Highlights
 Silver Quest has a 25% interest in the Davidson property, part of the Blackwater Project operated by Richfield Ventures. On April 4, New Gold announced a takeover bid for Richfield. We explain why it may also be motivated to buy Silver Quest.
 Silver Quest has a large strategic land position in the region around the Blackwater Project in central B.C. that an operator of the project would likely want to control. It also has one of the largest land positions in the White Gold district in the Yukon, where one of Canada’s largest staking rushes occurred in 2010–2011.
 We believe that Silver Quest shares offer excellent underlying value and exploration upside. We initiate coverage with a Speculative Buy rating and one‐year target of C$1.30.

Investment Thesis
The April 4 announcement of New Gold’s $550M bid for Richfield highlighted the highquality of the latter’s Blackwater Project, despite its relatively early stage. Naturally, it turned our attention to the joint‐venture partner, Silver Quest, which owns 25% of the Davidson joint‐venture property, the northern portion of Blackwater. Despite being onethird of the 4.2Moz Blackwater resource, exploration of the Davidson property was limited by the lack of a signed joint‐venture agreement. The agreement was signed on March 29 and two sets of drill results have since indicated the potential to add resource ounces and boost the average 1.0 gpT grade of the Blackwater resource. We outline reasons why we believe Silver Quest’s 25% joint‐venture interest might be deserving of a premium. The company also has other properties, including two promising and potentially strategic projects in the same region as Blackwater, and a large land position in the Yukon. Collectively, we believe that Silver Quest’s property positions offer investors excellent value and upside.

Catalysts
Richfield shareholders vote on New Gold’s acquisition offer on May 30. We expect Richfield shareholders to vote in favour and the closing to follow shortly thereafter. An aggressive exploration project is under way on the Davidson joint‐venture that has delivered two promising sets of drill results. We expect more results before the May 30 vote, but also expect New Gold to place a priority on exploring Davidson. It would be uncharacteristic of a major mining company to want a junior as a joint‐venture partner, especially given that Blackwater will probably need to be operated with two sets of books, virtually as two mines. Once the Richfield acquisition is closed, we would expect New Gold management to come knocking on Silver Quest’s door. With drills turning, the longer New Gold waits, the more valuable Davidson will likely become. Silver Quest investors also have exploration results from the company’s other properties to look forward to.

Valuation and Conclusion
We have applied two methods to assess Silver Quest’s underlying value. We have assigned what we believe to be conservative values to the non‐Davidson properties, yet still conclude that Silver Quest shares offer attractive value. Our calculated ITC of $706/oz is well below our Takeover 20 average of $841/oz, and at 0.55x NAV Silver Quest shares are in line with its peer average of 0.53x NAV, attractive given the low political risk and exploration upside. We initiate coverage with a Speculative Buy recommendation and a $1.30 target price.

Incentives for Richfield (New Gold) to Acquire Silver Quest

We see three reasons why the operator of the Blackwater project — be it Richfield, New Gold, or some other acquirer — would want to acquire Silver Quest. Today’s unsettled market conditions might well put such a move on hold, but readers can see that the operator would otherwise be incented to acquire sooner, rather than later.
1) Future exploration seems likely to add disproportionately more value to the Davidson property. It has the potential to both increase resource ounces and boost the grade.
The longer the operator waits, the better the Davidson resource will likely become, and therefore more expensive the takeover.
2) Construction and operating under the joint‐venture agreement will take plenty of additional accounting and work (read cost) for what, effectively, represents about 10% of the overall project.
3) Silver Quest has a large, somewhat strategic land position in the area — the Capoose property potentially being on trend. The operator would probably not want to see the package end up in a competitor’s hands. Our $21.2M valuation is probably very conservative, given Capoose’s strategic location, size and 1.78Moz Au equivalent current resource.
Following the Richfield acquisition by New Gold, which is expected to close in early June, we wouldn’t be surprised if New Gold comes knocking on Silver Quest’s door. Davidson, in our opinion, will be the property that will increase the current 4.2Moz resource at Blackwater due to its relatively unexplored nature. The combination of increased ounces and grade at Davidson make Silver Quest’s 25% share well deserving of a premium, in our opinion.

Paradigm Capital Inc, IIROC/TSX member date May 24, 2011

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