Why I think that if IGO bids it needs to be at least $4.00 per share.

I only tend to post here if I think there’s a chance that shareholders in a company I own might accept a deal on what I believe to be poor terms.It happened a couple of years ago with the takeover of Stanmore, and again last year with Universal Coal.

Disclaimer:I try and post what I believe is a balanced and factual view and explain the logic behind my thinking.You can choose to agree or not to agree.I own shares in both WSA and IGO.The majority of my WSA shares were now bought at around $2.70-$2.80 per share. My IGO shares were bought at around $4.60.Iown far more WSA shares then IGO shares.Please note I’m not your financial advisor, this analysis could all be wrong, and you should do your own research and probably not listen to random people on the internet without fact-checking! Apologies also for any weird formatting. I've discovered hc is not really setup for long posts as post formatting breaks.

TL/DR: If IGO bids I believe the minimum bid amount has to be at least $4.00 per WSA share. Assuming a mostly scrip bid, based on relative valuations, a bid of $4.00 per WSA feels about the bare minimum. I would accept that offer for my shares. This bid level also provides enough of a premium to what I infer the key institutions on WSA’s register value the company at, such that a bid around this level likely gets accepted. The blue-sky scenario for WSA shareholders if is BHP submits a competing bid. Based on recent precedent, we can infer that, if BHP bids, it could be at +$5.00 per share.

It’s been interesting to follow the speculation around a potential WSA and IGO merger over the past week.It started with a StreetTalk post in the AFR on the 18^th.An extract of this post is shown below:

"Western Areas, whichhas been carrying on like a company in takeover defence mode for the past month, is understood to be in the crosshairs of a deep-pocketed suitor, withfingers pointing to the acquisitive IGO Ltd as the most logical candidate. Fund managers reckon that whoever iscircling Western Areas would need north of a $1 billion bid just to get in thefront door,given the board’s belief in the company’s Odysseus growth project and theinvestor appetite for nickel and other battery metals. Should a bidmaterialise, it would be another blow for short-sellers, at a time when there’splenty of smoke around long-term short targets like Western Areas, and red hotconditions for M&A. Rothschild is understood to be advising WesternAreas.

At the time, it was noteworthy that WSA had taken the inbound interest seriously enough to apparently appoint a defence advisor. There didn’t seem to be a non-binding or indicative offer, but it did seem a potential takeover was possible given all the announcements WSA have made in the past month or so. All of these seemed to be aimed at a short-term boost to their languishing share price (e.g. the release of 10-year production guidance and stronger emphasis on New Morning/Diggers as potential development options).

The timing was also curious,being a couple of weeks after Diggers. As we know, mining companies tend to try and announce big mergers at Diggers & Diggers (e.g. NST + SAR to give one example). WSA were also about to mine the first stoped ore from Odysseus in the current quarter. If a strategic such as IGO or BHP was going to buy them, then now would be the time to do it, before they signed away long-term off-take from Odysseus/Cosmos.

The AFR leak then noted the next day that it was IGO that was in preliminary discussions with WSA.If it was to be believed, then Macquarie was advising IGO and WSA was being advised by Goldmans and Rothschilds.A quick check showed that neither Macquarie nor Goldmans had published a research note on either IGO or WSA in the last few weeks. That made sense, as if they were acting as advisors they wouldn’t be able to publish research.We also saw WSA come out and release an ASX announcement to respond to the AFR article, and then IGO issue a response to WSA. Both confirmed they were in preliminary discussions about a change of control transaction.There was (and still isn’t) any assurance that a transaction could occur.

Some back of the envelopecalculations showed that if IGO was going to be bidding for WSA, it was goingt o be extremely favourable relative to the last WSA share price of $2.48 per share.

If we assumed a bid at $1,000mEnterprise Value, then

Add back cash at 30 June of$151m plus $12m from the delayed shipment last quarter = +$163m. Also Assume they are cash flow neutral this quarter.
Then add back the current value of their Panoramic shares = +$70m
This gives $1,233m equity value. Divide by 325.6m fully diluted shares (basedon the last 2A release) and you get $3.79 per WSA share.

Even if the bid didn’t come inat around $1bn EV it still likely needed to be well north of the current share price for all the institutions on WSA's register to accept.

Let's take WSA’s largest shareholder Perpetual, who owns ~40m shares, or around 13% of WSA. Perpetual were buying WSA shares all the way up to around $2.60 per share and selling between $2.60-2.75 per share in February 2021 when spot nickel prices were around US$19,000/tonne, about where they are today. You can find this table in the substantial shareholder notice lodged on 12 March 2021.

That means at spot nickel prices they probably have an internal valuation for WSA shares of at least$2.60.If you add a standard 30% premium to $2.60 per share you get $3.40.Later, it was also revealed that Andrew Forrest’s Wyloo Metals had also secured a ~5% shareholding .Wyloo had been building a position in WSA since March and invested a total of $38m, at an average cost of around $2.24 per share.It looked like they picked up a decent block of WSA shares on the 19^that around $2.70-$2.80 per share to take them above the 5% threshold.

I genuinely didn’t understand why anyone was selling WSA shares on the 19^th.I sold a lot of my other positions on the 19^th and piled most of my portfolio into more WSA shares at around $2.77 per share (this is not financial advice and you probably shouldn't do this). Proof of trades on one of my accounts:



In my opinion the downside looked like it was around $2.50-2.80 if a bid didn’t proceed and WSA reverted back to “fair value”.Upside was up to $5.00.This looked like one of those rare, value-creation opportunities that don't come around that often.

WSA have extremely strategic assets, including their 20%position in Panoramic. We know IGO wanted to buyout Panoramic because they tried to take them out in 2019. You aren't getting WSA without paying a large control premium to what the shareholders think the company is worth. If you add a standard 30% premium to $2.60 (being what we infer is the minimum that Perpetual value WSA shares at) you get $3.40 per share.

Given IGO don't really have a lot of cash at the moment, if they bid, the majority of the consideration they offer had to be in IGO shares (e.g. acquiring WSA shares by offering WSA shareholders new IGO shares). The AFR leaks seemed to imply this also.
When we are dealing with scrip-heavy bids, we need to think about relative valuations - e.g. what is WSA worth relative to IGO, and if you combine WSA and IGO, what % of the "MergeCo" should existing WSA shareholders own?

1. If we use a share price of $9.00 then IGO's market capis around $6.8bn. Add in $571m of net debt and you get an Enterprise Value (EV)for IGO of $7.4bn.

2. Let's make the basic assumption that IGO bids via a 100% scrip deal for WSAat a $1.0bn EV valuation. As noted above, under this assumption the implied equity value of WSA shares is around $3.80 per share.

Under this exchange ratio IGO is worth 7.4x what WSA is valued at. So if you combine the two companies in a share deal, and for simplicity ignore cash adjustments, WSA shareholders end up owning 1/8.4 (12%) of the combined "MergeCo".

3. The key question is: isIGO worth 7.4x WSA? As a current shareholder of both companies I would say no - the "relative value" favours IGO.

Recent consensus earnings suggested that IGO will generate $475m of EBITDA in FY23.This obviously assumes some aggressive lithium price forecasts. Consensus also says WSA generates $84m EBITDA in FY23. So IGO generates 5.65x WSA's future EBITDA (475/84).

So if IGO generates 5.6xWSA’s earnings then how can IGO be worth 7.4x WSA? You can repeat the same analysis for EBIT, NPAT, NPV, cash flow etc and you'd come to similar conclusions.

So add in what we know about the entry prices of the key institutions on WSA's register and I think you can come to the conclusions that:

1. If they did a deal, there is no way in hell it would be a nil premium merger.

2. Buying WSA at a $1bn EV actually represents value forIGO and they could pay more. A bid with an implied value of $4.00 is not unrealistic.

As part of this analysis let’s also remember that Nova has at, at amaximum, 4-5 years of mine life left at increasing costs. Fast forward 2 years and WSA has Odysseus up and running, and if nickel prices stay strong, can possibly pull the trigger on other growth projects like New Morning and Diggers. At this point Greenbushes is probably a lot bigger but Nova is basically done.

IGO could also gear part of this transaction if they wanted to and it would probably have a positive carry. They'd borrow at 3-4% p.a. and if they can buyWSA cheaply enough then the cash flows from WSA would cover their financing costs. Add in the fact that all of the big Australian instos would basically be forced to buy IGO if they want nickel exposure and you'd expect IGO's share price to rise after the transaction.

However the lopsided relative valuations between IGO and WSA creates a short term issue. And the longer the merger speculation goes on, the worse it is for IGO.

If you thought the merger happens on favourable terms to WSA then the clear carry trade for all of the institutions is either to short IGO and go long WSA, or sell their IGO shares and buy WSA shares. Ignoring tax, if you sell your IGO shares and you use the proceeds to buy WSA shares you end up with IGO shares in the end anyway, just more IGO shares than you started with. This is why the WSA share price has been going up and IGO has been going down following the AFR leak.

This is clearly bad for IGO's share price and it makes thedeal economics look worse given, if they bid, it's mostly going to be in newIGO shares. The IGO/WSA share price ratio has already fallen from around 4xbefore the AFR leak (IGO 9.90/WSA 2.50) to around ~3x currently (IGO 9.30/WSA3.10). So this forces IGO to accelerate discussions to either get to anagreement with a locked in exchange ratio, or they have to walk away quickly before their share price tanks any further. All of the bankers, lawyers, andadvisors would be aware of this.

Western Areas reports its full year results tomorrow(24th). IGO reports its full year results on the 31st August.

Given ASX disclosure requirements, if a deal is close, I think the absolutely earliest time they would announce it would be tomorrow. It doesn't make much sense for WSA to have to go into a trading halt right before they release their annual results.

I actually think the earliest time that any IGO/WSA deal gets announced is atthe same time/after the IGO results. At that point both companies have then reported their full year results so this information is "cleansed"into the market. As a shareholder of both companies I think it's a very logical merger, but it needs to be done at the right price for WSA shareholders.To me, that price is at least $4.00 per WSA share.

We’ve seen BHP get on their soapbox and make a big song and dance about becoming more ESG-focused.Their profitable oil and gas assets are being de-merged so that they can conform to net-zero. And they’re looking to make further investments into battery metals.They bought some pretty marginal nickel assets at Honeymoon Well last year and this year they’ve bid for Noront.

Nickel West made US$149m in EBIT in FY21.A $1 move in the iron ore price actually matters more for BHP then all of Nickel West’s earnings.But Nickel West has gone from almost closing due to being a money sink to being allocated over US$500m in capital over the last two years.BHP has invested more capital into Nickel West then into Potash, which is apparently their new growth pillar.The nickel assets are also getting expanded.This reads like they’ve strategically committed to nickel as part of their long-term planning. They probably can't really go back now.

IGO potentially controlling most of the third party nickel concentrate offtake to Nickel West is clearly a terrible scenario for BHP. Imagine a situation in January 2023 where IGO lets the BHP offtake agreement at Forrestania roll off to sign a deal with someone like POSCO.BHP is then left short of nickel concentrate for their refinery and smelter.They’ve already committed to customers such as Tesla (and made a huge deal about it even though its essentially meaningless for their actual earnings).That would force them to change their mine sequencing and bring forward production from other sources.How much does that cost them?Not sure, but probably a lot.

We've seen BHP come over the top with some enormous premiums when they're forced to make a move.When Forrest and Tattarang made a bid for Noront, which BHP had been monitoring for years, they came back over the top with a bid at a +129% premium to the undisturbed Noront share price. If you put a 2x multiple on the undisturbed WSA share price of around $2.50 you get $5.00. BHP could bid $5 a share for WSA in an all cash deal and it would still be a rounding error for them.

The other thing to note was that according to shortman,short interest in WSA was 3.7% as of last week, and had been rising. 3.7% of321.6m basic shares outstanding is a total short position of around 11.9mshares. WSA's average trading volume over five days prior to the AFR leak was1.44m shares/day. The shorts were going to have to try and cover fast.

To be clear, it is worth noting that there doesn't seem tobe a binding or non-binding proposal yet. It could all still fall over if Danand Joe have stars in their eyes about what they think WSA is worth.

I’m not a huge believer in technical analysis but to me arising share price on massive volumes would be a very bullish sign.

The volumes we’ve seen on the 19^th, 20 ^th, and 23^rd are not retail volumes.Most of the volume is coming through the big investment banks.These are institutional prime brokers not retail brokers. I'm speculating, but to me these volumes and the rising WSA share price appear to be indicating that the institutions and hedge funds think this merger gets done and are getting their positions set.