HudBay battle gets nasty

Vancouver – After spending $460 million to acquire a nickel project that’s now unfeasible to develop and then attempting to takeover Lundin Mining (LUN-T) in a deal that shareholders resoundingly rejected, the board of directors of HudBay Minerals (HBM-T) are fighting to keep their jobs.

But their opponents – a hedge fund out of Monaco called SRM Global Master Fund that wants to replace the current board, led by president and CEO Allan Palmiere, with a slate led by HudBay’s former president, Peter Jones – has done its homework. Backed by HudBay documentation made public in SRM’s court proceedings against the major, SRM is charging Palmiere’s team with neglect and self-interest.

It is clear shareholders were generally unhappy with HudBay’s plans to more than double its outstanding share count to take over Lundin; their dismay led the Ontario Securities Commission (OSC) to require HudBay to get shareholder approval for the deal. Faced with the prospect of a vote it seemed doomed to lose, the board of HudBay cancelled the deal.

SRM, which owns 11% of HudBay, was one of those unhappy shareholders. SRM was so concerned about the deal – in particular, it was concerned that the HudBay and Lundin boards would rush the deal through before the OSC verdict – that it took its challenge to the Ontario Superior Court, filing an oppression application with the court to prevent HudBay from completing the deal without a shareholder yes.

The OSC made its binding ruling before the oppression application had its day, leaving most to think that the oppression application process had been a clever but ultimately useless step. But SRM’s recent proxy circular reveals how the court process, which included open access to HudBay documentation and examinations of board members under oath, exposed new information about the the Lundin deal.

Shareholders and analysts saw two key problems in the Lundin deal: the price and the lack of a shareholder vote. In terms of the latter, Palmiere has said HudBay’s board wanted to put the issue to shareholders but Lundin refused to sign on unless they could be assured of deal certainty.

“So we could have walked away from a compelling and opportunistic acquisition or continued on without a vote,” said Palmiere in an interview with The Northern Miner. “The board decided the attractiveness of the deal justified going ahead without a vote.”

SRM says evidence discovered since contradicts the claim that the board decided against the vote, alleging that it was Palmiere alone who made the decision.

“In their cross-examinations, after being shown the relevant [board meeting notes], both Messrs. Palmiere and Gillin admitted that the decision of the Board on November 12, 2008, was in fact to insist on a shareholder vote or there would be no deal,” states the SRM circular. “What happened next is that Palmiere took it upon himself to give up the condition for a vote in a one-on-one meeting the next day with [Lundin president and CEO] Phillip Wright.”

As for the other key issue with the Lundin deal – the price HudBay was paying – SRM also uncovered startling information. In cross examination Palmiere said he and Wright agreed to a 50-50 value ratio in the takeover during a private meeting in late October, because they believed that the relative valuations would indicate approximately that. He conceded that he did not perform any net asset value (NAV) analysis.

HudBay’s financial adviser, GMP Securities, did perform NAV analysis and reported back to the board the day before the deal was signed. GMP determined that, using spot metal prices, HudBay’s NAV was more than $750 million or 70% more than Lundin’s NAV, including the incomplete Tenke copper-cobalt mine in the Democratic Republic of Congo. Excluding Tenke, HudBay’s NAV rose to more than $1 billion or 95% more than Lundin’s.

“Neither the minutes nor notes prepared by HudBay’s general counsel regarding this meeting indicate that Palmiere disclosed to the board that his basic building block for the whole Lundin transaction had been invalidated by the huge difference in asset valuations in comparison to his initial assumptions,” SRM writes.

SRM points out other corporate governance concerns that came to light during the court proceedings. One is that the HudBay special committee had no involvement in the negotiation of the Lundin transaction, including who would become CEO of the combined company. Palmiere was apparently the sole point of contact with Lundin throughout the negotiations.

SRM says it found out HudBay conducted only 12 days of due diligence on Lundin before entering into the deal. The rush, SRM contends, stemmed from fear that HudBay was a takeover target: “SRM believes management and the current board knew their jobs were in jeopardy and they therefore rushed into the Lundin transaction after a slipshod process, management-dominated negotiations, and board neglect.” SRM says the deal made HudBay less of a target and thus entrenched management and the board.

The private placement associated with the deal also causes SRM concern. The deal originally called for HudBay to loan Lundin $135.8 million; later HudBay was to acquire 19.9% of Lundin in a private placement costing $135.8 million. After announcing those terms, HudBay then cancelled the loan and instead just closed the private placement, wherein it paid $1.40 per Lundin share.

At the time, Lundin shares were trading at $1.21. Typically, private placement financings come at discount, not a premium. Lundin shares are now sitting at 75¢, which means HudBay’s investment has lost 46% or $62 million.

SRM summarizes its concerns over the Lundin transaction with a question: “How can HudBay now in its management circular state that in negotiating the Lundin transaction ‘your board followed good corporate governance practices’?”

And the challenger also charges HudBay’s current board with trying to hide its mistakes.

“The facts that SRM uncovered in respect for the current board’s and Allan Palmiere’s conduct as it related to the Lundin transaction are quite disturbing,” SRM wrote in its circular. “HudBay knew that what SRM had learned…would be detrimental and quite damaging to their version of the Lundin transaction and accordingly HudBay brought a motion…asking the Court to seal the evidence so shareholders would not learn what SRM had discovered. Fortunately the Court dismissed HudBay’s motion.”

Palmiere and the current board also sent out a circular, outlining their side of the story. Their circular came out several days ahead of SRM’s and at press time Palmiere had not responded to any of the new charges. But he is fighting for his job.

First of all, Palmiere still defends the Lundin deal vigorously. In an interview he said the only thing he would change about it was the timing: it offered a 32% premium compared to Lundin’s 30-day volume-weighted average share price but on the day the deal was announced Lundin’s price was particularly low, which put the premium at just over 100% compared to the previous day’s close.

“On the day we announced it did not look very pretty, I agree,” he said. “But that’s the timing thing. The premium was arrived at based on a lot of work, valuation, and negotiation and I still feel comfortable with it.” He made these comments before SRM’s circular was released.

More generally, Palmiere has slammed SRM’s motives for trying to oust the current board. First and foremost, Palmiere argues that electing a board of directors proposed by SRM and directed by SRM’s vision essentially gives control of the company to the hedge fund.

“If SRM wants to take control of HudBay Minerals, let them make a premium offer on the open market instead if doing it for free through the back door,” says Palmiere. “Do shareholders want a Canadian board of directors committed to growing long-term shareholder value or a board controlled by an off-shore hedge fund with a short-term focus that would only weaken the company?”

Palmiere says the SRM-proposed board would not work according to the best interests of all shareholders but only according to SRM’s needs.

One of those needs, according to Palmiere, is short-term gain. HudBay’s board says that SRM has asked several times over the past two years that the HudBay board consider spending some of its almost $700 million cash on a share buy-back program as a way of returning cash to investors and attaining a short-term share price gain.

“Media reports suggest SRM is under pressure to improve its short-term investment results before some of its investors have the opportunity to withdraw their funds,” said Palmiere in the conference call. “That’s a powerful incentive for SRM to boost its short term numbers. That’s also why HudBay shareholders should be wary of what SRM intends to do if it gains control of the board.”

More generally, Palmiere is concerned that SRM has not described a long-term strategy for the company.

“We therefore view SRM’s plan as misguided at best and value-destructive as worst,” he says. “SRM has not advanced a long-term plan for the company, but in a practical sense a hedge fund has no use for a long-term strategy of any kind because their time frame is relentlessly short term.”

SRM responded directly to that charge in its circular.

“SRM is not interested in controlling HudBay,” the company writes. “The sole purpose of SRM’s solicitation is to replace the current board, which has completely failed at creating shareholder value… SRM has only one concern and that is the creation of value for all shareholders.”

SRM says it has “no arrangements” with the proposed board about a future strategy for HudBay. The company says that, if elected, the board nominees intend to undertake a full review of HudBay’s operations and then design and implement a strategy.

And Palmiere’s third argument is that the SRM-proposed slate lacks the experience needed to run a major mining company. He says three of the eight SRM nominees have no significant mining industry experience and five have no significant experience as independent directors of a Canadian public company. In contrast, current board members have an average of 27 years of experience in the mining industry and 12 years of experience as independent directors of public companies.

SRM defended its nominees as a group with “broad experience and expertise in mining, finance, capital markets, mergers and acquisitions, corporate governance, negotiation, and legal matters.” And it is worth noting that the SRM nominee list includes HudBay’s former president Peter Jones, who would replace Palmiere as CEO, as well as former chief financial officer John Knowles and former general counsel Brian Gordon.

Palmiere also harbours no regrets about the other major deal he orchestrated during his tenure to date at HudBay: the major’s $436-million takeover of Skye Resources to acquire the Fenix nickel laterite project in Guatemala. Four months later HudBay halted all development work on the $1-billion project, citing a crash in the price of nickel.

“If you look at the fundamentals in today’s market the value of the asset substantially exceeds what we paid for it,” Palmiere says. “It’s a world-class resource but the world shifted under our feet so we couldn’t go ahead and develop it. It’s still a great asset to have in the bank.”

Not surprisingly, SRM disagrees: “We fear that any further transactions negotiated by the current board and Mr. Palmiere, who seem to be concerned solely with attempting to build an empire at the expense of HudBay shareholders, will prove as destructive as the Lundin transaction and the acquisition of Skye Resources.”

The outcome rests with HudBay shareholders, who will vote on the matter at a meeting on March 25.

Before the Lundin deal was announced HudBay’s share price sat near $5.50. On news of the merger deal it plunged $2 and spent December and January between $3 and $4. When in late January the OSC decreed HudBay needed shareholder approval to buy Lundin HudBay’s share price gained $1.38 in three days and has since sat between $5 and $6.