Callinan sues HudBay over profit agreement

Callinan Mines (CAA-V) wants a look at HudBay Minerals‘ (HBM-T) books over suspicions that the company isnt complying with a net profits interest and royalty agreement signed in 1988 for a copper-zinc property in Flin Flon, Man.

The company has filed an action with the Manitoba Queens Bench against Hudson Bay Mining & Smelting, a subsidiary of HudBay, for the right to conduct an audit of the books and records for the Callinan mine and the 777 mine, which is HudBays flagship project.

A statement issued by HudBay says the company believes it has made all appropriate payments to Callinan.

Under the NPI agreement, Callinan was granted 6-2/3% interest in the Callinan Mine and any other projects developed on the property, which is now home to the 777 Mine. Callinan also has a 25-per-tonne royalty for ore milled from the site, which HudBay has paid.

HudBay Minerals reported earnings of $565 million in 2006, but the vertically integrated company does not report earnings from each mine.

Braden Maccke, director of investor relations at Callinan, says that under the agreement HudBay is required to provide Callinan with the annual accountings for the mines, which they company hasnt seen for a few years.

Theres a long established paper trail of us trying to get a hold of them but theyve been less than forthcoming, says Maccke. Its been a stonewalling operation and we eventually got blue in the face about it and decided to file this action.

Maccke says Callinan would be happy to back off if HudBay could show that it is not making money.

But it would be pretty incredible to not be making money off their biggest, richest asset, Maccke says.

The 777 mine has a proven reserve of 5 million tonnes grading 2.3 grams gold per tonne, 27.5 grams silver per tonne, 2.8% copper and 4.5% zinc. Probable reserves are 11.8 million tonnes grading 2.1 grams gold, 26.9 grams silver, 2.3% copper and 4.5% zinc.

Production at 777 was increased to 1.35 million tonnes of ore in 2006 from 1.1 million tonnes in 2005.

Analyst Mike Collison of Dundee Securities says Callinans problem is not atypical for an NPI.

These type of agreements benefit those who define what profit is, says Collison. At this point there is nothing that would remotely indicate that HudBay has acted in bad faith.

Collison says it depends on how the agreement defines profit, which, when left up to the operator, can be completely valid but not in the best interest of the company holding the NPI.

HudBays 2005 financial report states that Callinan would receive the NPI of net proceeds of production if aggregate cash flow for the year and cumulative cashflow are positive. HudBay reported that cumulative cash flow was negative in 2005.

Collison points out that the 777 project cost more than $400 million and says its possible 777 is not at a break-even point yet.

He says its possible there might be some cash for Callinan by the end of 2007 if 777 continues its success.

But it wouldnt surprise me if there isnt, Collison says.

Through the suit, Callinan also wants declarations that HudBay must maintain separate records for 777 and the Callinan mine, that the cumulative cash flow defined in the NIP agreement and accumulated for the Callinan mine should not be used in calculating the net profits interest from the 777 mine, an order forcing HudBay to make financial records for both mines available to Callinan, an order for an accounting of all sums improperly included or excluded in calculating the net profits interest, general damages for breach of contract and breach of fiduciary duty and aggravated and punitive damages, interest and costs.