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Lundin Mining Corp. (LUN:TSX) has made a formal bid to buy Nevsun Resources Ltd. (NSU:TSX; NSU:NYSE.MKT; NY US$3.67), jettisoning erstwhile partner Euro Sun and offering all cash in a hostile takeover. At C$4.75 (about US$3.66, almost exactly the market price), the offer significantly undervalues Nevsun, and presages further activity including, we think, another bid from another company.
Real value and strong potential
Nevsun management, and the board when it makes its formal response next week, will reject the bid as too low. We agree. Nevsun has four parts (plus cash of $125 million).
- The steady cash-flowing Bisha mine, where metallurgical issues that plagued the mine last year seem to have been resolved with improving copper recoveries, plus other Eritrean properties; an Eritrean discount, notwithstanding the recent official end to the war with Ethiopia.
- The high-grade Timok Upper Zone where preliminary construction is underway and financing negotiations commenced.
- The high-potential and long-life Lower Zone, of which Nevsun owns 46% (in partnership with Freeport). The problem is that the Upper Zone has to be mined first and it could be up to 20 years before mining the Lower Zone.
- The regional exploration properties, where drills have started turning on a summer drilling program; in the Bor area, some 27 deposits have been discovered so the odds are strong that Nevsun would eventually find at least one more deposit. The problem is that in Serbia exploration permits last only seven years; some of these will start to expire soon, requiring renegotiation with the government.
Clearly, inside Nevsun are a couple of assets with hard valuations and a couple with longer-term or more speculative, but highly prospective, valuations. Of course, a buyer expects to buy at a discount, but buying one of the world's best undeveloped copper projects—if not the best—at a low point in the copper price cycle, gives plenty of upside. That's worth a premium for a major global mining company.
You do not need to take any action. The Lundin tender is open for 120 days (from July 26th), so there is no rush, and is a tender, meaning you do not need to do anything. It requires 66.67% of shares outstanding to be effective. If you are inclined to take the C$4.75, then just sell in the market, get a couple of pennies above the tender price to cover commission, and you don't have to wait three months!
Possible scenarios
We suspect Lundin will be forced to raise its price, perhaps to C$5.25. Remember, someone has been buying millions of shares since the proposal; they are looking for a higher price (given they are buying at the tender price). Many long-suffering Nevsun retail shareholders also tend to think the company is worth more. I don't think the current tender will be successful.
It is possible—likely?—that Lundin, having already made a failed bid for Timok two years ago, will raise its offer, perhaps to C$5.25. It has C$1.5 billion in cash, though could draw on credit lines or top up with shares to increase its offer. (We would like to see shares in a solid company structured as a merger, to avoid immediate tax consequences for U.S. shareholders). It is also possible that another company will come in after seeing how high Lundin will go, perhaps in a friendly acquisition.
We could write reams on all the various factors—Nevsun's largest shareholder owns more dollar value in Lundin; its second-largest shareholder has been aggressively selling shares, over 9 million shares in June, and likely responsible for the huge volume trading days (including one well over 10 million shares); the resignation of Lundin's CEO on the day the proposal went formal; and so on—not to mention the various and varying rumors swirling around these companies.
What's the risk?
But the bottom line is simple: the current bid appreciably undervalues the assets; another bid is likely; while the downside is protected by Lundin's bid. The major risk is that Nevsun does something such as selling a strategic interest in Timok to a partner, which would encumber the project and make it less attractive to another buyer. Given a proposal is currently active, such a move now would not be in shareholders' best interest. If a major company—Rio Tinto, say—were to make such a strategic investment, even at a price above the current market, the stock will likely fall back because many recent buyers, including arbitrageurs and opportunistic traders, would immediately get out, sensing that an acquisition of the company had been thwarted. Depending on how low the stock price fell, it would then be a good long-term purchase. But the immediate profit potential would be gone.
Give the tender price and market price undervalue the assets, given the likelihood of a higher bid, and given the relatively low downside, we would hold Nevsun here. On the other hand, if you are overweight the stock, you might take the opportunity to reduce your position, given the not-insignificant risk.
Adrian Day, London-born and a graduate of the London School of Economics, heads the money management firm Adrian Day Asset Management, where he manages discretionary accounts in both global and resource areas. Day is also sub-adviser to the EuroPacific Gold Fund (EPGFX). His latest book is "Investing in Resources: How to Profit from the Outsized Potential and Avoid the Risks."
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