In Kyrgystan With MK Gold

 

Late last July, I flew across 12 time zones, via Frankfurt, to land in Alma-Ata, the capital of Kazakhstan. Despite many hundreds of thousands of miles of foreign travel logged over the last 20 years, this was only my second trip to the old Soviet Empire; my first is recounted in Chapter 29 of Crisis Investing for the Rest of the 90s.

The object of the exercise was twofold: Get some reality on MK's Jerooy property in Kyrgyzstan and, just as important, get to know MK's management. Along the way there was plenty of time and opportunity to see the country and the people. I can tell you it's nothing like Kansas.

The country, located west of China and northeast of Afghanistan, is about the size of South Dakota with 4.7 million inhabitants. Even though the people speak a Turkic language, they're ethnic Mongols, tall and rangy. Almost all are Muslims, but fundamentalism isn't an issue. Ethnic Russians are unpopular and are rapidly vacating the premises. It's a pastoral society; once you're out of the city it becomes apparent that the people prefer yurts to the god-awful apartment blocks the Soviets tried to herd them into.

I got mixed signals on what is really happening in the place. The unofficial line pays lip service to free marketization and liberalization. But talk is cheap, and anecdotal evidence that the country's going nowhere fast is omnipresent.

Upon disembarking I was greeted by a surly, but unarmed, customs officer collecting a form asking how much currency I was carrying-a stupid nuisance, and. always a tip-off of a country with problems. But it was a less intrusive experience than when an armed and midnight blue-jumpsuited little bedbug from U.S. Customs asked me the same questions as I boarded the plane in Dallas.

No construction cranes grace Kyrgyzstan's cities. Gasoline is rarely sold in filling stations, which are usually stripped and abandoned because they're still state property; gas is pedaled from tankers by entrepreneurs on the roadside.

You'll see men squatting in courtyards, smoking cigarettes and palavering, for lack of anything better to do. No restaurants, no shops, no foreign newspapers or magazines. No foreigners, for that matter. Make your own bed in the hotels. Expect grim and unsmiling service, although "service" isn't quite the right word.

Meanwhile, all the old government officials remain employed, which basically means hanging around their offices, figuring out ways to bedevil and extort the citizens so as to justify their own existence. Clearly, if any improve ments are to be made in the lot of the common man here-or any of the surrounding countries, from what I could gather-it's going to have to be imported from the West. But that's not the kind of help they're getting.

 

Development in Central Asia

What passes for development aid from the West is simply perverse. The place is awash with bureaucrats from the World Bank and IMF, anxious to squander Western taxpayer dollars on all manner of cockamamie schemes hatched by the apparatchiki. I question whether there's a single employee of either boondoggle institution who has any experience running a business, or would last five minutes in a real venture capital firm. In recent years they've emphasized privatization, deregulation, and tax reduction, which is fine. That's not because they believe in those values, but because they recognize it's the only way they stand to recover any of the uneconomic loans they've made to these countries, and keep their jobs. The IMF, the World Bank, and the UN should be abolished, tomorrow morning if possible.

But you expect to find these types running around in Third World countries, playing bigshot, instead of working for the post office, where they belong.

What really scared us was making the acquaintance of a female lawyer employed by the SEC, on loan to the Kyrgyz government to assist in setting up a stock exchange. In a brief (and predictably unpleasant) conversation, it was possible to detennine that she was a firm believer in regulation, had no practical investment experience, but did have an abiding distrust of markets. Your tax dollars at work. Speaking of tax dollars, I'm informed the IRS is also on hand to instruct the natives on how to set up a proper tax system. I kid you not.

That's not going to make business here any easier. But, notwithstanding all the foregoing, this is a place in which an enterprising fellow could do very well.

 

Business in Central Asia

If I were looking for an interesting way to make a fortune and gain some unique experience, I'd be tempted to open a restaurant in Bishkek, the capital, or Talas. The success of McDonalds in Russia and China is instructive, and several friends who have financed a pizza chain in southern Poland are also doing well.

The first thing people do with disposable income-all people, everywhere-is eat out once in a while. There's nothing wrong with catering to the masses, of course. But the big money, and the fun, doesn't lie in slinging hash to the hoi polloi; it's in running an upmarket gin joint, perhaps in the style of Rick's Cafe Americain. The people who have big money here-at the moment most of it appears to have a genesis in things like stolen cars from the West, sale of recently liberated government property, and plain old fashioned corruption-simply don't have any place to spend it.

For the life of me, I can't see why anyone would put up with a low-retum, highly competitive, aggravation-intensive business like a restaurant in the developed world when, in a place like this, there is no competition and infinitely higher returns; admittedly, aggravation is an integral part of the restaurant business. But the real money here is in deals-real estate, construction, import/export, venture capital. A properly run bar in Bishkek, which is the ideal entree, would result in a hundred times more commerce than any stock exchange from hell set up by some lawyer from the SEC.

This needn't be just interesting theory and cocktail party chatter if you were to send your son or grandson (female progeny have the odds loaded against them in this part of the world, unless they're already really tough and street smart) to check it out for a few weeks or months. I promise you he'll get far more value than from years in an MBA program, "learning" from professors who couldn't make it in the business world.

There are six provinces in Kyrgyzstan, and we were hosted by the governors of two of them. One governor made no secret of the fact that he was at a stage of life when getting rich was important; we discussed the prospect of the restaurant with him, knowing he could make things a lot easier. I asked if the various mafias that control Russia had moved down into Kyrgyzstan, and asked if we were likely to have any trouble with them. The governor answered, "Don't worry. I am the mafia."

 

MK Gold

Longtime readers have already encountered MK Gold; the company (MKAU, $3.75) owns 52% of the American Girl Mine. The other half was owned by Eastmaque (see the June 1990 and November 1988 issues), which was subsequently taken over by longtime favorite Equinox. Equinox was in turn taken over (at its all-time high, I'm pleased to say, although it was long in coming, which pleased me somewhat less) by Hecla, a company in which I have no interest. More significantly, they own 25% of Viceroy's 160,000-ounces-per-year Castle Mountain Mine.

MK Gold is the gold mining arm of Morrison-Knudsen, a NYSE-traded engineering firm in the mold of Bechtel or Fluor. The mother company spun it off in 1993, in conjunction with a public offering that raised $52 million for MKAU at $6 per share.

This is an outfit you probably haven't heard about, and that's unlikely to change much, at least if promotion is a factor. It's run by big company engineering types. They're all fine people, very serious, and quite competent. But they're not promoters. Oftentimes, mining companies that are listed only in the U.S., and not in Canada, tend to get overlooked for the same reason a jewelry store wouldn't get much traffic if it were located in a district full of auto repair shops. As a result, its current shareholder base is almost entirely institutional.

MKAU has 19.4 million shares out (half of which are still owned by Morrison-Knudsen), and still has US$43 million of cash, which equals $2.20 a share. Unlike most companies of its size, it's actually profitable, showing $0.12 per share of earnings and $0.50 of operating cash flow. Between its two current mines, MKAU produces 75,000 ounces per year, at an average cash cost of $260 per ounce, and has 400,000 ounces of proven reserves, with the prospect to perhaps double reserves with further exploration.

The Jerooy property is MKAU's gambit to catapult itself into the major leagues. The property is isolated (like everything in Central Asia) but, like all the Soviet adventures in mining I've encountered or heard about, has been drilled and tunneled to death. So MK has a fairly exact idea of what's there (six million tons of 0.25 grade material). Of course, the Soviets paid no mind whatsoever to economics. For instance, part of the 70(!) miles of tunneling they did in the mountain followed high-grade ore veins. Instead of stockpiling the material for future processing, they just dumped millions of dollars worth of ore down the mountainside, so it's now unrecoverable.

MKAU estimates it will take $135 million to bring the Jerooy into production, at the rate of 150,000 ounces per year, and an operating cost of $140 per ounce. The good folks at the World Bank will provide a $105 million loan, with MKAU putting up the rest in equity. MKAU gets a 100% return of capital off the top, then keeps a 30% carried interest. Total operating costs after depreciation, taxes, and such are $290-a low-cost operation.

This is a first-rate outfit just based on conventional value analysis, but there's more. First, its 50% ownership by the parent simultaneously gives MKAU a form of leverage, and something of a safety net. Second, the parent's substantial reputation in many Third World countries will give MKAU a competitive advantage with most other juniors-offsetting part of the disadvantage of being an American company. Third, this is primarily an operating, not an exploring, company; 30% of its cash flow is from providing management services on gold mines, and that's a valuable stabilizing factor. Fourth, MKAU can use the substantial resources o-f Its parent at cost, a big saving.

Although the chart (which resembles that of most junior golds this past year) doesn't quite show it, the previous high on MKAU was US$8.50. At this point the stock is selling for only 180% of cash. After backing out the cash and its two producing mines, the Jerooy property is, in effect, free. But I'm disinclined to pay a big premium for anything in this part of the world, and that includes Cameco's (CCO.T, C$29.12) Kumtor (which I also helicoptered to), a deposit with 5.2 million proven ounces, and the prospect of perhaps 20 million. I'm a longtime fan of the company, but for its uranium, not the Kumtor. If these properties were almost anywhere else in the world-South America, Africa, Southeast Asia, etc.- it would be a different story.

I have a feeling that even in MKAU's case, where the company and its management are clearly held in high regard by all the locals (Cameco appears to have generated some bad feelings), it's not going to be easy sledding. For one thing, it's going to take a generation, if not forever, to overcome ingrained corruption. Everyone will have his hand out, awaiting the right amount of baksheesh, before signing papers or granting permits. MK, as a U.S. company, is constrained by American law to abstain from bowing to local traditions of that nature. I questioned them about it, and they feel that being known as straight shooters will inure to their long-term advantage. But this is Kyrgyzstan, not Kansas, and I suspect that the non-observation of this time-honored practice will generate non-cooperation from those in a position to benefit.

We didn't engage in any bribery on this trip, but we did partake in some other local customs.

 

A bit of local culture

Close to the Jerooy mine, near where the workers will live, was a camp of nomads, living in yurts, dressed in traditional garb, riding skinny little ponies; things didn't look like they'd changed much since Ghengis Khan came through town. Just as they rode up to my house, I'd go out to greet them and offer them a Coke, they did likewise with fermented horse milk. The stuff tastes somewhat like a watery alcoholic yogurt.

On the way back, the governor of another province hosted a traditional Kyrgyz feast for us. The site was next to a stream in an aspen grove, in a valley overlooked by snow-capped peaks; it could have been Colorado. Two large yurts were joined together, and all manner of bizarre food was served; it was something like combining a quaint picture from your fourth-grade geography book with the feast from Indiana Jones and the Temple of Doom. It seems like every meal here is planned around mutton. It was no secret that Jerry Sneddon, MKAU's VP of Exploration, was the guest of honor, but the fact was publicly acknowledged when he was presented with the sheep's head. By the time it got around to me, all the choice parts, like the nose and eyeballs, had already been high-graded. I consoled myself with other dishes whose components defied recognition.

 

The future in Central Asia

You may remember that song from the '60s whose refrain goes something like, "The French hate the Germans, the Germans hate the Dutch, and I don't like anybody very much." Well, multiplied by 100 nationalities, that could be the theme song for the entire old Soviet Empire for many years to come. What's currently going on in Chechnya is simply a well reported version of what's happening all over the old U.S.S.R. In Tajikistan, just to the southwest of Kyrgyzstan, there have been over 100,000 casualties, including 20,000 deaths, due to their civil war just in the last year. Heard about it? If so, you read obscure publications.

For some reason (probably because they all get their copy from the same State Department press releases), the media thinks these places are "countries" in some real sense. It's more realistic to forget about the borders, which are just meaningless lines some successful criminal in a capital city drew on a map after some war. And forget about inane concepts like democracy, which Joseph Schumpeter (correctly) described as "a surrogate faith for intellectuals deprived of religion." Even in the West it's just a polite variety of mob rule; here the concept is considered a laughing stock, useless except for pieties delivered to credulous reporters.

Here's the real problem I have with mining in this part of the world. The deposits controlled by various companies are generally huge and rich. They have generally been drilled to a fare-thee-well by Soviet geologists. Environmental and official (as opposed to baksheesh-driven) regulatory problems are trivial. Labor is cheap and plentiful. Financing is usually subsidized by some government or international agency. All this is perfect except for one thing: this part of the world is a ticking bomb.

That doesn't, strangely enough, mean that companies like MKAU and Cameco won't succeed in making mines, and making them work. The various warring factions have more interest in plucking a golden goose than killing it. They know they can't run a high-tech mine-after all, they watched the Soviets try it for decades. And they know the foreigners will cut and run if it gets too unpleasant.

When I made the trip to Kyrgyzstan, MKAU was trading at about $5. A mining engineer from London hazarded the stock should trade at about $4, pending a positive feasibility, which impressed me as a fair bet. The bear market in gold drove it down to $2.50 at the tail end of December, not much more than its cash. That's when I decided to write this article. Then, just after Christmas, MK came out with a positive feasibility on the Jerooy; the stock popped $2 in as many days, and it's trading at $3.75 now.

The upside is clear if all goes well; it should certainly exceed its old high. The downside is that the stock may drop back under $3 because of some political thing in Central Asia which we can't even anticipate. I apologize for this article appearing just days after their feasibility study-but in this market, I thought we'd have plenty of time. As a consolation prize, some of you may have picked it up after I mentioned it in September.

What to do now? If you don't own it, I'd sit back and wait for a politically driven buying opportunity taking it to the $3 area; if you do own it, that's a thought to keep in mind from the sell side. It may well drift back there once the excitement from the positive feasibility on the Jerooy settles down, at which point I see little risk, and likely a triple within 18 months. It's a really solid, value-driven company I want to own.

The broker most familiar with MK is our old friend Rick Rule (800-4777853 or 619-943-3939). Incidentally, Rick and his organization have left Torrey Pines Securities, and he's set up his own shop, Global Resource Investments. I urge you to be sure your entire account has moved with him. If you don't have an account with Global, you should open one; its commissions and currency translation (especially on Canadian stocks) are among the very cheapest, and its executions are consistently great. If you have had trouble reaching Rick, keep trying.

Call MK Gold at 208-386-5061 to get a care package, and be placed on their news release list.