Lundin's deal with Tenke didn't deserve the drubbing it got
FABRICE TAYLOR
00:00 EST Thursday, Apr 12, 2007
The death-defying bull market in base metals, with its easy gains and quick flips, is spoiling investors. For supporting evidence, consider how differently the market greeted Lundin Mining's two latest moves.
Yesterday, the fast-growing base metals mine said it would take over Tenke Mining in a share swap. Lundin's stock fell more than 7 per cent at one point and closed at $13.90 on the Toronto Stock Exchange, down 98 cents. Last week, when Lundin made a stock offer for Rio Narcea, Lundin shares behaved favourably.
There are a few explanations for these bipolar reactions, but a major one is simply that the Rio Narcea acquisition is immediately accretive to cash flow per share while the Tenke deal is not. A lot of investors prefer less money sooner to more -- even a lot more -- later. They are usually wrong; those who practise the delicate art of profiting from others' impatience tend to win the race. That seems to apply to an investment in Lundin.
Rio Narcea fits well with Lundin's portfolio. It has properties and projects in Portugal, Spain and Mauritania. Lundin is involved in Portugal, among other places. Financial synergies are usually small in mining deals, but they can accrue, especially when you acquire mines near your own.
Operational synergies are easier to accomplish, and the Rio Narcea deal came packaged with some of those. But the best part of the Rio deal, for Lundin shareholders, was that it armed a management team adept at making acquisitions with more cash flow and a bigger market value with which to pursue other purchases. The Rio deal won't provide much production growth beside the initial bump, but it will help finance production growth. So Rio looks like a good deal for an ambitious concern like Lundin.
But the Tenke deal looks better. Tenke owns a quarter of the Tenke Fungurume copper deposit in the Democratic Republic of the Congo. By most accounts, it is one of the richest undeveloped copper/cobalt projects in the world. The operating partner is Freeport-McMoRan (which consummated its acquisition of copper giant Phelps Dodge last month). The feasibility studies are complete. The mine plan is ready. As for the economics of the mine, including cobalt credits, the cost of mining the copper will be negligible. (In fact, it will be negative: So-called byproduct accounting means that if you take a ton of copper/cobalt ore out of the ground, you can use the byproduct revenue -- in this case the value of the cobalt -- to offset the cost of mining your primary commodity, in this case, copper.)
Better yet, there's tremendous "optionality" on the Tenke property, meaning it has a good chance of being even richer than we know it to be. In other words, Lundin shareholders (and Tenke's, since this is a share swap) have a call option on what could prove to be a very accretive upside. The only glitch? It doesn't start producing until late 2008. Since this is a share deal, then, Tenke is an earnings drag until it starts producing. Even though it promises a bigger earnings boost than Rio Narcea's assets, investors don't like to wait. Lundin officials don't mind. On yesterday's conference call, they explained that, to them, the long term is not two or three years, but 40 or 50 or 100 -- given the potential lifespan of the Tenke property.
There are other reasons to like this deal. Lundin, including Rio, is big in zinc and nickel. If the Tenke purchase closes, it will bulk up on copper -- and you can't be a major player in base metals without exposure to that substance.
To be sure, there are other explanations for yesterday's selloff in Lundin shares. Europe, where the bulk of Rio and Lundin's assets are, is perceived as a safer place to do business than the heart of Africa.
But management stresses that the Congo is not the horror show you read about in the press. They would, of course, say that. But the Lundin family, big shareholders in the company with a long history of building long-term value, obviously believe it. That's a good reason to overlook short-term noise on a promising stock changing hands at single-digit multiples to its earnings power.
Fabrice Taylor writes research for Pollitt & Co., a brokerage firm. The views expressed here are his own.
taylor.fabrice@gmail.com |
