interesting article on merger

Mineral Securities - An emerging mid-tier mining group, trading like a depressed junior
by R. Ekins


Junior miners have been hit hard by rising costs, shortages of equipment and personnel, and lack of access to capital. AIM and ASX listed Mineral Securities (Minsec) is no exception and its share price has halved in twelve months, despite continually trading at a wide discount to its net asset value.

In late January, management acted to close the discount and to respond to the new operating environment by agreeing to merge with ASX-listed CopperCo, the emerging copper producer that has been one of Minsec’s flagship investments. The agreement was that CopperCo would issue 2.2 shares for each Minsec share. The merger timeline was ambitious: CopperCo shareholders were to meet in March, with an unconditional offer to be made in April. In the end, shareholders approved the deal in mid-May and an unconditional offer was made at the end of June.

The delay may have been necessary to give management time to convince shareholders of the merits of the arrangement. In April, the company received an independent valuation of Minsec, which, at $2.57 per share, compared favourably to the effective offer price of $1.43 and in May the merger was duly approved, despite the opposition of a sizeable minority of shareholders.

CopperCo shareholder approval was the major hurdle to be cleared. Minsec has trailed the share price of CopperCo since the merger announcement, often offering a nice arbitrage opportunity. At yesterday’s close, for example, the merger equivalent price for Minsec was 55.63p, a 15.9% premium to its mid-price of 48p. It is very unlikely that Minsec shareholders will reject the proposed deal and with the merger now nearing completion, it is an opportune time to look again at the investment proposition that New CopperCo offers.

The enlarged company has investments worth, as at 20 June 2008, US$194.97m (A$201.54). The flagship investment, valued at US$132.73m, is a sizeable interest in AIM and TSX listed Platmin, which will produce 250k oz/annum PGE metals from early 2009. Platmin has shallow, low-chrome ore deposits, which are relatively cheap to mine and smelt. It is very good value given the strength of platinum prices and its imminent transition from developer to producer. The company’s other major investments are in earlier-stage associate companies in which it also has close technical and strategic involvement: Tianshan Goldfields (ASX and AIM: TGF), Herencia Resources (AIM: HER), Mineral Sands (ASX: MSN), NiPlats (ASX: NIP), and Buka Gold (ASX: BKG). Investments in various other juniors are likely to be sold off to repay debt.

New CopperCo has several direct project interests, the two most advanced of which were recently valued at $244m. The first is the Sappes gold project in Greece, which, while locked in permitting, has attractive metrics and was valued at $66m at a 13% discount rate. The second is the company’s 25% interest in the Lady Loretta project, a 13.7mt deposit, grading 17% Zn, 5.8% Pb, and 96g/t Ag. The valuation report estimated total capex to be $195m and opex to be $163/t (including toll milling at Xstrata’s Mt Isa operation), with a value net to Minsec of $178m at a 15% discount rate. This assumes development from late 2008, and full production in 2011.

A key benefit of the merger is that CopperCo’s production facilities are adjacent to Lady Loretta. Integrating these facilities into development planning will require further study and may delay a production decision until 2009. Even if modestly delayed, the economics are outstanding. The best way to see the scale of the opportunity is to look at the value of each ton of ore, which, at 90% recoveries, is $355, even at low metal prices: Zn at US$0.75, Pb at US$0.50 and Ag at US$12. If opex is $163/t, the operating margin is $192/t. At a production rate of 1mt per year, the company’s 25% share would yield $48m gross profit each year, for 13yrs, with a one-year payback.

New CopperCo is, of course, producing copper now, initially at a rate of 19kt/annum, but ramping up to 25kt by the end of the year, and then to 30kt from September 2009. The company has hedged 9kt/annum for three years at a US$3.18/lb equivalent price. The rest will be sold at spot, which is currently $3.83/lb. The company will spend $47m on capex this year, and a further $17m in 2009. Opex is $0.83/lb for the 19kt operation and $0.64/lb for the next 11kt. At the hedge price, the gross profit margin on the first 19kt is $2.35/lb, and $2.54/lb on the next 11kt. At spot, the margin rises a further $0.65/lb. Even if one assumes only the hedge price, the operation will be exceptionally profitable. For the second half of 2008, the company would cashflow $25.41m, net of capex. For 2009, the figure rises to $123.52m, and in 2010, to $159.06m. These figures are before tax or interest repayment, so do not translate directly into earnings. However, the company will be able to service its $135m debt and has significant tax loss assets.

From September 2009, with most production at current spot prices, the company is on track to earn $123m/yr, net of 30% corporate tax and assuming $13.5m interest payments. And if the latest forecast from Citigroup is anywhere near right, and copper rises sharply to an average of $5.00 in 2009 and $5.50 in 2010, then earnings will be vastly higher.

At the expanded rate of production, mine life is only six years, but the company is working aggressively to expand its reserves. Recent outstanding drill results (including 55m at 3.3%) are encouraging. Further, the enlarged group will have a very large and prospective land package in the region: Minsec’s subsidiary Australis has 34,000 sq km adjacent to CopperCo’s deposits.

The post-merger company will have 800.79m shares outstanding (assuming the cancellation of Minsec’s shareholding in CopperCo), plus 48.58m options, with an average strike price of $0.724. At yesterday’s close, $0.52, the market capitalisation of the enlarged group would be $416m. The company will have debt of $135m, and cash in hand, after merger costs, of $7.5m. If one subtracts the listed investments, at $202m, and the net present value of the two leading direct project interests, at $244m, the company has an enterprise value of $97.5m. Yet it is highly profitable now and is on track to earn $123m/yr or more from September 2009. If one attaches a forward P/E ratio of three to this earnings stream, the sum of the parts valuation, net of debt, rises to $689m, 65% higher than the current capitalisation. And this makes no allowance for any rerating of Platmin or progress towards Lady Loretta development.

Less tangible but equally important are the strategic advantages that New CopperCo will enjoy. The post-merger company will be well placed to overcome the predicament that now faces junior miners. Its scale and diversification should attract a greater institutional following, offering improved access to capital, and its cashflow will mean that in any event it has the capacity to advance its development projects with minimal dilution. The size of the company will help it retain its excellent management team and technical personnel, which is critical to operational success. And the combination of these advantages, together with the otherwise depressed state of the junior mining sector, leaves New CopperCo well placed to acquire and develop promising projects.

The enlarged group is thus a compelling value opportunity with a very strong strategic position: effectively, it is an emerging mid-tier mining group, trading like a depressed junior