Inside the Dragons Den: Exco Resources

The Intelligent Investor's Dragons' Den is where our team's stock ideas are tested. The analyst responsible for the idea prepares a brief and takes it into the Den, where the waiting Dragons look to take it apart. Scenarios are examined, questions asked and ideas tested. It's tough. And while I got out intact yesterday, my idea didn't.

The stock in question was a small copper/gold developer, Exco Resources. While I think current copper prices, at well above $4/lb, are overcooked, this particular little copper stock has one or two attractions that distinguish it from the bubbling copper crowd.

The key asset is a project in Cloncurry, Queensland that has outlined a generous copper/gold resource. This is fine by itself, but the real kicker is that a deal with a neighbouring miner may allow Exco to commence supplying ore to an established processing facility without having to construct its own, and therefore provide a quick and cheap path to production.

The calculation we had to make was deciding whether the probability of a successful deal outweighed the risks of wading into a sector we fear is overpriced. That is, will a copper stock that looks cheap at high copper prices still be cheap if prices fall?

For my thesis to pan out, not only does a deal need to be done, but it has to be done at a fair price. Exco has to show credibly that it has an alternative to the deal, or risk being steamrolled by its larger, more powerful potential partner. So Exco has to demonstrate the ability to construct an independent development, even if this isn't the true endgame.

My financial modelling suggests that at current prices and at somewhat lower levels, the project has value. But should copper prices fall substantially, the project would become marginal, leaving investors exposed to a substantial loss. Importantly, big falls in the copper price may spook the banks and equity markets which would have to support Exco in its quest to fund a standalone development.

The optionality on the corporate deal is the main point of attraction, but buying a stock for a corporate event is perhaps too far down the speculative tunnel for us to pursue. Nor do we wish to make a recommendation with so many caveats attached to it, especially where the possibility of a large loss exists.

Alas, Exco joins a lengthy list of stock ideas to meet their end in The Intelligent Investor's Dragons' Den. All the better for the few that get through.