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 assetsŚup over 40% before the Fortuna announcementŚwhile 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 beŚhow shall I put it?Śmore 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."[NLINSERT]
1) Adrian Day: I, or members of my immediate household or family, own securities of the following companies mentioned in this article: Lara Exploration, Orogen Royalties, . I personally am, or members of my immediate household or family are, paid by the following companies mentioned in this article: None. My company has a financial relationship with the following companies mentioned in this article: None. Funds controlled by Adrian Day Asset Management hold shares of the following companies mentioned in this article: All. I determined which companies would be included in this article based on my research and understanding of the sector.
2) The following companies mentioned in this article are billboard sponsors of Streetwise Reports: None. Click here for important disclosures about sponsor fees. The information provided above is for informational purposes only and is not a recommendation to buy or sell any security.
3) Statements and opinions expressed are the opinions of the author and not of Streetwise Reports or its officers. The author is wholly responsible for the validity of the statements. The author was not paid by Streetwise Reports for this article. Streetwise Reports was not paid by the author to publish or syndicate this article. Streetwise Reports requires contributing authors to disclose any shareholdings in, or economic relationships with, companies that they write about. Streetwise Reports relies upon the authors to accurately provide this information and Streetwise Reports has no means of verifying its accuracy.
5) From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles and interviews on the site, may have a long or short position in securities mentioned. Directors, officers, employees or members of their immediate families are prohibited from making purchases and/or sales of those securities in the open market or otherwise from the time of the decision to publish an article until three business days after the publication of the article. The foregoing prohibition does not apply to articles that in substance only restate previously published company releases. As of the date of this article, officers and/or employees of Streetwise Reports LLC (including members of their household) own securities of Lara Exploration, Fortuna Silver Mines and Orogen Royalties, companies mentioned in this article.
Adrian Day's Disclosures: Adrian Day's Global Analyst is distributed by Investment Consultants International, Ltd., P.O. Box 6644, Annapolis, MD 21401. (410) 224-8885. Publisher: Adrian Day. Owner: Investment Consultants International Ltd. Staff may have positions in securities discussed herein. Adrian Day is also President of Global Strategic Management (GSM), a registered investment advisor, and a separate company from this service. In his capacity as GSM president, Adrian Day may be buying or selling for clients securities recommended herein concurrently, before or after recommendations herein, and may be acting for clients in a manner contrary to recommendations herein. This is not a solicitation for GSM. Views herein are the editor's opinion and not fact. All information is believed to be correct, but its accuracy cannot be guaranteed. The owner and editor are not responsible for errors and omissions. ę2020. Adrian Day's Global Analyst. Information and advice herein are intended purely for the subscriber's own account. Under no circumstances may any part of a Global Analyst e-mail be copied or distributed without prior written permission of the editor. Given the nature of this service, we will pursue any violations aggressively.