Why Passport Potash Is Undervalued Relative to Holbrook Basin Peers

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Submitted by Mike Anthony as part of our contributors program .

According to a 2008 geological study by the State of Arizona, there are between 700 million and 2.3 billion metric tons of potash in the Holbrook basin of east-central Arizona. The deposits have relatively shallow depths between 700 and 2000 feet and lie in a 600 square mile area. The potash reserves in the area are worth over $1 trillion.

There are four entities seeking to profit from the potash industry of Arizona's Holbrook basin:

1. Prospect Global Resources ( PGRX )
2. Passport Potash (PPRTF.pk)
3. HNZ Potash of Hunt Oil (private)
4. Native American tribes

Prospect Global operates over 90,000 acres of state and private leases, followed by Passport with 81,000 acres, and HNZ Potash with 75,000 acres. (Native American tribes have small claims on scattered property throughout the basin.)

This article will look at Prospect Global and why it appears overvalued compared to Passport. Because HNZ Potash and Native American tribes do not disclose financial statements or internal reports, they will be omitted from this report.

Valuation And Fundamentals

Potash currently sells for $460 per ton and hit an all-time high of $870 per ton last year. Prices have stabilized and are widely expected to increase over time amid population growth and corresponding demand for increased crop yields.

Prospect Global has 55.3 million shares outstanding with a market capitalization of $153 million compared to 172.8 million shares and a market capitalization of $34 million for Passport. These two companies are comparable in terms of potash reserves and land ownership, yet their valuation gap is four-fold.

Both companies hold similar land packages and expect to reach production by approximately the same time (2016). Based on estimated resources, both companies have significant amounts of potash. According to Passport's NI 43-101 estimate, the company has 3.7 million tons measured, 37.8 million tons indicated and 87.3 million tons of inferred potash at an average depth of 800-1400 feet. By comparison, Prospect Global's mineral resource estimate is 3 million tons measured, 25 million tons indicated and 53 million tons inferred at an average depth of 1427 feet. Passport's potash inferred resource is larger and shallower than Prospect Global's by a healthy margin, although Prospect Global's resource is more definitive due to its more advanced PEA versus Passport's NI 43-101 report.

One reason cited for Prospect Global's higher valuation is the company's prior release of its Preliminary Economic Assessment (PEA) report. This pivotal document is a major milestone in the progression toward mining. In contrast, Passport has completed its NI 43-101 Mineral Resource Estimate (a precursor to the PEA) and expects to complete its PEA during the first quarter of 2013.

Another reason for the valuation gap is that Prospect Global entered into an agreement with Sichuan Chemistry Industry Holding to buy a minimum of 500,000 tons (up to 1,000,000 tons) of potash per year for 10 years. The amount represents about 25% to 50% of Prospect Global's estimated annual production of potash. The problem with this, however, is that it is contingent upon many factors, including payments and negotiations that must occur with Passport (its competitor).

Specifically, over 10% of Prospect Global's proposed mine lies on Passport's land. Another 20% of Prospect Global's proposed mine lies underneath National Petrified Forest land, which will require an additional 5-10 years of negotiation with the federal government. Finally, Passport's land holdings have gatekeeper status for railway access to ship Prospect Global's mined potash to the required ports. It will be forced to negotiate with (and, presumably, pay) its competitor in order to ship its potash to the announced buyer.

Recent Developments

Passport needs only approximately $40 million from now until 2014. Prospect Global, in contrast, has much higher cash needs. Specifically, Prospect Global acquired 50% of American West in August 2012; as a result, the company owes a promissory note in the amount of $125 million to the former owner, the Karlsson Group. Prospect Global needs to come up with $50 million by December 24, 2012 and the remaining $75 million by July 31, 2013. Prospect Global has less than two months to obtain this $50 million and only slightly more time to obtain another $75 million.

At the same time, Passport entered into a joint exploration agreement with a third potash miner in the area, HNZ Potash. According to this agreement, the companies will jointly (50/50) explore and potentially develop 21 permitted parcel, in which Passport holds Arizona State Land Department exploration permits.

Land Permits, Rights and Owernship

When valuing both Prospect Global and Passport, it is important to note the ownership structure and exploration permits. Prospect Global owns via leases the mineral and surface rights of 94,000 acres (157 sections) it plans to explore for potash. Of these, it leases 41 sections from the State of Arizona Land Department (on which it will have to pay a royalty) and the rest from private owners.

On the other hand, Passport owns or leases a mix of mining rights, permits and land as follows:

* owns the mining rights (4 permits) for the Southwest Exploration Property (7,055 acres of Federal land)
* leases the Twin Buttes Ranch (28,534 acres) with an option to buy the land at expiration
* recently purchased the Fitzgerald Ranch (41,564 acres), which is adjacent to Twin Buttes Ranch
* owns 8 permits including rights to mine on Arizona State land that were formerly owned by American Potash (5 permits) and Mesa Uranium (3 permits)
* acquired the Ringbolt Property (9,594 acres and 15 exploration permits), the terms of which are under dispute, although the Utah court has granted the company's request for preliminary injunction and Passpor is still defending its rights under the option agreement

Overall, Passport has 78 Arizona State Land Department exploration permits (45,726 acres) and has a full/partial interest in 132 private land sections and prospecting permits on Federal land as discussed earlier (full list of permits).

Outlook

Both Prospect Global and Passport have comparable potash resources (if anything, Passport's holdings are shallower and therefore cheaper to mine). Furthermore, Passport has several advantages over Prospect Global, including massively lower capital needs at this point ($40 million versus $125 million by 2014). Prospect Global will also need to negotiate with a competitor in order to access a train line while also building about five miles of railroad tracks in order to connect to that line; Passport has no such needs. Lastly, Prospect Global's proposed mine lies partially on the land of the federal government and a competitor, which are significant operational risks.

Of course, both companies have tremendous upside potential iof they achieve mining status. U.S. potash peer Intrepid Potash ( IPI ), with operating mines in Utah and New Mexico, has approximately 103 million proven and probable tons of potash and 50 million tons of langbeinite as of the end of 2011 . Its recent market capitalization was $1.65 billion. (Both Prospect Global and Passport command less than $200 million of combined market capitalization.)



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas , Stocks , US Markets

Referenced Stocks: IPI , PGRX , POT , PPRTF , RIO

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