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  • "The market can remain irrational longer than you can remain solvent" - John Maynard Keynes

    Friday, October 23, 2009


    Asymmetric trading opportunity in Felix Resources ( ax:flx)

    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):

    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;





    Annualized Profit %

    No Counter, deal goes ahead



    2 months


    Counter/ increased offer @ 19+



    3 months


    Counter @ 21+



    4 months


    Deal Fails



    24 months


    * 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;





    Annualized Profit %

    Deal Fails



    2 months


    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.

    Wednesday, October 14, 2009


    Lynas Corporation (LYC LYC.AX)

    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:

    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:

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

    Before tax based on:

    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.

    Tuesday, October 13, 2009


    Revised NGP Proposed Transaction with Eagle Rock (EROC)

    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:

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

    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).

    Tuesday, October 06, 2009


    Valuing Strathmore (STM STM.V) and progress on Bayswater (BAY.V) Deal

    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.


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    Disclaimer and Disclosure Analyses are prepared from sources and data believed to be reliable, but no representation is made as to their accuracy or completeness. I am not paid by covered companies. Strategies or ideas are presented for informational purposes and should not be used as a basis for any financial decisions.
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