Fortuna Silver Mines Inc. (FSM:NYSE; FVI:TSX; FVI:BVL; F4S:FSE, US$6.03) announced on April 26 a friendly share bid for Roxgold Inc. (ROXG:TSX), a low-cost West African producer, offering 0.283 of a share (plus 1 cent) for each share of Roxgold, a better-than 40% premium when the offer was made. Fortuna will own about 64% of the pro-forma company.
The deal is not based on synergies. However, it is accretive on all relevant metrics; at the time of the announcement, Fortuna was trading at 1.89 x NAV compared with about 0.58 x NAV for Roxgold, hence the all-share offer.
Timing of offer not coincidental
Roxgold has assets in Burkina Faso and the Ivory Coast, with low-cost, technically straightforward assets, a near-term development project, several exploration properties, a strong team and solid balance sheet. The merger brings together robust assets and strong technical teams. The transaction, which requires the approval of both companies' shareholders, is expected to close in late June or July.
The acquisition is opportunistic and well timed. Lindero, in Argentina, is virtually complete now with no more meaningful capital requirements. And political risk in Latin America is increasing. On the Roxgold side, the market is beginning to recognize its assets—up over 40% before the Fortuna announcement—while it is ahead of the expected production decision later in the year on its Seguela deposit. In addition, the all-share bid makes sense given the discrepancy in price to NAVs, while the financially conservative Fortuna was relatively stretched following the construction of Lindero and I do not think would want to take on debt for an acquisition.
Buying the whole package
For Fortuna this is a departure from its Latin American home base and a further move away from silver. Jorge Ganoza, CEO, bases his "pitch" for the deal on the company buying high-quality, undervalued assets, with a strong team and strong exploration potential. "We are buying not an asset but a platform." The combined company would be able to build Roxgold's next mine (with an estimated low capex of $140 million) from internal financial sources, without requiring debt or equity. For the notably conservative and debt averse Mr. Ganoza, this was no doubt a compelling factor.
Fortuna recognizes the difficulty of running West African assets from Latin America, with a team whose skillset was honed in Latin America. Hence, he has tied up the technical team, including the CCO and VP of exploration, with employment contracts. The community and government relations are critical.
Success in the mining business, Mr. Ganoza said, comes from the quality of assets and from execution. Mining is frontier business. He would prefer a mine in Nevada, but would rather a strong, undervalued asset in Africa than a weak, overvalued asset in Nevada. Both Fortuna and Roxgold have a track record of strong execution. Ganoza said the company had spent the past year or two looking at assets up and down the Americas but found nothing that compared with Roxgold.
Fortuna is not leaving Latin America or silver, despite difficulties
Fortuna has stated that the move should not be seen as a move away from Latin America and the increasing risk on that continent. Political risk in developing countries, the CEO notes, ebbs and wanes. Further, in answer to a question, he said that geographic diversification was not a big factor in the decision to buy a company with assets outside of Latin America.
However, there is little doubt that political risk is increasing throughout the continent, and in particular in all three countries in which Fortuna currently has mines. In Argentina, although Fortuna is currently repatriating capital, companies can expatriate only to service loans, and at present not profits. In Peru, an extreme leftist who wants to take big chunks of mines operated by foreign companies is significantly ahead in the polls after winning the first round. And in Mexico, in addition to the overall less attractive climate since the new president came to power, with delays in mine permitting and in particularly new exploration permits, Fortuna has a fight with the government over a royalty dispute, and has lost each round in court, including rulings in two parallel cases at the end of March.
Fortuna also said it is committed to silver. "But more," Mr. Ganoza said "we are committed to quality assets that can perform in precious metals cycles." Pure silver mines are few and far between; new ones are discovered, not acquired.
The market does not like it
The market reaction has been vicious, with Fortuna down 25% in the week since the announcement. In such transactions, the shares of the acquiring company always drop while those of the target increase. When Equinox announced a friendly takeover of Premier in December, for example, its shares fell 16% in two weeks. So some decline in Fortuna's shares was to have been expected.
However, there are additional factors here, factors that led me to believe that Fortuna's shares will continue to be soft. On the Fortuna side, the further move away from silver will disappoint silver-focused investors who tend to be—how shall I put it?—more dedicated than gold investors. In addition, some will not like the entry into Africa with its higher perceived political risk. Fortuna's second-largest shareholder, a fund out of London, has a mandate to invest only in the Americas and Australia and will be forced to sell. (The largest shareholder is the GDX fund, which will own about 8% of the combined company.)
Will there be another offer?
On the Roxgold side, many shareholders own the shares precisely for a takeover, which has long been expected. In such a case, most, particularly retail investors, typically sell on completion of the takeover. In addition, many Roxgold shareholders to whom I have spoken are disappointed with the premium offered, particularly given the timing of the announcement with a new mine ahead. Now that Fortuna's share price has declined, the all-share offer is worth even less, not even a 9% premium on Roxgold's price as of the date of the announcement. So less-than-long-term investors holding Roxgold precisely for it to be acquired will be disappointed.
Roxgold is still an undervalued company, despite a 40% rally over the past month, including the move after the Fortuna offer. Now that the Fortuna offer price has declined, there could be a competing bid. In the region, there are several well-capitalized larger firms, with local operating skills and a history of regional consolidation, albeit none that come to mind with compelling synergies with Roxgold's specific assets. And none did bid, despite the company being available. Fortuna expects the significant break fee of $40 million to act as a deterrent. It may well, though one must assume many regional companies are sharpening their pencils this weekend.
Fortuna said it is "not going to chase prices." There is the potential perhaps for it to offer some cash instead of some shares, though part of the attraction of the transaction is the resulting strong balance sheet, so I would not expect a high level of cash. Given the wide discrepancy in valuation metrics, there is some room for an increased offer in my mind.
The merger creates a great company
All in all, the potential merger will create a very strong mid-tier company with quality diversified assets, low costs, a strong balance sheet and a good growth profile. In the near term, there will be softness, with different shareholders exiting for different reasons, though most of that weakness is already behind us. But when the dust settles, this will be a very attractive buy.
BEST BUYS now include Lara Exploration Ltd. (LRA:TSX.V, 0.71), Royal Gold Inc. (RGLD:NASDAQ; RGL:TSX, US$111.86), Orogen Royalties Inc. (OGN:TSX.V, 0.365) and Barrick Gold Corp. (ABX:TSX; GOLD:NYSE, US$21.25).
Originally posted on May 2, 2021.
Adrian Day, London-born and a graduate of the London School of Economics, heads the money management firm Adrian Day Asset Management, where he manages discretionary accounts in both global and resource areas. Day is also sub-adviser to the EuroPacific Gold Fund (EPGFX). His latest book is "Investing in Resources: How to Profit from the Outsized Potential and Avoid the Risks."
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