Let me get right to it.
Today I have an interesting ‘risk-arbitrage’ play (aka merger-arbitrage – a strategy that speculates on the completion of a merger or acquisition) for speculators that I believe offers positive asymmetry (low risk – high reward) in the battery metals space.
Here’s some context. . .
Two days ago – Cobalt 27 (TSX-V: KBLT.V) – announced that they entered into an agreement in which they would be acquired by Pala Investments for C$501 million Canadian dollars – or a 66% premium at the time of the offer.
(Cobalt 27 is basically a company that raised cash to buy physical cobalt and store it in a warehouse. They also bought royalties and streaming agreements with nickel and cobalt mines/deposits. You can view their recent corporate slide-show here if you want to know more).
Now – this means Pala’s offering Cobalt 27 shareholders C$5.75 per common share. Which is much higher than the C$3.48 Cobalt 27 traded at when the announcement was made.
But – there’s a catch. . .
Pala Investments wants to acquire Cobalt 27 with both cash and shares of a new to-be-listedcompany – Nickel 28 Capital.
Thus – putting it simply – Cobalt 27 shareholders will get C$3.57 in cash and C$2.18 worth in shares of Nickel 28 – which equals C$5.75. . .
What makes this deal attractive is that – at the time of writing this – Cobalt 27 shares are only trading at C$4.00 – meaning there’s still about 30%-plus to be made in arbitrage if the deal finalizes.
And while this may sound like free money – or as Benjamin Graham (the father of value investing) put it – it’s like buying one dollar for fifty cents – it’s not quite that simple.
Like I wrote in the second sentence of this article – it’s called risk-arbitrage for a reason. . .
Even famed investor Joel Greenblatt wrote in his popular book ‘You Can Be A Stock Market Genius To’ – risk-arbitrage just isn’t for the faint of heart. (I hate the name of this book. But it’s still a very good read for speculators).
For starters: shareholders of Cobalt 27 must vote on agreeing to this acquisition. And who knows how they’ll feel until more time passes. (Thus creating uncertainty).
And secondly: the newly listed company – Nickel 28 – isn’t even trading yet. So the $C2.18 is just an implied value (not a market value).
That means once Nickel 28 begins trading – the shares could fall immediately. Wiping out some of the acquisition gains. (Or vice versa and prices increase – increasing gains).
Thus – it’s important to gauge what Nickel 28 will be worth before entering this arbitrage play.
Let’s take a look. . .
At the time of writing this – Nickel 28 will hold a portfolio of 11 royalties on nickel-cobalt assets. (Meaning once they begin producing, they’ll get a fixed payment worth a percentage of the mines revenues).
Some are pretty interesting – like the royalty on the world-class Dumont mine in Canada. And the royalty on the Turnagain project – one of the world’s largest undeveloped nickel assets.
(Keep in mind that none of these mines are operating yet – thus no royalty income).
That’s why – for now – the best asset will be the 8.56% stake in the world-class Ramu mine.
To give you some context – Ramu is an open-pit nickel-cobalt mine that’s located in Papua New Guinea. And is currently operating.
The mine hit a record annual production last year (2018) with 35,355 tons of nickel. And 3,275 tons of cobalt.
It also has a potential 30-plus year mine life (built in 2008). And an attractive cost profile (relatively low-cost of mining).
Thus the cash-flow from Ramu (even if nickel and cobalt prices stay flat) should give Nickel 28 shares at-least some worth.
It’s clear that Nickel 28 will be a high-leverage play in the cobalt-nickel space (aka battery metals) with some very attractive assets.
And I imagine they will continue adding to their royalty/stream portfolio (so beware share dilution later as they raise capital).
So – in summary – I think there’s an asymmetric (low-risk high reward) risk-arbitrage play with 30%-plus upside for those that enter now.
It’s clear that Pala Investments wants Cobalt 27’s cobalt stockpile (2,982 tons) – currently worth roughly $85 million.
And since Pala is offering Cobalt 27 C$501 million for the rest of the 81% of shares (remember – Pala already owns 19% currently) – they will really only have to spend C$405 million to acquire the rest.
For this – they will acquire Cobalt 27’s balance sheet ($35 million and no debt), the stockpiled cobalt, and the rights to the Voisey Bay cobalt stream. (This will not be part of the Nickel 28’s portfolio).
(Keep in mind that Cobalt 27 raised $300 million to acquire the Voise Bay stream last June when the price for cobalt was about 300% higher than today. Thus those that bought in at the time are angry they’re selling it at a discount – which may cause shareholders to vote down the deal as they’d rather wait until prices potentially rise).
But – with Cobalt 27 currently trading at C$.400 per share – I think there’s enough upside that warrants the potential risk.
Or – said otherwise – there’s a thick ‘margin of safety’ (a term coined by Ben Graham about buying when the market price’s lower than a company’s intrinsic value) at these prices.
For instance – even if the deal doesn’t go through – Cobalt 27 will still have a healthy balance sheet, a cobalt stockpile, and interest royalties/streams. Thus I don’t see their shares dropping much lower than now. (They will also remain a pure-play in the battery metal space).
But if the deal does go through – Cobalt 27 shareholders will get the $3.57 per share in cash – plus the new shares of Nickel 28 – netting a 30% plus premium. (Which still give them significant leverage to the nickel-cobalt market).
I’m bullish on the long-term fundamentals for cobalt – and especially nickel. So I’ve personally owned Cobalt 27 for a few months now. And have continued taking advantage of it’s huge sell-off over the last year as cobalt prices sank.
I plan to buy more Cobalt 27 on the dips – or when I can below C$4.15 a share. But I wouldn’t buy much higher than that.
There are still uncertainties – but for those wanting exposure to the battery metal space (or simply like risk-arbitrage) – I believe this is an asymmetric opportunity. I hope you found this worthwhile.
Please do your own diligence.
PS – This was just a brief overview of the risk-arbitrage play. I know I didn’t cover everything. And I’ll do another article later on the fundamentals for both metals.