Donner Metals (DON, TSX) enigma

Issue 14, March 29, 2010 - By James Winston

Donner was our hot pick in December when I claimed it would be an easy double in 2010. By January 17, I recommended that we take some profits off the table and the next day it hit a new high of 37 cents which presented a double. (Clearly that Ouija Board I got for Christmas really paid off!)

Since mid-January, Donner has dropped as low as 26 cents in early February, back up to 32 cents and is now back down to 28 cents. It just goes to show that when you're dealing with these venture plays, it's always smart to take profits off the table especially when you have a double.

With your average mining exploration play, this type of volatility is quite normal. However, Donner Metals is to me something of an enigma. On paper, this stock should be trading considerably higher, perhaps a further double or a triple but it isn't. And therein lies the opportunity.

Let's review again the project which in my mind seems outrageously bullish.

The Opportunity

About six months ago, Donner announced that their blue chip joint venture partner Xstrata Zinc would be fast tracking the Bracemac-McLeod discovery in Quebec to "full feasibility" by June of 2010 thus foregoing Pre-feasibility.

If the feasibility study looks good, the next step is mine development followed by production in 2012.

So why is Xstrata so gung-ho?

Well for starters the Matagami mining camp is already a proven world class mining district where historically 18 VMS deposits have been discovered and 10 mines have been in production. In 2000, Xstrata Zinc discovered their Perseverance deposit (the 11th mine) put into production back in 2008 and is scheduled to be mined out and closed in 2012.

Just 6 km away Xstrata has their Matagami Lake Mill which they spent $130 million refurbishing. So with ore running out in a couple of years they need to MOVE. Assuming the feasibility study is a go, the next step will be to build a ramp down to the deposit from an existing open pit next door. That could start in July of 2010 and would take about 12 months to complete. After that they will have enough time to prepare for actual mining and production starting in 2012.

Given that Xstrata wants to complete a feasibility study on the Bracemac-McLeod project by June so they can continue to feed their multi-million dollar Matagami Lake mill, one would think that Donner's stock would be trading at a much higher premium than 28, 37 or even 50 cents.

I think there are a couple of things going on.

One is that Donner had done a number of cheap financings with institutional fund management groups who are now more then happy to blow out their shares for a few pennies of profit.

Number two, there is a concern in the market that if in June, Xstrata does decide to move forward in building a mine at the Bracemac-McLeod discovery, how will Donner be able to participate in the joint venture interest of the project if they haven't earned their 50% by spending the required $25 million?

When I recently posed this earn in question to David Patterson, Chairman of Donner, he responded by saying: "the option that we have with Xstrata requires Donner to spend $25 million on exploration by May 2011, and we have spent close to $23 million. There is no provision in the option that can force Donner into an early earn-in if it is not in Donner's interest, so if Donner has not secured debt and equity financing then Xstrata must wait for our earn in. Donner cannot be diluted on a project when we have yet to earn our interest, and the May 2011 date is firm in the Donner/Xstrata agreement. We've had so much success that no one considered a scenario where we might make a production decision prior to earn in at Bracemac-McLeod."

So given that Xstrata does move forward in developing the Bracemac-McLeod mine, a couple of scenarios will play out which look rather amazing for Donner shareholders.

The overhang of cheap Donner paper that the funds control will eventually be sold off. If Xstrata wants to move forward with mine, Donner only has to spend another $2 million by May of 2011 and they are in for 35% of the mine's cash flow or perhaps a buy out. Any way you look at it, it is undoubtedly a bullish scenario for Donner.