Bre x michael de guzman

Bre-X, Indonesia A Short Case Prepared by Professor Heather Elms

(this case is a synopsis of Deborah Spar’s 1998 Harvard Business School cases

“Busang: River of Gold (A), (B), & (C)”) In early 1988, David Walsh formed Bre-X Minerals, Ltd. and listed it on the Alberta Stock Exchange. Walsh was a Canadian, who after taking finance and accounting classes at night while working the investment desk at a small financial trust company (1963), had become the head of the firm’s investment department (1969), and by the early 1980s had been recruited as VP for institutional equity sales at Midland Walwyn Capital, Inc., a larger and more prominent company. In 1984, Walsh left to start his own company--a junior mining company he eventually called Bre-X. At first he focused on oil and gas properties in Louisiana, but found them uneconomical—and instead focused on goldfields in northern Quebec, including the claims he established there into the new company, and hoping to raise the capital he needed for exploration. From 1989-1992, there was little activity in Bre-X—the stock traded at around $0.27 per share, and going as low as $0.02. In 1993, Walsh and his wife declared personal bankruptcy, but shortly thereafter, Walsh contacted an old mining friend, John Felderhof. Felderhof was a Dutch geologist who hade been in the mining industry for over 20 years and in multiple locations: Canada, Africa, Australia, Indonesia, and Papua New Guinea. In the latter, he had co-discovered the Ok Tedi copper deposit. In 1986, Felderhof had met Michael de Guzman, a geology graduate from Manila’s Adamson University, and the two had explored Indonesia (Borneo in particular) on the theory that gold deposits might accumulate at fault lines. They had little success, at least partly attributable to the “exceedingly arduous nature of the surveying and exploration: Borneo, covered in mountains and thick tropical rainforest, and for one of the least hospital environments in the world. It receives up to five feet of rainfall a year, and is sweltering hot in the summer months. Roads are few, and malaria is rampant. Felderhof reportedly contracted it 13 times.” (Spar, 1998: 6). When Walsh contacted Felderhof in March, 1993, Felderhof was evaluating several properties in Borneo with de Guzman for Montague Gold NL, an Australian mining company. One of these properties, in an area referred to as “Busang”, was virtually untouched, and while remote and hilly, de Guzman (after spending a week surveying the terrain and collecting gold samples), wrote a favorable report on the property, estimating that it could contain 2-3 million ounces of gold. But Montague Gold (which at the time was scrambling even for exploration funds), was willing to sell the property, along with two sites on the islands of Sumatra and Sulawesi, for $180,000. While several companies had looked at the site and passed on the purchase, Felderhof and de Guzman still felt it had potential, and after spending a week reviewing mineral prospects on Borneo, they and Walsh decided that perhaps mining companies were pulling out of Indonesia too quickly, and it might be an opportunity for Bre-X to acquire claims on potentially high value areas.

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Walsh was able to raise an initial $200,000 at $0.40 per share in Bre-X just from friends and colleagues to purchase the properties from Montague Gold. While difficult on only a limited budget given the terrain, Bre-X drilled its first holes in September, 1993. Shortly thereafter, in December, 1993, Barrick Gold Corporation, an integrated Canadian mining company (one of the biggest integrated gold mining companies in the world), offered to buy majority control of the property. Junior mining companies were referred as such relative to integrated mining companies, like Barrick Gold and Freeport-McMoRan (the two top integrated mining companies also active in Indonesia at the time), because integrated mining companies had the capital and expertise to build and operate a large scale mine. Junior mining companies instead specialized in exploration, and the integrated companies would then buy any finds. Walsh, refusing to give up control of the property to Barrick, instead offered it 14% of Bre-X for $500,000, but Barrick walked away. Another Canadian-based mining company, Teck Corporation, also expressed interest, but Walsh eventually worked with Toronto brokerage house Loewan Ondaatje McCutcheon Ltd. to secure a $4.5M private placement for Bre-X, providing the money to continue exploration. “Bre-X spent the rest of 1994 drilling on the Busang property, following the gold in the ground. As Felderhof recalled, ‘We stepped out one kilometer and drilled five holes 150 metres apart. Each time, we found traces of gold. We stepped out another 1.75 kilometres and drilled seven ore holes. We got a hit each time.’ By March, 1995, Bre-X shares were trading at $2.05. The trail led Bre-X to the western edge of the Busang property. And here they found the dome [which they Felderhof and deGuzman believed lay at a fault-line crossroads]….The dome, however, lay almost entirely outside the property for which Bre-X had the necessary approval for exploration and drilling. It lay instead just southeast of the Busang property, on land abandoned by Australian interests after the 1987 stock market crash. Bre-X’s official announcement of the dome was associated with the stock rising to over $14 a share. Busang obtained the necessary exploration and preliminary drilling approval (the KP, or Kuasa Pertambangan), as well as for continued exploration and limited drilling (the SIPP), and applied for permission to engage in deep drilling (the CoW). Bre-X engineers continued the exploration, and began drilling in what they now referred to as Busang II. By December, 1995, Bre-X quoted reserves of 10 million ounces, and expecting to prove 30 million ounces within a year, and the stock had risen to $50 a share. Analysts suggested the reasonable possibility of 40 million ounces. In January, 1996, Bre-X confirmed 30 million ounces, and the stock price rose to over $160. In March, 1996, Bre-X admitted the property might contain even 50 million ounces, and gossip within the trade suggested 100 million ounces might be more likely. By May, 1996, shares were at $287, and in July, samples provided evidence of as many as 47 million ounces of gold in Busang II. In addition, Busang II’s geological formation allowed for open pit mining, which was both easier and cheaper to operate than an underground mine. Busang II could be both one of the biggest (it already ranked 2nd after Freeport’s Grasberg deposit of 82 million ounces), and one of the lowest-cost gold mines in the world.

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“As the size of the potential discovery grew, however, so did the scrutiny of the world’s biggest mining houses and the Indonesian government…Barrick began leveraging its own formidable resources. One of these was an international advisory board that [Peter] Munk [Barrick’s founder & CEO] had established in 1995. The board included former Prime Minister Brian Mulroney and former President George Bush. In June 1996, Ida Bagus Sudjana, Indonesia’s Minister of Mines and Energy, and Kuntoro Mangkusubroto, the Ministry’s top technocrat, were invited to Toronto to promote the Indonesian mining industry. During their visit, Sudjana received a letter outlining Barrick’s interest in Busang. It was signed by Brian Mulroney…..On September 22, former U.S. President Bush sent Indonesian President Suharto a letter outlining Barrick’s abilities.” (Spar, 1998: 10-11). Hoping to at least avoid a forced merger with Barrick, Bre-X announced that it would consider selling a controlling interest in Busang to a major mining company, and hired J.P. Morgan and Republic National Bank as financial advisors. In the meantime, however, “Excitement over the Busang reserves had engendered resentment among some Indonesians, who questioned the right of foreigners to exploit such a valuable resource. Political forces within the country had begun to express their displeasure to the Indonesian authorities, pressuring them to restrict Bre-X’s control over the Busang field.” (Spar, 1998: 2) Although widely considered an authoritarian leader who used his power to promote family and friends, President Suharto “nevertheless presided over a substantial liberalization of Indonesia’s economy and a remarkable surge of economic growth. Between 1980 and 1992, the country grew at an impressive average annual rate of 6.5%, boosting substantially the living standards of most of its 200 million citizens. Eager to join the ranks of the world’s fastest growing economies, Suharto aggressively opened the economy in the early 1990s, loosening regulation and privatizing a number of formerly state-owned enterprises. He also reversed decades of commitment to an import substitution policy, and began instead to court foreign investors and the international capital market.” (Spar, 1998: 2). On November 12, 1996, Minister Sudjana announced that Bre-X and Barrick had 8 days to reach a contractual agreement concerning the details (including compensation) associated with the following arrangement: Barrick would obtain a 67.5% stake in Busang, Bre-X would keep 22.5%, and the Indonesian government would take the remaining 10%. Case Analysis In 1993, Bre-X “had been just another junior mining company, looking for mineral deposits in the jungles of Indonesia” (Spar, 1998). Now it was a successful one on the verge of losing control. What should Bre-X do? In the short-term? In the long-term? Be sure to consider the sources of Bre-X’s success (i.e., both resources and capabilities), as well as those of Barrick (and the other integrated mining companies), and even those of the government.

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Exhibit 1: Indonesia’s Estimated Gold Deposits

Deposit Gold (millions of ounces) Grasberg 82.3 Busang* 46.9

Batu Hujau 15.1 Kelian 5.8

G. Pongkor 3.3 Cabang Kiri 2.5

Mesel 2.0 Mt. Muro 1.3 Awak Mas .8

Weter .7 * Resource evaluation incomplete

Exhibit 2: Worldwide Gold Deposits (Maar Diatreme gold, like Busang’s)

Deposit Gold (millions of ounces) Busang 46.9*

Olympic Dam (Australia) 40.0 Lepanto (Philippines) 25.0 Cripple Creek (U.S.) 24.0 Puebla Vieja (Peru) 24.0

Acupan (Philippines) 19.0 McLaughlin (U.S.) 7.0 Santa Rosa (Peru) 4

Montana Tunnels (U.S.) 2 Ortiz (U.S.) 2

Rio Chiquito (Costa Rica) 1 * Resource evaluation incomplete

(Both exhibits, Spar, 1998: 19, adapted from Michael T. de Guzman, “Potential of Bre-X Minerals to be the World’s Largest Producer of Gold,” July 1996.)

References Spar, D., 1998. Busang: River of Gold (A), (B), & (C). Cambridge, MA: Harvard Business School Press.