Wednesday, October 31, 2012

Is the Baffinland Takeover Saga About to Escalate?

We have been following the takeover saga for Baffinland Iron Mines (BIMGF.PK) since the original $0.80/share (CAD$) offer from Nunavut Iron Ore Acquisitions. (All offering prices are in Canadian Dollars for this article as Baffinland is primarily traded in Canada, currently USD/CAD is trading at approximately par). We have held long positions at different points as arbitrage trades since the original bid by Nunavut, and we think the price action today in the shares of Baffinland Iron Mines indicates a higher bid is coming for the company and its massive Mary River iron ore deposit.

Starting at 11:41 AM yesterday, over 840,000 shares of Baffinland traded at prices above the previous intra-day high in a two minute window and the stock ran all the way up to $1.60 when it had been trading in the $1.50 region during the day up to that point. Based on the closeness of such a massive amount of volume, we have concluded that this was a buy order.

If we are pessimists and assume the lowest price for the stock since 11:41 AM was the price for all those shares ($1.50, the open price at 11:41 AM), then over $1.25 million worth of Baffinland was purchased in a two minute period and that suggests to us that someone is making a major bet on a higher offer coming for the company. We think it is rather significant that this buyer did not choose to space out his purchases and instead chose to apparently clear off the order book for the stock all the way up to $1.60/share.

At the time of this writing, Baffinland is trading at $1.52 which is above the peak offer of $1.45/share from Nunavut for a controlling stake and the $1.40/share offer from Arcelor Mittal for 100% of the company.

We think this block order is a major tell as to how this takeover saga will progress. Bloomberg published an articlequoting a Chinese official as stating that a Chinese firm is involved in bidding for Baffinland. We do note that this article was published one hour after the price action we noticed which suggests the article is not what moved the stock. According to the article:

"As far as I know, global miners including ArcelorMittal, a Texas-based U.S. oil company and others are all bidding forit,” Liu Yikang, who heads the Expert Group for Overseas Resources Projects under China’s Ministry of Land and Resources, said today in a telephone interview. “A Chinese company is also involved."

The interesting part of this story is that only two bids have been made public, the hostile Nunavut bid and the management-backed Arcelor Mittal (MT) bid. Former Baffinland CEO Gordon McCreary has previously mentioned his efforts to bring a Chinese bid to the table, but it has not yet materialized. With a Chinese official publicly stating that he believes all these other groups are involved and that China is involved in the Baffinland bidding process, it is our opinion that the upside to Baffinland shares at these levels are good for those who enjoy a good arbitrage opportunity. In simpler terms, we think a third bidder is going to join the Baffinland takeover talks.

The downside on this trade is that fifty percent of the shares are tendered to Arcelor Mittal (MT) and the stock drops to $1.40 and we would take almost a ten percent loss, but we think the upside is much higher than ten percent. The risk/reward is attractive in our opinion.

Arcelor Mittal and other steel makers desire to not be so dependent on iron ore miners for one of the critical ingredients for steel. The Mary River deposit is one of the largest untouched iron ore deposits in the world and the deposit is of very high quality (see Baffinland website for specifics, we cannot explain it better than the company can). With such a high quality deposit in play, we are further convinced that more suitors will be joining the bidding.

There are issues with the Mary River deposit, and our personal favorite is the fact that the sun does not rise for over a month in the winter because it is in the Arctic. But the quality and size of the deposit in such a politically stable country (Canada) suggests to us that the obstacles are surmountable.

The other major issue is that the capital expenditure to bring the entire Mary River property into production is very high. We have seen a figure of $4.1 billion on the company website pulled from the definitive feasibilty study, but the after-tax net present values for the project was $2.9 billion with a 7% discount rate from the same feasibility study with an after-tax IRR of over 15%.

We note also that this feasibility study does not include all nine deposits that encompass the Mary River property. Just to put these net present value numbers into perspective, the current bids for Baffinland value the company at less than $750 million.

Based on the price action in Baffinland Iron Mines yesterday and supported by the Bloomberg story, our editor has opened a position in Baffinland Iron Mines at $1.52/share and does not intend to tender shares to either existing tender offer. We think a third bid will come to the table in this takeover drama and move the price higher.

Disclosure: I am long BIMGF.PK.

No comments:

Post a Comment