Hycroft Mining Holding Corporation (“Hycroft” or “the Company”) is a Nevada-based gold and silver producer. Based upon the 2019 Hycroft Technical Report (attached), as of July 31, 2019, Hycroft had proven and probable mineral reserves of 12.0 million ounces of gold and 481.4 million ounces of silver. Hycroft claims their mine is one of the largest gold & silver deposits in the world with a low-capital, low-cost process and a 34-year mine life. Hycroft currently trades sub-$7 / sh with a market cap of $412mm, well below its first de-SPAC trading day price of $10.37 / sh on January 13, 2020. In July 2020, Hycroft disclosed an NPV net of royalty of $1,994 million and an NAV of $1,787 million (after adjusting for $150mm of debt and $121 of corporate G&A), representing an implied P / NAV multiple of 0.3x.
Why This Opportunity Exists: I believe a small position in Hycroft is actionable at current levels. I attribute Hycroft’s trading weakness to two key drivers; i) operational underperformance, which is currently begin addressed, and ii) new dilutive equity capital which was raised to improve liquidity and extend runway as the operational ramp took longer than initially expected. I think the market has given up on the Hycroft story and is fundamentally mispricing this asset, which if new management can reorient to profitability is cheap on nearly any valuation metric.
Investment Thesis:
I. Large Nevada-based gold and silver mine with significant proven and probable reserves trading at a steep discount to NAV and NPV
II. New CEO Diane Garret is impressive with a history of driving successful mining projects
III. Largest shareholder Mudrick Capital has been involved in the asset through predecessor Allied Nevada for more than 6yrs, Jason Mudrick “all-in” on Hycroft’s success
Investment Risks:
I. Hycroft’s low-capital, low-cost process has never been successful at scale
Mitigant: Science of mining sulfides is well understood in the industry, technical report seems to validate the feasibility of the project.
II. Negative net income and cash flow burning mine with limited financial reporting to diligence
Mitigant: Hycroft’s weak operational history to date suggests its struggles may continue. However, Hycroft’s new management team appears to have gotten their arms around the various issues at the mine and are anecdotally driving an impact. This is an execution story, but one the new management team appears to be well-suited for.
III. Liquidity is tight and has elicited “going concern” warnings
Mitigant: Pro forma for the close of Q320, Hycroft raised $83mm of incremental equity capital from a combination of existing and new institutional shareholders. Existing shareholders are deeply invested in the asset, this is a “fund-maker” for Mudrick Capital.
IV. Commodity price risk
Mitigant: If management can reorient operations to hit the targets outlined in the technical report, Hycroft is a feasible project at a range of conservative commodity spot prices
Summary & Catalysts: I believe Hycroft fits the characteristic of a misunderstood, small-cap special situation equity worth digging into. Given weak performance to date, I view Hycroft as an execution story that will depend on the new management team’s ability to improve operations and drive profitability. While an immediate liquidity crunch has been solved, there is still a ton of work to be done to prove the mine and the sulfide heat leach process can be successful at scale. However, 85% of Hycroft’s ADTV is sold short, and if Hycroft can begin to show a turnaround when they file FY 2020 results and publish FY 2021 guidance, the market will recognize Hycroft as a significantly mispriced and re-rate the equity. I’ve started a small position, split between both the common shares and the warrants.
Areas of Future Diligence: Valuation work, deep dive on the technical consulting report and plant operations.
Hycroft Mining Operations Overview: During the first nine months of 2020, the Hycroft Mine produced 16,699 ounces of gold and 96,881 ounces of silver and sold 16,854 ounces of gold and 97,954 ounces of silver. This performance has improved sequentially, but is well below initial forecasts. Management attributes the operational underperformance to a combination of factors resulting in lower gold and silver production, lower sales volume, and higher operating costs. The Company has not generated positive net income or cash flow to date. The operational challenges Hycroft had to deal with were significant:
1. Hycroft’s pressure systems weren’t able to consistently deliver adequate pressure to the mining pads, requiring major maintenance
2. General mismanagement of Hycroft’s process solution control system
3. Undersized reagent distribution system, which negatively impacted quantities of soda ash that were delivered to the pads
4. Hycroft was plagued by aging, outdated equipment on site, which required repairs and increased operational downtime
The combination of these factors contributed to write-offs of gold and silver inventory, which impacted production volumes and revenue. During the first nine months of 2020, the Company recognized a write-down of production inventories, including production costs of $16.7 million, and capitalized depreciation and amortization costs of $1.3 million.
On the Q320 earnings call, Dr. Garrett gave an update on the operations. From Dr. Garrett’s perspective, sulfide oxidation chemistry is a process that is very well understood in the industry. What is unique to the Hycroft project is that the Company is performing chemistry under atmospheric heat leach conditions. Due to low grade nature of the ore in the Hycroft mine, capital costs are much lower than other sulfide oxidation process-focused mines, and helps to explains what some vocal minorities in the industry have gotten wrong about the validity of the Hycroft project. From a pure chemistry perspective, it is well known that sulfides can be oxidized in an alkaline environment – Hycroft is pioneering the ability to do this on a large commercial scale, utilizing the heat leach process. The main complication around the heat leach process is that it requires extremely careful management to maintain proper alkalinity, Ph, and oxygen levels, among others.
While the operational challenge for Hycroft is considerable, Hycroft’s other cash flow issue is the sheer amount of oxide and transition material they must work through before they are able to reach the sulfides (from which Hycroft will subsequently extract their gold and silver). Prior management conducted two 50,000 ton pre-commercial pads of sulfide material. After stacking those first two sulfide commercial pads, the Company began stacking multiple 50,000 ton test pads of predominantly transition material. The test pads are undergoing various stages oxidation and leaching, which is a necessary step before Hycroft can access the sulfide deposits. With new members added to the process team, many operational issues which contributed to a lengthy oxide and transition mine have anecdotally been addressed. Dr. Garrett also stated that through her team’s latest observations on the sampling of pads and confirmed by additional lab testing, there may be opportunities to further streamline Hycroft’s mining and treatment of the transitional material. While these findings are still preliminary, this is a strong data point indicating how Hycroft’s new management is further optimizing operations and driving improved cash flow. Dr. Garrett stated that she has confidence that the pre-production results to date are not representative of what Hycroft can achieve going forward.
New Liquidity: Immediately following the close of Q320, Hycroft announced on their earnings call a successful capital raise of $83mm in equity, bringing onboard 13 new institutional shareholders. While dilution is never a positive for existing shareholders, management stated that several existing shareholders contributed new money. For public shareholders contemplating an investment, I would argue the existing capital raise partially de-risks the asset from a credit perspective, and buys management critical time they need to drive a turnaround.
Financial Performance: Financial reporting during the Mudrick Capital-hold has been limited to date, and I believe not representative of the run-rate potential of the plant. Historical financials prior to the Mudrick ownership I would argue are not relevant. Nonetheless, I’ve included a summary of the key performance indicators from the SEC filings below:
Mudrick Capital & Acquisition Detail: Mudrick Capital is run by distressed debt investor Jason Mudrick. He founded Mudrick Capital in 2009 after an 8-year career at Contrarian Capital Management. With the dearth of public market distressed credit opportunities, Mudrick Capital decided to make a play on the private markets, specifically distressed-for-control (more on this below). Mudrick Capital Acquisition Corporation ($MUDS) priced its IPO on February 7, 2018, offering 20mm units at $10/unit. Each unit consisted of one share of the Company's Class A common stock and one warrant enabling the holder to purchase one share of the Class A common stock at a price of $11.50 per share. Mudrick’s SPAC vehicle and Hycroft Mining Corporation announced their merger in a January 13, 2020 8-K.
Allied Nevada Bankruptcy Detail: Hycroft was an asset of once-bankrupt Allied Nevada Gold Corp, which filed Chapter 11 back in March 2015. Mudrick was a lender in various parts of Allied Nevada’s structure. I’ve dug through the court filings, and it appears that Mudrick Capital (a) lent into the DIP and exit facilities and (b) owned a considerable amount of 8.75% senior unsecured notes – notes that lenders ultimately exchanged for 100% equity (subject to dilution) in connection with the company’s plan of reorganization.
M3 Engineering and Technology Corporation ( “M3 Engineering”), in conjunction with SRK Consulting (U.S.), Inc. (“SRK”) and the Company, completed the Hycroft Technical Report Summary, Heap Leaching Feasibility Study, with an effective date of July 31, 2019, for a two -stage, heap oxidation and subsequent leaching of transition and sulfide ores. The 2019 Hycroft Technical Report projects the economic viability and potential future cash flows for the Hycroft Mine when mining operations expand to levels presented in the 2019 Hycroft Technical Report.
There’s a great deal of information to unpack in this report.
Key Takeaway: Based on the below metal price sensitivity tables, it appears that at a range of gold and silver commodity prices, Hycroft is a viable, cash flowing project.
Going Concern Warning
Per the Q320 Financials:
As of September 30, 2020, substantial doubt existed about our ability to continue as a going concern as we may need additional capital, which is contemplated based on, among other things, our current estimates of production, costs, metal prices, capital expenditures, and debt service obligations over the next twelve months.
The Company is currently evaluating if it will have sufficient cash to meet its future obligations as they become due as the Company continues to ramp up the Hycroft Mine's operations from current levels to those which are consistent with the 2019 Hycroft Technical Report
The Company is currently working through its budgeting process for 2021 to determine the quantum and timing of sources and uses of cash, and if additional capital resources may be required during the next twelve months. Using estimates of future production, costs, and operational metrics, at current metal spot price levels, the Company projects its monthly mine-site net operating cash flows to be at, or slightly above, break-even levels towards the end of the second quarter of 2021. However, during the second quarter of 2021, the Company will also begin remitting cash payments required pursuant to the Sprott Credit Agreement, which are currently estimated at $2.9 million over the next 12 months, and continue to incur corporate general and administrative costs.
The Company’s ability to continue as a going concern is contingent upon increasing sales, by achieving higher operating tonnages and recovery rates consistent with the Hycroft Technical Report. Additionally, the Company plant to reduce its production costs, by limiting its reliance on contractors needed to supplement its work force, enhancing its ability to monitor and control the use of reagents in the leach pad and reducing the costs of its mining fleet by increasing the availability and utilization of the fleet and reducing the maintenance costs. If the Company is not successful in achieving its plans, it may require additional financing.
Pro forma for Q320, the Company successfully raised $83mm of new equity capital from both new and existing shareholders.
Warrants Detail
Per the Q320 Financials:
[Hycroft] had a total of 47,011,521 warrants outstanding as of September 30, 2020. On October 6, 2020, as part of the Public Offering, the Company issued 9,583,334 shares of the Company's common stock and warrants to purchase shares of the Company's common stock at an exercise price of $10.50 per share to purchasers in the Public Offering to Restricted Persons, as defined under the Seller Warrant Agreement.
Five-year Public Warrants
The Company has 34,289,898 publicly-traded warrants outstanding that entitle holders to purchase one share of HYMC common stock at an exercise price of $11.50 per share for a period of five years from the May 29, 2020 Recapitalization Transaction. The Company has certain abilities to call such warrants if the last reported sale price of HYMC common stock equals or exceeds $18.00 per share (as adjusted for share splits, share capitalizations, reorganizations, recapitalizations and the like) for any 20 trading days within a 30 trading day period.
Royalty Obligation
A portion of the Hycroft Mine is subject to a mining lease that requires a 4% net profit royalty to be paid to Sprott, the lender to the Company’s credit facility. Per Q320 financials:
Net profit royalty
A portion of the Hycroft Mine is subject to a mining lease that requires a 4% net profit royalty be paid to the owner of certain patented and unpatented mining claims. The mining lease also requires an annual advance payment of $120,000 every year mining occurs on the leased claims. All advance annual payments are credited against the future payments due under the 4% net profit royalty. An additional payment of $120,000 is required for each year total tons mined on the leased claims exceeds 5.0 million tons. As of September 30, 2020, total tons mined from the leased claims exceeded 5.0 million tons, requiring an incremental amount of $120,000 due to the owner of the mining claims. The total payments due under the mining lease are capped at $7.6 million, of which the Company has paid or accrued $2.7 million and included $0.4 million in Other assets, non-current in the condensed consolidated balance sheets as of September 30, 2020
The Sprott Credit Facility is expensive financing, with an all-in cost today of 8.5% per annum, which is PIK interest until Q221. There is $63.1 million outstanding today. Subject to certain financial covenants, Hycroft can draw an incremental $40mm on the facility. However, operations will need to improve before that liquidity can be accessed.
Mudrick Has Significant History with Hycroft Asset & Board Representation:
One of Mudrick Capital’s Senior Analysts, David Kirsch, currently sits as Chair of the Hycroft’s Board of Directors.
Dearth of Public Market Ideas Creates Opportunity for Distressed SPAC:
Jason Mudrick and David Kirsch spoke on a YouTube interview with CommonStockWarrants.com about the Hycroft SPAC opportunity: https://www.youtube.com/watch?v=RiMBmsfL8YA.
Jason Mudrick: “We did sponsor a special purpose acquisition vehicle, called…MUDS. It has since been ‘de-SPAC’d’ as we’ve merged with Hycroft Mining…we IPO’d our SPAC a couple of years ago…thinking at the time…was very different from the world we live in today…[but] nobody had raised a SPAC that we had known about with a very specific mandate of merging into a post-bankruptcy company…A lot of SPACs had been raised by industry veterans to go after certain industry verticals (management team focused on Paper & Packaging, looking for a paper and packaging asset)…but nobody had looked at the problem of post-bankruptcy equities that many of them were very illiquid.” (Emphasis added).
Mudrick acknowledges in the interview he and his team very opportunistically went to market to be either the or among one of the first SPACs targeting a post-reorg company to merge with. He also articulates one of the main problems faced by funds investing in bankrupt companies – lack of liquidity for their post-reorg equity.
While David Kirsch’s states in the interview that the fund has been involved in Hycroft Mining for “around six years,” Jason Mudrick states his fund is “all-in” on the name. Per the interview:
Jason Mudrick: “…We are very involved still in Hycroft Mining…so whereas a lot of SPACs merge and the original sponsors are sort of gone, we put new money into Hycroft, we were a $25mm check into the deal, in addition to our existing ownership that was created through the SPAC and through our prior ownership in Hycroft, we are very much ‘all-in’ in the success of Hycroft Mining...”
While it’s clear from the commentary that Mudrick is continuing to support Hycroft with the new capital they need to grow, six years is a long time for any fund to be holding onto its investment. Similar to many SPACs in the market today, there is some sponsor ‘self-help’ taking place; Mudrick is using his SPAC to create some liquidity for the fund’s long-term holdings. Based on information contained in the Allied Nevada bankruptcy dockets, it appears as if the unsecured notes were converted to equity.
It also looks like Mudrick was part of the group that provided not just the DIP but the Exit facility.
Takeaway: Based on my read of the SEC filings here, Mudrick’s SPAC went effective on February 7, 2018 with a 24-month window to close on a transaction or wind up. With the clock ticking down, the merger target selected in month 23 was one of his own portfolio companies. Using a bit of new money and a whole lot of SPAC, Mudrick essentially engineered a path forward out of one of his longest held positions.
While there’s certainly some financial shenanigans going on here, I don’t believe any of this at face value invalidates that Hycroft represents an interesting opportunity at current levels. An equity investor today benefits from Mudrick’s experience with the asset far more than being penalized by the fund’s historical ownership and conversion of debt into equity.
