Hecla withdraws US Silver bid

Hecla Mining’s (HL-N) attempt to derail a merger agreement reached last month between U.S. Silver (USA-T, USSIF-O) and RX Gold & Silver (RXEXF-O) has fallen short.

Both U.S. Silver and RX Gold shareholders have voted in favour of a merger between the two companies, causing Hecla to withdraw its offer.

Hecla was looking to scoop up U.S. Silver in an all-cash hostile offer that valued U.S. Silver shares at $1.80 — a 28% premium to the $1.41-per-share imputed offer price under U.S. Silver’s proposed merger with RX Gold.

U.S. Silver’s board had agreed to combine with RX Gold, and Hecla’s hostile move came less than two weeks before shareholders were expected to vote on the merger.

U.S. Silver operates the Galena mine in Idaho, which has a reserve base of 23 million oz. silver, 91.2 million lb. lead and 11.7 million lb. copper. The junior also owns the past-producing Coeur mine, which is expected to move into commercial production at the end of 2013.

From a geographic point of view, Hecla likely would have enjoyed more synergies than RX and U.S. Silver. Hecla’s Lucky Friday mine is just 10 km east of Galena, while RX Gold’s flagship project, the Drumlummon mine, is 400 km east. Galena itself sits 77 km east of Coeur d’Alene.

RX pegged the value of its operational synergies at $10 million per year, while Hecla failed to provide an estimate.

Hecla CEO Phil Baker said at the time of its bid that despite favourable geographics, the acquisition offer was less about synergies and more about the exploration package that Hecla would acquire in Idaho’s Silver Valley.

“It’s a large land package,” Baker said of U.S. Silver’s exploration assets. “We think there is a chance of finding more than what is there today, and that’s the sort of risk we want to take on. We’ve been there forever and we have the best chance of finding it. No one knows how to mine that rock better than we do.”

Hecla traces its history in the Silver Valley back to 1891.

While neither U.S. Silver nor RX Gold responded to a request for comment, U.S. Silver wrote in an earlier statement that “the board of directors believes that significant synergies and strategic benefits would accrue to Hecla upon acquiring U.S. Silver because of the proximity of the companies’ respective assets, and [U.S. Silver’s] large and dominant land position in the Silver Valley.”
It went on to list what it believes are the key synergies of a Hecla acquisition, which include better mill sequencing, economies of scale and greater access to labour.

Baker, however, countered that U.S. Silver is already running an efficient mine, and is limiting its ability to capture synergies.

“They’re already doing a great job at Galena,” Baker said, “and there’s not much opportunity to improve it.”

This picture is contradictory to the one painted by RX CEO Darren Blasutti. Blasutti went on the record saying that U.S. Silver has operational issues at Galena and would benefit from having a stronger management team run its assets.One of RX’s major points in arguing for the merger was that U.S. Silver shareholders would gain a stronger management team with knowledge of how to unlock the company’s potential.

Blasutti spent 13 years at Barrick running their mergers and acquisitions team. RX’s management is made up of former Barrick and Kinross managers that seized control of RX through a proxy battle last summer.

For Baker, RX running the company without paying a premium and holding just 30% of the newly merged company should be a bone of contention for U.S. Silver shareholders.

The RX merger calls for RX’s current management team to occupy four out of five management positions, while the board would be made up of five members chosen by RX and four members chosen by U.S. Silver.

But the loss of control didn’t seem to bother U.S. Silver’s management. It stood by the RX proposal, arguing that the Hecla offer lacks a premium when U.S. Silver’s working capital is taken into account.

U.S. Silver reports it has $29 million in working capital — which is typically made up of a company’s cash and inventory. Often when calculating the enterprise value of a target company, its cash position is not included in the calculation. In the case of U.S. Silver, its last financial statement for the period ending March 31 showed a balance of $26.8 million in cash.

U.S. Silver’s own numbers say that if the $29 million is deducted, Hecla’s offer would be $1.39 per share, which was roughly the company’s share price before the Hecla offer was made.

Baker countered that U.S. Silver is making a false argument, and reasoned that “$30 million is barely an adequate amount of working capital to run a mine . . . so that statement is not based on the realities of running a mine.”

He pegs Hecla’s own working capital for its mines at closer to $100 million, and said that Hecla’s offer is superior to RX because it would bolster working capital to appropriate levels.

BMO Nesbitt Burns’ Andrew Kaip outlined some of the metrics affecting the company’s bottom line in a recent research note, saying that “U.S. Silver 2012 production guidance for the Galena mine of 2.4 million oz. would provide a significant increase in Hecla’s production pro forma . . . Hecla looks to be making a tuck-in acquisition that provides the company long-term regional synergies and a dominant land position within the Coeur Silver district in Idaho, at an acquisition cost well within the company’s capabilities.”

Hecla has a cash position of US$233 million and no bank debt — so look for it to be on the hunt for other targets.

In terms of valuation, Kaip says Hecla is trading at 0.9 times the 10% nominal net present value (NPV) of US$5.23 per share, at spot metal prices versus the intermediate silver peer average of 1 times.

“By not motivating U.S. Silver shareholders to tender to its bid, Hecla looks to have walked away from a tuck-in acquisition that could have provided a second production centre to offset risk at the deeper Lucky Friday mine, currently undergoing shaft rehabilitation,” Kaip stated after the voting results were released.

Sprott Asset Management had signed a lock-up agreement supporting the U.S. Silver and RX merger. Sprott is the largest shareholder of both companies, and as of June 7 held 14% of U.S. Silver shares and 8% of RX shares.