Kalahari Minerals investment in Extract Resources could deliver a big pay day

With every drilling update released from Extract Resources, it becomes harder and harder to ignore the sheer potential of its Rossing South uranium discovery in Namibia.  Drill results have been flowing thick and fast, with several rigs working their way through Zone 1, and to date the results from drilling has been nothing less than impressive.  Grades and widths of the uranium mineralisation reported this week suggest that Extract are truly sitting on what could be the most significant uranium discovery of recent years, and Rossing South has the potential to be a "world class" deposit - a term we do not use lightly.

It's always interesting to see how the share price of a company that is firing out batch after batch of highly encouraging drill results reacts against a backdrop of doom and gloom in the wider natural resources sector and, for that matter, global markets in their entirety.  Since completing a secondary listing on the TSX in 2007, Extract has swung between 80 cents and C$1.50.  They are currently hovering around the $1.10 mark - a pretty stellar performance compared to many other uranium companies - underlining that fact that Extract does have support.

Valuing an emerging uranium company is never an easy task, and companies of this size almost always receive a "speculative buy" from analysts as there are so many risks that cannot be discounted until the project is far more advanced.

However, with Extract Resources, the "valuation" potential became abundantly clear when George Forrest International launched a bid for Forsys Metals, another TSX listed uranium company with another uranium discovery in Namibia.  George Forrest is paying C$573 million for Forsys Metals, which controls the Valencia Uranium Project.  The Valencia project hosts an inferred, indicated and measured resource of approximately 62 million pounds of uranium, half of that number sites in the higher category of probable reserves.  This implies that George Forrest is paying approximately C$9 per pound of uranium for Forsys Metals.  An updated 43-101 resource statement is overdue from Forsys Metals, but it is not clear now whether this will be released before the company is delisted. 

Regardless, the takeover price gives a rough valuation of what Extract Resource could command from a potential suitor. Extract has already defined approximately 25 million pounds of uranium at Ida Dome, but the focus has switched to Rossing South. At Zone 1, Extract is anticipating a maiden resource of 57.3 - 92.5 M lb U3O8.  However, recent drilling at the southern extension of Zone 1 has highlighted the potential that Zone 1 and Zone 2 to the south could indeed be one system.   Regardless, assuming a maiden resource of 75 million pounds for Zone 1, and adding in 25 million pounds at Ida Dome, but applying a $4 per pound valuation, would value Extract at $400 million - double the current capitalisation.  

Increase the resource to 150 million pounds for Zone 1 and Zone 2, add in 25 million pounds at Ida Dome and apply the takeover price tag per pound for Forsys Metals, and Extract's valuation leaps to C$1.5 billion...members of the mining community looking at the project, believe Rossing South could host up to 200 million pounds.

Potential suitors certainly appears to be lurking.  RAB Capital, the natural resources specialist hedge fund, recently sold its equity stakes in Extract Resources and Kalahari Minerals to Rio Tinto (LSE:RIO).  Rio Tinto in turn has a 68.6% stake in the Rossing Mine, the largest open pit uranium mine in the world, which just happens to lie directly north of Extract's Rossing South discovery.

So high is the threat of Rio Tinto acquiring the company, that a recent proposed merger between Kalahari Minerals (AIM: KAH) and Extract Resources was called off, as Rio would have had a substantial interest in the combined group, and there were fears that it may attempt to push the newco into a joint-venture or other deal to gain access to Rossing South rather than pay a premium to acquire the whole company.  Kalahari Minerals was the driving force behind the merger, and also opted to call off the deal after its own shareholders expressed concerns about Rio's intent.

Kalahari Minerals finds itself in an interesting position. It holds approximately 39% of Extract Resources, and is very keen to maintain or increase on that position. On current Canadian-Sterling exchange rates, Kalahari's equity stake in Extract is valued at £42 million versus Kalahari's market capitalisation of approximately £40 million.  It has two seats on the board of Extract Resources, and as the largest shareholder has considerable say over how Extract manages itself.  Yet at the same time, there appears to be some friction between the companies, highlighted by a request for the chairman of Extract Resources to resign, and a further request that Extract drop its secondary listing in Toronto to cut overheads.   

Kalahari also announced that it had raised nearly £4 million at almost no discount to the prevailing share price this week.  Under Australian rules, Kalahari can purchase up to 3% of Extract Resources every six months. Last March, it snapped up 3% to take its stake to 39%.  It seems very plausible that it is planning to acquire shares again, pushing its stake to 42%.  

With Extract valued a $200 million, but consistently delivering solid results from Ida Dome and Rossing South,  Kalahari is keen to at the very least maintain its interest - that would seem like the best strategy for its shareholders considering the potential upside in Extract's uranium assets.