Inmet and Lundin propose to merge

The proposed merger of Inmet Mining (IMN-T, IEMF-O) and Lundin Mining (LUN-T), which both companies describe as a “merger of equals,” would create a large base-metal producer in Canada that would replace those the country has lost in the past, such as Noranda, Falconbridge, Inco, and Rio Algom.

The combined company, to be called Symterra, would have a market capitalization of $8.8 billion based on closing prices on Jan. 12, and would generate about 80% of its revenue from copper with the remainder from zinc and nickel.

Symterra would have $1.3 billion on its balance sheet ($1.1 billion Inmet and $200 million Lundin) and five operating mines in Europe (Las Cruces in Spain; Neves-Corvo in Portugal; Zinkgruvan in Sweden; Pyhasalmi in Finland; and Cayeli in Turkey). The combined company would also have two major development projects: Tenke Fungurume (24% Lundin) in the Democratic Republic of the Congo and Cobre-Panama (80% Inmet) in Panama.

“Lukas and I have been involved in the copper and zinc mining business for many years and we both recognized that to be a relevant player in the copper business going forward,  scale and financial strength will be more important than ever,” Jochen Tilk, Inmet’s president and chief executive, told analysts and investors on the conference call. “Given the positive outlook for copper prices, acquisition and capital costs for world-class copper assets will continue to escalate in the future. The combination of Lundin and Inmet is not only very logical for both of us given the location of our operating assets, but it is important to our long-term ability to survive and thrive in the copper business over the long term.”

The established operations and development projects of both companies could drive production growth of the combined company to more than 500,000 tonnes of copper a year by 2017.

“Scale is important in the copper business,” Tilk said on the conference call. “With this one transaction Symterra will be a $9 billion company, launching us into the new peer group of senior mining companies, with plenty of room to move up.”

“As we believe investors will be looking for strong liquid companies with outstanding leverage to copper, Symterra will have it, and our leverage to the copper price will only grow over time,” he said, adding that Symterra will have a “solid base of long-life, low-cost mines in favourable mining jurisdictions and a significant growth profile.”

Under the proposed merger, neither company will receive a premium to its share price. Lundin shareholders will receive 0.33 shares of Symterra and Inmet shareholders 3.49 shares of Symterra. The plan of arrangement must get approval from two-thirds of the shareholders of both companies and carries a reciprocal break fee of $120 million. Each company has granted the other the right to match any competing offer. So far the proposal has a soft lock-up of Inmet’s 18% shareholder, Leucadia, and Lundin’s largest shareholders holding 12.3%.

“We view this as a brilliant transaction as it would create a sizable copper producer with a meaningful pipeline of growth,” Tom Meyer, a mining analyst at Raymond James wrote in a research note to clients. “The Tenke expansion potential combined with the Cobre Panama development project provides world-class operations today with a potentially world-class operation in the near future, an ideal combination in a robust commodity price environment.”

Peter Campbell of Jennings Capital notes that currently Inmet has a stronger balance sheet than Lundin and in general says he prefers Inmet’s production and growth assets to Lundin’s. He also points out that the two corporate cultures are quite different and so it could take longer to integrate the two companies. But on balance he believes the benefits of the deal accruing to Inmet outweigh the drawbacks.

“While there are no significant, direct synergies that we can identify, Symterra will be a major copper “pure play” with much greater visibility and much better liquidity resulting in a net benefit to Inmet,” he reasoned in a note to clients. Campbell is increasing his 12-month target price on Inmet to $100 per share, up from his previous $90 per share.

The new board of Symterra will be made up of five directors from each company. Tilk will become chief executive and Lukas Lundin, chairman.

According to Onno Rutten of UBS Investment Research, Inmet’s desire to merge with Lundin is driven by “(1) the need to expand the balance sheet to tolerate the $4 billion (80%) value-at-risk of Cobre Panama; and (2) the near-term growth of Lundin’s Neves-Corvo and Tenke mines. IMN stand-alone offers 0% production growth, whereas Lundin offers 7% growth (5-yr CAGR).”

“We continue to believe that stand-alone Imet would have to reduce its holding in the $5 billion Cobre Panama project (currently at 80%) to less than 55% to provide for a more acceptable risk profile,” he continued. “In the context of the expanded market capitalization of Symterra ($9 billion), the exposure to the risks associated with the $5 billion Cobre Panama project would be meaningfully mitigated.”

Rutten also noted that he was “somewhat surprised” at the timing of the transaction, given that the DRC government has not yet ratified the new contract terms of Tenke Fungurume. “This introduces a substantial degree of risk, especially in view of the DRC’s increasingly unpredictable political situation in the run-up to the national elections” scheduled for Nov. 27 2011.

In terms of the relative value of each company’s assets, Rutten said that while both have strategic value, he views Lundin’s as ” strategically slightly more attractive.” Lundin’s 24% stake in Tenke Fungurume “provides a well-established entry into the DRC and exposure to long-term production growth of Tenke, which could exceed 600,000 tonnes per year by the end of the decade,” on a 100% basis, he wrote.

Inmet’s stake in Cobre Panama is strategically important because of its potential production and long mine life, he continued, but on the flip side, “the project’s return characteristics (approximately $2.50 per lb. long-term copper is required to obtain a 15% IRR on investment, in our view), are not substantially differentiated from other large-scale copper porphyry projects that are already controlled by the global copper miners.”