Dominion Diamond grapples with activist shareholders

Yellowknife-based Dominion Diamond (TSX: DDC; NYSE: DDC) is the latest Canadian miner to land in the cross hairs of activist shareholders. On Dec. 21, Toronto-based hedge fund K2 & Associates Investment Management emailed a letter to the company’s lead director, Daniel Jarvis, on behalf of a group of investors who say Dominion’s share price has “suffered excessively and unnecessarily” as a result of “misguided policies and missed opportunities.”

At the time of the letter, Dominion’s share price had dropped 54% year to date over 2015 versus 30% for the S&P/TSX Global Mining Index.

The struggles are largely driven by weak fundamentals in the diamond market and relatively volatile production results at the company’s major assets: the prolific Diavik and Ekati diamond mines in the Northwest Territories, which lie 220 km south of the Arctic Circle at Lac de Gras.

The activist investor consortium owns 5.4% of Dominion’s outstanding shares and features a few names outside of K2, including: Sprott Asset Management, Swiss Financier Carlo Civelli and Haywood Securities chairman John Tognetti.

The group claims that Dominion is “undervalued by the public markets,” but so far management has “failed to articulate a clear plan of action to remedy issues” surrounding project priorities, capital allocation, diamond marketing and corporate governance.

In early December the company reported positive free cash flow of US$8.5 million during the third quarter, despite capital expenses of US$52.3 million, which includes investments in the A-21 pipe at Diavik and in the Misery Main, Pigeon and Jay pipes at Ekati. Dominion said it had unrestricted cash and equivalents of US$328 million, and minimal debt obligations.

The company did increase its cost of sales guidance at both mines, however, which it largely attributed to lower throughput levels at Ekati due to diamond liberation and inventory over the quarter. Dominion CEO Brendan Bell added that markets are experiencing “some headwinds,” with only the U.S. retail market providing relatively strong demand in the polished diamond market.

On Dec. 24 Dominion announced that two of its independent directors, Fiona Perrott-Humphrey and Ollie Oliveira, had resigned from its board.

The company also confirmed media speculation that it had kept multinational investment bank Rothschild Group to help with “a number of possible initiatives to maximize shareholder value,” including the possibility of a sale.

BMO Capital Markets analyst Edward Sterck notes that fiscal 2016 was always “flagged as a transitional year, with Dominion’s future cash generation the real attraction.”

BMO Research forecast cash flow per share of US$4.38 next year as the company moves to the “higher-grade Misery main pipe,” and models net free cash flow of US$1.5 billion over the next four years.

“We continue to see Dominion as a well-run company, but there may be an opportunity to be more proactive in supporting the share price,” Sterck wrote on Dec. 22. “It seems likely that the group behind this letter may seek to attract additional shareholders to their cause, and perhaps to put an appointee of its own on Dominion’s board.”

BMO Research has an “outperform” rating on Dominion along with a $25-per-share target price. The company has traded within a 52-week window of $9.96 to $24.60, and had recovered substantially to $14.27 per share at press time on Jan. 8. Dominion has 85.3 million shares outstanding for a $1.2-billion market capitalization.

K2 portfolio manager Josef Vejvoda has requested that Dominion contact Haywood investment advisor Kyle McLean “before the new year” to facilitate “collaborative dialogue” with the activist group, and identify “opportunities to maximize shareholder value.”

Representatives from K2 and Dominion were not available for comment at press time.