Pan American Silver Corp

Source: Exec Digital Canada

Date :5/23/2007 11:38:32 AM

Pan American Silver Corp: Silver Lining

Silver mining is a complicated dance, but it’s one Pan American Silver Corp. has mastered

In twelve short years the Pan American Silver Corp., based in Vancouver, British Columbia, Canada, has become one of the largest primary producers of mined silver in the world and intends to be the largest this year. To say the least, it is no easy task to have climbed such heights in such a short period of time as there are a number of moving parts within a company based in Canada, but whose mining facilities are located in Mexico and South America.

Further, mined commodities, which include silver, operate in markets with significant fluctuations that must be anticipated as new silver mines are sought and brought online by the company. It is one thing to have a producing silver mine, but the trick is pulling enough silver from the ground in a manner that is profitable when silver prices are waxing and waning. In short, can you grow and operate profitably during down cycles in the price of silver?

“Investors interested in the silver market can choose from about eight or nine silver companies as to which is the best silver mining company, and that is where, as a publicly traded company, we interface with the market,” says Geoff Burns, president and CEO of Pan American. “Our job is convincing the investor community that we are the best share to buy if they have a desire to get into silver within the precious metal stocks.”

How they do it…

Pan American operates under the stated mission of being the best equity vehicle for investors seeking exposure to higher silver prices. What this means, says Burns, is that the company could be thought of as a proxy for buying physical metal. When investors buy into the company through stocks they are purchasing a piece of the annual production of the company, which is silver, as well as a piece of their reserves and resources in the ground.

How the company maximizes the investor’s exposure is by increasing production, increasing the company’s reserves (meaning the amount of known, but as yet mined silver within the company’s holdings) and producing silver so that they are profitably selling that silver no matter what the spot market price is.

The company does not go the last mile of silver production, meaning they don’t smelt or refine the silver down to a purity that is commonly known in the industry as the four nines – 99.99 percent pure silver. Rather, the company mines ore from the ground and processes it into one of two products. The first is called dore, which is raw silver ore that has been taken at least part of the way toward the four nines and it is in bar form. Those bars are then sent to a refiner, where its purity is increases to 99.99 percent.

The second is called concentrate, which is sold to smelters who pay Pan American for the silver and base metal content contained in the concentrate.

Therefore, what investors are purchasing is a piece of the profit derived from mining the silver ore from the ground, processing it into one of the above two forms, and then selling that to refiners or smelters.

When asked how Pan American defines being the best equity vehicle for investors looking for exposure to the silver market, Burns says the company’s success can be measured against four criteria.

The first is to be the largest primary silver producer in the world. In other words, Pan American must be able to produce more ounces of silver than any other primary silver producer. By “primary silver producer,” Burns is saying that the principal product they mines is silver rather than some other commodity that yields silver as a by-product to production. For example, it is common to find some deposits of silver within zinc mines, so silver would be the by-product of a primary zinc mining operation. Burns says the company should out-produce other primary silver miners by the end of 2007.

The second is to be the lowest cost primary producer. “In 2006,” Burns says, “our cost to produce an ounce of silver from exploration to mining, processing and then to actual sale, that entire cost profile, we were clearly the lowest cost producer in our peer group.”

The third criterion is production growth. Pan American has been able to increase its annual production for every year over the past twelve years and is on track to keep that trend going for at least the next three years.

Lastly, the company wants to maximize its shareholders’ exposure to silver by remaining completely un-hedged, which gets back to the goal of remaining profitable during down cycles in the price of silver as well as when the price climbs. If the company is profitable when the price ebbs, then they will be more so when the price climbs.

To understand how the company goes about achieving the above criteria, especially while remaining profitable throughout price cycles, Burns says it is important to broadly understand the silver market. The annual world demand for silver is approximately 900 million ounces. Approximately two-thirds of that demand is met from mine production. Of that two-thirds, approximately 60 percent come from mines where the primary production is something other than silver, such as zinc or copper or some other mined commodity. The remaining one-third of mined silver supply comes from primary silver mines.

There is a market dichotomy between the two sources of mined silver (either from primary silver producers or from other commodity miners), which challenges Pan American and other silver miners. The silver that is mined as a by-product to other commodities comes into the market as price inelastic, says Burns. This means by-product silver is going to be mined and sold into the market no matter if the price per ounce of silver is $4 or $8 because the primary mover for that silver is some other commodity. This is of particular significance to a primary silver producer because, says Burns, “realizing that there is a lot of silver coming into the market that is inelastic, you have to be a low cost provider.”

Therefore, what it costs per ounce to mine and process silver ore from a particular mine determines the ability of that mine to remain profitable during silver price cycles. “When we bring a mine into production we rarely say, ‘Gee whiz, the price of silver today is $13 per ounce so we can make money because this is a $10 per ounce mine.’ We very much look at the long-term cyclical nature of the price and only bring mines into production that are going to withstand the down cycles. If they can do that, we make a very healthy profit at times like now when prices are high” Burns says.

There are plenty of silver producers seeking to take advantage of the cyclical nature of the product when prices are up, but only mining companies that are solidly constituted can ride both parts of the cycle, according to Burns.

Competing to be the Biggest and Lowest Cost Producer…With a total of seven mines in production, and another on the way, Pan American has grown to be one of the biggest primary silver mining companies in the world. Of the seven operating mines, four of them are in Peru, two in Mexico, and one in Bolivia. The company’s eighth mine, which is currently under construction, is in Argentina.

Burns says the primary consideration for focusing its operations in South America and Mexico is the simple fact that these regions are rich in silver deposits. “Peru is the largest silver producing country in the world,” he says. “Geologically, its segment in the Andes Mountains has been blessed with lots of zinc, copper and silver. If you want to be in the silver game you have got to be in Peru.”

Mexico holds the second largest silver producing nation, Burns notes.

Considering other regions of the world, he says, Africa has no significant silver mines; and while there are a few in Russia and China, the mining industry in those countries is not as well entrenched. The United States and Canada have some significant silver deposits, however, due to what he characterizes as “unsubstantiated and undefined” environmental concerns it is difficult to develop and operate a profitable mine.

It is interesting to note that Pan American has managed to evolve into a preeminent mining company in a relatively short period of time. Founded in 1994, the company has moved fairly quickly to expand its operations. Asked how they have managed to do this, Burns says it is simply a matter of focus and talent. “It comes down to your ability to identify assets where you can add value,” he says. “In our case, it is to purchase those assets then in turn implement the plans to add the value you recognize were lacking in those assets.”

Pan American was founded when the price of silver was rather low. At that time there were a number of mines and mineral properties that were available at a rather modest price. Seeing an opportunity, the founders of Pan American set about the task of identifying properties or mines where there were silver reserves or opportunities to expand production that perhaps the owners did not see, and where the company felt it could add value and expertise to bring economies of scale in order to reduce the cost profile.

Burns says they were very astute at finding mines where the above elements were in play. As an example, he sites their Huron mine in Peru. Pan American bought the mine from a competing company after it had shut it down because they couldn’t see how to profitably continue mining at that site. “Our view was that there was a significant unexploited resource still in that mine,” says Burns. “We bought it for a very modest price, invested in the infrastructure to reopen it, and now that mine has probably a 20 year life in front of it and is one of our best producing assets.”

Critical to being able to do the necessary due diligence to make such astute purchasing decisions is having a strong team of people with the expertise to recognize various opportunities. Burns notes, that Pan American has cultivated a core group of individuals with the necessary technical and operating expertise.

There are approximately 30 mines that Burns says could truly be classified as primary silver mines. Then there are a number of exploration projects that might have the potential to become silver mines. “Our team here is absolutely aware of each and every one of those assets and knows the location, the ownership, the reserves, and processing characteristics and is able to take a view on whether there is an opportunity at any point in time to add value to those assets,” he says.

What makes Pan American so capable when it comes to finding mines with silver reserves that can be taken from the ground in an economical manner is that they simply have the best technical team available, Burns says. “We are running seven mines with an eighth being built. There is no other primary silver producing company that has more than three mines so, by default, that requires us to have a level of expertise and sophistication of systems to operate eight different properties. It is marshalling that expertise and focusing that expertise on acquisition opportunities that give us the advantage,” he says.

How Pan American built up its team of the best and the brightest is almost a by-product of the tight knit community of technical experts within the industry. According to Burns, mining is a relatively small fraternity. There may be many mines, but the people with the technical skills to find and run them are relatively limited. For Pan American, the key was initially attracting a core group of ten or twelve people with international experience who also were keyed into the network of other technical experts from which they could draw upon. “Through this networking process,” says Burns, “you can create a very competent technical group, financial group, and legal group.”

The first means to attract an expanding core of experts across a number of disciplines, says Burns, is to establish a company that has a reputation for its growth and has a vision for the future. People want to work in such an environment and are motivated by being part of what Burns describes as the premier primary silver mining company in the business.

The next piece for attracting and retaining the best and the brightest is that people are truly empowered at Pan American, says Burns. “We have a head office staff of 19 people and I hazard to guess that of any company our size that would be the smallest staff by 50 percent,” he says. “And we are not going to make decisions by committee. People are empowered to do their jobs and make decisions and the reward for the company is that people love to show off what they can do.”

Of the company’s 5,500 employees, Burns says there are approximately 70 between each of their operations who make up the key management group that runs its operations. Within this management group are the managers for each of the countries the company works in. According to Burns, Pan American is a relatively decentralized organization in that each country manager is designated with the task of running their business in their respective country. The corporate headquarters in Vancouver provides technical support, review, allocation of resources and is the point of interface with the public markets, but each manager is responsible for profit, community relations, government relations, safety, and employee development in their respective country.

Looking to the Future…

Given their goal of continuing on the path to becoming the largest and lowest cost silver producer in the world, Burns said there are two key challenges they must continually work to overcome.

The first gets back to having the best possible technical staff. There was a very long downturn in the silver market during the late 1980s and early 1990s and during that time a lot of very qualified people simply left the industry to pursue more fruitful labors. During that time there was also a lack of new talent entering the study of geology, metallurgy, and the other technical disciplines that feed the industry. “There is a currently a shortage of people,” says Burns, “but our clear advantage is that we have largely built our team.”

The second area of challenge is in the public’s perception of mining as an environmental problem. Burns says that such an attitude might have been fair about 40 years ago when mining practices were not nearly as sensitive to the economic impact mining has on the land. But, he argues, the same could be said of cars, sewage disposal, and a great many areas where practices are far more accepted as moving forward to reduce environmental impact.

“Mining has come a long way in how the environment is treated, the way the land is disturbed and how we leave it when we are done,” says Burns. “We are an easy target because we’re not in a city; we are out in the wild. People love the products we produce, but the conundrum is that to produce them, miners are cutting down trees and disturbing the earth to build a mine. In North America and to some degree in Europe miners have almost been pushed out of business by the environmental lobby.”

To counteract the public’s perception and to ease the minds of the people living in the communities near their mines, Pan American makes great efforts to fully communicate their environmental policies and to listen to and resolve the concerns of their neighbors. It is an arduous and time consuming process, but it is one that Burns says is critical to giving assurance to people that they are a responsible mining company with the interests of the environment and their neighbors in mind. “We have won the environmental battle because we have cleaned up our practices,” says Burns, “but winning the public perception battle is something we are still working on and is a critical thing for us to do.”