Beyond the Surface: Adriatic Metals' Untapped Potential in Bosnia

Executive Summary

Adriatic Metals PLC (“Adriatic”) (ASX:ADT, AIM:ADT1, FSE:3FN) is an Anglo-Australian company that owns more than 40 km2 mineral rights in Bosnia Herzegovina, which it has called the Vareš project, named after an eponymous village located between these rights.

The tenement area covers a geological belt containing numerous showings which is highly prospective for polymetallic massive sulphide deposits. The two main targets are the historical open pit mine called Veovaca and the Rupice deposit, which was known from exploration drilling when the area was still part of Yugoslavia and under communist rule.

Adriatic first became involved in early 2017 when as a private company it acquiring Eastern Mining d.o.o. Sarajevo (“Eastern Mining”), a company registered in Bosnia and Herzegovina and holder of mineral rights over Veovaca and Rupice. According to Adriatic the acquisition of Eastern Mining also came with a large amount of historical geological studies and exploration results. A drilling programme was carried out between March and October 2017 on the basis of which JORC compliant resources could be defined for Veovaca and the prospectiveness of Rupice confirmed. With the added value of this work the company was in a position to get itself listed on the Australian Stock Exchange on 1 May 2017 and raise A$10 million. With the new funds it immediately launched a 15,000 m drilling programme with three rigs to which a fourth was added soon thereafter following some great results.

The company has since rapidly advanced the project, publishing in November 2019 a very positive scoping study (“PEA”) with a NPV8 value of more than US$0.9 billion far exceeding the market capitalisation at the time. This was followed by metallurgical testwork that improved on previous results. Small wonder the market was excited about the results of a pre-feasibility study (“PFS”) due at the end of Q3 2020, the release of which was delayed into October. The PFS was, however, a relatively disappointing as the value was only marginally higher at US$1.0 billion, mainly achieved by assuming much higher precious metal prices than for the PEA. All the drilling subsequent to the PEA had yielded little in terms of resources apart from increasing their confidence level to qualify inclusion in a feasibility study.

It was possibly for this reason that management had already cast its eyes elsewhere and agreed in May 2020 to acquire an exploration company active in Serbia, Tethyan Resources Corporation (“Tethyan”). The consideration was moderate as it came at a favourable time with funding hard to come by just after the COVID-19 pandemic start and Tethyan having to meet a bullet payment to the local owner of the prospect concessions.

Adriatic being an Australian and London listed company, is under no obligation to publish the full PFS study, unlike companies listed on the Toronto Stock Exchange. It is a matter of the company choosing what it wants to disclose and the reader having to accept or reject the summaries and conclusions that are presented. Crux Investor has only the summary PFS findings available, selected by Adriatic management in its press release and we do not take information at face value. Accordingly, Crux Investor has crunched the numbers based on the limited information provided and augmented it with industry benchmarks and guidelines.

This study has used the PFS input parameters for one scenario, with a few adjustments such as rejecting the 100% payment terms for Cu in the Cu-Pb-Ag bulk concentrate as this is not realistic given the 6.3% grade; using a lower gold payability for bulk concentrate; and ignoring the salvage value of the plant at the end of the life of mine (“LOM”). A second scenario uses spot metal prices at 24 December 2020 and included corporate overheads to arrive at a value of the company, not just the project.

Despite the changes, the modelled PFS scenario gross revenue is almost exactly the same as quoted by Adriatic, but the EBITDA is 12% lower due to lower modelled payabilities for Cu and Au. What is however strange is the larger proportional difference between the calculated NPV8 of US$0.73 billion and the NPV8 of US$1.04 billion quoted by Adriatic. Without Adriatic providing net free cash flow numbers this discrepancy cannot be reconciled by Crux Investor.

The NPV8 using spot prices is US$0.81 billion. This compares to the calculated Enterprise Value of US$0.40 billion using the share price of A$2.38 on 24 December 2020. The EV/NPV ratio is therefore only 0.51x, which is comparatively low for a project at this stage of advancement and with a relatively short lead time to production. Crux Investor would normally expect a project at the Pre-feasbility Study stage to trade closer to 0.7x NPV8. The larger than usual discount may relate to uncertainties with respect to barite revenue and the jurisdiction of the project, Bosnia Herzegovina.

Bosnia Herzegovina is still a divided country and there is reportedly much friction between the Bosniaks (as the Muslims in Bosnia are referred to) and locals of Serbian heritage. It also explains the slower than forecast progress being made in getting permits and approvals as these have to come from various levels, national, provincial and local. Fortunately, the area in which the Vares projects occurs is almost exclusively populated by Bosniaks, which makes for homogeneity. The local population is reportedly also strongly in support of mine development to extract itself from poverty and high levels of unemployment. Finally, Serbia is very desirous to join the European Economic Union and will be hesitant to upset its chances of joining by being a spoiler in Bosnian politics.

The discount to inherent value is considered overly harsh by Crux Investor as there are good prospects of adding LOM at Rupice with the deposit open in several directions, especially down dip to the northeast, plus the prospect of additional discoveries in the extensive Vareš tenement area and the prospect of exploration success in Serbia at the ex-Tethyan properties. Every year of additional Rupice production at average reserve grade would add approximately US$100 million to the company value.

DISCLOSURE: Analysts that contributed to this report own shares in Adriatic Metals.

Introduction

Adriatic Metals PLC (“Adriatic”) (ASX:ADT, AIM:ADT1, FSE:3FN) is an Anglo-Australian company which owns the Vareš project in Bosnia Herzegovina within which there are two proven polymetallic Cu-Pb-Zn- Au-Ag deposits: the high grade Rupice deposit and low grade Veovača deposit. The latter deposit has been mined to some extent by open pit methods, producing barite (BaSO4) and lead and zinc concentrates.

Figure 1.1_1 shows a map with the two deposits in regional context.

Adriatic first became involved in early 2017 when it acquiring Eastern Mining d.o.o. Sarajevo (“Eastern Mining”), a company registered in Bosnia and Herzegovina and holder of mineral rights over Veovaca and Rupice. According to Adriatic the acquisition of Eastern Mining also came with a treasure trove of historical geological studies and exploration results. A drilling programme was carried out between March and October 2017 on the basis of which JORC compliant resources could be defined for Veovaca and the prospectiveness of Rupice confirmed. With the added value of this work the company was in a position to get itself listed on the Australian Stock Exchange on 1 May 2018 and raise A$10 million. With the funds it immediately launched a 15,000 m drilling programme with three rigs to which soon thereafter a fourth was added following some great drill results.

Figure 1.1_2 shows the price history since listing.

The graph shows how the share price has since risen spectacularly from A$0.20 to peak at A$2.75 on 18 August 2020, making it a so-called +10 bagger.

The first fillip in the share price occurred only a few months after listing when drilling at the Rupice target cut long intercepts with spectacular grades for Cu, Pb, Zn and precious metals. Further drilling with positive results explains the upward trend in the price. However, during 2019 the rate of drill result announcements dropped substantially explained by these being less spectacular. Adriatic management is inclined to hold back disclosure of developments when these are not positive.

The price rise at the end of 2019 coincided with the release of a scoping study, also termed preliminary economic assessment (“PEA”) in November 2019 which gave a net present value at a discount rate of 8% (“NPV8”) of US$917 million for an initial investment of US$178 million. In January 2020 an announcement on metallurgical testwork that indicated improved recoveries further supported the price until the COVID-19 pandemic caused a sharp drop in line with the rest of the equity markets for mineral companies.

The price recovered in line with the general market, but also due to positive permitting developments and the announcement in May

2020 Adriatic had agreed a friendly takeover of another exploration company, Tethyan Resources Corporation (“Tethyan”) for an implied value of US$10.6 million payable in ADT shares, which gave Tethyan shareholders the equivalent of 6.9% of the enlarged shareholding. Tethyan owned a number of advanced base metal projects in Serbia. This takeover is partially explained by the law of diminishing returns exploring the Rupice deposit. During the whole of 2020 Adriatic announced drill results only three time. This compares very low to 5 times in 2019 and 9 times in 2018 since 12 June of that year.

Excitement about the impending release of the PFS findings pushed the share price to its all-time peak on 18 August, but started dropping since, not even supported by a considerable expansion of the mineral rights area in September 2020. A muted response to the slightly underwhelming conclusions of the PFS disclosed on 15 October 2020 that was released into a metals market in retreat phase precipitated the latest drop prior to stabilsation and price recovery.

According to slide 13 of a corporate presentation dated 17 November 2020, a total of 201.4 million shares are in issue plus 20.1 million unlisted options and performance rights (elsewhere specified as 16.97 million options and 3.56 million unlisted performance shares) for total fully diluted share capital of 222.5 million. Subsequently it raised US$20 milllion from Queens Road Capital Investment (“Queens Road”) through the issuing of convertible debentures, which theoretically can be redeemed before conversion into shares. For the purposes of Enterprise Value this valuation considers that the cash and debt cancel each other out. However, on 24 December 2020 the company issued 4.83 million shares to Sandfire Resources for A$8.65 million in terms of their non-dilution right. At the share price on 24 December 2020 of A$2.38 the diluted market capitalisation is A$541 million. To the cash balance of A$13.9 million must be added the funds received from Sandfire Resources for an Enterprise Value (not accounting for cash flow from options and warrants, about which exact exercise prices are not given) of A$524 million, equivalent to approximately US$397 million. Figure 1.1_3 shows the shareholder breakdown as at 2 November 2020 which slightly understates Sandfire’s stake.

The chart from the latest presentation provides an impression of retail, institutional and management interest. The website also provides a list of the major shareholders holding more than 3% of the issued share capital, which is (before the latest share issue to reinstate Sandfire Resources 16.2% shareholding): Sandfire Resources (14.2%), Paul Cronin (8.7%), Milos Bosnjakovic (7.1%), Datt Capital (4.4%), Eric de Mori (4.5%), and RBC Capital Markets (4.3%). Interestingly, the presentation includes the recent EBRD investment but the website no long shows the Sprott investment.

Adriatic Metals does have good support from institutional investors, a large holding by management and the important stake of Sandfire Resources, which took a strategic position from the start and has been adding via open market transactions to its holding since. Sandfire is a mid-tier Australian mining company operating the high-grade DeGrussa Cu-Au mine 900 km north of Perth. Declared reserves at 31 December 2019 for the DeGrussa and adjacent Monty deposits was 4.2 million tonne (“Mt”) at a grade of 4.9% Cu and 1.6 g/t Au. Given the processing capacity of 1.6 Mt per annum the end of life of mine (“LOM”) is not far off and the company needs to find replacement operations, or close down. It has therefore started acquiring other deposits such as the Tsukudu operations in Botswana in October 2019. Sandfire must be seen as a prime candidate to acquire Adriatic, but with Adriatic management and institutions controlling more than half the company, unlikely to get it on the cheap.

The following sections will show that the Enterprise Value of Adriatic of US$397 million is at a considerable discount to inherent NPV8 value of US$1,040 million as per the PFS study. However, Adriatic being an Australian and London listed company, is under no obligation to publish the full study, unlike companies listed on the Toronto Stock Exchange. It is a matter of the company choosing what it wants to disclose and the reader having to either accept or reject the summaries and conclusions. So much for the ASX and LSE authorities protecting investors! These exchanges surely would have learnt by now to demand better disclosure of companies.

Crux Investor, however, does not take information at face value and has crunched the numbers based on the limited information provided and augmenting the analysis using benchmark and industry standard guidelines. The following sections give the findings of Crux Investor.

Valuation Of The Vares Mineral Prospects

General Background

The information and illustrations presented in this section are derived from:

• Numerous press releases about drill results, permitting and metallurgical testwork.
• A press release dated 19 November 2019 about the findings of a scoping study and a press release dated 15 October 2020 about the findings of the PFS.
• A corporate presentation dated 28 September 2020.
• A Crux Investor interview in mid-October 2020 of the CEO of Adriatic Metals.

Unless specifically otherwise stated, all text, illustrations and information in Section 2 have been extracted from these sources of information.

The Adriatic key asset is the Vareš polymetallic project, comprising the Veovača and Rupice deposits, which is situated in Bosnia and Herzegovina. The project is located near the town of Vareš, which was a historic mining and industrial centre with infrastructure including sealed roads, grid (coal / hydro) power, heavy duty rail and blast furnaces.

Figure 2.1_1 shows a map with the two deposits in relation to the regional geology. The mineralisation occurs in interbedded shales and dolomites, dolomitic shales, radiolarian chert and fine-grained quartz siltstone and shales (yellow brown colour), which is overlain by massive limestones and chert (blue colours), which are interpreted as having been thrusted in a southwest direction on top of the unit containing mineralisation.

Early technical reports by Adriatic postulate that the mineral field is of the Besshi-style type, which implies that the metals are of sedimentary exhalative origin. Figure 2.1_2 shows schematically the setting for Besshi-type deposits.

Getting a handle on what specific type of deposits Adriatic is dealing with has implications for regional prospecting. For example, Besshi-type deposits form in clusters along stratigraphic horizons and can be restricted in aerial extent. This means that there could be many more Rupice and Veovača type deposits at the same stratigraphic level in the project area.

It should be noted that the currently indicated mineralisation does not fit any general model. It is associated with very high grade and substantial deposits of barite, which is normally found with Pb-Zn sedimentary exhalative (“Sedex”) type deposits, but it has also a very important copper-precious metal component, normally not present in Pb-Zn Sedex deposits.

The map in Figure 2.1_1 shows the extent of mineral rights before Adriatic was granted a considerable extension in mineral rights on 2 September 2020, which covers as much as possible of the whole prospective belt. Figure 2.1_3 shows the outline of newly granted rights in blue bringing the total tenement area to 40.8 km2 from 8.7 km2 previously controlled. The gap between the two blue outlines is explained by the location of the Vareš municipality, where permitting for mining would be impossible to extremely difficult.

Before the latest amendment to the Concession Agreement Adriatic owned three concessions, being Veovača I & II and Rupice-Jurasavec Brestic, as outlined in red on the map. The latest amendment added three more blocks: Semizova-Ponikva, Vares East and Brezik, the latter two with either historical mineral resources, or defined exploration targets.

Permitting towards exploitation permits is well advanced with the Veovača area awaiting Ministerial approval of the Urban Planning Permit after which the company can submit its application for the Exploitation Permit. For Rupice the company has submitted the application for the water permit, which is currently progressing through the cantonal approvals process. The necessary public hearing for the Environmental Permit took place on 31 August 2020. On receipt of the Environmental Permit, the Urban Planning Permit will be immediately submitted for approval. After which the Exploitation Permit will be applied for in 2021.

The above implies a relatively short lead time to go-ahead decision for the Vareš project.

Geology of the Rupice Deposit

The Rupice deposit is known from exploration activities, which commenced in 1952 and continued intermittently until 1990, initially focusing on barite (chemical formula BaSO₄) mineralisation and later on the polymetallic mineralisation. The change is understandable in the light of very high BaSO₄ grades at shallow levels with low base metal values, but with deeper drilling encountering much higher base metal and precious metal values.

Figure 2.2_1 shows the traces of drill holes completed at August 2019 at Rupice, after which drilling started focusing on the south-eastward extension of the deposit.

Interpretation of drill results Rupice concluded that the mineralisation appears to be dominantly strata-bound and hosted within brecciated sediments in a shoot dipping approximately 45 degrees to the east. The “shoot” is in actual fact a wide horizon of mineralisation terminated by faults on either side. It is somewhat of a simplistic presentation as there are areas where the faulting does not clearly define such a configuration. This is illustrated in Figure 2.2_2 which shows three cross sections through Rupice from North to South, referencing their location using Figure 2.2_1.

The reason for referencing the sections to Figure 2.2_1 is that the sections are extracted from a press release on 28 November 2019, which contains a drillhole location map much less clear than provided in August 2019.

Figure 2.2_3 shows the longitudinal section through the “shoot” where it is best developed.

According to this interpretation the Lower HG Zone shoot plunges at 25 degrees for almost 400 m down plunge length.

On 23 July 2019 Adriatic declared resources for Rupice as summarised in Table 2.2_1. The cut-off date for drill hole data included in the exercise are not clearly stated, but considerable drilling occurred after this date with five press releases about drill results.

The base metal grades are greatly supported with good precious metal grades for a metal content of 0.53 Moz Au and 55 Moz Ag. Also noticeable is the very high barite grade, which could be an important by-product if it can be upgraded to achieve a density required as a drilling mud without exceeding limits on Pb (0.1 %), Sb (3 g/t) and Hg (1 g/t) content. Given the association of the barite with lead mineralisation, it still has to be proven that lead minerals can be sufficiently separated to yield a marketable barite product.

Since the release of the resource estimate further drilling had traced the mineralisation in a south-east direction. Here the mineralisation is less affected by faulting, but also much less thick as in the “shoot” area. Figure 2.2_4 shows a cross section of the southeast extension of Rupice, which had a down dip extent of 200 m, but with width of approximately 6-15 m.

The width and dip will make conventional longhole open stoping not an option, but the grades are high enough to support more expensive underground mining methods.

Figure 2.2_5 gives a drill location map to demonstrate the intercepts (e.g. BR 02-20) to be well outside the resource outline shown as red-white dots.

The illustration has also been included to show the gravity anomalies on which the drilling was superimposed. Previously drilling was also guided by induced polarisation (“IP”) anomalies.

Gravity surveys are expensive and difficult, but when done correctly can be better suited to finding this type of mineralisation than IP. Electro-magnetic responses can be caused by many factors leading to ambiguous results. Gravity simply measures the strength of gravitational pull at a particular point. This is only determined by two factors: altitude and density of the rock below the measuring point. To get an accurate measurement of the rock density it is therefore important to account for altitude. According Adriatic, GPS measurements used for an older interpretation of the gravity data were good enough and when replaced by LIDAR (using a laser in a flying object), the new interpretation clearly showed good anomalies, which coincide with mineralisation proven through drilling. Considering the very high density of barite (approximately 4.5 g/cm3), thick deposits with high concentration of barite should stand out as they occur in host rock with densities of approximately 2.7 g/cm3. As mineralisation consistently occurs associated and somewhat proportional to the barite content, high gravity anomalies are very promising targets.

Figure 2.2_5 shows how hole BR 02-20 with an intersection of 8.9 m at 0.35% Cu, 3.16% Pb, 1.79% Zn, 2.39 g/t Au and 398 g/t Ag was drilled in a non-anomalous area. The 45% BaSO4 content over 8.9 m was simply not sufficient to result in a gravity anomaly.

However, 150 m further southeast there is a strong anomaly with an east-west trend over almost 300 m to then continue southeast to

Jurasevac-Brestic where grab samples from material dumped from previous mining had very high grades. The size potential is at least of the same order as the high-grade Rupice “shoot”.

However, management was essentially quiet about why subsequent drilling of the gravity anomalies did not intersect wide barite deposits or other high-density rock. Crux Investor has picked up a tendency for management to bury bad news and to be very vocal about good news. Crux Investor’s explanation is that the re-interpretation of the gravity measurements was erroneous.

Geology of the Veovača Deposit

Similar to Rupice, Veovača is a sediment-hosted deposit with mineralisation present in a brecciated zone within a folded sediment package. This sediment package and the breccia zone appear to be steeply dipping to the northwest and plunging to the northeast.

Figure 2.3_1 shows a geological map of the immediate surroundings of the deposit and indicating interpreted potential down plunge.

Figure 2.3_2 shows two cross sections and a longitudinal section along trace X-X’ on Figure 2.3_1 to illustrate the deposit outline and potential at depth and down plunge.

Figure 2.3_3 shows the outline of the planned Veovača pit on an IP anomaly map and below that a soil sample anomaly map, both indicating excellent potential for discovering extensions to Veovača, or for finding satellite deposits.

Mineral Resources and Mineral Reserves

Rupice

The database for the 2020 resource estimation includes a total of 167 diamond drill holes (46 historical drill holes and 121 drill holes from Adriatic’s drilling programmes in 2017 (8 holes), 2018 (39 holes), 2019 (52 holes) and 2020 (22 holes)) for 38,135 m. The deposit was drilled and sampled using diamond drill holes at a nominal 20 m by 20 m spacing, drilled at angles between 50º and 80º mostly towards the southwest.

The press release on the mineral resources includes a number of illustrations with grade interpolation which are pretty meaningless as they cannot be placed in context with illustrations previously released by the company. For example, it is not clear whether hole BR 02-20 in Figure 2.2_4 is part of the updated resources, or not.

Wireframes were created for economical and potential deleterious elements, except for Hg, As and Sb, using cross sections taking account of lithology and faults. Drill data was composited to 2 m length. A block model was constructed, constrained by the interpreted mineralised envelopes. A parent cell size of 5 m (East) x 5 m (North) x 5 m (vertical) was adopted with standard sub-celling to 1 m x 1 m x 1 m to be able to determine the volumetric size of the mineralised lenses. Grade estimation was carried out using ordinary kriging.

For JORC reporting purposes resources must have “reasonable prospects for eventual reasonable extraction. CSA Global, the agency responsible for the resource estimation only gives conceptual reasons for this plus a statement that their chosen cut-off grade of 50 g/t Ag Equivalent is considered “reasonable for underground mining”. At a silver price of US$24/oz and a prospective overall recovery of 92% and overall payability of 87%, this would convert to less than US$31/t in-situ value. The cut-off grade must be considered very optimistically low.

Table 2.4.1_1 gives the mineral resource statement, effective August 2020 and the changes from the July 2019 mineral resources.

The statement shows that the company has very little to show in terms of mineral resource addition from their drilling after July 2019. The average metal grades have fallen across the board by around 20% even with a cut-off grade that was increased from 0.6% Zn Eq. (= approximately US$13/t in-situ) used for the July 2019 exercise to 50 g/t Ag Eq. for the latest resources.

The conversion of mineral resources to mineral reserves assumes underground mining by means of longitudinal longhole open stoping (“LLHOS”) and transverse longhole open stoping (“TLHOS”) with a mining recovery of 95% and dilution of 10.5%. The higher mining recovery is explained by the use of cemented fill.

Table 2.4.1_2 is the reserve statement for the Rupice Deposit together with the conversion rates relative to Indicated resources. Whereas the press release proudly announced the company had used a much higher cut-off grade for mineral resources than in the previous exercise, it states in one line ‘The Ore Reserve assumes a direct conversion between Indicated Resources and Probable Reserves”. In other words, no difference in cut-off grade which, at 50 g/t Ag Eq. (approximately US$31/t), is far lower than the 5% Zn Eq, (=US$84/t) used to arrive at the mineable inventory for the PEA.

The mineral reserve statement published by Adriatic includes antimony at 0.22% grade. Since the reported mineral resources do not include antimony, its inclusion in reserves is against the JORC code.

The mineral reserve statement shows the amount of metal converted is roughly 90% of what is in M&I resources. What needs further explanation, however, is that, despite dilution of 10.5%, the grades are higher than for M&I mineral resources. This means that during the conversion process from Resource to Reserve which captures about 90% of the resource the grade goes up, so the 10% of the resource that does not make it into Reserve is lower grade. How this happens is difficult to see and Crux Investor would like to see more supporting information and working explanations to be entirely comfortable with the reserve modelling.

Veovaca

The database for the Veovaca resources estimation includes a total of 84 diamond drill holes (51 historical drill holes and 33 drill holes from Adriatic Metals PLC’ 2017 (16 holes) and 2019 (17 holes) drilling campaigns. Of these 83 assayed holes intersected the interpreted mineralisation. The Veovača deposit was sampled using diamond drill holes at nominal 20 m - 25 m spacing on 20 m spaced northwest-southeast oriented sections. All of the historical holes were vertical. Holes drilled by Adriatic were generally angled –60º to –90º towards the north-northwest with dip angles set to optimally intersect the mineralised bodies.

Adriatic has assayed for copper and precious metals, not done previously. This allowed the company to declare the resources as summarised in Table 2.4.2_1 using a cut-off grade of 0.6% Zn equivalent.

The PFS press release includes the following reserve statement for Veovaca.

Again, the Adriatic reserve statement includes metals such as copper at 0.07% and antimony at a grade of 0.11% (not shown above), which is against the reporting regulations of technical codes when these elements are not reported as part of mineral resources.

For Veovaca without infill drilling to convert Inferred Mineral Resources to Indicated Resources, the conversion rate has been low with close to 45% of the metal in total mineral resources not included in mineral reserves. As for Rupice, despite dilution of 10%, the reserves grades are clearly higher, except for gold.

Mining Method

Rupice

Primary access to the underground workings for personnel and trackless equipment will be via two parallel declines developed from surface (refer to Figure 2.5.1_1).

The two main declines will allow dedicated traffic in each direction with minimal disruption to the hauling operations and serve as the essential intake airways into the underground mine. The declines are planned with dimensions of 5.5 m wide by 5.8 m high and at a maximum gradient of 16% (1 in 6). Generally, declines are developed at 14.3% (8.3 degrees or 1:7), but the Rupice ore body requires the portal positions to be located to enable optimal placement of mining infrastructure on surface, yet require to get to a certain mining elevation at 1,045 m above mean sea level (“amsl”) speedily to enable the development of the highest grade blocks at depth.

Internal decline ramps will be developed off the main decline to allow for access to the sub-level development. The proposed ramp dimensions will be 5.2 m wide x 5.2 m high with a maximum gradient of 14.3% (1 in 7) and a minimum curve radius of 20 m for the turns which would allow 50 tonne (possibly 63 tonne) trucks from loading points on each sub-level to enter the ramp and then the main decline for transport to surface. The size of trucks would ensure there is not significant equipment traffic in these declines. In addition, there are several underground stockpiles and re-muck bays planned to allow for passing of equipment.

The sub-levels will be spaced at 20 m vertical intervals. Secondary development is anticipated to consist of sub-level ramps that are driven to connect with the footwall drive on each sub-level with a minimum of 20 m stand-off from the deposit (measured from the outside of the drive to the inside of the stopes. The footwall drives are proposed to have dimensions of 5 m wide x 5 m high.

Figure 2.5.1_2 shows that LLHOS is planned above the 1,065 m level and TLHOS below this level, which will be the main mining method and used first before mining the lower-grade, shallower levels later.

Horizontal cross-cut drives at dimensions of 5 m wide x 5 m high, are proposed to be developed at right angles to the strike of the deposit with the cross-cutting ore/drill drives spaced 15 m apart to adequately traverse the deposit and provide for a 15 m stope strike drilling envelope in a primary-secondary stope sequence (see the primary stope outline indicated as a red P and adjacent two secondary stope outlines with green S in Figure_2.5.1_2).

Once the crosscut ore-drive is in its final position (just through the hanging wall contact), a 10-hole (9-holes charged) blast slot will be developed using a long-hole production drilling rig to create a free face for subsequent ring blasting (1.5 metre spaced rings) by retreat extraction. It is proposed that loading of the blasted material be at the intersection point of the crosscut and the footwall drive and hauled via the internal ramp and decline to surface, tipped into the primary crusher and then deposited in different stockpiles before being reloaded onto on-highway trucks for haulage to the Veovaca processing plant.

For stability backfilling using cemented process tailings is planned. Test results indicate secondary stoping can commence 14-16 days after backfilling of primary stopes.

Crux investor records that the mine will be very compact with a strike length of only 600 m and depth below portal of 320 m. This makes for relatively low underground mine development capital expenditure, both initial and sustaining.

Veovaca

Mining at Veovaca will be by conventional open pit methods, including drilling and blasting on 10 m benches with selective mining of ore on 5 m flitches, followed by loading and hauling. Where possible in the near surface weathered zone, free diggable material could be mined without requiring drilling and blasting. Ripping by bulldozers may also be employed in transitional areas to reduce the quantity of drilling and blasting required. All mining activities are planned as contract mining.

The envisaged scale of mining at the Veovaca Deposit is relatively small scale with a peak total material movement including waste of approximately 4 Mtpa.

The majority of the plant feed material is conceptually planned to be loaded directly from the pit into the primary crusher reception bin. Selected waste rock would also be used for the construction of the run-of-mine (”ROM”) Pad, tailings storage facility (“TSF”) walls and other infrastructure items during the site construction phase and potentially for further TSF wall lifts during the life of mine.

Excess waste rock will be dumped in a site located immediately north of the processing facility at Veovača and later in a long-term facility in a valley south and adjacent to the processing facility.

The majority of the plant feed material is planned to be loaded directly from the pit into the primary crusher reception bin. It has been assumed that a small buffer stockpile will be maintained at 10% of the total monthly feed tonnage.

Metallurgy and Processing

Results of Metallurgical Testwork

Adriatic released in September 2019 preliminary metallurgical testwork results for Rupice and Veovaca samples which would serve as input for its PEA. The objective of the testwork was to establish basic processing data, to test processing options and to develop and test a flowsheet that would demonstrate that a marketable concentrate could be generated from each deposit.

The proposed process route indicated it would yield a 92.6% BaSO4- concentrate, 54.3% Zn concentrate and combined Pb-Cu-concentrate with 47.4% Pb. Not separating lead and copper would have a very detrimental effect on the proportion of Cu produced paid for and also result in less than optimal payability for Pb.

Phase 2 metallurgical testwork results were announced on 21 January 2020, which included separation of Cu into its own concentrate.

Table 2.6.1_1 summarised the results in terms of metal recovery and concentrate grades.

The plant feed grade isunfortunately not representative of the resources, being double the grade forall elements except for copper. Adriatic possibly chose such a sample grade asit will focus on the very high-grade resource component in the early years torecoup investments expeditiously.

Highlighted in lightpurple are the most important recovery rates and in light grey the concentrategrades most important for payability. Overall metal recoveries are good, exceptfor zinc. Recovery of less than 70% of gold is partially explained by pyrite(FeS2) containing a proportion of the gold. In subsequent testwork thepossibility of concentrating pyrite to a saleable gold concentrate was studied.

Given the above, the PFSvery surprisingly included a process flow without the separation of copper fromthe initial bulk Cu-Ag-Pb concentrate. The reasons for this are ignored in thediscussion, but Paul Cronin in the Crux Investor interview mentioned that thetestwork had shown that producing a Cu-Ag concentrate first caused degradationof the Pb-Ag concentrate and Zn-concentrate thereafter.

Planned Processing

The PFS process flowprovides for crushed ore to be received and stored in two coarse ore bins priorto the grinding circuit, which consists of a Semi- Autogenous Grinding (“SAG”)mill, ball mill, and cyclone to grind and classify material to a 80% passing(“P80”) of 40 μm, which is a relatively fine grind. Using sequential flotationthe process first generates a bulk Cu-Pb-Ag concentrate and a Zn-concentrate,each with a regrinding stage before cleaning flotation. The pyrite in thetailings of the zinc flotation circuit is concentrated by flotation in aseparate circuit followed by flotation of the barite.

Tailings from the facilityreport to a thickener and filter press where the material is dewatered toproduce filtered tailings, which is initially trucked to the Rupice site foruse as backfill in the underground mine and later trucked and placed at the tailingsstorage facility located near the Veovaca concentrator.

The forecast metallurgicalperformance of this process flow is summarised in Table 2.6.2_1.

Comparing this table with Table 2.6.1_1 shows that all overall base metal recoveries (in bottom row) are consistently higher and the precious metal recoveries the same. The PFS is more circumspect about the estimated recoveries, not giving any decimals.

Whereas overall recoveries are important, the split of such recoveries between concentrate is also important as it will determine whether and by how much the recovered metal is paid for. For example, the Zn contained in Pb concentrate is unpaid. The forecast performance also includes recovery of Sb into the Cu-Pb-Ag concentrate, previously ignored.

Noticeably absent from the discussion on metallurgical performance is barite. The most detailed information is in the press release of January 2020 about metallurgical test results. At a feed grade for BaSO4 of 60.6% (again much higher than resource grade) recovery was 77.6% into a 92.3% concentrate. The PFS does not provide information on forecast recovery, but working back from total LOM production of 1.71 million tonnes concentrate, this seems to be 60%.

At a specific gravity of 4.4 this far exceeds drill mud additive requirements of 4.1. However, levels of some potential impurities (Hg, Cd, Pb) may require further investigation. The PFS is quiet on this, just claiming “it has passed the current API (American Petroleum Institute) tests in terms of sizing and other specifications”. This does not mean it has passed ALL specifications.

There are indications penalties for the mercury content may apply, but the PFS gives no details about the Hg content of the various concentrates.

Required Infrastructure

Abundant accommodation is available as the town of Vareš is only 3.5 km from Veovača and 9 km from Rupice. Even the capital city Sarajevo is only 35 km away.

A 132 KV overhead distribution line runs in close proximity to the Rupice site alongside the main sealed R444a road. The construction of approximately 2.5 km overhead line will be required to connect to the 132 KV line. The estimated maximum demand for the underground operation is 6.1 MVA with an expected operating load of 8.9 MW. It is proposed that 1 MW emergency generator be installed at the Rupice mine site for the provision of emergency power to main ventilation fans and pumping infrastructure.

At Veovača, the derelict processing facility has historically been connected to the HT electrical network and significant electrical upgrades are not expected. The estimated maximum demand for the processing facility operating at 0.8 Mt per annum is 12 MW and the expected operating load of 10.3 MW. The open pit mine services area load is expected to be low and would require a 2.5 km medium tension line extended from the processing plant. One 2.5 MW diesel generator will provide emergency power to the process plant at Veovaca.

Surface and ground-water estimates have indicated that the project will have a negative water balance and the mining and processing water requirements will require augmentation by either a planned well field or supplied mains water supply.

Over the first nine years of the mine life, it is envisaged that most tailings produced from the processing of Rupice ore will be returned underground as backfill. Tailings generated in excess of backfill demand, will be stored in a dry-stack tailings facility, to be developed in the valley immediately south of the former Veovaca processing plant. Tailings generated from the processing of the Veovaca deposit will be also be stored in this dry-stack facility. The facility will therefore be built in two stages, first providing 1.5 Mt capacity, followed by an additional 4.1 Mt. The starter embankment is constructed of rock fill, and the facility will employ upstream construction techniques utilizing compacted filtered tailing .

The project is estimated to require between 5 l/s and 8.6 l/s make-up water. This is planned to be drawn from surface water systems in catchment areas at Rupice and Veovaca using impoundments to store sufficient water for reliable supply during dry periods.

At the town of Vareš there is a railway siding from where concentrate can be transported to the port city of Ploče.

In conclusion, the prospects are situated close to bulk services infrastructure and will require relatively little investment to service operations.

Economic Evaluation

Metal Prices and Marketing Terms Assumed

This valuation has adopted one scenario with PFS prices and another with the spot prices on 24 December 2020 of US$1,873/oz Au, US$25.5/oz Ag, US$3.53/lb Cu, US$0.88/lb Pb and US$1.26/lb Zn were used as the base case metal prices. For antimony the PFS price of US$3.04/lb was adopted as per https://price.metal.com/Tungsten- Cobalt-Antimony.

The PFS does not give the marketing terms which forced Crux Investor to use another source, the PEA study of the Cordero project of Discovery Metals, dated April 2018 by M3 Engineering & Technology Corporation (“M3”). In the PEA report Table 22-4 gives a detailed breakdown of payability terms and treatment and refining charges.

Table 2.8.1_1 reproduces the marketing terms assumed by M3. These marketing terms includes upscales/downscales for treatment charges as function of the prevailing lead and zinc price, which have not been shown to keep the table from being even busier. The penalty terms given have also been ignored as the metallurgical plant feed and metallurgical performance provided is not sufficient to calculate the content of deleterious metals in concentrates.

It should be noted that Crux Investor has also consulted a very experienced metal trader, who provided less attractive terms than the Cordero Project terms. Therefore, even using the terms used, this valuation must be seen as having an optimistic bias.

The transport charges for barite have been based on the information provided by Paul Cronin, CEO of Adriatic, in a Crux Investor interview following the release of the PFS. The US$249/t logistical cost (transport to port, handling and harbour charges, shipping) for all other concentrates is the balancing item to bring total off-mine charges to US$52.1/t treated as per PFS press release.

The table shows the bulk concentrate to be the most valuable with its high precious metal content and Cu and Sb credits. The pyrite concentrate has little value and the barite concentrate adds approximately US$150 million to the at-mine revenue. In the Crux Investor interview Paul Cronin mentioned that the product is very low margin when considering the processing cost for barite, but the company does not want to incur the cost of storage or environmental hassle of not dealing with the barite content. This statement implies that processing is envisaged in addition to (cheap) flotation to generate a marketable product.

Gross revenue calculated using the above marketing terms and using PFS metal prices gives gross revenue that is almost exactly equal to the quoted number for the PFS of US$296.3/t treated.

The PFS press release includes a table with payable products on an annual basis. The total payable metal production derived from using the payability terms in Table 2.8.1_1 was compared to the Adriatic Metals numbers and are in good agreement, except for Cu and Au, as is shown in Table 2.8.1_2.

The difference in payable copper metal is explained by the PFS assuming full payment of all copper contained in the bulk concentrate. This Crux Investor rejects as not realistic for a product with a copper grade just above 6%. Similarly, the payability of gold content in the bulk concentrate is assumed at 90% whereas this valuation arrives at 71.4% given the average grade of 8.9 g/t, but with a number of years of clearly lower grade.

Table 2.8.1_3 shows the relative contribution of each metal to at-mine revenue and the implication for silver equivalent grade.

The large difference between gross revenue and at-mine revenue for Pb and Zn is due to allocating the treatment and logistical charges in full to these elements as being the main metal of the concentrate. The precious metals, copper and antimony are “free carried”.

Production Schedule

Crux Investor had to generate its own production schedule based on the information provided by Adriatic in its Table 2 of the PFS press release which gives payable metal in each year. With the metallurgical recoveries and marketing terms determined, payable metal can be calculated for each year on a trial-and-error basis by hardcoding the feed grade of each metal in the first ten years.

Figure 2.8.2_1 has been included to demonstrate the high grading in early years for the most important precious metal and base metal revenue earners: Ag and Zn.

In year 11 the last remaining Rupice ore is forecast to be mined with production from Veovaca from then on modelled at average reserve grade.

Estimated Capital Expenditure and Operating Cost

Table 2.8.3_1 gives the estimated capital expenditure for the Vareš project.

The capital expenditure on plant amounts to US$870/t monthly capacity which is comparatively high and probably reflects the complex nature of the process flow with four product streams and the need for regrinding of concentrates.

The limited scope of infrastructure construction required explains the low provisions for this item. It is not clear what “project delivery” refers to, but could well be Engineering, Procurement, Construction and Management (“EPCM”) amounting the 15% of expenditure on plant and infrastructure. This is a reasonable rate for EPCM, but leaves nothing for other delivery activities.

The contingency of 17% is low for a study that claims an accuracy of +/- 25%. This valuation has ignored salvage value.

Adriatic provides unit operating cost with very little detail. Mining cost are a mixture of open pit and underground mining cost. When assuming a rate of US$3.5/t mined for contractor open pit mining, the underground mining cost would have to be US$31.2/t to give the overall mining cost of US$26.5/t treated forecast by Adriatic. This is a low rate, but not unreasonable given the chosen mining method and compact nature of the Rupice deposit.

Processing cots of US$31.5/t seems high, but is a reflection of the complex nature of the process and inclusion of ore haulage from Rupice to Veovaca and approximately US$2.8/t.

Th suggested US$4.8/t treated for G&A amounts to US$3.84 million annually, which is very low, possibly explained by the low-cost structure of Bosnia Herzegovina.

Conclusion: in general the cost provisions look realistic except for overheads. To the on-mine expenses one should also add corporate overheads of Adriatic Metals (US$4.2 million pa based on 2020 financial year actuals) for purposes of valuing the company.

Working Capital

The PFS study ignores investment in working capital, which, for an operation producing concentrates and having a long period between production and receipt of revenue, is a material oversight.

Table 2.8.4_1 gives the assumptions used to calculate the investment in net current assets.

The total investment has been assumed recovered at the end of life of mine, ignoring obsolesce and pilferage.

Taxation

Whereas the PFS results are given on an after-tax basis no information on taxation is provided by Adriatic. From earlier documentation it is however evident corporate income tax in Bosnia Herzegovina is levied at a very favourable 10%.

There are no royalties payable to the central government, but the Concession Agreement between the Company and Zenica-Doboj Canton allows for a fee of US$0.85 per run of mine (“ROM”) tonne with a minimum fee based on 100,000 tonnes per annum. According to Adriatic, on a Net Smelter Return (“NSR”) basis, this royalty is equivalent to 0.2%.

This valuation has assumed that amortisation and depreciation is on a unit of production basis with all investments written off at the end of LOM for tax purposes.

Results

Table 2.8.6_1 gives the forecast financial performance for PEA input parameters and this valuation’s amendments and at Base Case metal prices.

Whereas modelled gross PFS revenue is almost exactly the same as the US$296.3/t treated number quoted by Adriatic, the EBITDA of US$1.76 billion is 12% lower than quoted which must be due to the lower modelled payabilities for Cu and Au. Crux Investor derived a net free cash flow number of US$1.39 billion whereas Adriatic has not released information to that level of granularity. What is however strange is the large difference between the NPV8 number of US$0.76 billion with the NPV8 number of US$1.04 billion quoted by Adriatic.

Using spot metal prices and adding corporate overheads this study arrives at a NPV8 value of US$0.81 billion. The Vareš project is extremely robust with the NPV8 being 4.7x initial capital expenditure. There is however a distinct risk that the barite revenue may not come about, wholly should the specification not meet requirements such as having a lead content below 0.1%, or partially, because the 6 Mtpa market cannot absorb the addition of approximately 0.15 Mtpa without affecting the price. Removal of barite as a marketable product drops the NPV8 by US$72 million. According to Paul Cronin in his interview with Crux Investor the difference is even smaller at US$30 million, which means this valuation has not accounted for an additional cost, probably relating to refining the product to an acceptable quality.

The purpose of Figure 2.8.6_1 is to highlight the very strong net free cash flow in the early years, which would make the project very insensitive to changes in the cash operating cost and capital expenditure.

Every additional year of Rupice production at reserve grade would add approximately US$100 million to the NPV8 value. The diagram explains why the undiscounted cash flow pay-back period is only 1.3 years. It also explains the very insensitive nature of the NPV values for one percentage point changes in the main input parameters as shown in Table 2.8.6_2.

Evident from the table is the little difference in sensitivity between the two scenarios for metal prices, which reflects the similar base for revenue under base case metal prices.

For this valuation, every percentage point increase in metal prices increases the NPV8 by US$17.0 million or 2.1% and for every percentage point increase in the cash operating cost (i.e. US$0.62/t treated) the NPV8 drops by US$3.3 million, which is a 0.4% change. The sensitivity to capital expenditure changes is even lower with a drop in NPV8 of 0.2% resulting from a 1%-point increase. Naturally the sensitivity to changes in operating cost and capital expenditure is exactly the same for both scenarios.

Those readers who prefer valuations at metal prices more conservative than spot prices can adjust their valuation according. A 10% drop in metal prices (i.e. to US$1.13/lb Zn and US$23.0/oz Ag, etc.) would drop the NPV8 to US$0.64 billion.

Acquisition Of Tethyan Resource Corporation

On 11 May 2020 Adriatic announced it and Tethyan Resource Corporation (“Tethyan”) had entered into a binding letter of agreement in terms of which Adriatic will acquire 100% of the issued share capital of Tethyan, by way of a plan of arrangement. The purchase price with a deemed value of C$14.7 million (US$10.6 million) would be settled in shares whereby 0.166 Adriatic shares would be exchanged for each Tethyan share. Following this Tethyan shareholders would hold 6.9% of the enlarged Adriatic.

The indicative time table for the takeover has the closing date in mid- August 2020 after getting the necessary approvals and completion of a satisfactory due diligence.

Tethyan has the exploration licence over the Raška prospect and also has the exclusive rights to acquire a Serbian company EFPP d.o.o. (“EFPP”), which is the holder of two exploration licences over the past-producing Kizevak and Sastavci silver-zinc-lead mines in the Raška district of southwestern Serbia. The EFPP mineral rights are adjacent to the Tethyan licences (see Figure 4_1).

Tethyan has explored and drilled the Rudnica and Kremice prospects which have potential for copper-gold porphyry deposits. The results were not entirely convincing as grades encountered until now were sub-economic, which may explain their re-focusing on the lead-zinc prospects of EFPP.

Concurrently with the acquisition of Tethyan, it was agreed that Adriatic would advance a 1.3 million Euro loan to Tethyan for it to be able to exercise its option to acquire the first 10% of the shares of EFPP, commence drilling at the Kizevak prospect and to cover expenses related to the transaction. Tethyan has another 12 months to decide on whether or not to acquire the remainder of EFPP shares.

Mineralisation at Kizevak comprises steeply dipping, southeast striking, structurally controlled lenses of quartz-carbonate-sulphide vein breccias and stockwork zones hosted in volcanic rocks. Historic drilling and underground sampling data indicate that mineralisation occurs over a strike length of at least 1.2 km, is between 1 m and 30 m wide, and extends up to 200 m down dip. The mineralisation has a dominant southeast trend as is evident from Figure 4_2, extracted from a news release dated 3 December 2020.

During 2018 and 2019 Tethyan drilled 14 holes along the southeast trend. This was followed up in 2020 with the latest seven boreholes results announced on 3 December. It should be noted that the 1.2 km strike extent implied in Figure 4_2 ignores a substantial strike length in the middle of the strike length apparently not worthwhile to infill drill as is evident from the absence of red dots. It is another example of the company over promoting itself.

Figure 4_3 shows two cross sections A-A’ and B-B’ identified on Figure 4_2 as being in the centre of the northwest portion of the strike length tested. No cross section for the south eastern portion was provided, which is somewhat concerning.

The grades of the intersections are clearly of economic interest and further drilling warranted.

Sastavci was also mined historically by open pit, but on a smaller scale than at Kizevak. Outcropping, steeply dipping, massive sulphide veins up to 5 m wide are visible in the pit walls. Tethyan has collected rock-chip samples across the Sastavci area, which returned assays ranging from trace to >30 % zinc, 7.1 % lead, 94.3 g/t silver and 0.47 g/t gold in the Sastavci pit. The December press release gives the result for a single borehole, which may be of interest if supported but adjacent holes. Adriatic points to zones of silicification at 500 m distance of the hole that coincide with anomalous gold grades in soil samples.

For the deposits there are old resource statements, which are not compliant to current technical code requirements. Table 4_1 gives these non-compliant resources as an indication of what can be expected.

Red Flags

Crux Investor finds Adriatic Metals interesting due to a number of attributes that the company has, such as a really good project that is open to further resource growth, has good infrastructure and a cracking net present value. Paul Cronin is a good CEO (Mines and Money did, after all, award him CEO of the Year in 2019), he has built a good board around him, and yet there is a whiff of trying-too-hard. Good news is heavily promoted, bad news is buried, a habit which sits at odds with the first bullet point on the ESG slide in the latest presentation “Honest and Transparent”. Hmm. Perhaps that should read “Honest and Transparent up to a point, as long as it presents the company in the best light”? Indeed, when critically assessing the investment case for Adriatic, reviewing the challenges and opportunities for investors, writing down the Red Flags and Green Lights, most of the red flags are related to a lack of transparency. The project is good enough to withstand scrutiny, and Crux Investor believes it would build market credibility, and add value, to publish the full study details, and incorporate all of the real-world factors such as commercial payability terms on the concentrates. Still, these are minor gripes that can easily be addressed by the Company in the future. And after all, Sandfire Resources is still a powerful presence on the shareholder register, and Adriatic Metals is still trading at a harsh discount to the NPV8 of Vareš, a great project.

• Presentation of PFS summary and conclusions only, the full technical document would be much better
• Stretched interpretation of “Honest and Transparent” with a marked tendency to bury bad news and preference to release good news
• Use of 100% payability on the bulk concentrate, which is unrealistic for copper and for gold, and therefore overstates profitability by 12%
• Lack of explanation of results from the drilling of gravity highs as part of the regional exploration programme

Green Lights

• High value project with high margins and strong economics
• Logical long-term buyer already on the shareholder register (Sandfire Resources)
• Potential upside from exploration, and Adriatic now has a significant land package in the region, as well as targets coming through recently acquired Tethyan Resources.
• Barite is a potentially valuable product stream should the metallurgy be viable and deleterious elements kept below critical limits
• Overly-harsh discount to NPV, indicating a longer-term re-rating possibility with an associated share price rise
• Commercially-minded CEO and suitable Board for development and potential sale

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These CRUX Reports are written for expert investors AND for people new to natural resource investing. But whether you are an expert or a newbie, we all have the same driver. We invest to make money. Sometimes investors get emotional about the investment. They actually think they own a mine. They don’t. They own shares in a company. So focus on your investment strategy, work out the best plan for your needs, stick to the fundamentals and remember that the only way you make money is if your shares go up in value… assuming you don’t forget to cash them in!