SouthernEra Diamonds poised for a comeback

It’s been a while since SouthernEra Diamonds’ (SDM-T, SDMFF-O) share price touched $20 — eight-and-a-half years, to be exact. Since then, its shares have fallen on hard times; in the last year, the highest they traded at was just 62.

But that might soon change. The Toronto-based, diamond-focused company has developed one of the industry’s most aggressive exploration programs. Spanning six countries, SouthernEra has built itself the fourth-largest exploration program of any diamond company in the world. That’s impressive for a company with a modest market capitalization of roughly $62 million.

The building of SouthernEra’s ambitious portfolio is tied to its willingness to take on more country risk than the average company — but then again, SouthernEra has a history of risk-taking.

The company had a strong presence in Angola in the mid-to-late-1990s — when the country was still in the grips of a 30-year civil war. While that investment is nearing a payoff with its Camafuca mine, the company has set its sights on another troubled region — the Democratic Republic of the Congo (DRC).

Canaccord Adams analyst David Dattels describes SouthernEra’s interest in the country as “one of the largest and most exciting exploration land packages in the DRC.”

Under the protection of the UN’s largest and most expensive peacekeeping mission, and a transitional government that has managed to hold itself together against the odds, more companies are venturing onto the DRC’s resource-rich soils — giving SouthernEra’s early entry an air of prescience.

The company staked its ground immediately after the new mining code was implemented in 2003, and it wasn’t long before its kimberlite exploration project caught the attention of bigger fish.

BHP Billiton (BHP-N) eventually signed on for a joint venture for 39 of the permits along the kimberlite emplacement corridor that extends from the DRC southwest into Angola’s renowned Lunda Norte diamond-producing province. BHP can earn a 65% interest by funding the completion of a bankable feasibility study. BHP also became SouthernEra’s largest shareholder — taking a 12% stake in the company.

SouthernEra’s vice-president of exploration, James Abson, says with BHP on board, the development of the kimberlite projects will go two or three times faster than if SouthernEra went ahead on its own. The company will use US$4 million of BHP’s US$8-million cash injection for follow-up sampling and drilling.

To date, the company has identified top-priority targets with kimberlite-like geophysical signatures with diameters ranging from 170 to 175 metres.

In addition to the kimberlite sites, SouthernEra also has alluvial diamond permits independent from its joint venture with BHP. While sampling is still at an early stage, the historically diamond-rich Tshikapa project in the Kasa-Occidental province — the Belgians mined roughly 14.5 million carats in the region up until 1955 — could be generating cash flow for the company as early as 2007.

Thus far, one sample from Tshikapa recovered 164 diamonds weighing a total of 20.35 carats from 10.44 tonnes of material. In addition to prospective river channels in the region, there is also diamond potential within the large alluvial flats. SouthernEra plans to develop a bulk-minable project there. The company says aggressive alluvial testing will continue throughout 2006.

Beyond the DRC, SouthernEra has its hands in Angola, Gabon, South Africa, Zimbabwe and Canada.

Gabon

In 1999, the company made a big entrance in Gabon, acquiring four diamond exploration permits. The company currently holds 100% of the Kango and Sud projects, 95% of the M’bigou project, and 60% of Makongonio. The latter is a joint venture with the Gabonese mining company Cogemat and Geoscan.

Since the onset of exploration in Gabon in 1999, SouthernEra’s stream samples have identified five geographically distinct diamond regions. In 2006, it will focus on evaluating the diamond potential of known kimberlitic bodies discovered in 2004 and 2005, and follow up on kimberlitic indicator mineral stream-sample results that indicate there are still more kimberlitic bodies to be found.

One of the eight bodies already discovered is a pipe measuring at least 80 by 70 metres. It is the first known kimberlitic pipe discovered in Gabon. The other seven bodies occur as wide dykes, up to 21 metres wide. In 2005, an additional six kimberlitic bodies were discovered at Makongonio.

Testing of two rock samples from two different kimberlitic bodies from Makongonio, conducted in Canada, confirmed the first positive primary-rock-hosted diamond results in the region.

The first sample returned one microdiamond from 100.21 kg of kimberlitic material. Another 14 microdiamonds were found in a further 56 kg of material. The second sample returned eight microdiamonds from 100.2 kg of kimberlitic material taken from a 7.5-metre-wide dyke.

Abson says 2006 will be the turning point for Gabon as the company hopes to have a feasibility study done by the end of the year, at which point, it will know if it’s “in or out.”

Angola

Directly south of Gabon lies Angola — a country struggling to regain normalcy, and the place where SouthernEra hopes to finally get its Camafuca project into production.

After years of government delays in granting the necessary permits, the company decided to roll back its interest in Camafuca to 18% from its original 51% stake. Those permits, however, were granted in October 2005, and now all that is needed is more money.

Minex, an Angolan company that holds a 38% interest in the project, is obligated to contribute US$20 million. But until it raises those funds, the project will remain on hold — a frustrating situation given that it is considered to be the world’s largest known kimberlite complex, covering 1.6 sq. km.

Once financing is secured, the project can begin development immediately, likely entering production 15 months later.

While an updated feasibility study is pending — the original feasibility was completed in 2000 — SouthernEra’s guidance puts the diamond value at Camafuca between exchange places US$120 and US$140 per tonne, with operating costs at roughly US$60 per tonne, giving the project a gross margin of US$60 to US$80 per carat. The mine is expected to produce roughly 330,000 diamonds a year.

Endiama, the state-owned mining company, has a 37% interest in the project with Comica, a local company, holding the remaining 7%.

By reducing its stake in the project to 18%, SouthernEra doesn’t have to make any payments in the development stage.

South Africa

With a 56% interest in the Klipspringer joint venture — Naka Diamond Mining is its Black Economic Empowerment (BEE) partner — SouthernEra is waiting for a weaker South African rand before it gets the mine going again.

SouthernEra’s chief executive, Alasdair MacPhee, says if the exchange rate went back to R7 per US$1, the mine would be economic. But with many analysts forecasting continued strength for the rand, MacPhee is considering all of the company’s options.

“We could downscale to 80,000 carats a year and 160,000 tonnes,” he says, “or there’s the potential to dispose of it.”

In 2003, the last year of production, Klipspringer turned out 75,000 carats at a grade averaging 0.4 carat per tonne with an average value of US$81.

The mine has a remaining resource of 760,000 tonnes grading 0.49 carat per tonne for 374,000 carats in the indicated category and 1.66 million carats in the inferred. Diamonds average US$110 per carat.

According to Dattels, if the exchange rate improves to R7 per US$1, Klipspringer could provide a profit of US$29 per carat; that would give SouthernEra around US$840,000 a year in cash flow. It will cost roughly US$3 million to get the mine back into production.

Zimbabwe

Given the grim political outlook for Zimbabwe, SouthernEra is taking a long-term view on its Tsholotsho diamond project.

Recen
tly, Zimbabwe’s Zanu-PF government announced a plan to take a 51% stake in all foreign companies operating in Zimbabwe, only compensating companies for half of what is taken.

“We’re keeping abreast of the situation in Zimbabwe, but we’re not involved in any negotiations. Our presence is fairly low-key,” MacPhee says. “We went in with a long-term view of seven to ten years.”

In 2005, SouthernEra entered into a joint venture with Rockover Resources — a Botswana-based private company with multiple plays in southern Africa — for Tsholotsho. The company can earn up to 100% in the project by funding a multi-year exploration program and by paying a sliding-scale royalty based on the value (per tonne) of a discovery.

Tsholotsho is a 14,000-sq.-km area that runs on the same trend as De Beers’ Orapa and Lethlekane diamond mines. Combined, those mines produce roughly 17 million carats per year.

While the diamond potential in Zimbabwe is well known — to date, over 80 kimberlites have been discovered — only Rio Tinto’s (RIO-N) 200,000-carat-per-year Murowa mine is in operation.

Preliminary sampling in the project area has returned high quantities of kimberlite indicator minerals in clusters. Further soil sampling and ground geophysics are set to follow to identify future drill targets by the end of 2006.

Despite its strong African holdings, SouthernEra has not forgotten where it came from. SouthernEra first started exploring for diamonds in northern Canada, and the company continues to maintain a presence there.

Along with Rio Tinto and Aber Diamond (ABZ-T, ABER-Q), SouthernEra was rooting around near the Ekati mine in the Northwest Territories back in 1992. And while its two competitors now hold the lucrative Diavik mine, SouthernEra discovered uneconomic kimberlite after uneconomic kimberlite.

It’s now hoping that its luck will turn.

Its most advanced project in the country comes by way of its roughly 5% interest in the WO diamond project. The project is 55% owned by Peregrine Diamonds (PGD-V), and has thus far returned favourable mini-bulk samples of 108 tonnes grading 0.98 carats valued between US$57 to US$78. Dattels estimates SouthernEra’s implied value in the project to be roughly $13 million.

Beyond that, SouthernEra has eight other licences in the N.W.T. with exploration ranging from geochemical to aeromagnetic surveying to bulk samples in drilling. The company also has exploration programs in Ontario, Nunavut and Quebec.

With its net cast from southern Africa to northern Canada, investors may wonder if the company has spread itself too thin. But in many ways, SouthernEra’s current portfolio is a return to its roots. In the ’90s, the company had interests in platinum and as many as 10 exploration programs worldwide.

Now it’s focused squarely on diamonds, and even if balancing operations in Africa and Canada is challenging, the company believes it has the stuff to take it on.

“You have to do it carefully so you don’t lose focus,” Abson says. “The key is to be on as many hot properties as you can.”