Fortuna Silver Mines (TSX: FVI; NYSE: FSM) is contesting demands for a royalty of 3% of the billing value of minerals obtained from the concession hosting its San Jose mine in Oaxaca, Mexico.
The company recently received a notice from Mexico's Direccion General de Minas (General Directorate of Mines) that its mining concession will be cancelled if US$30 million plus value-added-taxes (VAT) in royalties owed from 2011 to 2019 isn't paid before March 15.
The company could not be reached for clarification and comment on the dispute.
Fortuna said the Mexican Geological Service (SGM) first notified the company in 2017 that a previous owner of one of its concessions at the San Jose silver-gold mine had granted the 3% royalty to SGM.
The company said it started administrative and legal proceedings in 2018 against the DGM to remove reference to the royalty on the title register and the proceedings are "progressing in accordance with the procedures of the Mexican administrative court."
Now the company will start "legal proceedings to contest the cancellation procedure and also to stay the cancellation process," it said in a news release on Jan. 29.
If the company has to pay the royalty, or post security that it will do so, it can use its available working capital, it noted.
"In the event that that company is unsuccessful in cancelling the action taken by the DGM or in obtaining a stay of execution, it may be required to pay, or post a bond or other security, up to the amount claimed, in order to preserve the mining concession," it said. "In that case, the company would immediately thereafter proceed with dispute proceedings."
Fortuna also stated that it has adequate funds to meet sustaining capital requirements at its San Jose silver-gold mine and its Caylloma silver-lead-zinc mine in southern Peru, as well as for capital required to complete its Lindero project in Argentina.
Lindero is an open-pit gold project in Salta province with a mine life of about 13 years. Construction started in September 2017.
Ryan Thompson, a mining analyst at BMO Capital Markets, said the news was the first he had heard of the dispute.
"We currently model a trough cash balance of $81 million (assuming the revolver is fully drawn), so we think Fortuna has the liquidity to make the potential payment," he comments in a note. "Nonetheless, we view this as a negative update with unfortunate timing given the imminent startup of Lindero. Any operational missteps at Lindero during the startup could potentially put pressure on the balance sheet if Fortuna is required to make the payment."
Jacques Wortman, a mining analyst at Laurentian Bank Securities, outlined two "potential valuation impacts" of the royalty in a "worst case" scenario.
"Prior to this announcement, our net asset value (NAV) was C$5.86 per share," he wrote in a research note. "If we adjust our NAV for a US$30 million payment, our NAV falls to C$5.61 per share. In addition, if we assume that the 3% royalty applies on a go-forward basis (estimated 6 years of mine life based on existing reserves), our NAV would fall further to C$5.48 per share and our 2020 and 2021 EBITDA estimates would also be negatively affected."
But the analyst said he isn't changing his estimates just yet, and has maintained his buy rating on the company and target price of C$6.60 per share.
Thompson of BMO has a target price of $7.00 per share.
At press time in Toronto, Fortuna was trading at $5.13 per share within a 52-week trading range of $3.23 to $6.12.
The company has 160 million common shares outstanding for an $823-million market capitalization.