C79—a speculative investment---changing gold assay sampling

First, C79 is a speculative investment. Broadly, I define these as having a likely large dispersion of outcomes around my base case, which could include permanent capital loss. For this reason, the positions are below 1%, usually well below, and could be described as tracker positions. The story will become more certain as we get more data points, and if the SP remains attractive I will be willing to increase the position. That said my record in speculative investments is well below investing in the more mature record. The potential reasons for that I will leave to another post! Lol

C79 (Chrysos Corporation) began as a CSIRO-funded venture to develop an alternative to fire assays that sample the attractiveness of gold deposits. The inventor, James Tickner is still with C79. The CSIRO involvement does give me some confidence that the technology has some substance.

The company has moved on and listed in 2022. The aim is to replace as much of the fire-based assay technology currently used by gold miners and lab operators. The technology is promoted as safer, quicker and more accurate. The pricing is to match the existing fire assays and the customer has the benefit of the other advantages.

Total Addressable Market (TAM)

C79 identifies 610 possible sites for its units. These are split between 200 lab-based units and 410 site-based units. The labs are the large testing operators such as SGS and ALS, there are four major labs. The site-based units are directed to the larger mines that can sustain a unit on their own (defined as 40kg/pa). Management has indicated that they wish to capture 100% of the market. There are several issues with this likelihood. Firstly the units are $4m each and are leased out by C79. That means they are on the C79 balance sheet, for the time being anyway. There is the logistical process of building, selling and locating these units, some in remote areas. Secondly, the patents associated with the technology expire in 2032. Possibly that could see a competitor enter the market, although as would be expected C79 are already patenting more ancillary technologies and processes. The ability to keep out competition is unknown in the medium term. 100% replacement is possible but probably not likely and I have ended up assuming 60% (360 odd) in 20 odd years. Which sets a doable but not easily achievable limit. The number of units deployed so far is 31.

Unit Economics

Management has stated that the ROI they are experiencing and pricing for their units is 50-80%. That is a very attractive return. The leases are long-term and designed to offer good and safe returns for C79 through take-or-pay arrangements. The upside comes through extra volumes. These are priced at lower marginal pricing. The marginal cost for C79 is very low. The ability to capture that upside gives the range in the ROI. C79 is exposed to the overall health of the gold mining industry although not explicitly exposed to the gold price. GMs are in the 70-80% range, very attractive. On the last call management indicated that since fire assays are exposed to labour, energy and consumables costs, that will increase over time, C79 will follow. Management also indicated that as they assess the increase in mine productivity that is expected over time using their technology, those gains are expected to be shared with C79. we shall see.

Overheads

A perennial issue with smaller companies is the level of overhead required to sustain and grow the business. that overhead has to be deployed ahead of profits therefore delaying profitability. Secondly, overheads, at some point must stop growing as fast as the top line for operating leverage to occur. C79 has stated that the S&M, product development and G&A costs have largely been put in place and increases should be incremental from here. C79 has also stated that when they enter a new geography diseconomies occur due to service levels (costs) needing to be put in place before units are deployed to cover the cost. The overhead run rate is about $30m pa. the costs will increase but are now expected to lag revenue growth and with the high GM’s, overhead coverage or fractionalization of the cost base should occur from about now.

Funding

C79 has about $45m in cash and $95m in debt facilities (undrawn) from CBA. We can see a race between the capex involving $4m per unit and increases in overhead to expand the business offset by the high incremental return on capital deployed. There is a cadence in which the deployment of units becomes self-funding. If everything goes well there may not be any further requirement for equity, however, clearly, there is a large build required if all 610 units are deployed at $4m each of $2.4b. It will take some careful timing and some luck will be involved. I am not overly concerned with the funding if the requirement is due to huge demand for the units but not, for example, if funding is required to cover a blowout in overheads. I have assumed debt running at $45m average for ten years, 8% pretax cost. This is a guess and it is not significant to the valuation. A large equity raising would be impactful for the valuation.

VALUATION

The critical drivers are 1. Units deployed 2. Unit economics holding and 3. Overhead cost stabilisation. If units are deployed as management expects, the value balloons out if unit returns hold and overhead growth slows. My valuation is $11-12. Maybe you could say the same for every speculative investment. The above are the main factors to monitor, IMO.

Inverting the current SP means almost no growth is assumed but the current ROI holds.

The C79 is mostly dependent on maintaining a high ROI. If it is reduced to 25% (halves), there is little extra value apparent in my numbers. If ROI falls it opens up a whole range of issues. One of the main risks is that as the business expands it encounters customers who don’t see the value and either want a discount or don’t participate, either is bad but lower returns are a much larger issue.

Disclaimer – This is not advice and could contain errors. My success rate in speculative investments is below my average, beware. lol