Investment Comment Waiting for Lac/Corona decision

It has been nearly four months since Lac Minerals and International Corona Resources wrapped up their arguments to the Ontario Court of Appeal over the ownership of the Hemlo Page-Williams mine.

At the time of writing, still no word from the panel of five judges on which way the decision will swing. So the market, like the rest of us, continues to wait it out.

Currently shares of Lac and Corona are trading almost nose to nose at between the $38 and $42 levels. Teck Corp., which stands to gain a 50% interest in Corona’s position in the Page-Williams mine, sees its B shares trading in the $35 range.

Which all goes to prove what a difference a year makes. As recalled when trading resumed after the March 7, 1986, Ontario Supreme Court decision transferring the mine from Lac to Corona, Lac shares dropped to $23 from $41.63, while Corona shot up to $25 from $13. Teck traded at $25.13, up from $19.50. The price of gold then was at the $350(US) level.

Now when the Appeal Court of Ontario decision is expected shortly, it’s not surprising investors are wondering what strategy to kick into motion. Three-strategy plan

Analysts Mike Pickens and Robert Sibthorpe with Yorkton Securities have come up with a 3-strategy plan that is elegant in its simplicity.

The two analysts write that at present the value of the Page- Williams mine is not reflected in the share price of either Corona or Lac. Estimates of the value of the mine centre around $1 billion(C).

Given the uncertainty of predicting the final resolution of the issue, investors appear unwilling to assign the $1-billion value to either company. “Our analysis indicates that, on a relative basis at least, both Lac and Corona shares are worth in the order of $35-$40 without the Page- Williams gold production,” they say.

Presumably, once the appeal decison is made, the approximate $1 billion in value will be assigned to the shares of Corona, Teck and Lac in some combination as incremental value. This situation raises interesting high capital gain, low risk investment opportunities.

Messrs Pickens and Sibthorpe plot out in graph form the current market capitalization of 13 senior gold stocks against their forecast gross profitability for 1987/88. This effectively measures what a company “costs” versus its pre-tax profits for two years and also reveals which companies are expensive or inexpensive on this basis. Market valuations graph

The following points are evident from the graph:

* While this profitability measurement is by no means the only method of gold share price evaluation, it does appear to approximate market criteria. Note that 11 of the 13 stocks form a very tight correlation along a control line of $16 of market capitalization for every $1 of annual gross profits.

* Two of all the companies which are aligned along this control line are Corona and Lac, both excluding Page-Williams gold production. In other words, both stocks are correctly priced, relative to the other gold stocks, in the $35 to $45 price range without this asset.

* If production from the Page- Williams mine is added to either Lac (100%) or to Corona (50%, shared with Teck) both stocks require a market capitalization of double current values in order to return to the control line. This implies a share price in the order of $80 for any clear-cut winner.

If this graph represents true equilibirum prices for senior Canadian gold stocks, the outright winner of the Page-Williams should experience a share price increase to around $80 (a capital gain of 100%) while the outright loser’s share price should decline to about $35 (a capital loss of 20%).

Distortion from these values could come from a variety of sources including cash compensation between the companies and/or initial investor over-or-under reaction to the settlement. Whatever the outcome, Messrs Pickens and Sibthorpe say they firmly believe that some $1 billion in incremental market capitalization will be assigned in some combination to the share prices of Corona, Teck and Lac. The strategy

The strategy the analysts present therefore are:

* Hold positions in all three stocks.

This follows naturally from their view that the winner will gain more in price than the loser will decline. It is relatively low risk strategy and would have worked well during the initial Page-Williams judgment last year.

* Switch positions from the winner to the loser.

“Our theoretical target prices not withstanding, it is likely that the share price decline of any clear cut `loser’ will decline well below the $35 area as an initial market reaction,” they say. But, the analysts continue, “our analysis indicates that this stock will then rebound to this level (assuming no significant change in external influences such as the gold price).”

Thus, not only will the “winner” position likely produce a larger capital gain than the capital loss produced by the “loser” position, but profits can likely be further magnified by using the proceeds from the gain side to double (or triple) down on the losing side.

* Hold both stocks and hedge against a gold price decline.

It is possible that between the time the stock positions are established and the judgment on the appeal is made, the gold price will decline significantly. This would likely result in lower starting point prices for these stocks. This situation can be defended against through gold index or gold bullion option strategies.

In summarizing their position, Messrs Pickens and Sibthorpe note that purchase of either Lac or Corona shares at this time carries significant non-market risk. Purchase of Lac and Corona shares reduces this risk and should result in a significant capital gain.