Alberto Arispe: Insights into the Peruvian Market


Alberto Arispe Mining is big in Latin America. The mining sector represents the lion's share of the main Peruvian indexes, and Chile and Argentina have significant mining operations as well. Kallpa Securities CEO Alberto Arispe talked exclusively with The Gold Report about some of the most promising small-cap plays in the area and the prospects of Peru, Chile and Argentina trading under a single exchange and what that might mean for the future of mine financing and investment opportunities.

The Gold Report: Why did you choose to specialize in the mining industry?

Alberto Arispe: It's not so much that I chose to be in the mining sector; it's that here in the Lima market you have to be in the mining sector. Peru is a mining country. The mining industry is around 15% of the Peruvian GDP. On the Lima Stock Exchange, mining stocks comprise between 60% to 65% of the main Peruvian indexes, a very high percentage compared to other exchanges. For example, in Chile, which is a country where there's a lot of mining activity, only 3% to 8% of the index is composed of mining companies. Companies that list and trade in the Peruvian market produce gold, copper, zinc, tin and other metals.

TGR: The Peruvian Finance Minister Ismael Benavides recently said that he expects mining companies to invest more than $40 billion in Peruvian mining projects over the next 10 years or so. What are the crown jewels among Peru's mines and mining projects?

AA: There are several projects that are pretty big in Peru, and they require huge investments. One of the most important is Las Bambas, a huge copper project that Xstrata PLC (LSE:XTA) is operating. Candente (TSX:DNT, TSX:CDG) also has big reserves of copper, zinc and gold, which require huge investments.

However, not all of them will be financed through capital markets. Most of them are done through subsidiaries of big public companies that list and trade in markets in the the U.S., Canada or London.

TGR: How many people does the mining sector employ?

AA: That's difficult to say, but it is a significant number of people. However, that's one of the criticisms that some people have expressed in Peru. Mining is not that labor intensive, it's more capital intensive. That is why the government is trying to attract more foreign investment.

TGR: One of the things that the minister was trying to fend off was a call for a larger tax on mining companies, correct?

AA: Yes. Two or three years ago there was a debate about that. In the end, the Congress did not approve higher taxes for the mining industry. About four years ago, there was an agreement between the mining companies and the government for the mining companies to "donate" a small percentage of their net income. These "donations" would go into a fund that would invest in the communities where these mining companies operate—which tend to be in the mountains and tend to be poor. This "voluntary donation" has been working OK so far. Now we have to remember, there will be elections in April 2011 for Congress and for president. Things could change. I think a lot will depend on the results of the elections.

TGR: What are some issues and challenges facing the industry in Peru?

AA: Peru has been growing at a very fast rate for the past 20 years, about 5% per year on average, with very low levels of inflation, with reserves accumulating and with a lot of indirect foreign investment in the country. Poverty is down from around 65% in 1990 to 33% now. In the rural areas in the mountains—where most of the mining activity is—the rate is even higher. So it is necessary to find a way to have the people who live around these communities be happy and feel part of the mining companies' success. These communities need to feel part of the success because if there are no arrangements with the communities, some of these communities could stop projects that could be very profitable. This has happened before. If the local communities and the companies can work together and succeed in producing copper, gold or zinc or whatever metal is there, both the community and the company will be profitable. When the companies don't do their job correctly, and think they can go into the communities and just do whatever they think is right, things don't work out.

TGR: Do you have any ideas of how that can happen?

AA: There's a saying in Peru, "you don't have to invent dynamite." In English that would be, "you don't have to reinvent the wheel." It's just getting a good team and going to talk to these people and telling them what you're going to do. Let them participate. Give them jobs in the projects. Help them out with basic things like schools. Some companies just think, "Well, it's not our job to do this. We pay our taxes and the government should take care of these things." That's true, but sometimes things don't work as they should. It's in the companies' interest to get things to work in their projects.

TGR: What's the state of mining finance in Peru and in South America in general?

AA: The Peruvian Bolsa is the only regulated market in Latin America that has a junior market, a venture capital market for junior companies. Given that they are juniors, they have very little or no access to commercial banks, so they tend to raise capital from the Peruvian capital markets. Most investors here know how the mining industry operates and how to invest in these types of investments and what their inherent risks are. So even though in Peru we haven't had an IPO for a mining company in a long time, we do have a lot of private placements where junior mining companies can obtain funds, with 100% of the funds coming from Peruvian investors.

This is an important part of our business. Right now for example, Kallpa Securities sponsors 10 of the 11 junior companies in the market. A sponsor is the broker that represents the junior company. We present the company to the Exchange and then represent the company and the issuer before the Lima Stock Exchange, and of course when there are placements. A sponsor is like a "nomad" on the AIM Exchange in London.

TGR: I understand there is a movement afoot to combine the Bolsas of Argentina, Peru and Chile. Can you talk about that?

AA: Yes, the regulators and the Bolsas of Peru, Colombia and Chile want to integrate these markets. The first stage would integrate the markets and in the second stage, the three Bolsas would merge to increase liquidity in the three markets.

TGR: What are the hurdles to that merger?

AA: We don't have any big hurdles, but there are things we have to work on. For example, taxation is not the same in the three countries. And the private pension funds of some countries cannot invest in certain markets. The private pension funds are the main players in Colombia, Chile and Peru. For example, private pension funds in Chile cannot invest in countries that have a lower risk classification. Since Colombia and Peru are riskier than Chile, the Chilean private pension funds cannot invest in some of these countries. So we're working to change that. I think that the first stage will be ready to begin in the first quarter of 2011.

TGR: You mentioned needing to change some rules to allow Chilean pension funds to invest. Does this mean that the pension funds just can't find enough to invest in?

AA: Exactly. The four private pension funds in Peru have assets under management around $32 billion. That's around 25% of GDP. By law, private pension funds can only invest 28% to 30% of their assets abroad. They can only invest the rest in Peru, but there are not enough regulated companies to invest in.

I was just talking to a private pension fund manager, who said that the private pension funds in Peru receive around $145 million every day. If this continues, they will need more securities to invest in. If the integration goes forward, we will have to see if an investment in Colombia or in Chile would qualify as a foreign investment. Maybe any investment in the integrated market could qualify as a domestic investment.

TGR: What are the people behind some of the large mining companies there like Xstrata and Tech saying about the merger idea?

AA: For companies like Xstrata or Altadena, which is privately held, the more access they have to funds, the better it is. In the future, some of them, if there's enough liquidity, could think about going public. You never know.

Integration will help us because Peru could become a small hub of mining capital markets for Latin America, because Peru is where most of the knowledge is about mining and capital markets.

TGR: Well I'm sure the TSX doesn't like the idea.

AA: You know, the Bolsas compete among themselves. In the past 11 months, we've had a couple of interesting plays totaling around $25 million in placements from junior companies. The managers of these companies were pretty happy because sometimes in Canada there's much more access to capital, but there are a lot companies, too. In Peru you have very few companies, so you have more exposure.

Of course, if you need to raise $30, $40 or $50 million, it's difficult to do it in Peru. But you can raise $5 or $10 million here. What we're doing, for example, is placing shares using syndicates. We lead the syndicate and we do it with five or six brokers. So that's something new for Peru that works very well because the brokers make their commission and more people have access to this type of risk. The company issuer is able to raise more funds. Everybody makes money and if things go right, more investors make a nice profit.

TGR: What are some small-cap plays in Peru that you think have some promise?

AA: Rio Alto Mining Limited (TSX.V:RIO; BVL:RIO; OTCQX:RIOAF) is a good example. They have a project called La Arena in the northern mountains of Peru. It was explored by IAMGOLD Corporation (TSX:IMG; NYSE:IAG) and they did a deal with IAMGOLD to obtain the rights. It's like an option agreement, at a very low price.

In the fourth quarter of 2009, Rio Alto contacted us and we listed the company on the Lima Bolsa. They also are listed on other markets, including the Toronto Venture Exchange. Basically, we did a private placement for them: 100% Peruvian investors for around $5 to $6 million when the stock was at $0.33.

At that time, management owned around 30% of the company. There were no big funds owning the stock. They needed to raise around $25 or $30 million in 2010 to build the plant and start producing gold. They have a reserve of gold and a reserve of copper. Some people bought it. Others of course didn't.

The company delivered what they promised investors. They got a loan with a prepayment of gold agreement with a U.S. hedge fund, Red Kite, for $25 million. Then we raised another $8 million. Afterwards, J.P. Morgan asked the management to participate and there was an issuance of another $8 million. The stock is trading now now $1.34—a 200% profit. It's the most profitable stock on the Lima Stock Exchange.

Now we are four months away from production. Everything is on track. We have the permits from the government, the environmental approval and the communities have approved. Everything has gone as expected. They have already everything fully financed for the first part of the project. We expect them to be producing around 90,000 ounces of gold next year. Cash costs will be around $500 per ounce; you know where the price of gold is right now. That project will last around eight years.

So the story is that through capital markets these guys were able to finance basically 100% of all their cash needs. A good part of it was done in the Peruvian market and in the U.S. Now, Rio Alto is a $128 million market-cap company. When we started this a year ago it was a $35 million market-cap company. So it's a success story. Of course, not all stories have happy endings.

TGR: Rio Alto recently announced reserves of 2.57 million ounces of gold and 1.57 billion pounds of copper.

AA: Correct. So this is basically a copper operation. But the good thing that management has done is that here in Peru you have four or five junior companies with very big copper deposits that in three or four years can be huge unit producers. But the problem is that to get these things into operation, the companies need to invest $300, $400, $500 million and these companies have a market cap of $30, $40 million. It's impossible for them to develop these projects. So they have to sell sooner or later, or they can joint venture.

What Rio Alto has done, which is very smart I think, is say, we have this big copper project, but we also have the oxides on the top of the hill. We have a small gold project. They are going to concentrate on the small gold project, which is easier to develop. They will start producing gold and use those cash flows for two or three years. That will make the market cap of the company go up from $40 million where it was a year ago to maybe $150 million. It's different to try to get a joint venture or raise money or even sell the company for the big copper project when you're worth $150 million and when you have a cash flow, than when you are $30 or $40 million and you don't produce anything.

TGR: And you can raise much more money with less dilution when you're financing at $2, $3 or $4 a share versus $1.25.

AA: Exactly. So I think there Rio Alto has played it smart. If not, they would be another junior with a lot of potential, and maybe in three or four years you could see that unit producing. For that you need a joint venture or to sell to somebody or huge dilution. So far management has delivered and I have a lot of confidence in them. We have a pretty good relationship. They have an open-door policy. When the stock came down at one time, we had a lot of investors visiting them and I think that says a lot about management.

TGR: Can you give us an example of a company that could see significant share appreciation?

AA: The other one that I like is Minera IRL Ltd. (TSX:IRL). These guys trade in Lima and AIM, and just started trading in Toronto. IRL is the only company in Peru that has passed from the junior segment to the main board. In 2007, when their mine called Corihuarmi started producing, they were in the junior segment. They started producing gold as well, around 40,000 to 50,000 ounces, in a smaller mine. They also have projects in Argentina. In two or three years, they probably will be producing 120,000 or 130,000 ounces of gold per year when these new projects come into production. The company's worth around $90 million, maybe a little bit more because the market is up. It has around a $100 million market cap. Their Don Nicolas project in Argentina needs an investment of around $30 million and will start producing in 2012. Another project called Ollachea in Puno, Peru, is bigger. That will require a higher investment, around $120 million. Their plan is to go first to Don Nicolas to make the market cap bigger and then to finance Ollachea. I think that's the right way to go because as you start producing and risk goes down, the market cap goes up. It's much better to raise money at a higher price.

TGR: Any parting thoughts?

AA: Macro-economically, Peru is doing really well. In the U.S., Canada and London, the money is on Brazil, Russia, India and China (BRIC). That's the right thing to do because these are emerging markets. They are huge countries that are growing, with great potential. But Peru has better numbers than these countries. The only difference is that Peru is small, but GDP is growing 7%, 8% in the past few years, with the exception of '09 when GDP was flat. It is one of the countries that's growing the most in Latin America, with the lowest levels of inflation. There are no fiscal structural problems at all. We have a free market. We have free trade agreements with the U.S. and several countries. The poverty rate is going down and there is a lot of stability.

There's a lot of direct investment from big companies that operate in other parts of the world, as well as from Peruvian companies and from smaller investors that are forming junior companies. That is something very interesting.

The mining industry in Peru is doing very well. The Peruvian capital markets specialize in mining. All of our analysts are basically focusing on that. The private pensions know about mining. The hedge funds in Peru know about mining. The brokers in Peru that do equity research know about mining. And investors that buy these stocks get more familiar with these types of risks because they discuss it with the analyst and with the broker. There is deep knowledge about the mining sector in the Peruvian capital markets. That's a competitive advantage for companies that want to raise money in the mining sector in Latin America. If you go to other countries like Chile or Colombia, there's very little knowledge of the mining sector.

TGR: Alberto, this has been very informative. Thanks very much.

Alberto Arispe is CEO of Kallpa Securities SAB, a Peruvian brokerage and boutique investment house. He has an MBA from the Stern School of Business at New York University and a Bachelor degree in economics from the Universidad Catolica del Peru. Arispe previously worked as a vice president of emerging markets institutional equity sales at Fox-Pitt, Kelton, Inc., in New York City, In the mid-'90s he was a mining analyst at the Peruvian brokerage house Macrovalores. Arispe has more than 18 years' experience in capital markets. He also is a professor of finance at Universidad de Lima.

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1) Karen Roche of The Gold Report conducted this interview. She personally and/or her family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Rio Alto.
3) From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise.

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