Eastern Platinum (ELR-T) - Huge Discount To Post-Deal Cash Balances
Eastern Platinum is a mining company that owns platinum group metal mines in South Africa. All of the company's mines are currently on care and maintenance, primarily due to the political and labor unrest in South Africa and issues with electricity supply. The company has agreed to sell all of its South African subsidiaries to Heibi Zhongbo, part of the Heibi group, which is a Chinese company with interests primarily in steel and iron ore.
Deal and ProceedsThe net proceeds to the company from the deal closing will be $175.5 MM, broken down as follows:
Source: Management Information Circular, Sedar
The company also has $75.4 MM of cash and equivalents on its balance sheet as of its most recent financial statements. This combined with the net transaction proceeds should result in a company with no operations, but $2.71 USD per share in cash. At the company's recent share price of $1.30, purchasers are paying only 48% of the company's cash pro-forma for the deal. This would make the company a net-net well into Ben Graham territory, and should inspire some sort of activist value creation if management does not take action to improve the share price.
Future PlansThe obvious action to take would be to dividend out the cash, or liquidate the company and distribute the cash to shareholders. In the aforementioned management circular, however, the company indicated they intend to find an acquisition and remain an operating business. While this is not a great outcome, it does seem unlikely that they would buy an asset for $1.00 that was immediately worth less than $0.47. In this case, the margin of safety from the huge discount protects shareholders. Additionally, both the CEO and CFO have change of control payments ($2M and $670k respectively) that they would receive after a transaction if they leave. So they have a potential incentive to wind up this company and collect their payments.
A private equity fund manager (Harrington Global) has also recently announced they had acquired 11.5% of the company. This firm (formerly known as Salida Capital) has taken activist stances in junior resource companies in the past, which is a good sign for effective allocation of Eastern's capital going forward.
Risks to DealThe largest risk to this opportunity is that the Heibi deal does not close. If that were to happen, the company would once again have $0.81 per share in cash and be burning cash from keeping its mines on care and maintenance. However, the Heibi group is a large company with a history of buying assets from Canadian junior resource firms. The group has bought a stake in a Canadian iron ore project in the past, a deal which was approximately the same size as this one. Additionally, the deal has been approved by Eastern Platinum shareholders and the Chinese regulatory authorities. The only remaining hurdle is South African approval. Ownership by historically disadvantaged groups has become a major factor in South African mining takeovers. Since Heibi is a larger, more liquid company, which is more likely to operate the mine (which means more jobs/taxes) and will be able to carry the capital contribution of its Black Economic Empowerment partners, this should be a formality. Additionally, the deal contains an $11 MM break-up fee if Heibi does not close, so they have an incentive to complete the transaction.
Why is this Available?This opportunity seems nearly too good to be true, with upside of approximately 100% against potential downside of approximately 38%, with the upside case being materially more likely. If the deal does not close, the company would likely trade at around its cash ex-deal, which is about $0.80 per share. I believe there are a few reasons why the market has not closed the arbitrage gap here. The first is that Heibi is not a well-known company in the west, even though the group's leading company has a multi-billion market capitalization. It is also Chinese, and small-cap investors have been burned repeatedly by Chinese frauds in the past. However, Heibi is a large, real-asset company which has completed similar deals, so the chances of this one closing are very good.
The other major reason for this opportunity being overlooked is that it has no natural constituency to buy the shares right now. Mining investors were burned in the mine shutdown (shares used to trade at much, much higher prices before a 10 for 1 consolidation)
. The company has had no analyst coverage at all for over two years. Finally, arbitrage funds who would normally buy a security in this situation are put off by the company's stated plan to keep the cash. They have short timelines, and do not want to end up owning a junior mining company, even if the value is materially in excess of what they paid for the shares.
ConclusionIn conclusion, Eastern Platinum is a special situation equity opportunity, where the market price is over reacting to the potential for the deal to be cancelled or the money wasted. Post the deal, the company will have material excess cash balances, which are likely to be used to benefit shareholders, either directly or indirectly. |
