Nzuri Copper merger arbitrage

A merger that I have had a small position in for some time, and recently bought more of, is Nzuri Copper Limited (ASX:NZC). The company is being acquired by Chengtun Group (SHA:600711) for A$0.37 in cash while it is currently trading at A$0.31 for 19.4% spread. That’s a big spread, but when we are talking about an Australian listed company that has a mine in Congo and that is being acquired by a Chinese company I think it’s clear why many investors aren’t trilled to get involved. While the spread has always been quite big since the deal became public news, it got bigger again when the company announced last week that Chengtun is expecting delays in receiving regulatory approvals in China.

I simply don’t think that those approvals represent a huge risk. China has a long history of acquiring natural resources in Africa, and this acquisition fits perfectly in their long-running strategy. In the press release Chengtun Group also seems pretty optimistic about the regulatory approvals. They expect them to get them at the end of August, which is just a one month delay, and they state that they have no reason to believe that the approvals will not be provided:

“Chengtun Group has submitted all of the applications and ancillary documentation required to obtain the PRC Regulatory Approvals, and has attended to all further requests for information in relation to those applications received to date.

Chengtun Group understands that its applications for the PRC Regulatory Approvals are being processed, and as at the date of this announcement, Chengtun Group has no reason to believe that the PRC Regulatory Approvals will not be provided.

Of course, this requires a bit of trust in what a Chinese company is saying. I don’t see any reason to really doubt this, but at the same time, you never know for sure what is going on in China. But given the very big spread I think you are compensated more than enough for some risk, and I think the other aspects of the deal shouldn’t pose any problems. Chengtun can pay the acquisition in cash, they got regulatory approval in Congo already and shareholder approval should be a formality. At the same time the stock is also not trading a big amount above the pre-deal price, so downside risk in case of the deal breaking should be acceptable. I’m not betting the farm on this deal, but I think it’s pretty attractive.

Location of Nzuri's Kalongwe Project in Congo

Disclosure

Author is long Nzuri Copper

Half-year portfolio review, 2019 edition

With the first half of the year behind us it’s once again time for the obligatory performance review. Absolute performance was quite satisfactory with a solid double digit return, but simultaneously I’m underperforming the MSCI ACWI for the first time since starting this blog. With my focus on special situations it’s a result that you would expect since these often offer a more or less fixed return, making it tough to keep-up with a rapidly rising stock market. Since I’m not too far behind I’m hopeful that I’ll be able to catch up in the second half of the year. There are a couple of special situations that are on the verge of being completed that could meaningfully boost my performance. But even if I don’t catch up, I can’t really complain!

Year Return* Benchmark** Difference
2012 18.44% 14.34% 4.10%
2013 53.38% 17.49% 35.89%
2014 30.11% 18.61% 11.50%
2015 24.23% 8.76% 15.47%
2016 64.97% 11.09% 53.88%
2017 29.04% 8.89% 20.15%
2018 13.07% -4.85% 17.92%
2019-H1 14.51% 16.67% -2.16%
Cumulative 709.22% 132.71% 576.51%
CAGR 32.15% 11.92% 20.23%

* Return in euro’s after transaction costs, net dividend withholding taxes and other expenses
** Benchmark is the MSCI ACWI (All Country World Index) net total return index in euro’s

As you can see below, the majority of the performance is driven by the special situations while both HemaCare and Viemed Healthcare were also significant contributors. The graph looks a bit like the one of 2018, and as a matter of fact, the top four is the same as at the end of 2018 (but the order is slightly different). The performance of the special situations bucket got a large boost when the situation around the Sorrento Tech liquidation payment got resolved earlier this year (+158bps). To some extent this is a bit of an artificial gain because the position was marked at zero by my broker last year, and most of it is just a reversal. But thanks to this, the special situations bucket is managing to keep up with the overall stock market reasonably well.

The performance of my long-term value stocks was a bit more mixed. There were unfortunately quite a number of losing positions which is not a great result in a period when everything seems to be going up. Luckily, not every holding was a laggard. Both Argo Group and Goodheart-Willcox launched big tender offers to buy back shares at a significant premium. I sold my entire stake in Argo Group for a decent profit, while I decided to hold on to all my Goodheart-Willcox shares. Based on the information provided in the tender offer document itself (and my own valuation) the company seems to be worth more, and so far the market seems to be agreeing with that assessment since the stock hasn’t traded down below the price of the tender offer. But liquidity is, especially now, after the tender offer, almost non-existent.

The tender offer was for $150/share while the shares were valued at $168/share in an external appraisal, and that number included both a 11.1% discount for a lack of control and a 15% discount for a lack of marketability.  Without these discounts the value per share would rise to $237. With Argo Group I was happy to sort of meet management in the middle and split the discount, but because I have a lot less concerns about the corporate governance of Goodheart-Willcox I’m more inclined to hold it if there is still a significant discount to “fair” value. Additionally, the management projections for revenue and earnings that were included in the tender offer documents looked pretty optimistic as well. I usually put very little value in these kind of projections, but it’s another data point that suggest that the stock is still undervalued at the current price. I guess we’ll see how it will play out.

Disclosure

Author is long or has been long all the stocks mentioned in this post

Nevada Gold & Casinos merger completed

Last year, in October, I wrote about the Nevada Gold & Casinos merger. Back then I thought that it was a simple merger that would probably close before the end of the year, but that proved to be way too optimistic. The merger needed approval of the Washington State Gambling commission, and they took their sweet time. My guess is that this was mostly a bureaucratic delay instead of real regulatory risk, but of course, it didn’t have a positive impact on the annualized return of the position. Luckily the merger agreement contained a provision to adjust the price upwards in case of delays, and instead of a merger payment of $2.50/share the final price was $2.559333/share. I bought my shares for approximately $2.40, so the end result is a 6.6% absolute return which translates to 9.2% annualized. Not great, but not bad either for a deal that got severely delayed.

Disclosure

Still long UWN since the merger payment hasn’t hit my account

Exited the Aratana Therapeutics deal

Just one week ago I wrote that I initiated a position in Aratana Therapeutics (NASDAQ:PETX). At the time stock was trading was trading at roughly a 1.2% discount to the price Elanco Animal Health (NYSE:ELAN) was willing to pay, and a CVR with a max payout of $0.25/share was thrown in the mix for free. With Elanco now trading at $30.77/share and Aratana at $4.63/share the spread is a negative 1.6% and the CVR is implicitly valued at $0.07/share. My rough, and perhaps optimistic guess, of its value was around $0.10/share so there is little reason to keep my Aratana position. Unfortunately I decided to not hedge with short position of Elanco, so while the spread went in the right direction, I didn’t make any money. But that’s not a bad result for a week like this!

Disclosure

No position in Aratana Therapeutics anymore

Get a free CVR in the Aratana Therapeutics acquisition

Last Friday Aratana Therapeutics (NASDAQ:PETX) announced that it would be acquired by Elanco Animal Health (NYSE:ELAN). Elanco will pay 0.1481 shares of common stock – worth $4.85 at current market prices – while Aratana is trading at $4.79 for a spread of just 1.2%. While it’s a low-risk deal that should close soon, that’s not enough to get excited about. It gets interesting because Elanco will also issue a contingent value rights that will payout $0.25/share if certain sales milestones are reached before the end of 2021:

Each CVR will entitle its Holder to receive $0.25 in cash if Aratana, Elanco or their respective affiliates achieve cumulative net sales of an animal health product that contains capromorelin as an active pharmaceutical ingredient equal to or exceeding (a) $25,000,000 during the period beginning on July 1, 2019 and ending on December 31, 2020, or (b) $50,000,000 during the period beginning on July 1, 2019 and ending on December 31, 2021.  Elanco has agreed to use “Diligent Efforts” (as defined in the CVR Agreement) to achieve the foregoing milestone.

How likely it is that they manage to hit either the $25 million milestone before 2020 or the $50 million milestone before 2021? I don’t really know. It doesn’t sound like a crazy high hurdle to me, but then again, who knows what the market is for a drug that apparently is used to stimulate the appetite in dogs… If we assume that the CVR is worth something like $0.10/share today, the spread increases from 1.2% to 3.3%. Not spectacular, but for a deal that should close in roughly two or three months time that isn’t too bad. Couldn’t resist buying some shares.

Disclosure

Author is long Aratana