Scotia's TakeScotia's take:
Dominion Diamond Corporation DDC Rejects Opportunistic US$13.50/sh Cash Takeover Offer; Bid Illustrates DDC’s Intrinsic Value OUR TAKE: Yesterday, DDC confirmed that it had received an unsolicited, conditional and non-binding offer from The Washington Companies (WashCorp), to acquire 100% of the company for US$13.50/sh in cash (~US$1.1B total value). This represents a 36% premium to Friday’s closing price and a 53% premium to last Thursday’s (March 16) closing price, prior to DDC releasing financial guidance (see our note). Talks had broken down on Wednesday, March 15, over the terms of exclusivity and standstill agreements. The bid appears opportunistic to us but it does illustrate the intrinsic value of the company, particularly because the bidder has no apparent synergies with DDC. Near-term catalysts alone support our higher target price, with longer-term upside. We expect the company to begin selling significant volumes of goods from its Misery Main pipe over the upcoming quarters, which we expect to drive significant FCF and re-rate the stock towards our target price in the near term (absent this news). Other near-term catalysts include release of studies on Fox Deep and Misery Deep projects in Q2 and later this year, respectively, release of an improved LOM plan at Diavik and receipt of permits for the Jay project (mid-year). Although the bid value is close to our US$14 TP, in our view, the bid appears opportunistic. Our TP is conservative (0.8x NAV of ~US$17/sh) and is based only on delivering on DDC’s plan mentioned above over the upcoming year. Our target price does not ascribe value to the significant longer-term opportunities for DDC including (i) Fox Deep, (ii) Misery Deep, (iii) consolidation opportunities in the NWT, and (iv) other exploration potential on the large, underexplored Ekati property. In our view, WashCorp would not have any significant synergies with DDC, nor bring any additional insights into the mining or marketing aspects of the business, hence we believe this offer illustrates that the company's intrinsic value is not reflected in its share price. It’s possible that this proposal could act a catalyst for potential NWT consolidation or other transactions. Who else could be interested in DDC? In our view, Rio Tinto (RIO-GB, not covered) could logically be interested in DDC given significant potential synergies. RIO owns 60% of the Diavik mine (40% owned by DDC) and has expressed a desire to remain in the diamond industry even though it expects both of its current diamond operations to close by the early 2020s. We believe DeBeers and Alrosa could also be interested. ANALYST TEAM Link to ScotiaView GOLD & PRECIOUS MINERALS Tanya Jakusconek, MSc, Applied; ICD.D | Analyst 416-945-4083 Scotia Capital Inc. - Canada Joanne van Ballegooie | Associate 416-863-7431 Scotia Capital Inc. - Canada Scott Macdonald, CPA, CA, CFA | Associate 416-945-4648 Scotia Capital Inc. - Canada PERTINENT DATA Rating Sector Outperform 1-Yr. Target US$14.00 DDC-N DDC-T US$9.92 C$13.21 1-Yr. Return 45.2% Div. (NTM) $0.40 Div. (Curr.) $0.40 Yield (Curr.) 4.0% NAVPS $17.05 P/NAV 0.58x Valuation: 0.80x NAV This report is intended for replaceme@bluematrix.com. Unauthorized distribution of this report is prohibited. DDC in Play Rio a logical potential buyer, in our view. In our view, Rio Tinto (RIO-GB, not covered) could logically be interested in DDC. The company owns 60% of the Diavik mine (40% owned by DDC) and has expressed a desire to remain in the diamond industry even though it expects both of its current diamond operations to close by the early 2020s. In particular, the Jay pipe at Ekati is expected to produce very similar products to the Argyle mine owned by RIO, which is expected to close around 2021 – hence RIO already has customers/distribution for this product type in place. Furthermore, there could be significant operational synergies between the Ekati and Diavik mines which are nearby but currently operated independently. Other major players in the diamond industry include DeBeers, which operates the Gahcho Ku in NWT, and Alrosa which could also potentially be interested. Stornoway Diamond Corp. (SWY-CA, C$1.05 TP, SO; covered by Craig Johnston) would likely not be in a position to make a cash offer, and its market cap is less than half of the proposed offer value. Who is WashCorp? WashCorp is a collection of private companies owned by Dennis Washington, an American industrialist, that is engaged in a number of businesses, including operating a copper/molybdenum mine in Montana, but is not involved in the diamond business. DDC says that WashCorp did not have any unique plans for the business, although WashCorp indicated that they intended to lever up the balance sheet. Background: why did talks break down? WashCorp sent a non-binding, conditional proposal letter to DDC’s board of directors on February 21, offering US$13.50/sh to acquire 100% of the company (see link for WashCorp’s NR and copy of letter). The letter indicates that WashCorp may be willing to increase its offer after completing due diligence. The letter requests a 45-day exclusivity period to complete due diligence and negotiation of a definitive acquisition agreement. WashCorp met with DDC’s board in person on March 9. WashCorp indicated that DDC requested a 12-month standstill agreement but WashCorp refused to agree to give up its right to go public with the proposal. DDC also indicated that WashCorp insisted on having veto power over DDC’s selection of a new CEO during the exclusivity period (before completing negotiations of the acquisition terms). DDC believes that its request to have a standstill agreement in place before giving due diligence access is customary, and that the CEO vetoing power would effectively paralyze the company. DDC has characterized the proposal as opportunistic as a result. Talks broke off last Wednesday, March 15, and DDC then released detailed financial and operating guidance on Thursday evening, which now appears to have been a defence tactic that sent the stock up ~12% on Friday. DDC has retained TD Securities as its financial advisors, Kingsdale as strategic advisor, and Stikeman Elliott as legal advisor. WashCorp has said that it remains fully committed to completing this proposed transaction and that DDC said it is open to engage with WashCorp on customary terms.