future is now more assured with this giant in its corner.

The deal signed with OZC secures IMA’s funding to production

The deal with OZC is far-reaching and ensures collaboration all the way through to production and beyond.

IMA is on track to become an on par player in the mineral sands space, at the heart of Australia’s production line – and it’s still capped at just $14M. At the same time, caution should be applied when considering investing in the company.

Here are the highlights of the deal, still subject to shareholder approval:

• IMA will acquire a wet plant including MZ’s ancillary equipment to be used in future operations (shown below)

Company presentation, June 2015

• OZC will purchase 90% of all zircon produced by IMA via non-binding off-take agreement;
• OZC to provide US$8M in working capital;
• IMA will receive a conditional loan of $4M from MZ which isn’t repayable if IMA doesn’t get into production within the next 3 years. This is a great incentive for all involved, including IMA shareholders who will likely see an expedited path to production;
• MZ’s key personnel will contribute their knowledge and expertise on IMA’s projects going forward;
• MZ will receive a 42% stake in IMA which could rise to 47% if all project financing is completed and mining begins within 2 years. Another positive incentive, and;
• Last but not least, IMA will receive an option to purchase MZ’s dry mineral separation plant.

In addition to the major capital injection from OZC, earlier this year, IMA raised $1.55 million at $0.08 per share through a placement of shares to new investors. The successful placement provides further working capital and underlines that investor interest in IMA is broad-based.

In summation, IMA is due to receive a wet plant and key infrastructure (worth around $20M in itself – more than IMA’s current market cap) as well as a total package worth over $20M in exchange for 42%-47% shareholding in IMA. Fully funded and a JORC resource already in the bag, IMA is now busy adding offtake partners.

By securing strong commercial deals with reliable off-take partners, IMA is sending a message to its rather large neighbours that IMA will soon be joining their ranks as fully-fledged producer.

The prospect of having a smaller, more efficient producer on their doorstep that could potentially disrupt the mineral sands industry, is stirring rumours of an imminent deal between Tronox and IMA.

As they say, if you can’t beat them, join them.

Equity research firm Morgans has recently put out a research note on IMA...

Here’s what Morgans Resources Analyst, James Wilson has to say about IMA...

Morgans Research Report, May 2015

In the same report, Mr. Wilson estimates a price target of $0.21 per share on IMA. Morgans broader analysis sees the higher price target based on a 6-year stand-alone start-up operation, discounted by 30% relative to its stage of development.

When using the MZ deal to value IMA, he says, “Assuming the value of this package is worth circa ~A$32m for a 42% equity position in the company, this would imply a A$0.17ps valuation on the stock (on an expanded share capital basis)”.

When compared to IMA’s current share price of 0.06ps, the potential upside is significant. Using either the $0.17 or $0.21 target suggests IMA is likely undervalued by up to 250%.

Now, please note that these price targets are only one analyst’s opinion – IMA is a speculative stock, and may never reach these levels.

Also bear in mind, that Morgan’s analysis is assuming a 6 year mine life and integrating a 30% discount. IMA is likely to have a 10 year mining life if all goes well in the Feasibility Study update currently ongoing – which could mean a higher price target given the additional 4 years mine life. But there are no guarantees, especially for speculative stocks like IMA.

IMA’s resource is abundant and high grade – an excellent platform from which to enter production AND attract collaborative offers

Here is the full list of IMA’s prospects and what kind of minerals are contained within:

Company presentation, June 2015

IMA’s flagship asset, Boonanarring has had a Feasibility Study completed in 2013 for a prospective mine life of 7 years. However, given the quality of the resource and strong financial backing, IMA has commissioned a feasibility study update that will almost certainly allow IMA to expand its JORC resource size and mine life from 7 years to 10 years.

Let’s take a look at how IMA stacks up in terms of efficiency and competiveness to its peers.

From the chart below (left chart), we can see that IMA’s Boonanarring site allows for the most competitive capital expenditure requirement compared to all of IMA’s peers.

The operating cost for the life of IMA’s proposed mine is estimated at A$350 per tonne which is in line with the industry average.

But not only is IMA able to maintain capital expenditure at a minimum, it also can extract some of the highest HM (8.3%) and Zircon (24.5%) grade compared to its peers (right chart).

Company presentation, June 2015

This aspect is key for IMA because by being the most competitive high grade producer of mineral sands, the explorer can attract the most lucrative off-take agreements and potentially attract the attention of Tronox and Iluka who are adjacent to IMA’s operations.

The real differentiator is IMA’s cost-base which is significantly better than all its rivals as shown above. This means IMA will not only enter production with a lower capital expenditure compared to its peers but will also have a much better production margin moving forward.

In fact, IMA has a very business friendly relationship with close quarter competitors such as Tronox. In April, IMA signed an agreement to sell its Mullering mineral sands tenements in Western Australia’s North Perth Basin to Tronox (NYSE:TROX) for $50,000 in cash and a sliding royalty.

The sliding royalty will be based on quarterly production rates as follows:

@ 2.5% average grade the royalty equals 1.25%
@ 3.0% average grade the royalty equals 2.50%
@ 3.5% average grade the royalty equals 3.75%
@ 4.0% average grade the royalty equals 5.00%

This type of agreement is yet another feather in IMA’s cap should the Mullering tenement bear fruit. IMA can effectively scale back on some its tenements in exchange for guaranteed royalty payments.

More importantly, the deal represents a seminal moment for IMA’s future collaboration with Tronox. This could be the first of a series of deals given the commercial synergies that are written on the wall for both explorers.

The most likely avenue for future collaboration is via IMA’s northern tenements...

Mapped out above are IMA tenements in blue outline and Tronox operations shown in green. The royalty agreement mentioned earlier is shown in dotted red outline. Most interestingly, Tronox’s planned dredge path for discovering more HM is moving along strands that extend into IMA’s Atlas tenement. This is great news and adds weight to the argument that the mineralisation being found by Tronox overlaps into IMA’s tenement.

This presents a key strategic advantage for IMA in both bargaining power and commercial value of its tenements.

IMA has recently embarked on an intensive drilling programme aimed at extending it resource at Boonanarring

IMA is completing a 257 hole drill program aimed at extending resources at Boonanarring. Most recent results have outlined 3m @ 23% HM and 6m @ 6.4% HM from 14m at Boonanarring and 6m @ 10% HM from 27m to the south near Gingin.

Mineral sands exploration is rather different to other resources and not considered a difficult resource to mine, according to geologists. ‘Prospective strands’ are tracked and graded before being extracted at low depth. IMA currently holds tenements with over 100km of space to track these zirconium-rich strands within its mineral sands resource.

With drill hole depth only generally requiring a depth of 20-30 metres, IMA is finding it easy to detect, track and explore for zirconium on its tenements. The benefit for IMA is that costs of production are likely to be low and therefore, allow IMA to obtain the best profit margin possible as well as attract good off-take partners.

At the moment, IMA’s deal with OZC and MZ is waiting for MZ to complete its own internal due diligence work for the deal to finalise. Once MZ’s due diligence is completed, things may really start to look up for IMA.

Heavy Minerals are entering a strong growth period, with IMA nicely positioned for take-off...

IMA is a mineral sands company that has excellent future potential in a very lucrative niche market that could go mainstream on the back of nuclear power.

Via an MoU with Murray Zircon and OCZ, IMA is on a fully-funded path to production in 2016 on its 100% owned tenements in Western Australia.

Multi-billion dollar mineral sands players Tronox and Iluka pose an opportunity for IMA given the market disruption caused by IMA’s recent MOU. Essentially, Tronox and Iluka must decide whether to allow IMA to eat into their dominant market share. Or alternatively, try to take IMA out of the equation through an off-take agreement or takeover.

On one hand, IMA still has a 12 month lead up to production, but on the other, the explorer has secured pivotal commercial agreements and infrastructure that now threatens Tronox and Iluka down the track.

Could these billion dollar Goliaths be wary of $14M-capped David taking up a position between them?

If they’re not, David has the chance to deliver his famously effective knockout blow by being more nimble and efficient.

And if they are, David could be in line for a significant improvement in fortunes courtesy of Goliaths’ deep pockets.

In either case – given all the factors lining up for IMA, we think the stock has a lot of room to grow from its current valuation.