South32 offers US$1.3B for Arizona Mining

After taking an initial 15% stake in junior zinc developer Arizona Mining (TSX: AZ) in April 2017 for US$81 million and boosting it to 17% over the next year for another US$23 million, South32 (LON: S32) is now offering US$1.3 billion in cash for the remaining shares, warrants and options it doesn’t already own.

The $6.20-per-share offer represents a 50% premium to the junior’s last close and a total equity value for Arizona Mining of $2.1 billion.

The two companies announced the agreement, along with a $67-million termination fee, on June 17, and the deal has been approved unanimously by Arizona Mining’s board.

As a major shareholder and active participant on Arizona Mining’s board and technical committee over the last 18 months, South32 has had a ringside seat at the junior’s Hermosa zinc project, 80 km southeast of Tucson, Ariz., and 13 km north of the U.S. border with Mexico.

The project lies within the Laramide belt, a copper-porphyry belt that extends from Nevada to Mexico, and contains two deposits: the zinc-lead-silver sulphide Taylor deposit and the silver-manganese-zinc Central oxide deposit.

If Taylor were operating today, Arizona Mining says, it would be the world’s fourth-largest zinc-equivalent producer, based on its first five years of average annual production of 946 million lb. zinc equivalent.

An updated preliminary economic assessment of Taylor completed in January outlined a US$2-billion after-tax net present value (NPV)  at an 8% discount rate, and a 48% after-tax internal rate of return.

“It’s one of the best projects I’ve ever seen in the business,” Richard Warke, Arizona Mining’s founder and executive chairman, says in an interview. “It’s no surprise that with an NPV of US$2 billion, South32 obviously paid close attention.”

Earth moving operations ahead of construction of a water treatment plant at Arizona Mining’s Hermosa project. Credit: Arizona Mining.

The PEA estimated pre-production capex of US$519 million, a payback period of just over 1.5 years, and total cash costs of US49¢ per equivalent lb. zinc and all-in sustaining costs of US61¢ per equivalent lb. zinc.

The study outlined life-of-mine annual payable production of 211 million lb. zinc, 262 million lb. lead and 5.6 million payable oz. silver, over nearly three decades.

“Right now in the measured and indicated category of the resource there’s a 29-year mine life, and there are also inferred resources, which probably add another 20 years,” Warke says, noting that the 50% premium in South32’s offer reflected the world-class nature of the project.

Warke added that the Hermosa project is similar in scope to South32’s Cannington underground lead-silver mine in northwestern Queensland, Australia, which is nearing the end of its mine life.

“Their main base-metal asset — Cannington — is quite similar to Hermosa,” Warke says. “It’s not as big or as high grade, but it’s a similar mine and it’s running out of ore.

“The one thing that South32 lacked within its portfolio was growth,” Warke continues. “They have done very well with their cash flow, their stock price has climbed, and if there was any criticism within the company, it was, ‘Where are you going and growing from here?’ And being a similar project to Cannington, Hermosa fit perfectly into their portfolio.”

For his part, South32 CEO Graham Kerr describes Hermosa as “one of the most exciting base metal projects in the industry.”

He adds that “our deep understanding of this high-grade resource and surrounding tenement package, and extensive experience at Cannington, makes us the natural owner of this project and ensures we are well positioned to bring it to development.”

Like Cannington, Taylor will produce a lead-silver concentrate and a zinc concentrate.

Over the last two years, Arizona Mining has more than tripled the resource at Taylor, and the deposit remains open laterally and at depth.

Arizona Mining’s Taylor zinc-lead-silver project, 80 km southeast of Tucson, Arizona. Credit: Arizona Mining.

Measured and indicated resources stand at 101 million tons grading 4.1% zinc, 4.3% lead and 2.1 oz. silver per ton, or 10.4% equivalent zinc. Inferred resources add 144.6 million tons grading 4.1% zinc, 4.4% lead, 2.5 oz. silver per ton, or 10.8% equivalent zinc.

Arizona Mining’s initial mine plan for Taylor represents 96.7 million tons (87.7 million tonnes), or 67% of the deposit’s total resource.

“We have enough space on private land to do state-only permits and get into production, and produce for the first eight or nine years,” Warke says. “What we need to do for the next 21 years of measured and indicated is to get federal approval to expand on unpatented land, and that can take anywhere from four to six years.”

Warke is confident that approvals will be forthcoming under the Republican administration of U.S. President Donald Trump. “The current administration under President Trump has been tremendous, as far as being more open for business — being more pragmatic at getting things done — and it’s been much more attractive than the previous administration.”

In addition to Taylor, Hermosa’s second asset, the Central deposit, offers a longer-term development option. Central has 63.5 million tons grading 2.2% zinc, 2.3 oz. silver per ton and 9.6% manganese of measured and indicated resources, and another 1.8 million tons grading 2.6% zinc, 1.6 oz. silver per ton and 7.4% manganese.

Whether a competing offer materializes for Arizona Mining is hard to predict, Warke says. “If I’m some of these other major mining companies, I would be having a hard look at Hermosa, but it depends on what commodities they feel they want to be in, long-term. It’s pretty hard to say.”

Edward Sterck of BMO Capital Markets in London points out in a research note that apart from Glencore (LON: GLEN), South32 is the “only company making meaningful acquisitions at this time.

“The 50% premium appears full, but this is difficult to gauge, given the unknown upside potential and given the lack of activity from the other diversified peers.

“With exploration drilling having continued and a feasibility study due out shortly, South32 has presumably taken a view that there is additional upside potential within the Hermosa project, which remains prospective for further zinc-lead-silver and copper deposits, as well as the Taylor deposit remaining open for expansion.”

If successful in its current form, the transaction is expected to close in the September quarter.

South32 was spun out of BHP Billiton (NYSE: BHP; LON: BLT) in 2015.