aztec disclosure gives mt gibson strong grounds to

The Australian, 25/10/2006

IF takeover target Aztec Resources is to be believed, it's just a coincidence that it issued a further 7 per cent of its capital on the very day it was released from an obligation to obtain prior shareholder approval to the issue.
Aztec is the subject of a hostile and strongly resisted takeover bid from Mt Gibson Mining. The ASX listing requirements state that a company cannot issue, or agree to issue, equity securities without the approval of shareholders for three months after the company is told in writing that a person is making, or proposes to make, a takeover bid.

The rule is intended to regulate share issues "during" a takeover, but it is badly worded and needs revising. A bidder does not have to make a bid until two months after announcing an intention to bid. A bid must remain open at least one month, but it is almost invariably the case that bids are extended beyond that minimum, sometimes for several months.

It's therefore almost certainly the case that most bids will still be ongoing after expiry of the ASX three-month rule - and that's the case with the Mt Gibson bid for Aztec. Target companies can avoid the intent of the ASX rule simply by waiting until the three-month deadline has passed before unilaterally issuing new shares.

Mt Gibson announced its bid on July 24, just before the opening of trading on the ASX. Aztec issued the 77.777 million shares yesterday, shortly after trading commenced - that is, immediately after the requirement to first obtain the approval of shareholders expired.

The shares were issued at 22.5c each - a discount of at least 10per cent to the value of Mt Gibson's scrip offer, which the Aztec board categorises as inadequate.

The shares were issued to Australian Royalties Corp in consideration for ARC forgoing a royalty of $1 per tonne of ore shipped from Aztec's Koolan Island iron ore project, and an option to repurchase its original 30 per cent interest in the Koolan Island tenements if production hasn't started by June 15 next year.

According to Aztec chief executive Peter Bilby, the company didn't wait until the ASX deadline had expired before settling with ARC and issuing the shares - it was "just the way the circumstances arose". But he also admitted that the company was well aware the listing rules only required prior shareholder approval if the shares were issued within three months of the announcement of the Mt Gibson bid.

It's inherently difficult to accept that the timing of the agreement with ARC was unrelated to the expiry of the ASX deadline. The ASX should amend the rule to ensure the requirement for shareholder approval continued while a bid is still ongoing, perhaps with a provision to seek an exemption if the bid drags on for several months.

Aztec bought the 30 per cent stake in the Koolan Island tenements in mid-2003 but gave no details. In the 2004 accounts, it was revealed that it involved an upfront payment of $1 million and that Aztec would be obliged to pay the vendor a royalty on tonnes of ore sold but, again, no details were provided.

Late last year, Aztec made a $42million rights issue of shares and options and the prospectus disclosed some details about the deal. It showed that the agreement originally provided for an initial royalty of $1.50 a tonne on the first 10 million tonnes of ore shipped, rising to $2.75 a tonne in excess of 30 million tonnes. It also revealed that ARC had the right to repurchase its 30 per cent for a peppercorn $1 if production hadn't started by June 15, 2007.

It also revealed that the arrangement had been renegotiated. In return for $2 million cash and $9 million in Aztec shares, the royalty would be reduced to $1 a tonne on all ore sold. Those payments were made in May, and ARC was issued with 47.5 million Aztec shares, or 6.5 per cent of the capital at the time. It was subsequently diluted to 4.5 per cent by the exercise of options.

The share register now shows ARC as holding 26.1 million shares.

Unless it has further shares under another name, that stake is now down to 2.5 per cent.

But, together with the 7.45 per cent it has just been issued, it now holds a very strategic 9.2 per cent of Aztec: sufficient, should it wish, to prevent Mt Gibson from satisfying the 90 per cent compulsory acquisition criteria.

ARC said yesterday that it would accept the bid if three criteria were satisfied - extending the offer to include the shares issued to ARC, Aztec directors recommending acceptance and Mt Gibson declaring its offer unconditional within 21 days.

ARC also said that it reserved the right to deal with its new shares in such a manner as it considered appropriate.

Mt Gibson can satisfy two of those criteria, but it cannot speak for the Aztec directors, who have recommended rejection of the Mt Gibson 1-for-3 scrip offer, contending that it is inadequate.

But, on the face of it, ARC has reserved the right to accept even if the Aztec board doesn't recommend acceptance. Asked yesterday to clarify whether that is the case, the lawyer who signed ARC's statement, Sevag Chalabian, declined to elaborate.

Mt Gibson has a relevant interest in just over 33 per cent of Aztec. It acquired 15.2 per cent from John Byrne's Cambrian Mining, which also accepted for the remainder of its stake, taking it to 32 per cent, but has only been able to attract just over 1 per cent from other holders.

If Mt Gibson could obtain the ARC stake, it would have over 40 per cent of Aztec, which, arguably, would give it control and enable it to remove the Aztec board should it remain obdurate.

Aztec, for some months, has been confident of stitching together a $100 million banking facility to enable the iron ore project to succeed, but the expected draw-down date keeps slipping back.

Last Thursday, Aztec suddenly advised that "an issue" had arisen because ARC had lodged caveats over its Koolan Island tenements.

It appears the banking syndicate was responsible for raising the issue. It wouldn't finalise the debt facility unless ARC's repurchase right was extinguished, while ARC acted to prevent the banks taking charge of assets over which it had an option. That Aztec appears to have been taken by surprise reflects poorly on the company's management, which should have been aware that ARC would need to be accommodated if the bank facilities were to be secured.

The issue was critical. Aztec confirmed that if the banking facilities weren't available by the end of October, there was significant uncertainty over whether the company could continue as a going concern - that is, it could be insolvent and headed for administration.

The share issue to ARC values is royalty and buy-back option at $17.5 million, which Aztec claimed was a "substantial saving" to the undiscounted value of the royalty of $29.1 million, based on the planned mining schedule of 29.1 million tonnes over a nine-year life of the mine.

But that is an inappropriate way of valuing the transaction. The payment should be discounted to a net present value, and it should take into account time-value and risk. The discount rate adopted can make a huge difference to the NPV figure, but it's arguable that the payment to ARC was generous and that a price in the range of $10 million to $15 million would have been more appropriate. Of course, ARC had all the negotiating power.

The share issue breaches one of Mt Gibson's bid conditions, but it remains to be seen whether it will rely upon this to walk away. One option available to Mt Gibson is to go to the Takeovers Panel to argue that the share issue is a frustrating action designed to prevent its bid, and should require the approval of Aztec shareholders.

However, Aztec could, no doubt, argue that it had no alternative. Resolution was necessary to avoid insolvency and, as the company had no cash or available funding, it had no option than to issue the shares.

If Aztec now manages to secure its bank finance, it wouldn't be a surprise if Mt Gibson were to declare its bid unconditional and seek to at least secure majority ownership and, therefore, outright control. Mt Gibson may also consider complaining to ASIC about what it regards as a pattern of inadequate disclosure, and it could take advice as to whether it has any grounds for legal action against the Aztec directors.