OSC ruling could stymie HudBay-Lundin merger

 With one ruling from the Ontario Securities Commission (OSC), the future of both HudBay Minerals (HBM-T, HBMFF-O) and Lundin Mining (LUN-T, LMC-N) has been drastically altered. 

 In January, the OSC overturned a Toronto Stock Exchange decision that allowed HudBay to acquire debt-laden Lundin without the approval of HudBay shareholders.

But while shareholders of HudBay are welcoming the decision, Lundin shareholders are left to wonder if their company has the financial stability to carry on.

The turn in the story came when the OSC reversed an earlier decision by the TSX approving the issuance of 157.6 million new Hudbay shares — double its current amount — to be used towards the all-share acquisition of Lundin.

But the OSC ruled the fair treatment of investors is more important than a given company’s ability to cleanly close a deal, adding that the market itself “would be significantly undermined by permitting the transaction to proceed without the approval of the shareholders of HudBay.”

With their vote secured, HudBay shareholders are expected to strike down the deal.

Key shareholders like Jaguar Financial (JFC-T, JGFCF-O) — which holds roughly a 1% stake in HudBay and was the party that brought the matter before the OSC — labelled the proposed combination an “embarrassing value-destructive transaction,” and garnered much support in its contra stance.

Jaguar’s opposition to the offer stemmed not only from the heavy dilution the deal would bring, but also from its assertion that it would jeopardize HudBay’s strong cash position. The bid offered a premium for Lundin, a company that has roughly $300 million in debt and a portfolio of mines with narrow to no profit margins.

Shortly after HudBay announced the move to acquire Lundin, Jaguar declared its own takeover offer for HudBay that, if successful, would scuttle the Lundin acquisition. With the OSC ruling, Jaguar says it is withdrawing the bid.

Hudbay announced its offer for Lundin on Nov. 21. The deal would see Hudbay issue 0.3913 of a share for each Lundin share — valuing Lundin shares at $2.08 apiece — a 32% premium at the time. The agreement also commits HudBay to loan Lundin $135.8 million, to be paid back with 97 million Lundin shares.

HudBay management argued at the time that the deal gave it a rare chance to triple its zinc reserves and double its copper reserves at a discounted price, thanks to the current bearish state of the market.

As for Lundin’s ability to survive should the deal fall apart, Canaccord Adams analyst Orest Wowkodaw says he expects it will persist, but that the company will likely need another US$50 million in financing by the end of this year.

And while Lundin’s US$575-million line of credit — of which US$188 million had been drawn down as of Sept. 30, 2008 — would seemingly provide more than ample funds should the company need them, the details of its arrangement are murky.

It isn’t known what covenants are attached to the line of credit, making it impossible to know if the company is in danger of breaching them.

When asked for specifics, a spokesperson for Lundin replied only that it has “not released any public information regarding bank covenants.”

Several analysts polled by The Northern Miner said it was unusual for a company not to make such disclosures.

Another central issue in determining the company’s financial health going forward is the provisional pricing of its metal concentrate sales.

Provisional pricing is the practice of estimating an upcoming quarter’s selling prices at the end of a previous quarter. For Lundin, when the fourth quarter is reported, the estimated price from the third quarter will have to be adjusted to the actual selling price.

And while analysts can’t be sure how much of a loss the company will have to adjust for — since no one knows the exact dates the company settled its sales on — the fact that zinc and copper prices fell throughout the quarter indicate a loss.

Justin Reid, an analyst with Cormark Securities, estimates the loss will be in the neighbourhood of US$100 million.

Fortunately for Lundin, however, it isn’t all bad news if the HudBay deal collapses.

Mitigating against such losses connected with provisional pricing is the boon that the HudBay interest brought to Lundin’s coffers. At the time of the offer, HudBay agreed to participate in a private placement that netted Lundin US$135.8 million and brought HudBay up to a 19.9% stake in the company.

That cash injection came at a most welcome time as the company’s last financial statement, from the period ending on Sept. 30 of 2008, showed a dramatic drop in earnings per share (EPS) compared with the same period a year earlier.

For the first nine months of 2008, EPS came in at negative 59¢ while for the same period in 2007 EPS was a positive 88¢.

The period also showed the company had net debt of US$194.8 million compared to a cash surplus of US$35.1 million Dec. 31, 2007.

On top of that, Lundin’s cash position decreased $84.7 million since the end of the second quarter, largely due to capital spending — it was on the hook for US$92.7 million in funding for its massive 24.75%-owned Tenke Fungurume copper project in the Democratic Republic of the Congo.

Those financials made it clear Lundin would have to become a leaner company, and since then, it has shown a willingness to make the necessary cuts.

On Jan. 22, it announced it would close its Galmoy zinc-lead-silver mine in Ireland by May; on Dec. 23, it sold off its Aljustrel zinc mine in Portugal, which had been on care an maintenance since early November; and in November, it announced that zinc production at its Neves-Corvo copper and zinc mine, also in Portugal, were being suspended, leaving the mine to produce only copper concentrate.

Analysts agreed that such moves were prudent, but said there was little left for the company to do in terms of cutting back on costs should cash flows continue to be constricted.

Still, for his part, Reid is optimistic the company will survive.

“They can continue as a going concern as long as they execute this year,” he says. “They should be OK. But commodity prices have to hold on or improve. It would be a different story if they fall further.”