McEwen’s Funding Model Threatened by Argentinian Law

Argentina’s repatriation law may create challenges for McEwen Mining‘s (NYSE:MUX,TSX:MUX) El Gallo project in Mexico. On a conference call aimed at discussing the matter with shareholders, McEwen executives revealed that their internal funding model is in jeopardy.

McEwen Mining operates under the premise that if a company that has a cash flow is connected with a company that has development projects, a stronger company can be built.

McEwen owns a 49 percent stake in the San Jose mine in Argentina, with Hochschild Mining (LSE:HOC) owning the remaining 51 percent. That operation has seen four consecutive years of resource growth. In 2011, it produced 5.9 million ounces of silver and 80,000 ounces of gold.

El Gallo is a McEwen asset located in Mexico that the company intends to construct in phases. According to McEwen executives, Phase 1 is currently within budget, on schedule, and expected to go into production in July.

Phase 2, for which a feasibility study is being conducted, is expected to increase that production by 5 million ounces of silver and 40,000 ounces of gold. The potential problem with this plan is that McEwen intended to invest funds from San Jose into the second phase of this project, but is now unsure whether that will be possible.

In October, Christina Fernandez de Kirchner was re-elected as president of Argentina. Her administration is described as one with “high growth, high inflation policies.” Shortly after her victory, the government announced that oil, gas, and mining companies would be required to repatriate their export revenues.

Repatriation requirements for San Jose are estimated to have an annual pre-tax cost of approximately $2 million for the partnership based on anticipated revenues of about $340 million.

As this is a small amount, less than one percent, some shareholders initially seemed unclear as to what exactly McEwen is concerned about.

Currently, as the law is understood, once the metal is sold, the funds will be repatriated to Argentina and must be converted into pesos before being used in the course of business. Those pesos can then be converted into another currency if the company so chooses. McEwen executives claimed to be unaware of any regulations that currently prevent the flow of the converted funds out of Argentina. However, they are concerned about the possibility of not receiving cash flow as anticipated.

At the beginning of the conference call, Executive Chairman, Director, President, and CEO Rob McEwen apologized for not foreseeing changes in Argentina that create a large amount of uncertainty and place the company’s internally-funded model at a disadvantage.

The changing of the repatriation timeline creates uncertainty as to what possible next steps may be taken by the government, he said.

McEwen was referring to events outlined by Andrew Elinesky, vice president of McEwen for Argentina.

After the repatriation announcement in October, Elinesky said importation was hindered by a pre-clearance requirement in February that slowed the majority of imports in Argentina.

In April, the government took control of 51 percent of the oil firm YPF. That month, the government also changed the repatriation timeline to 15 days from the time of export from the original 120 to 180 days.

In May, the government issued further clarification that repatriation was to instead occur 15 days from the collection of revenues.

This, Elinesky said, was followed by a report from Bloomberg that five senior producers were instructed to formulate a plan to replace the importation of products with those manufactured in Argentina.

These events and other elements highlight the challenges faced by the Argentinian government in managing their economy, he said. And, this uncertainty causes the company to believe its internally-funded model is in jeopardy.

While McEwen executives did not elaborate on what will happen in the future, it was clear from shareholders’ questions about the potential of money getting trapped that there are concerns about McEwen’s ability to get money out of Argentina in the future.

In October, Bloomberg reported that capital flight from Argentina was estimated at about $3 billion per month. Even beyond McEwen, there are many who have expressed the belief that the repatriation requirements are an attempt to control those outflows, and further regulations may follow.

Though McEwen recognizes the situation in Argentina as a nasty bump in the road, it is not going to put the company down. Shareholders were told that the worst case scenario is that without Argentina, the company will have to go back to the market and look for about $150 million.

In the best case, the confusion around policies will get resolved, revenues will resume, and though there there may be a reduction, operations will go on as planned.

If this situation doesn’t play out in a favorable manner, McEwen said the company is blessed with a number of properties that are of long life and such size that they are of interest to a large number of players.

The company has already entertained discussions about partial or full sale of Los Azules, a copper project in Argentina that could provide some or all of the funding needed to carry out business, according to McEwen.

The company executives did not announce a concrete alternative strategy to their internal-funding model. Shareholders were, however, assured that the company has sufficient funds to continue operations for at least about twelve months. They were also reminded that McEwen has $110 million invested in the company. He does not draw a salary.

Securities Disclosure: I, Michelle Smith, do not hold equity interests in any of the companies mentioned in this article.