Investing

I have made some good risk arbitrage trades most recently on Corvette and Cape Lambert and before that on Dow and Rohm & Hass. There is an opportunity now in Felix resources.

Yanzhou Coal ( YZC ) have agreed to purchase Felix Resources. The Australian Foreign Investment Review Board was a major sticking point. That is now resolved with the conditional approval provided yesterday. Felix closed at $16.75 on Friday 23rd. The YZC offer price is $17.5. That is 4.5% in 2 months or 27% annualized. Though that isn’t the exciting opportunity.

The YZC bid for Felix was barely adequate when it was announced. On the basis of coal price and market moves since the August announcement the YZC offer is too low. I estimate that there is now a much better than 50% chance of a competing bid (or an increased offer from YHZ):

• A DCF of Felix values it closer to $24-$30
• YHZ have accepted onerous conditions from the FIRB
• The market for M&A has reopened
• There is some minor discontent about the deal within FLX shareholder ranks.

I suggested in this post on sniping Felix that a competing bid would wait until November. I also identified the potential alternate bidders for Felix in another post. BHP and Vale are obvious suitors. Xstrata was a no show at that time but things have improved for them since and they have an obvious advantage with their Ulan mine next to Moolarben.

The trade and the odds

Buy FLX at 16.75;

* including dividends

The probability adjusted profit is $2.78 over a probability adjusted period of 5 months for an annualized profit of 40%.

Short Term

If your timeframe is just a risk arbitrage on this position, then deal fails case becomes;

The probability adjusted profit is $1.78 over a probability adjusted period of 2.9 months for an annualized profit of 44%.

It’s not often that you get the opportunity to make a risk adjusted profit of 40%+ where your downside is limited by the cheapness of the assets.

posted by Neil  # 10:14 PM 0 comments

Lynas Corporation (LYC) is traded on the ASX. They are building a Rare Earths (RE) mine in Western Australia and a processing plant in Malaysia.

Rare Earths have been capturing quite a lot of attention amongst early investors. A short introduction can be found at the following links:

• Rare earths are vital, and China owns them all
• China predicts rare earths shortage
• Rare earths offer unique investment opportunity

Until recently they were going to sell slightly over 50% of themselves to the Chinese in exchange for equity and guaranteed loans. The Australian Foreign Investment Review Board (FIRB) rejected the application and the Chinese deal collapsed. Instead LYC have launched a massive capital raising, made much easier by Australia’s laws which allow rights issues and institutional sales without a prospectus. Large capital raising can go ahead in only a few hours.

The capital raising consists of:

• $88M placement
• $295 rights offering
• $67M conditional placement

Based on 670M shares (inclusive of in the money options) outstanding before the offer they will add about 1bn shares.

Before tax based on:

• $9.6 US per kg of RE sold, increasing by 5% per year
• $7.45US per Kg of all in costs , increasing by 3% per year
• Long term AUD/USD of 90c
• 10,500 tonnes in year one growing to 20,000 in year 6
• Production commencing in 1 year
• Cost of equity of 13.4%

LYC would be worth about 32c after the capital raising. To get to today’s price of 60c AUD you need to assume that RE price grow by 8% per year. 8% a year may not seem like much but that is $41 per kg in year 20. Alternatively you get to today’s price by taking the $14 all time high for LYC’s basket of RE’s and growing that by 3% per year for 20 years. Again, if that happens then you break even. Remember this is all before tax.

Lynas is planning to get to production without any debt having had bad experiences with debt financing up to now. While the value of the firm should not change based on the capital structure (Modigliani and Miller equivalence and all) the returns to equity would have been much higher with a mix of debt. While this is often true it’s worth noting in this case because the dilution from this capital raising is so substantial.

Buying into Lynas is a leveraged play on Rare Earths. If you think they are going to go up over 4 times in the next 20 years then you’ll break even!

You would have to have very bullish assumptions on RE prices to buy into Lynas at these prices.

posted by Neil  # 10:13 AM 0 comments

Natural Gas Partners (NGP) proposed a series of transactions with Eagle Rock Energy Partners (EROC), as detailed in this post. NGP have just submitted a revised term sheet to EROC.

The changes mentioned in EROC’s press release are:

• $145M instead of $135M for Mineral Business
• $4M less in fees to NGP and fee can be paid in units if the equity raising is less than 105M
• Option on remaining GP units extended to 2012 from 2010

By redlining the two documents the following changes are also proposed:

• Warrants only exercisable four times a year
• If the public equity offering price is above $3.40 then EROC will issue up to $140M instead of $105M
• Sale of the Mineral Assets will be effective on January 1^st, 2010. All profits from then until closing will accrue to NGP.
• EROC can set up a data room and may market the mineral business. An alternate deal has 100 days and can be for all or part of the minerals business. It must be for more than $145M and must either close within 100 days or have no conditions.
• They clarify that the transaction fee is only payable if the approvals are obtained
• Proceeds can be used for hedge resets
• NGP could terminate the agreement between the definitive agreement and the approval if the share price dropped below $2. This has been changed to $1.50.
• EROC’s conflicts committee has a fiduciary out. That would allow them to accept another, superior, proposal if their fiduciary duty requires them to. NGP would get a $7M break fee. This out is only available until the Approval date.

All of these revised terms are more favourable to EROC though not substantially so. At best this may provide a few extra percent in value from $6.90 to $7.20 (versus $7.66 before the NGP EROC deal). The pricing of the equity offering is going to be much more important than the minutiae of the NGP EROC terms.

This revised term sheet indicates that a deal is very likely and the timeframe for realizing a good profit on EROC should be around 3 months. EROC closed at $4.57 so there is still a 58% gain if you see through the whole rights issuance (though we may not see all of that gain in 3 months).

posted by Neil  # 6:25 AM 0 comments

As discussed in late August, Bayswater is trying to purchase Pine Tree-Reno Creek and the Wyoming properties from Strathmore Minerals (STM STM.V).

Bayswater just received a positive pre-feasibility study on the Reno Creek Uranium project. This study is for less than the 10% of Strathmore that BAY is purchasing.

The NPV of the Reno Creek project is US$164M using an 8% discount rate. Assuming that this is a reasonable average NPV for each remaining 10% of STM, it would value STM at 9x164 = $1,476M USD or $20USD a share.

I don’t think 8% is the correct discount rate for STM. Using a regression Beta from Reuters you get a cost of capital (it’s all equity) closer to 20%. That would make the NPV closer to $63M for Reno Creek and a total value for STM closer to $7.60 USD per share or $8 CAD. That is slightly higher than my liquidation value for Strathmore of $4-$7 CAD. Last night STM closed at $0.56 CAD.

Why is STM worth so little as a going concern versus an orderly selloff of their properties? The answer is their cost of capital. An established mining company could bring a much lower cost of capital to the project thereby capturing value closer to $20. Over time, as STM matures, their cost of capital will decrease and they will be able to capture more of the value that is currently discounted away.

This is yet another support for a valuation of STM in the $4 - $7 (or $8) CAD range today and an eventual value of close to $20, albeit with much higher than market risk.

posted by Neil  # 8:36 PM 0 comments