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BIG PICTURE - Does Paragon Diamonds re-rating reflect the full potential of twin Lesotho projects?

Published: 19:15 11 May 2015 AEST

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The operation comes with a processing plant, which will be upgraded, and the seller has developed some of the mine infrastructure already.

The appointment of Philip Falzon Sant Manduca as chairman of Paragon Diamonds (LON:PRG) has led to a sparkling revival of the share price, which is up 72% since last August.

But, given significant corporate developments seen under his short tenure, there is an argument that the re-rating, which values the business at £17mln, underplays Paragon’s potential.

For the company is at the point where it now has two projects in Lesotho that are fully financed and on track for cash generative production later this year.

The stock, currently changing hands for just over 6p, is worth 12.9p, according to Northland Capital, although this price target was calculated before Paragon acquired the Mothae kimberlite for US$8.5mln.

That deal, as we’ll see, could be transformational if Manduca and his team get the execution phase of their strategy for Paragon spot on.

On May 5 the AIM-listed explorer and developer said it had signed a memorandum of understanding with the Lucara Diamond Corp of Canada to acquire Mothae, which is close to its Lemphane project and just three miles from the world-class Letseng mine, owned by Gem Diamonds (LON:GEMD).

Lemphane and Mothae will be constructed in tandem “at the lowest possible cost to benefit from economies of scale” and will go into production in the third quarter of the year.

Expected revenues from the first full year of production are put at US$36mln, while the cost of bringing Mothae online is expected to be US$8mln.

This sum, as well as the acquisition cost, will be financed by Paragon’s Dubai backer, International Triangle General Trading (ITGT), which has already committed to a US$12mln debt and equity package to start up Letŝeng.

It means the development capital has been secured at no additional dilution to existing investors.

Paragon is acquiring an exciting asset in Mothae, which contains an indicated and inferred 39mln tonnes of ore at 2.7 carats per hundred tonnes.

These are large, high value diamonds with 14 recovered in excess of 10.6 carats and one touching almost 57 carats. The asking price can be anywhere between US$5,482 and US$41,869 per carat.

Stones of this quality are known as “investment grade diamonds that are used as a surrogate for cash”, according to Paragon's chairman Manduca.

Broker Northland said a size frequency distribution analysis on diamonds recovered from Mothae’s southern lobe indicates that 15% of the diamonds can be expected to be larger than 10 carats and 2% above 100 carats.

This is comparable to Lemphane where 12% of diamonds are estimated to be larger than 10 carats and 1% larger than 100 carats.

The mine economics, meanwhile, are attractive. Mothae’s net present value is estimated to be US$115mln – discounted at 12% over 13 years - while the internal rate of return is put at 116% for an initial 750,000 tonnes a year operation, rising to 2mln.

The operation comes with a processing plant, which will be upgraded, and the seller has developed some of the mine infrastructure already.

Chairman Manduca told Proactive Investors: “It [this deal] is so important, particularly in an environment where it is well known that no new kimberlite diamond mine for over 20 years.

“So, to be able to acquire one and effectively double our production is not only against the scientific trend in the industry, but is incredibly important for Paragon in terms of its size.

“It re-rates Paragon, it de-risks Paragon and it establishes Paragon as a mid-size, excellent prospect diamond company.”

In the same announcement Paragon revealed plans to offload its Motete dyke project, also in Lesotho, to a company called NFL, which will invest around US$1.5mln developing it.

Both Northland and the resources boutique SP Angel said there are risks of developing two projects at the same time, but there are synergies and cost benefits to be gained from doubling up.

“Paragon’s retention of the management team in Lesotho provides not only continuity benefits for Mothae but also the efficient use of quality personnel for Lemphane,” said Northland analyst Ryan Long.

Holders of the stock will be hoping Manduca and his team can pull off this seemingly daring feat of logistics.

If they do - and hit their production targets - then 6p is likely to be little more than base camp for this stock.

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