Bumi Resources Minerals (BRMS): clear catalysts ahead - JP Morgan

Investment thesis
Other than being the only gold and copper play in Indonesia, investment in BRMS presents a mixture of (1) arbitrage value opportunity for NNT, operator of Asia's third largest copper and gold mine, significant value and earnings contributor to the US$26bn NYSE-listed Newmont Mining Corporation, world largest gold company, (2) metal and diamond exploration upside with the Bakries, a politically connected business group with strong track record in Indonesia's mining sector, and (3) execution upside on Dairi, one of the best zinc and lead deposit in the world with above average metal content of 22%. It could also be seen as trading play on the plan by its parent company to de-leverage balance sheet, qualifying BRMS as potential take-over target.

Recent Positives
* Debt default risk goes to near zero. Yesterday, BRMS parent company converted US$546mn worth of parent company loan into shares, at a price of Rp670/share (vs last close of Rp660). What’s left on BRMS balance sheet is the US$271mn CS loan facility, with interest and principal repayment tied to dividend income from NNT (the facility is ring-fenced around NNT stake only). So even if NNT stops paying dividend for the next 8 quarters, debt servicing for this particular debt will not be a problem.

* One step closer to start of Dairi project. According to BRMS management, president SBY has signed the decree confirming that miners are allowed to mine undergound within the protected forest area. Next, the forestry minister will need to issue the Pinjam pakai (borrow-to-use) permit authorizing the exploitation activities. Once obtained, BRMS may spend US$10mn per month for the next 20 months on capex on Dairi, to generate US$200mn EBITDA (1mn tons of feed per year, with Zinc and Lead price between US$1.10-1.20/lb). Dairi project offers impressive zinc grade (13.7% Zn and 8.2% Pb), four times higher grade than the average zinc mines in China.

* Strong gold price and normal NNT output in 1Q11. Heavy rain has delayed NNT’s phase VI expansion, and as a result NNT produced normal output in 1Q11. Average gold price was 24% higher yoy in 1Q11, while for copper it was 33% higher yoy. Average gold price for 1Q11 was 12% higher compared to full year 2010 average, while for copper it was 28% higher. At the time of IPO for BRMS, JPMorgan analyst had expected year 2011 net profit to collapse by 64% yoy. The reality may not look as bleak, and the yoy comparison for 1Q11 may even look healthy.

Potential Catalysts
* Warrants exercise period nearing. It is quite crucial for BRMS to obtain fresh US$170mn capital from the conversion of its outstanding warrants, despite the US$170mn cash balance now. The management had hoped that proceeds from IPO and warrants can cover the two year exploration plans for Gorontalo copper & gold, Liberia diamond, and Citra Palu copper & gold, and the exploitation plan for Dairi zinc & lead and Mauritania iron ore. The warrants have a conversion price of Rp700/share, valid from 9-Jun-2011 until 12-Oct-2012.

* Parent company deleveraging process nearing. BRMS parent company plans to de-leverage its balance sheet. One of the possible ways to achieve such objective is to spin-off its stake in BRMS. Tender offer for BRMS shares is a debatable possibility.

* NNT stake sale decision in March-April 2011. The central government is due to decide and act on its first right of refusal to buy the last 7% stake in NNT, over the next few weeks. Lack of action by the central government may lapse the offer, and the right to purchase will be passed on to the regional governments of Nusa Tenggara (who partners with BRMS in their bid to purchase the stake). The offer price of US$270mn for the 7% stake is perceived to be an attractive price by the market.

* IPO of NNT in June 2011. The Newmont consortium (56% stakeholder) plans to offer 10% new shares in NNT to the Indonesian public in June 2011, a plan that is supported by BRMS consortium (24% stakeholder). Before the IPO can go ahead, there are two prerequisites: (1) finalization of the 7% selldown, and (2) all parties (Newmont, BRMS, and Merukh consortiums) must agree to waive non pre-emptive rights to buy the new shares. The IPO can potentially set the real valuation benchmark for NNT, that I believe can be at big premium to the purchase price by BRMS.

* Exploration results. BRMS management appears confident on Gorontalo proofing itself as a world class copper and gold mine, comparable to that of NNT Batu Hijau mine. The confidence came from the old drilling results by previous owner BHP, before ex-president Soeharto put a national park boundary right on top of the concession. On NNT, the Indonesian spokesman told the press recently that the copper-gold reserves at Elang is estimated to be 1.5x bigger than that of Batu Hijau. At the time of IPO, they were at advanced exploration stages only for Elang, 60km away from Batu Hijau.

Risks
* Stock liquidity risk with average daily turnover of US$2mn.
* Famine period for NNT dividends, eight consecutive quarters starting from 2Q11.
* Skyrocketing costs of exploration. BRMS executing exploration and exploitation plans without third party contractors.
* Geopolitical risks in African countries.