On May 28, 2020, J Capital Research released a report alleging that NovaGold Resources' (NG -0.58%) Donlin Project is a "pipe dream ... that will never be mined."
NovaGold responded on June 8, 2020 with a sentence-by-sentence rebuttal of the report. Since J Capital's report was released, NovaGold's stock price has struggled. And now in the last couple of weeks, multiple law firms have announced investigations into NovaGold as a result of J Capital's report.
In this article, we will look at J Capital's report and NovaGold's response while trying to determine how all of this affects investors.
Image Source: Getty Images
J Capital's report contains three main accusations. First, the report accuses the company of misrepresenting the initial capital required by the project. Second, J Capital asserts that the proposed natural gas pipeline to power the mine "is dead on arrival." Third, the report claims that management, specifically the Chief Executive Officer and Chief Financial Officer, are reducing their equity positions in the company.
NovaGold allegedly misrepresents the initial capital required
Claiming it as the "original sin," J Capital states that "management continually and deliberately misleads investors on capital costs for Donlin." The report says that the initial capital expenditures (capex) for the project should be $8 billion, not the $6.7 billion that NovaGold uses. The difference they claim is a line item in the second feasibility study called "IFRS Total Capitalized Opex (Sustaining Capital)." J Capital writes, "We believe that excluding this additional cost was a deliberate attempt to mislead the market."
In response to this accusation, NovaGold reaffirms the $6.7 billion figure as the "initial capital requirement as per the FSU2," referring to the second feasibility study. NovaGold says that the line item in question refers to "mine stripping costs incurred in the production phase of a mine." According to the company, generally accepted accounting principles (GAAP) treats the costs as operating costs, which are expensed, while International Financial Reporting Standards (IFRS) -- which Canada-based NovaGold uses -- allows the costs to "be capitalized and reported as sustaining capital."
NovaGold's plan for powering the mine is allegedly "dead on arrival"
J Capital claims that NovaGold's plan of building a 316-mile pipeline to provide natural gas to power the mine will not work and that its cost is "management's biggest misrepresentation." The report compares NovaGold's proposal to the Mackenzie Valley Pipeline that was "abandoned in December 2017...because it was just too expensive to build." J Capital says that it "consulted a pipeline expert...[who] reluctantly agreed with our view." The report also criticizes management for having proposed several different ways of bringing power to the site over the years.
NovaGold responds to this accusation by saying that the estimate for the pipeline was calculated by reviewing requests for proposal (RFPs) from eight different firms, some of which "have extensive Alaskan construction experience." The company also states that, "the Mackenzie Pipeline is not an appropriate comparison to the Donlin Gold pipeline and J Capital's measurements relying on this assumption are fundamentally flawed." The response includes multiple details about each pipeline to support this assertion. The company notes that it can not verify the claims of the "expert" because no details were given about the person. Lastly, NovaGold admits to considering multiple options for power but denies that it is a "'problem,' let alone a 'fundamental' one."
NovaGold's management are reducing their equity positions
J Capital claims that the insider activity over the last five years is evidence of them "[voting] with their feet". To support this, the report targets the CEO and CFO saying that, "the CEO reduced his net position by 26%" while the CFO allegedly reduced it by half. In total, the report says that insiders sold $35 MM during the last five years.
To address this, NovaGold claims that J Capital is conflating "sales of shares by insiders with the exercise of options by insiders." Regarding the CEO and CFO, NovaGold reports that during their time at the company, the CEO has gone from owning 116,000 shares to 1.83 million shares, and the CFO has increased his position from 35,000 to 617,000 shares.
We can verify the holdings by looking at the Form 4s of the CEO and CFO ourselves. Below are the total share counts for the CEO and CFO at the end of every year since 2014.
| Name | Position | 2014 | 2015 | 2016 | 2017 | 2018 | 2019 | Latest |
|---|---|---|---|---|---|---|---|---|
| Lang, Greg | CEO | 1,821,839 | 1,639,872 | 1,343,689 | 1,280,381 | 1,657,615 | 1,800,376 | 1,839,595 |
| Ottewell, David | CFO | 611,034 | 557,483 | 485,531 | 491,971 | 558,540 | 616,056 | 617,753 |
Data Source: SEC EDGAR
The Form 4s of these two men clearly show that over the last few years, the number of shares they own has been increasing.
Questions for J Capital
In going through J Capital's report, a couple of questions come to mind. Why does the report not clarify when it is referring to prior management's quotes or decisions? Greg Lang became CEO in January 2012. Repeatedly making attributions to "CEO" and "management" without clarifying who the CEO and management were at the time gives the false impression that the current management is responsible for the prior's comments and actions.
And why is J Capital not going after Barrick Gold (GOLD -0.81%), too? Barrick is only mentioned briefly in the article, and when it is, the report describes the company as not being convinced by NovaGold's management and being unenthusiastic about the Donlin project. As evidence of this, J Capital uses Donlin's absence from Barrick's 10-year plan and a quote from the Barrick CEO saying that they would not change the rules on what to include in the plan. However, this is a strange thing to say considering in the exact same call, the CEO said Donlin "offers a huge optionality to the gold price across multiple gold price cycles in an excellent jurisdiction."
Moreover, why would NovaGold need to convince Barrick of anything? The company has been involved with Donlin since well before NovaGold's current management arrived. Barrick controls two of the four directors of the joint-venture company Donlin Gold LLC. And Barrick has contributed about $30 million over the last three years to the project. So if J Capital's claim about Barrick is correct, then why doesn't Barrick write Donlin off instead of continuing to fund and speak positively about it? And if J Capital really believes its own claim, then why is J Capital not going after Barrick as well for deception and misleading investors?
What does all of this mean for investors?
Given the numerous issues with this report, NovaGold and its shareholders appear to be the unfortunate victims of a baseless short-seller attack. Because of its seemingly unfounded allegations, J Capital has created a potential legal storm for NovaGold. But unless new and more credible evidence is presented, this should all eventually blow away.
Investors need to keep in mind that NovaGold should be a long-term investment. While there is risk to shareholders given the uncertainty of the legal process, long-term investors should see this as just a second chance to add to their positions if they have not already achieved their desired allocations.
J Capital's report can be found here, while NovaGold's response can be found here.
