Re:        Expresses - Wednesday, November 16, 2005
Title:     Express 2005-15: Peregrine Diamonds to conduct reverse takeover of Dunsmuir
Publisher: Kaiser Bottom-Fishing Report
Author:    Copyright 2005 John A Kaiser

Express 2005-15

November 16, 2005

Peregrine Diamonds to conduct reverse takeover of Dunsmuir

The intense market focus created by the aggressive evolution of the Fort a la Corne diamond play in Saskatchewan and the absence of any spectacular new diamond discoveries has created a general mood of disappointment with regard to the junior diamond exploration scene. While it is true that the juniors have not found any new diamondiferous pipes with obvious world class potential, several projects have made significant advances. De Beers has received approval to develop its Victor pipe in the Attawapiskat region of northern Ontario as an open pit mine at a cost of $880 million. Victor is expected to produce 6 million carats of high quality diamonds. De Beers has also initiated a $38.5 million permitting-feasibility study for the Gahcho Kue pipes of Mountain Province Diamonds Inc (MPV-T: $2.52) in the Northwest Territories. Tahera Diamond Corp (TAH-T: $0.52), which is developing the Jericho pipe, recently announced micro diamond results for the nearby Muskox pipe optioned from De Beers that suggest a grade potential 2-3 times higher than the 30-50 cpht indicated by earlier mini bulk samples extracted by De Beers. If follow-up bulk sampling confirms these latest results, the considerably larger Muskox pipe will garner a lot more respect for Tahera than the small Jericho pipe which is expected to produce only about 5.5 million carats. On November 8 Ashton Mining of Canada Inc (ACA-T: $1.13) and SOQUEM put Quebec back on the diamond map with an announcement that its four best pipes in the Renard cluster had the potential to host 18.6-22.0 million carats. Ashton and SOQUEM, perhaps inspired by Shore Gold's success with the Star pipe, have decided to proceed with a major bulk sample designed to recover 5,000 carats. Lost in the shuffle has been the biggest surprise story of the year, namely the revival of the infamous DO27 pipe, formerly known as Tli Kwi Cho, as a potential world class pipe.

Earlier this year Peregrine Diamonds Ltd reported significantly better results for a 151 tonne mini bulk sample extracted from the centre of the DO27 pipe than reported in 1994 by Kennecott for an underground bulk sample that appears to have tested only the periphery of this large complex pipe. I provided a detailed analysis of this story on June 20 in Express 2005-10 (Tli Kwi Cho reinstated as a world class mine contender). On August 29 Peregrine reported valuations for the main parcel that ranged from US $58-$78 per carat, not spectacular, but considerably higher than averaged by the larger 1994 parcel. The parcel was considered too small to allow value modeling, but the big news was that larger, better quality diamonds were much better represented than in the 1994 parcel whose larger stones were uniformly poor quality. It is suspected that the Kennecott sample tested an eruptive phase whose diamond population is different from that of the phases that dominate the heart of the DO27 pipe. The key question now awaiting an answer is how much tonnage is associated with the higher grade kimberlite, which will help answer the big question of whether or not DO27 and possibly its twin DO18 have the critical mass to sustain a standalone mining operation. The consolation scenario would be a destiny as future mill feed for the Ekati or Diavik operations which will run out of ore in 10-20 years unless more economic pipes are found nearby existing mines.

Because of the fragmented ownership of DO27 and the uncertainty over how and when Eric Friedland would bring Peregrine Diamonds public the market lost interest in this story and the DHK juniors that have a piece of the DO27 pipe. This changed on November 15 when Peregrine announced that it would merge with Dunsmuir Ventures Ltd (DVV-V: $0.12 halted) on terms that involve a 20:1 rollback for Dunsmuir shareholders. Dunsmuir is Frank Giustra's largely failed foray into diamond exploration. Upon completion of the merger the new company will have 46,122,449 shares issued and 61,328,899 shares fully diluted. These capitalization figures include a $40 million financing of 8 million special warrants at $5 through a syndicate led by Canaccord. Giustra's Endeavor Financial receives credit for putting this merger deal together. Dunsmuir, which was halted on November 3, will remain halted until the RTO paperwork is completed. The special meeting to approve the plan of arrangement will be held on January 6, 2006.

Peregrine intends to conduct a bulk sample in early 2006 designed to recover at least 3,000 carats. We are still awaiting micro diamond results for the three pilot core holes drilled near the RC holes that recovered the mini bulk samples, as well as micro diamond results for a delineation drilling program Peregrine attempted for the DO 27 and DO18 pipes during the summer. The old micro diamond data reported by Kennecott in 1992-94 is worthless for grade modeling because it does not conform to the sieve system used today, and the micro diamonds themselves apparently are not available in a form that allows sieving. The new delineation holes will provide a better understanding of the DO27 pipe's internal geology and will allow mapping of micro diamond size distribution curves to the various phase units.

The merger terms and financing price imply a hefty valuation for the WO project as the DO27/DO18 play is called. With 61.3 million shares fully diluted, a 54.475% net interest, and a $5 stock price the merged company will represent an implied value of $563 million for the WO project on a 100% basis. That is five times higher than implied project values implicit in the prices of the three DHK partners who each have a 6.7% working interest in the WO project. Dentonia Resources Ltd (DTA-V: $0.16) with 43.1 million shares fully diluted has an IPV of $103 million, Horseshoe Gold Mining Inc (HSX-V: $0.30) with 25.4 million shares fully diluted has an IPV of $114 million, and Kettle River Resources Ltd (KRR-V: $0.70) with 12.9 million fully diluted has an IPV of $135 million. During the summer Eric Friedland attempted to negotiate a deal which would consolidate the fragmented interests under one umbrella, but not surprisingly these negotiations went nowhere. Instead, Friedland beat up poor Dunsmuir with whom Peregrine was supposed to merge last year on much better terms. There exists a political assumption within the Peregrine camp that the DHK juniors will not be able to raise their 20% share of the bulk sample, but Friedland is likely in for a surprise as this play gets rolling.

Peregrine's primary asset is its 54.475% stake in the WO project. It has other diamond prospects, but these are early stage and should be considered as worthless in relative terms. The projects inherited from Dunsmuir such as Nanuq also are not worth much based on the brutal merger terms which effectively treated Dunsmuir as a shell. Furthermore, most of Dunsmuir's projects are encumbered by BHP-Billiton back-in rights. The news release does not reveal how much cash the merged company will have prior to the financing, so it is safe to assume it is not a significant amount that is being transferred by Peregrine, whose South American base and precious metals projects do not appear to be part of the merger. Given that the planned bulk sample program will likely cost in excess of $30 million, I think it is appropriate to treat Peregrine Diamonds as a diamond junior with a single flagship project, much as one treated Shore Gold and its Star project as a single project play.

Assuming the merger and financing close as described, one would expect the prices of the DHK juniors to gravitate toward the valuation implicit in Peregrine's price. The exit strategy for the DHK juniors is not obvious, but they do have the advantage that their total market capitalizations are relatively low. All three companies are in a position to use a rising stock price to raise money for other projects in which they own or can earn a much larger interest than 6.7%. Most likely they will end up securitizing their stakes in the WO pipe and go their separate ways. Kettle River is financially the weakest, but it is in the process of closing a private placement of 1.5 million units at $0.50 that appears to be going into strong hands. Kettle River used to be an expensive bottom-fish recommendation that I closed out at a sizable loss last year as a housekeeping matter. Horseshoe Gold has about $600,000 working capital, but has the support of Chan Buckland's Bolder Investment Partners. Horseshoe Gold has been a bottom-fish buy recommendation in the $0.30-$0.49 range since late 1994, and at this point I am confirming it as a medium priority buy in the $0.30-$0.49 range. The weakest link in terms of share structure and financial backers is Dentonia, which has about $1 million working capital. Dentonia has been an extreme risk bottom-fish buy below $0.10 since 2000. Dentonia for now is the best trading vehicle for speculators who wish to bet on the WO project.

Another spoiler in the equation is Stew Blusson's Archon Minerals Ltd (ACS-V: $2.00), which has a 13.3% participating interest in the WO project. Blusson pretty much weaseled that stake out of the DHK bunch for next to nothing, but may not be keen to fork over hard cash to Peregrine. He has already loaned $13 million to his 97% owned Archon to meet BHP-Billiton's cash calls on the 31% owned Buffer Zone, and will have to meet some very hefty cash calls if BHP proceeds this winter with a major bulk sample on the Jay pipe. Delineation drilling this summer nearly doubled the size of the Jay pipe from 7.7 hectares inferred from interpretation of geophysical data to 12.4 hectares. BHP had previously estimated Jay at 28.7 million tonnes with a grade of 210 cpht based on a parcel of only 219 carats. The 60 million carat resource of the Jay pipe would seem to be a production slam dunk, but the recovered diamonds were poor quality, averaging only US $30 per carat. But other high grade pipes with brownish diamonds such as Misery do contain a sub-population of high quality diamonds, which is why BHP is planning to recover 5,000 carats through a bulk sample involving 25 RC holes on a 50 metre grid. For a more detailed discussion of Archon see the Archon Profile at Kaiser Bottom-Fish Online. Archon's stock suffers from a severe liquidity problem and a historical reluctance by BHP to make proper disclosures. It is no secret that Blusson would like to privatize Archon, and I have a hunch that he will have to pay a substantial premium to buy out the 1.6 million shares still in public hands. In fact, I would not be surprised to see Archon get privatized at $10 or better. With 49 million shares fully diluted and a net 31% interest the current implied project value of the Buffer Zone at $2 Archon is only $316 million, a number that grossly undervalues the potential of the Buffer Zone. As Ekati approaches depletion BHP will become ever more interested in developing the pipes it has found in the Buffer Zone. The Jay bulk sample will not be cheap and Blusson may seek some way to securitize Archon's 13.3% WO stake. A chisel-off between Eric Friedland and Stew Blusson is doomed to result in a stalemate, which is why I tend to view the Archon and DHK stakes as a 33.3% package available to a strong competitor.

The $120 million financing Shore Gold just announced for its Fort a la Corne diamond projects indicates that there is strong investor appetite for advanced diamond projects. The $40 million financing Peregrine is securing for the WO project at a price that values the DO27 pipe at more than $500 million is in the same vein. I do not think the DHK juniors will have any problem financing their share of the WO bulk sample. During the next two months I expect Horseshoe Gold, Dentonia and Kettle River to triple or quadruple as the market catches on to the relationship between Peregrine Diamonds, the WO project, and the DHK juniors.

*JK owns shares of Kettle River

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Message sent on Wed Nov 16, 2005 at 1:32:47 PM Pacific Time