If Hudbay Minerals (TSX: HBM; NYSE: HBM) succeeds in its hostile takeover bid for Augusta Resource (TSX: AZC; NYSE-MKT: AZC) and the exploration company’s attractive Rosemont copper porphyry project in Arizona, the base metals producer will not only diversify its project portfolio outside of Canada and Peru, but also get its hands on what is expected to become the third-largest copper mine in the U.S.
“We’ve been paying close attention to Augusta for some time now, and believe the acquisition aligns with our key strategic initiatives,” David Garofalo, Hudbay’s president and CEO, said on a conference call, noting that Hudbay made its initial investment in the Vancouver-based exploration company in 2010. Hudbay owns 16% of the company, or 23 million shares, and a Korean consortium is earning into a 20% interest.
Under the terms of Hudbay’s all-stock proposal launched on Feb. 9, Augusta shareholders will receive 0.315 of a Hudbay share for each Augusta share held, representing $2.96 per Augusta share based on Hudbay’s Feb. 7 closing share price on the Toronto Stock Exchange.
The offer represents an 18% premium to Augusta’s closing share price on Feb. 7 — in addition to Augusta’s 26% share price increase during the two trading days preceding the offer — and a 62% premium to its 20-day volume-weighted average price. The deal values Augusta at an enterprise value of $540 million on a fully diluted, in-the-money basis.
Augusta says its board of directors will meet to discuss the offer and has urged shareholders not to take any action for now.
On the conference call, Garofalo told analysts and investors that his management team had assessed several projects that might fit with their growth strategy of acquiring high-quality, development-stage assets in friendly mining jurisdictions in the Americas, and that Rosemont “ticked all the boxes.”
He said that project timing was key when evaluating the acquisition, and that Rosemont “dovetails nicely with our existing operations” and the construction timeline at its Constancia project. Hudbay has completed 56% of its Constancia porphyry copper-development project in Peru and expects that it will enter commercial production by the second quarter of 2015.
Garofalo noted that Hudbay has the technical and operational expertise to develop and operate Rosemont, and pointed out that since the company’s initial investment in Augusta, Hudbay “has built [the Reed and Lalor mines in Manitoba] and significantly advanced [Constancia].”
Unlike Augusta, he added, Hudbay has the financial wherewithal to build Rosemont, where construction costs are estimated to ring in at $1.2 billion. On Jan. 30, Hudbay completed an equity offering raising $173 million, and its current liquidity stands at $1.4 billion. “We will be in a strong position to internally fund the development of this asset,” he said, particularly once Constancia is fully operational.
By contrast, “having already sold a joint-venture interest, streamed 100% of the precious metals production and committed the majority of its off-take in a challenging capital-market environment, Augusta has few remaining financing options, other than a highly uncertain project financing and the prospect of materially diluting its shareholders’ equity,” the company outlined in a press release.
Hudbay emphasizes that the two companies differ on how they view the permitting process. Augusta believes it will receive the final Record of Decision and a 404 Clean Water permit for Rosemont — ostensibly the final permitting required — in the second quarter of this year. (The U.S. Forest Service completed the final environmental-impact statement in November 2013 and issued the draft Record of Decision in December 2013.) According to Augusta, once the permits are in hand the company can secure project financing and production could start at the end of 2016 (see story above).
But during the question-and-answer part of the conference call, Garofalo said that based on Hudbay’s due diligence independent of Augusta, he believed Augusta’s management is overly optimistic about the permitting timeline. “They’ve been consistently optimistic. They’ve missed several deadlines on that,” he commented. “We don’t think the Record of Decision is necessarily going to be the end of the road on permitting.”
Alan Hair, Hudbay’s senior vice-president and chief operating officer, added that “we’ve been looking at this project for almost four years, and we’ve had a view on permitting that is considerably at odds with Augusta’s.”
Chris Chang of Laurentian Bank Securities, one of the first analysts to put out a research note on the proposed acquisition after the conference call, concluded that the offer is low “given the fundamental value of Rosemont and the significant share price rerating we expect upon securing the project’s two remaining major permits.”
Chang says he expects a positive permitting decision alone should improve the company’s share price by more than 18% over its closing price on Feb. 7.
“We believe an improved offer will likely be required to motivate existing Augusta shareholders to tender into Hudbay’s proposed takeover,” he forecasts.
At the same time, however, Chang says that “the number of white knights in a position to trump Hudbay’s proposal is relatively limited . . . OZ Minerals (ASX: OZL; US-OTC: OZMLF) and Teck Resources (TSX: TCK.B; NYSE: TCK) would be among the few companies that have the financial capacity to make a competing offer, as Lundin Mining (TSX: LUN; US-OTC: LUNCF), Capstone Mining (TSX: CS; US-OTC: CSFFF) and First Quantum Minerals (TSX: FM; US-OTC: FQVLF) already have their hands full with recent asset acquisitions. Majors such as Freeport-McMoRan Copper & Gold (NYSE: FCX) continue to look for avenues to reduce its capital expenditures and strengthen its balance sheet.”
Both Tom Meyer of CIBC and Gary Lampard of Canaccord Genuity describe the offer as “opportunistic,” and claim that it undervalues Augusta.
Lampard doesn’t expect Augusta’s shareholders will accept the bid in its current form, and in a research note says he believes that “several other mining companies” would be interested in acquiring the Rosemont project. He writes that “even though permitting uncertainty may constrain counterbids,” Augusta shareholders “have leverage to extract a better offer price from HBM to ensure deal completion prior to final permitting.”
Meyer says he would reject the bid, commenting that “a much higher price would be needed to ensure deal success.”
Hudbay’s “full focus and attention is on [final shaft development at] Constancia and Lalor, which risks delaying the start of construction of Rosemont,” he adds. “This leaves Augusta shareholders fully exposed to Hudbay’s project-execution risks without appropriate financial compensation, and the risk of delaying Rosemont until such capacity is available. At an offer price of $4.75 for each Augusta share, we would have a different view.”
For his part, Garofalo positioned himself as being unwilling to budge on Hudbay’s offer price.
“We know what we can afford to pay here, and if somebody wants to pay more, we’re going to tender our shares to them.”
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