KGHM starts the bidding on Quadra FNX

While $3 billion may sound like a tidy sum, when it’s the price tag on a global copper producer with a stable of enviable development projects, it may not be enough.

That was the general sense, as the Street doubted that Polish copper mining giant, KGHM’s initial offer for Quadra FNX (QUX-T) would be enough.

The offer breaks down to $15 per share – a sizable premium of 41% on Quadra’s 20 trading day volume weighted average price, but the market quickly showed its anticipation of a higher bid as Quadra shares finished the day trading for $15.88 in Toronto on 71.6 million shares traded.

The attraction for KGHM is Quadra’s portfolio of development projects and the growth in production they should bring. The idea being that KGHM’s strong cash flows from three mines in Poland and its access to financing put it in a great position to unlock Quadra’s assets’ true value.

“If we want to grow significantly we have to look for copper deposits that will give us the opportunity to produce at lower cash costs,” Krzysztof Kubacki, KGHM’s head of exploration and business development said on the conference call. “Domestically we are sitting on a world class deposit but it’s not easy to mine and it has higher costs than the porphyries in Chile for instance.”

Indeed, Quadra’s flagship development project, Sierra Gorda, is a large scale copper and molybdenum porphyry deposit in Chile’s Atacama Desert.

KGHM says that combined the companies would have had copper production of 1.16 billion lbs last year, but that number will rise to 1.4 billion lbs once Sierra Gorda reaches its designed capacity.

The terms of the deal include a “no-shop/no-talk” covenant (such covenants generally prohibit a target company from actively soliciting a rival bid), a $75 million break-up fee and a right for KGHM to match a superior offer.

Speaking on the same conference call as Kubacki, Quadra’s president and chief executive, Paul Blythe, defended those terms and said they weren’t so stringent as to scare off other prospective acquirers.

“The board has a fiduciary duty to consider any bids put up for the company,” he said. “The deal protection measures are normal course, and have normal course provisions…they do allow for the concept of a superior bid.”

Blythe went on to explain that if Quadra’s board determined that a rival bid was superior, than the offering company would be able to conduct due diligence on all of Quadra’s assets.

That is important, because the general line of questioning from analysts on the conference call centered on whether or not Quadra had done the right thing by backing the offer.

Tom Meyer, an analyst with Scotia Capital, was amongst those that found the offer somewhat lacking.

“In our view the deal is low and as such we anticipate others may step in and/or the offer will need to be sweetened,” he wrote in his mid-day note. “We believe a $17.50 per share offer would be more palatable.”

The timing of the deal also raised some eyebrows on the Street, as analysts on the call openly questioned if it was wise to sell just as Quadra was getting a handle on some of its key operating mines and development projects.

“The offer was on the table, we weren’t driving a deal,” Blythe said. “KGHM is aware of all the gains we’ve made at the Robinson Mine and where we are on Victoria and Sierra Gorda… but we are at a low point in the market and I think the stock has been trading with the copper price, so the timing wasn’t something we picked but the offer was there and we had to deal with it. This is how we dealt with it.”

Despite Blythe’s contention that the offer represents fair value, Meyer’s note argues that the KGHM offer implies a price to net asset value (NAV) multiple of 0.53 times whereas its peers trade at 0.62 times price to NAV.

Other analysts also brought up the low price to NAV multiple especially compared to recent comparable bids such as Minmetals offer for Anvil Mining (AVM-T).

But Blythe argued the market perception of what the company’s NAV is likely higher than what it actually is due to recent market troubles forcing the value of its assets downward.

“When you have a substantial bid on the table that may go away, do you proceed or move on to another process?” he asked. “We brought in two sets of advisors….we got their views and came to the conclusion that given the magnitude of the premium it would be in the better interest of our shareholders to accept the offer and move forward from there.”

But even if the bid does offer fair value, there are still questions around hurdles the deal may still have to clear back in Poland.

While KGHM trades on the Warsaw exchange, the government remains its largest shareholder with a 32% stake in the company.

That fact, combined with a Financial Times report which quoted a representative of the Treasury Ministry saying that it still had to look closely at the transaction, had analysts wondering how secure the offer was.

But Kubacki said the approval of the company’s supervisory board was all the deal required from KGHM’s perspective and that had been achieved.

“I cannot tell you what the process of communication looked like internally,” Kubacki explained. “But we have a Supervisory Board and seven of the nominees out of ten are representatives of the Treasury Ministry. That’s why if the Supervisory Board approved the transaction, we can say that it is a final approval and we don’t require any more approvals.”

As for the notion that Canadians could be losing jobs as a result of the acquisition, Kubacki did his best to quell those fears as well.

“We’ve made it clear that we want to retain the current management of Quadra and its operational people,” he said. “We have a lot of respect for the workers of the company and as far as headquarters go, that will be decided in due course. Right now Quadra has two offices, one in Vancouver and one in Toronto, and we don’t see any need to change that.”

The acquisition requires the approval of 66% of Quadra FNX’s shareholders. The deal is also subject to regulatory approvals that fall under the Investment Canada Act.

KGHM was established in 1961 as a state enterprise under the name Kombinat Górniczo-Hutniczy Miedzi. Its shares began trading on the Warsaw Stock Exchange in 1997.

The company operates three mines in Poland; Lubin, Rudna and Polkowice-Sierszowice, as well as three smelters, and a wire rod plant. It produced 425,000 tonnes of copper in concentrate in 2010, representing about 2.7% of global production, and about 547,000 tonnes of refined copper, or about 2.9% of global production. It also turned out 38 million oz. of silver in concentrate, representing 5.2% of global production.