Jan 30th 2013

The response to the most recent article citing the flaws and weaknesses in Jaguar Mining (JAG) has been somewhat of a disagreement in nature, primarily because a merchant bank agreed to provide the company with a $30M loan facility, of which the company already withdrew $5M onJanuary 25, 2013.

For some investors, the confidence illustrated by the merchant bank is a sign that better things are coming in the company's direction as the investment bank is more sophisticated in its due diligence and commitment of capital. Therefore, some investors have taken the loan as a sign of confidence, strength and a reason to commit new capital by purchasing additional Jaguar shares.

This notion might be true; however, the company's performance and margins speak for themselves as clearly outlined here. These particular investors failed to examine the other side of the story, conveniently the side that spells out the weakness that is clearly apparent in this loan facility. Were the company's mines profitable at current production levels and gold prices, the company would not need to dig into the loan facility as it already did. Using the facility simply means the company is not generating enough funds to finance its operations, which include the purchases and maintenance of equipment, a cost that is capitalized and not expensed as many seem to think. Once one adjusts the company's margins to capital expenditures taken by the company, one will notice why the company is in need of external financing and cannot sustain itself with cash flows generated by operations.

Similarly, the notion that the due diligence of an investment bank is so superior that an investment on the part of that particular institution is worth imitating could not be more removed from reality. These institutions might be more sophisticated in their due diligence than retail investors; however, they experience their fair share of misfortunes and losses.

For instance, Great Basin Gold (GBG) which trades on the NYSEAMEX and reported to have 12.6M ounces in measured and indicated resources in its South African mine, received a financing of about $57.5M in early 2012 from a syndicate of underwriters. Some members of this group of financiers include large financial institutions eclipsing the merchant bank that provided Jaguar with the loan facility. Using the logic used by the investors mentioned above, this would have been an excellent opportunity to invest in Great Basin as the due diligence taken by these institutions is perceived to be flawless. Unfortunately, the company proceeded to experience increased operational challenges and never made it to profitability. Great Basin shares are now in the process of being delisted from the NYSEAMEX and its creditors have commencedproceedings to recover their funds leaving shareholders with the disaster well illustrated in the chart below.

(Click to enlarge)

This is not to say that Great Basin's fate is Jaguar's fate -- not at all. The Great Basin example simply illustrates that the confidence some shareholders hold in the loan (which is senior to common shareholders claims on company assets) advanced by an investment bank is misguided. Investors interested in investing in Jaguar need a clear sign that the company can be profitable and cash flowing before dedicating any more new capital to the company's shares. This means that the company's mines need to produce at levels that contribute free cash flows; a figure easily calculated using the company's financials. This is the sign investors should be setting their sights on for an indication of the company's strength and not the award of a loan facility by a bank.