A little more than two weeks after copper producer Quadra Mining (QUA-T) struck a US$900 million joint-venture deal with China's State Grid International Development, a subsidiary of the country's largest utility company and a huge copper consumer, to develop and operate Quadra's assets in Chile, the Vancouver-based miner says it will merge with FNX Mining (FNX-T) to create a new intermediate-sized player in the copper business.
If the merger goes ahead, and it has received approval from the boards of both companies, existing Quadra and FNX shareholders will own roughly 52% and 48%, respectively, of the combined company. The plan of arrangement calls for each share of FNX to be exchanged for 0.87 of a Quadra share.
The $1.6 billion all-share deal values FNX at $15.12 per share, or a 1.8% premium over its Monday close of $14.85 per share.
The new company, to be called Quadra FNX Mining, will have assets in Canada, the United States, and Chile with a market capitalization of US$3.5 billion and "the critical mass to be a leading industry consolidator," Quadra and FNX outlined in a joint press release.
In 2011 the merged company will have production of an estimated 300 million pounds of copper, 150,000 ounces of precious metals and "significant leverage" to by-product metals including nickel, gold, platinum and palladium. It will also have the option to produce primary nickel.
FNX stands to benefit from Quadra's three operating mines: the Robinson mine in Nevada, the Carlota mine in Arizona, and the Franke mine in Chile, as well as its Sierra Gorda development project with a sulphide resource of 1.35 billion tonnes, grading 0.42% copper, for contained copper of 12.5 billion lbs.
Quadra, which has expertise in open-pit mining, stands to benefit from tapping into FNX's expertise in underground mining. FNX produces copper and nickel, in addition to platinum, palladium and gold in Sudbury, Ontario, where it is developing its Levack, Podolsky and Levack Footwall deposits. In addition, FNX owns Dynatec Mining Services, and holds equity stakes in a number of emerging mining and exploration companies.
Following the merger the combined company will have an estimated US$580 million in cash and investments and US$50million in bank debt.
Quadra chief executive Paul Blythe will continue to serve as CEO of the combined company. The deal includes a break-fee of $40 million.
Pierre Vaillancourt, an analyst at Macquarie Securities in Toronto, believes the merger is positive for FNX and believes the merged company will generate $1.6 billion in revenue and $859 million in EBITDA in 2011.
"FNX is taking advantage of its high valuation to leverage itself into a larger $3.5 billion company," he penned in a research note to clients, adding that FNX's current market capitalization is $1.5 billion. "The deal provides diversification from its existing operations in the Sudbury basin by the addition of three operating mines and a strong development asset in Sierra Gorda."
Compared with Quadra, FNX has a lower production profile but brings to the table higher margin assets, Vaillancourt noted, especially when the Levack Footwall begins commercial production sometime in the middle of this year.
"On a net asset value per share basis, we estimate the combined company's net asset value to be $21.82 per share, compared to the current FNX net asset value of $13.93 per share and the Quadra net asset value of $27.94 per share," Vaillancourt wrote.
UBS Investment Research called the move "a significant acquisitive growth step" and pointed out that such merger-of-equals proposals are "rarely seen in mid-cap Canadian mining."
"This should in our view be welcomed as the payment of a control premium can be avoided, and a complementary management team and a more diversified asset portfolio can be created," analyst Onno Rutten commented in a research note.
On a pro-forma basis, Rutten is forecasting a 15% three-year compound annual growth rate in copper production relative to 2009, "followed by a growth hiatus until the Sierra Gorda project starts up." He also anticipates copper cash costs to fall from US$1.44 per lb. in the second half of 2010 to US$1.13 per lb. in 2012 due to the start-up of FNX's low-cost Footwall deposit.
Raymond Goldie, an analyst at Salman Partners, believes that in principle the transaction makes sense because "the classic Capital Asset Pricing Model (CAPM), with the Security Market Line representing the relationship between return and, as a measure of risk, beta, does not work particularly well in Canada."
"In fact, the Security Market Line in Canada has often sloped downward to the right, the reverse of that forecast by the CAPM. What works better in Canada is the use of liquidity or market capitalization as a measure of risk: i.e. the bigger its liquidity or market cap., the higher the premium that the market is willing to assign a stock," he explained in a research note. "In other words, one plus one equals something rather more than two. Good move, FNX and Quadra!"
News of the proposed merger sent Quadra's shares down 40¢ or 2.3% to $16.98 with 7.5 million shares trading hands. FNX rose 25¢ or 1.7% to close at $15.10 with 5.97 million shares trading hands.
Over the last year Quadra has traded in a band of $4.85-18.57 per share, while FNX has traded in a $3.85-15.70 per share range.
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