Shareholders of Gammon Gold (GAM-T) are the latest group to fall prey to a particular mix of promotion and overly optimistic mine planning that crops up in the junior gold sector from time to time.
Despite a stellar year for the gold price, Gammon lost more than $100 million in 2007. As a result, the value of its shares has plummeted 60% from a high of almost $22 set in early 2007 and the Halifax-based company is facing lawsuits from shareholders who allege they were misled about the health of the company's gold operations.
A rescue team from Highland Gold Mining -- a Barrick Gold (ABX-T) affiliate that has operations in Russia -- has taken root in Gammon's head office, but the new management will be challenged to turn the money-losing Mexican mines into profitable operations, especially if the gold price dips from current historically high levels of more than US$900 per oz.
Until recently, Gammon was a stock market darling whose shares rose from pennies in 2002 to more than $20 five years later as the company consolidated the Ocampo mining district in Mexico, then marched steadily towards status as a mid-tier producer in a rising gold price environment.
Gammon started construction of the Ocampo open-pit and underground mines in early 2005 and built two processing facilities, including a 11,400 tonne-per-day heap leach circuit and a 1,500 tonne-per-day mill. In 2006, during its commissioning phase, Ocampo sold 51,748 oz. gold, and 1.3 million oz. silver for 77,804 gold-equivalent ounces. All, it seemed, was well.
While Ocampo was ramping up to commercial production, Gammon acquired 100% of Mexgold Resources, owner of the producing El Cubo-Las Torres gold-silver mine complex in Guanajuato state, and the Guadalupe y Calvo advanced exploration property in Chihuahua state.
Then, on a "very proud day" in early January 2007, Gammon announced that Ocampo, its flagship mine, had reached commercial production and that the company was on track to produce 400,000 gold-equivalent ounces from Ocampo and El Cubo. The milestone was described as "a tremendous achievement," by chairman and president Fred George. Shareholders responded by lifting the stock to record highs.
The reality turned out to be shockingly different. Total annual production, at 218,734 gold-equivalent ounces, was almost half what the company had projected. To make matters worse, each ounce cost the company US$650 to produce -- compared with an industry average of around US$400 per oz.
As the problems in Mexico mounted, heads began to roll at head office in Halifax. The first to go was Gammon founder and CEO Brad Langille, who stepped down in early April to be replaced by Russell Barwick, former COO of Wheaton River Minerals and later Goldcorp (G-T). The following month, Colin Sutherland resigned as CFO to be replaced by Glenn Hynes. And in June, COO John Thornton lost his position to Dave Keough. George stayed on as chairman and president.
The first public disclosure that Gammon's operations were falling short of promise came in early May 2007, when first quarter results were released just weeks after the company closed a $200- million public offering at $20 per share. While analysts -- using management guidance -- were expecting quarterly production to come in at around 75,000 oz. gold-equivalent at cash costs of below US$270 per oz., actual production was significantly lower. Even more troubling was that cash costs, at US$575 per oz., were more than double expectations.
"The guidance relating to the company's Ocampo and El Cubo operations proved to be wrong," wrote mining analyst Wendell Zerb of Canaccord Adams in a May 2007 research report. With the first hint that some kind of legal action might be forthcoming, Zerb went on to say that analysts at Canaccord found it "difficult to comprehend how the company would not have understood at least the basic shortcomings the Q1/07 quarter would bring."
After digesting the first quarter results, Canaccord slashed its 12- month target price for Gammon from $22.15 to $14.65 per share. Even that significant downgrade proved to be optimistic. In the coming months, Gammon shares would sink to a 52-week low of $5.80 as the scope of the company's problems became increasingly apparent.
More heads would roll. By the end of September 2007, Barwick -- just a few months into the job -- was on a plane back to Australia to be with his family. He was replaced by Rene Marion, former CEO of Highland Gold Mining, who later completed his team by appointing his Highland colleagues Scott Perry and Russell Tremayne as CFO and COO, respectively. But by then, shareholders were furious enough to take action. The first lawsuit came in the form of a complaint filed by U. S.-based Midas Funds with the court of Southern District of New York. In the complaint, Midas claimed Gammon overstated its target production making "repeated and public misrepresentations" to induce investors to buy common shares in the April 2007 public offering at $20 per share.
Midas is a longtime Gammon investor. The fund first bought shares in 2004 and sold them for a profit. Based on reports of positive cash flow, Midas reinvested in the up-and-coming producer, buying 400,000 more shares for US$8 million. The fund is seeking $3 million in damages for its losses and $10 million or more in punitive damages, plus court costs.
The latest legal action to hit the company is an $80-million class action suit on behalf of shareholders that alleges Gammon manipulated stock options and made unrealized production forecasts leading up to the $200-million offering. The company's executive, directors and three financial institutions that provided underwriting for the stock are also named in the suit.
Gammon says both lawsuits are without merit and that the class action suit is simply a copycat of the Midas claim.
Leading the class action is Ed McKenna, who became a Gammon Gold shareholder by participating in the public offering in 2007 and subsequently took a significant loss on his investment. McKenna is "deeply dissatisfied with the level of disclosure contained in the April 2007 prospectus" for the offering, says his lawyer Dimitri Lascaris of London, Ont.- based Siskinds.
McKenna also accuses the company of manipulating stock options used to reward management. His statement of claim alleges that, "in a striking pattern that could not plausibly be the result of chance. . . grant dates of stock options charted below were either immediately followed by a sharp increase in Gammon's stock price, and/or coincided with a date on which Gammon's stock price was at or near a monthly low."
After McKenna filed his statement of claim, ScotiaMcLeod -- who sold the Gammon shares to McKenna and is a defendant in the suit -- forced McKenna to close out his brokerage account, says Lascaris. "We feel that this simply added insult to injury."
An annual loss of more than $100 million, a market capitalization slashed in half, three management teams in less than a year, and angry shareholders demanding compensation: how did things go so wrong for a company considered a rising star among the junior golds?
While management cites a dizzying array of startup problems -- including equipment availability, insufficient underground development and processing gremlins -- at Ocampo, the problems are deeper and more fundamental than that: the deposit is simply not as rich, nor as cost-efficient, as it was projected to be.
Two sources in the Toronto brokerage community who spoke off the record say they chose not to cover Gammon because they could see that the mine plan was unrealistic and costs were underestimated given comparable operations in Latin America. Since energy costs rise exponentially as the crush size for the heap leach gets finer, crushing to a 3 /16 particle size using an on-site generator became a significant contributor to cash costs. Grade also turned out to be disappointing, forcing the company to slash its resource estimates.
As a result of the discrepancies between the resource estimate for Ocampo prepared in 2005 by Tuscon-based Mintec and the company's actual mining experience, total reserves and resources have been cut from 10.8 million goldequivalent oz. at the end of 2005 (4.19 million oz. in reserves, a subset of 10.78 million in resources), to about 6.2 million gold-equivalent oz. today (2.84 million in reserves and 3.38 million in resources), though the company says the 2005 and 2007 numbers are not directly comparable.
Since only 555,000 oz. were mined from Ocampo by the end of 2007, what happened to the rest?
According to Gammon's recently released three-year operational outlook, there were generous estimations and inaccuracies associated with the original interpretation of the orebody. As a result, dilution assumptions for both the open-pit and underground mines have been increased, and reserves for one of the main underground veins -- Rosario -- have been pared down significantly.
"It is very difficult to give high-grade material a large influence. So I greatly restricted that high-grade material and that ended up reducing the ounces," says Marion, Gammon's new CEO, who adds that he learned to be conservative about highgrade material during his days working for Barrick. "That's not to say that the ounces aren't out there, just that statistically I don't have enough data points."
Another 665,000 ounces was slashed from the open-pit resource partly because assumptions about the surface topography were wrong, while interpolation from surface trenching to ore intercepts also proved to be inaccurate.
And even though the gold price is much higher than it was when mine plan was completed, the cutoff grade (the minimum metal grade at which an ore body can be economically mined) in the open pit has been increased from 0.2 to 0.3 gram per tonne.
The type of orebody at Ocampo may have been part of the problem. Ocampo is a classic low-sulphidation, quartz-adularia type epithermal system that contains high-grade ore shoots in the form of quartz veins and stockworks that are surrounded by lower grade halos. Because grades and geometry can be so variable, this sort of deposit requires a high level of confidence in the resource estimate for mine planning to be successful.
Still, Marion believes Ocampo, and Gammon, have a future. "Those things were unfortunate but they are behind us," he says. "We're starting to drill off the probable (reserves), which will not only raise the grade but also increase the confidence in the first three to five years of our mine plan. I fully anticipate bringing a considerable amount of reserves and resources back in this year and well into next year."
He says the experience of the new management team at Highland -- another undercapitalized gold company that required a turnaround -- will help Gammon claw its way out of a deep hole.
If the March 2008 numbers are at all representative, this may already be happening. That month, production increased to 22,051 gold-equivalent oz. for total first quarter production of 57,946 gold-equivalent oz at a total cash cost of US$489 per oz. As a result -- and the first time in the company's history -- Gammon was able to report positive quarterly net cash flow and use that to pay off some of its US$60-million debt.
Remaining shareholders, or those who have invested in Gammon as a turnaround situation, are taking a wait-and-see approach as the company attempts to meet the goals set out in its recently released 3-year outlook. The spotlight will be on Ocampo, which accounts for most of the company's production.
In 2008, the company expects to boost annual production from both mines to 245,000-275,000 gold- equivalent ounces at a total cash cost of US$480-US$515 per oz. by, among other measures, implementing optimal mining and processing methods, supporting a quality assurance and control program, containing costs for labor and consumables, and completing further underground development at Ocampo.
For 2009 and 2010, Gammon expects to produce 300,000- 330,000 gold-equivalent oz. at US$435-US$470 per oz. and 355,000-385,000 gold-equivalent oz. at US$395-US$430 per oz., respectively, by completing expansion projects such as ramping up underground production to 1,900 tonnes per day, beginning production at a second underground mine at Ocampo and expanding the Ocampo mill facility to 2,600 tonnes per day.
There is also exploration potential to consider. "We have only explored 20-30% of our land position at Ocampo and El Cubo so together with current exploration programs at Ocampo and El Cubo and the acceleration of our drilling campaign at our advanced Guadalupe y Calvo exploration property, we believe that we should be able to augment our reserves and resources from the stated 2007 year-end figures," Marion said in the three-year outlook.
But while the new management may be able to revive the Ocampo mine as a scaled down version of its original promise, the damage done to investor confidence in the junior gold sector may prove more difficult to repair.
-- The Author Is A Freelance Writer Specializing In Mining Issues, And Principal Of Toronto-Based Geopen Communications (www.geopen.com).
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Gammon CEO Rene Marion says the experience of the new management team at Highland -- another undercapitalized gold company that required a turnaround -- will help Gammon claw its way out of a deep hole.
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