KGHM starts the bidding on Quadra FNX

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

And the street seemed doubtful about Polish copper mining giant KGHM‘s initial offer for Quadra FNX Mining (QUX-T).

The offer breaks down to $15 per share and a sizeable premium of 41% on Quadra’s 20-day, volume-weighted average price. The market showed anticipation for a higher bid, with Quadra shares ending the day at $15.88 on 71.6 million shares traded.

KGHM is attracted to Quadra’s portfolio of development projects and anticipated production growth. KGHM’s strong cash flows from three mines in Poland and its access to financing put it in a great position to unlock the full value of Quadra’s assets.

“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 during a 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.”

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

KGHM says that the companies would have had a combined 1.16-billion-lb. copper production in 2010, with the number anticipated to rise by 1.4 billion lbs. once Sierra Gorda reaches its designed capacity.

The terms of the deal include a “no-shop and no-talk” covenant – which generally prohibits a target company from 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, Paul Blythe, Quadra’s president and chief executive, defended those terms and said they weren’t meant to scare-off prospective acquirers. 

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

Blythe explains that if Quadra’s board determined a rival bid was superior, the offering company would conduct due diligence on all of Quadra’s assets.

Analysts on the conference call routinely questioned whether or not Quadra had done the right thing by backing the offer. 

Tom Meyer, an analyst with Scotia Capital, found the offer somewhat lacking.

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

The deal’s timing also raised eyebrows – analysts on the call openly questioned if it was wise to sell while Quadra gets 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 says. “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 view that the offer is a 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 compare the low price-to-NAV multiple to recent bids, such as Minmetals‘ bid for Anvil Mining (AVM-T).

Blythe argues that the market likely perceived the company’s NAV as higher than what it actually is, owing 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 asks. “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.”

If the bid offers a fair value, there are still potential hurdles to clear back in Poland.

KGHM trades on the Warsaw exchange, but the government holds a 32% stake in the company and remains its largest shareholder.

Combined with a Financial Times report that quoted a Treasury Ministry representative on the need to look closely at the transaction, analysts are now deliberating the offer’s security. 

Kubacki says the company’s supervisory board approval was all the deal required from KGHM’s perspective, and that has been achieved.

“I cannot tell you what the process of communication looked like internally,” Kubacki explains. “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.”

Kubacki does his best to quell fears that Canadians could be losing jobs after the acquisition. 

“We’ve made it clear that we want to retain the current management of Quadra and its operational people,” he says. “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 66% approval from 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 Gorniczo-Hutniczy Miedzi. Its shares began trading on the Warsaw Stock Exchange in 1997.

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