Both sides firing as HudBay proxy vote draws near

Vancouver – The battle for control of HudBay Minerals (HBM-T) keeps getting uglier. In the week leading up to the proxy vote deadline both the current board and the challengers have used letters and conference calls to slam their opponent’s motivation for control of and ability to run the Canadian producer.

HudBay shareholders have to decide whether to support the current board of directors or replace them with a new slate proposed by 11% shareholder SRM Global Master Fund, a hedge fund out of Monaco. SRM started the proxy battle after the current board, led by then-CEO Allan Palmiere, made a highly controversial takeover bid for Lundin Mining (LUN-T).

The board ultimately withdrew the bid after the Ontario Securities Commission (OSC) forced them to get shareholder approval because it would have seen HudBay more than double its outstanding share count. SRM had also applied to the Ontario Superior Court to block the deal; testimony from that hearing seems to show that the board, and especially Palmiere, failed to protect shareholder interest in negotiating the deal.

Palmiere has since resigned, replaced by interim CEO Colin Benner. And though SRM had aimed its barbs primarily at Palmiere before his departure, the dissidents are now directing criticism at the rest of the current board.

“The incumbent board has made repeated misguided and misinformed decisions and has failed to consider shareholder interests – the interests which they were previously elected to protect,” the replacement director nominees wrote in a letter to shareholders, their first statement since being nominated by SRM.

The nominees charge that the current board failed to properly supervise or involve itself in the negotiation of the Lundin transaction. Court testimony revealed Palmiere made two fundamental decisions about the merger – the price and the absence of a HudBay shareholder vote – essentially on his own, without consulting with or asking approval from the board.

Under cross-examination Palmiere said he and Phil Wright, Lundin’s president and CEO, agreed to a 50-50 value ratio for the takeover during a private meeting because they thought the relative valuations would indicate roughly that. Palmiere did not perform any net asset value (NAV) analysis. When HudBay’s financial advisor, GMP Securities, did perform NAV analysis they found HudBay’s value far exceeded that of Lundin. GMP presented its findings to the HudBay board the day before the deal was signed but SRM says Palmiere failed to tell the board that the “basic building block for the whole Lundin transaction had been invalidated” and the board failed to realize this key issue.

As for the issue of a shareholder vote, Palmiere maintained that the board decided to go ahead without a vote because Lundin refused to sign on without an assurance of deal certainty. In the court proceedings, it became clear that the board had in fact insisted on a shareholder vote regardless of Lundin’s demands but that Palmiere gave up that condition in a private meeting with Wright the next day.

“No matter how many rules are put in place, the way the board operates and thinks is key to making sure the company operates correctly and shareholder rights are upheld,” said Peter Jones, the former CEO of HudBay who would become CEO again if the SRM slate is elected. “This board has failed, repeatedly, in its duties. The only way to restore the health of the company is to replace the board.”

Benner counters that the current board was hindered its in ability to act because of legal constraints around the Lundin deal and that SRM is distorting the facts. And Benner argues that the SRM-nominated slate lacks mining industry experience and will work in the interests of the firm that nominated them – SRM – and not in the interests of all shareholders.

“HudBay has the right board and the right strategy to enhance shareholder value,” said Benner. “In contrast, SRM has proposed a less experienced and conflicted board lacking a well thought out strategy, and it too much of a rick for shareholders to take with HudBay’s future.”

Jones, though, says the challenger board nominees have the experience they need to run the company. The group comprises three nominees who are former HudBay employees with 37 years of combined experience with the company, three lawyers, and two mining engineers with 40 years of experience each.

“These gentlemen were identified by myself after SRM contacted me late last year,” Jones says. “I was fortunate to convince eight highly qualified and experienced individuals to commit to this endeavour. This is a powerful board indeed, and one open to deliberation and committed to first class corporate governance.”

And he flatly refutes the contention that his board would be driven by SRM’s interests: “It is preposterous to think that with a fully independent board and an active group of shareholders that SRM could control HudBay.”

The current board argues that completely replacing the board will throw the company into a leadership void, especially because the dissident nominees do not have a clear plan for HudBay. Benner says the current board, in contrast, has a clear plan for the company: continue to optimize current operations, continue to grow organically, and look for accretive opportunities.

The SRM slate says it does have a plan for HudBay but the details of its plan cannot be finalized until it is elected and completes a full review of the company’s operations. The fundamentals of its plan are exactly the same as those of the current board.

In terms of existing operations, the nominees differ from the current board in that they want to re-examine the closures of the Balmat mine, the Chisel North mine, the Snow Lake concentrator, and the Fenix nickel project, as well as the imminent closure of the Flin Flon copper smelter to see whether “innovation and cost savings may make these operations economic.”

In response, Benner said Jones already re-opened Balmat once but did so on “overly optimistic production and cost assumptions” that forced the current board to close the mine after more than $80 million in losses. And Chisel North was closed for two reasons: to maximize the value of the resources that remain there, rather than mining it out at the current, depressed zinc price, and because if Chisel North reopen in a few years the company can transition its workforce to Lalor Lake once Chisel North is depleted.

The nominees also have a different outlook from the current board on two of HudBay’s key organic growth avenues, which are Lalor Lake and exploration spending. The zinc-rich Lalor Lake deposit sits 18 km west of Snow Lake, Manitoba, and also hosts copper, gold, and silver in a stratified sulphide horizon. HudBay has delineated 3.4 million indicated tonnes grading 1.9 grams gold per tonne, 20.5 grams silver per tonne, 0.71% copper, and 8.82% zinc as well as 13.2 million inferred tonnes grading 2.9 grams gold, 34.1 grams silver, 0.7% copper, and 8.19% zinc. The challenge at Lalor Lake is the depth: the deposit’s six lenses sit between 570 and 1,170 metres underground.

Since the resource estimate from fall 2008 drills have intersected notable gold and silver-rich zones outside the currently defined resource. The current HudBay board wants to concentrate on drilling from surface to better define this precious metal resource, in the hopes that it could be a high-return starter zone for the mine. In a conference call in February, Palmiere said driving an exploration adit into Lalor from the nearby Chisel Lake Mine would be prohibitively expensive and time-consuming. He said the board envisions production from Lalor in roughly 2015.

The challenger board disagrees: “I’m quite bullish on Lalor Lake,” said Jones. “I think a rapid access adit can be made into Lalor that doesn’t involve committing hundreds of millions of dollars. One thing this board will look at is a quick in to Lalor that could provide a pay-as-you-go style of mine development – that will be a high priority.”

The challenger slate also says it would re-examine recent cuts to HudBay’s exploration spending. The company recently reduced its 2009 exploration budget by 50% to conserve funds in the economic downturn. But Jones called exploration spending the “lifeblood of HudBay for many years” and says this board would re-assess that decision.

Finally, both boards plan to seek out acquisition opportunities – HudBay has $686 million in the bank at a time when many other companies cannot afford to keep drills turning.

“We will identify growth opportunities that make good business sense – they must be accretive transactions and must make sense to the company and its shareholders,” Jones says. “We will emphasize high quality assets being sold by senior mining companies…and I will certainly be disappointed it we can’t identify good targets within six months.”

In fact, Jones said he would consider buying one of Lundin’s properties – the failed merger left HudBay with the right of first offer on anything Lundin decides to sell within six months as well as a 19.9% stake in the company – arguing that the price for Lundin was the issue, not the quality of its properties.

The current board, though, has not held back in its criticism of Jones’ acquisition record: “A key part of HudBay’s strategy during Mr. Jones’ previous tenure as CEO was to grow the company by acquisition, and the HudBay board’s opinion is that Mr. Jones was unsuccessful in carrying out that strategy.” Indeed, Jones did not complete any significant acquisitions in his three years at the HudBay helm.

Benner says the current board will certainly continue to look for acquisitions but he stresses no one knows how long metal prices will remain depressed and that means prudence is key.

Both sides have been endorsed by independent advisors. RiskMetrics sided with SRM, advising HudBay shareholders to vote to oust the current board. The risk assessment firm is primarily concerned that, in negotiating the Lundin transaction, the HudBay board both failed to ensure a fair deal and failed to consider shareholders.

“We are concerned that on the one hand the board did not try very hard to renegotiate the transaction while on the other hand they appear to have tried very hard to avoid a shareholder vote,” the company wrote. “The OSC has made clear their view with regard to the incumbent board’s lack of recognition and concern for shareholder rights to the extent that their actions appear to have been for the purpose of preventing the exercise of shareholder rights. The board has not been accountable to shareholders.”

RiskMetrics also said it believes the SRM nominees have significant shareholder support, estimating 36 to 39% of shareholders were already behind SRM when RiskMetrics was assessing the situation in early March.

Benner points out, though, that even in its endorsement of the SRM nominees RiskMetrics expressed concern over the choice for chairman. Wesley Voorheis, a lawyer, is a paid consultant for SRM.

“We are not comfortable with Voorheis being appointed chairman,” RiskMetrics wrote. “A consultant who is paid by the dissidents should not automatically be installed in such an influential leadership role.”

Benner and the current board found support in Glass Lewis, another independent advisory firm. Glass Lewis is concerned that replacing the entire board could deprive the company of much-needed leadership amid a major financial downturn. The firm was also unconvinced that the dissidents’ plan, which requires a comprehensive review of operations, would yield better results than management’s current strategy.

HudBay’s share price hovered just under $6 for the first half of March, closing at $5.75 on Mar. 18. The company has a 52-week trading range of $2.70 to $20.49 and has 153 million shares outstanding.