Ashton rejects Stornoway offer

The board at Ashton Mining of Canada (ACA-T, AMCFF-O) has rejected the takeover bid for the company made by Stornoway Diamond (SWY-T, SWYDF-O), and is talking to other possible bidders to get a better deal.

In addition, it is challenging the lock-up agreement Stornoway has made with Rio Tinto (RTP-N, RIO-L) based on a recent Ontario Securities Commission (OSC) decision against American retailer Sears Holdings. Ashton applied to the British Columbia Securities Commission (BCSC) for a cease-trade order on the offer, and the Commission will hold a hearing Sept. 6.

Stornoway offered $1.25 for each Ashton share in cash, up to a limit of $59.5 million, or one share plus 1. Rio Tinto (which holds a 51.7% interest in Ashton through two Canadian subsidiaries) locked its shareholding up with the offer, and opted for the cash bid. (That cash distribution would be pro-rated among Ashton shareholders taking the cash option.)

Stornoway has also offered 0.36 of a Stornoway share for shares of Contact Diamond (CO-T, CONPF-O) in a bid to create a $200-million diamond developer. Agnico-Eagle Mines (aem-t, aem-n), which owns 31% of Contact, is advancing $22.5 million to Stornoway, to be paid back in Stornoway shares if the bid for Ashton is successful. The deal would give Agnico a 14% interest in the merged company.

Ashton’s president Robert Boyd told a conference call that Stornoway’s offer “fails to recognize the value of Ashton’s key projects and creates a riskier project portfolio.” He noted Ashton’s most advanced projects were the prefeasibility study on the Renard kimberlites in north-central Quebec, and three bulk-sampling programs on the same Foxtrot property as Renard, at the Artemisia property in Nunavut, and at the Buffalo Hills property in Alberta. Stornoway’s most advanced projects, as well as Contact’s, are not yet at the bulk-sampling stage.

Ashton’s board cautioned that the offer allowed shareholders of Stornoway, Contact, and Agnico to benefit from potential additions to value Ashton would make on Renard, where a 10,000-tonne bulk-sample program is under way. Boyd said that among diamond developers, market value tends to be added disproportionately by discoveries of large stones, which were probable during the bulk-sampling campaign on Renard and possible in the other more advanced projects.

Minority shareholders of Ashton would be left with about 12% of a merged company — not enough to retain control — and the directors had determined that four recent takeovers representing a change of control in the diamond sector had been priced at an average 51.5% premium to the market. Stornoway’s offer is a 15% premium to Ashton’s 20-day average price at the time of the offer.

Rio, which gained the Ashton Canada interest in its takeover of Ashton’s Australian parent in 2000, has been a largely passive shareholder, and has no access to insider information at the company. In 2001, it put its control block up for sale, but there were no takers at the time.

Boyd also said the large shareholdings retained by Agnico and Rio (in Rio’s case, assuming a full distribution of the Stornoway cash to all Ashton shareholders), and the need for U.S. investors to sell their new Stornoway shares — which are ineligible to trade in the United States — would create a significant overhang of offers in the market, depressing the price of the merged company’s shares.

‘Sears problem’

Stornoway has countered that the new company, because of its larger market capitalization, would be more liquid, and knocking out the Rio Tinto control block would increase the value of Ashton as part of the new company.

The “Sears problem,” in the view of Ashton’s board, is that the lock-up agreement between Stornoway and Rio gives Rio a $2-million break fee if Stornoway’s bid fails. Ashton is taking the view that the break fee is a benefit offered exclusively to one shareholder, and has applied to the British Columbia Securities Commission to have the bid or the lock-up agreement cease-traded.

In the Sears case, the Ontario Securities Commission ruled against Sears Holdings, which had bid for the 46% of Sears Canada that it didn’t already own, but planned a subsequent vote on a takeover by minority shareholders that had not tendered to the bid. The OSC ruled Sears Holdings could not count shares that had been locked into two voting agreements and a tender agreement as part of a “majority-of-the-minority” approval for the takeover.

The Securities Commission’s reasoning was that the two shareholders that locked up their votes — Bank of Nova Scotia and Royal Bank of Canada, and a third shareholder, Vornado Realty, which had tendered to the offer — had received benefits in those agreements that were not offered generally to the minority shareholders in Sears Holdings’ bid. (The banks got a tax advantage by agreeing to vote for the later takeover, rather than realize the value of Sears Holding’s bid; Vornado got an undertaking from Sears Holdings releasing Vornado from legal liability arising from their ownership of Sears Canada shares.) That ran foul both of Ontario Securities Act provisions that require equal treatment of all minority shareholders in a takeover, and of a Commission regulation that specifies voting procedures in takeovers.

British Columbia’s Securities Act carries virtually identical provisions, and the regulation is a national policy adopted by all provincial securities commissions.

The difference in the Stornoway-Ashton takeover is that majority shareholder Rio, unlike Sears, is selling its Ashton stake rather than buying out the minority shareholders. The rule under which the Sears decision was made applied specifically to business combinations between related parties. In addition, two of the Sears shareholders had not agreed to tender to Sears Holdings’ bid, but rather to vote their shares in favour of a business combination after the bid.

In their submission to the BCSC, Ashton’s lawyers argued that the break fee Rio would receive if the Stornoway offer was unsuccessful gives Rio downside protection that is unavailable to the other Ashton shareholders, and provides Rio with “a consideration of greater value than that offered to the other holders,” in the Securities Act’s phrasing.

Ashton’s application also argued that there is a public interest in maintaining the company’s ability to hold an unrestricted auction for its shares.

Extra benefit

The case will probably hinge on Stornoway’s ability to show that the break fee does not provide an extra benefit to Rio Tinto that other shareholders do not get — which it does not, provided the offer is successful.

In the Sears Holdings case, the OSC held that a legal release conditional on a tender to the offer was “valuable consideration” that was offered only to Vornado. It is not obvious that a break fee has the same effect, but Ashton’s application argues that the fee “provides a prohibited incentive to the majority shareholder(s) to agree to tender to a lesser offer than they might otherwise accept.”

The application, while asking in the first instance for a cease-trade order on the offer, asks in the alternative for Stornoway to be ordered to provide a termination payment to all Ashton shareholders, a move that would presumably cost Stornoway another $1.9 million if the offer failed.

Meanwhile both companies have trotted out exploration results, possibly not a coincidence given the temper and substance of their exchanges over the takeover bid. Ashton said that it and its equal partner at the Renard property, Quebec crown corporation Soquem, had sampled 2,000 tonnes of material from surface trenches on one of the kimberlites, Renard 4, and that the planned 525-metre decline on Renard 2 and 3 was now 71 metres along. A dense media separation plant is on-site awaiting assembly, and about 60 people are working on the property.

A 2.9-tonne sample from Renard 4, recently processed, yielded 4.97 carats of diamond in the size fract
ion above 1.18 mm; this translated to a recovered diamond grade of 1.71 carats per tonne. Two previous samples of comparable size (processed in October 2005 and December 2004) returned grades of 1.78 carats and 1.73 carats per tonne. Based on the grades from these smaller samples, Ashton believes it can expect to recover well over 2,000 carats from the new trench sample.

Buffalo Hills

Ashton also reached an agreement to increase its interest in the Buffalo Hills joint venture in Alberta. Oil and gas producer EnCana (ECA-T, ECA-N), which owns a 43% interest, and Pure Gold Minerals (PUG-T, PURGF-O), which has 12%, both agreed that Ashton could increase its 45% stake to 72.5% by funding the next $15 million to go into exploration on the property by April 2010. EnCana’s and Pure Gold’s interests will each be cut in half under the formula.

Ashton’s 2007 plans, which are part of a $4-million exploration commitment to the end of 2008, include a 200-tonne bulk sample on one of the Buffalo Hills kimberlites, K14. K14 and another kimberlite, K91, are being drilled to determine their size and Ashton believes both are potentially large, though low-grade. Bulk samples in 1998 returned grades of 0.12 carat per tonne from K14 and 0.13 carat per tonne from K91.

Stornoway received results of analyses on the AV-7E kimberlite at its Aviat project, on the northern end of the Melville Peninsula in Nunavut. The kimberlite is now known to be diamondiferous, an 80-kg sample having yielded 66 microdiamonds (all below 1.18 mm in size).

Stornoway also announced that joint-venture partner Shear Minerals (SRM-V, SRMUF-O) had discovered two new kimberlites, called Notch and Jigsaw, on the Churchill property near Rankin Inlet in Nunavut, where Stornoway has a 35% interest and BHP Billiton (BHP-N, BLT-L), 14%.

At the Qilalugaq property near Repulse Bay, Nunavut, Stornoway discovered a pair of kimberlite dykes, labelled Naujaat 1 and 2, near a known kimberlite pipe. Naujaat 1 has been traced along a strike length of 3,000 metres and Naujaat 2 over 600 metres. Stornoway has just over a tonne of material for caustic-fusion analysis and processing.