Hedge Fund SRM Wins Battle For HudBay

VANCOUVER — The battle for control of HudBay Minerals (HBM-T, HBMFF-O) got uglier in the week leading up to the proxy vote deadline, with both the incumbent board and its challengers using letters and conference calls to slam their opponent’s motivation for control of and ability to run the Canadian producer.

But a resolution came just two days before the scheduled — and now cancelled — shareholder meeting in Toronto on March 25, with the entire HudBay board of directors submitting their resignations, to be replaced immediately by the slate of nominees proposed by dissident 11% shareholder SRM Global Master Fund.

HudBay’s new board is comprised of chairman Wesley Voorheis, Bruce Barraclough, Brian D. Gordon, Alan Roy Hibben, Warren Holmes, Peter Jones, John Knowles and Alan Lenczner.

SRM, a hedge fund out of Monaco, started the proxy battle after the now-departed board, led at the time by then-CEO Allan Palmiere, made a controversial takeover bid for Lundin Mining (LUN-T, LMC-N).

That board withdrew the blockbuster bid after the Ontario Securities Commission (OSC) forced the company to get shareholder approval because it would have seen HudBay more than double its outstanding share count. SRM had also applied to the Ontario Superior Court to block the deal; testimony from that hearing seems to suggest that the board, and especially Palmiere, failed to protect shareholder interest in negotiating the deal.

Palmiere had since resigned, and was replaced for a couple of weeks by interim CEO Colin Benner. And though SRM had aimed its barbs primarily at Palmiere before his departure, the dissidents then started to direct criticism at the rest of the board in the week before the vote.

“The incumbent board has made repeated misguided and misinformed decisions and has failed to consider shareholder interests — the interests which they were previously elected to protect,” the replacement director nominees wrote in a letter to shareholders, their first statement since being nominated by SRM.

The nominees charged that the now-departed board failed to properly supervise or involve itself in the negotiation of the Lundin deal. Court testimony revealed Palmiere made two fundamental decisions about the merger — the price and the absence of a HudBay shareholder vote — essentially on his own, without consulting with or asking approval from the board.

Under cross-examination, Palmiere said he and Phil Wright, Lundin’s president and CEO, agreed to a 50-50 value ratio for the takeover during a private meeting because they thought the relative valuations would indicate roughly that. Palmiere did not perform any net asset value (NAV) analysis. When Hud- Bay’s financial adviser, GMP Securities, did perform NAV analysis it found HudBay’s value far exceeded that of Lundin. GMP presented its findings to the HudBay board the day before the deal was signed, but SRM says Palmiere failed to tell the board that the “basic building block for the whole Lundin transaction had been invalidated.”

As for the issue of a shareholder vote, Palmiere maintained that the board decided to go ahead without a vote because Lundin refused to sign on without an assurance of deal certainty. In the court proceedings, it became clear that the board had in fact insisted on a shareholder vote regardless of Lundin’s demands but that Palmiere gave up that condition in a private meeting with Wright the next day.

“No matter how many rules are put in place, the way the board operates and thinks is key to making sure the company operates correctly and shareholder rights are upheld,” said former HudBay CEO Peter Jones, who has now become CEO again, before the latest resignations. “This board has failed, repeatedly, in its duties. The only way to restore the health of the company is to replace the board.”

Benner had countered that the now-departed board was hindered in its ability to act because of legal constraints around the Lundin deal and that SRM was distorting the facts. And Benner argued that the SRM-nominated slate lacked mining industry experience and would work in the interests of the firm that nominated them — SRM — and not in the interests of all shareholders.

“HudBay has the right board and the right strategy to enhance shareholder value,” Benner said as interim CEO. “In contrast, SRM has proposed a less experienced and conflicted board lacking a well thought out strategy, and it is too much of a risk for shareholders to take with HudBay’s future.”

Jones, though, said the challenger board nominees have the experience needed to run the company. The group comprises three former HudBay employees with 37 years of combined experience with the company, three lawyers, and two mining engineers with 40 years of experience each.

“These gentlemen were identified by myself after SRM contacted me late last year,” Jones said. “I was fortunate to convince eight highly qualified and experienced individuals to commit to this endeavour. This is a powerful board indeed, and one open to deliberation and committed to first-class corporate governance.”

And he flatly refuted the contention that the new board would be driven by SRM’s interests: “It is preposterous to think that with a fully independent board and an active group of shareholders that SRM could control HudBay.”

The now-departed board argued that completely replacing the board would throw the company into a leadership void, especially because the dissident nominees did not have a clear plan for HudBay. Benner said his board, in contrast, did have a clear plan: continue to optimize operations, grow organically, and look for accretive opportunities.

The SRM slate said it had a plan for HudBay, but the details couldn’t be finalized until it was elected and had completed a full review of the company’s operations. The plan’s fundamentals are exactly the same as those of the now-departed board.

In terms of existing operations, the new directors differ from old ones in that they want to re-examine the closures of the Balmat zinc mine in New York state, the Chisel North zinc mine and Snow Lake concentrator in Manitoba, and the Fenix nickel project in Guatemala, as well as the imminent closure of the Flin Flon copper smelter in Manitoba to see whether “innovation and cost savings may make these operations economic.”

In response, Benner said Jones had already reopened Balmat once, but did so on “overly optimistic production and cost assumptions” that forced the now-departed board to close the mine after more than $80 million in losses. And Chisel North was closed for two reasons: to maximize the value of the resources that remain there, rather than mining it out at the current, depressed zinc price, and because if Chisel North reopens in a few years, the company can transition its workforce to Lalor Lake once Chisel North is depleted.

The new directors also have a different outlook on two of HudBay’s key organic growth avenues, which are Lalor Lake and exploration spending. The zinc-rich Lalor Lake deposit sits 18 km west of Snow Lake, Man., and also hosts copper, gold and silver in a stratified sulphide horizon. HudBay has delineated 3.4 million indicated tonnes grading 1.9 grams gold per tonne, 20.5 grams silver, 0.71% copper and 8.82% zinc, as well as 13.2 million inferred tonnes grading 2.9 grams gold, 34.1 grams silver, 0.7% copper and 8.19% zinc. The challenge at Lalor Lake is the depth: the deposit’s six lenses sit between 570 and 1,170 metres underground.

Since the fall 2008 resource estimate, drills have intersected notable gold and silver-rich zones outside the currently defined resource. The departed HudBay board had wanted to concentrate on drilling from surface to better define this precious metal resource in the hopes that it could be a high-return starter zone for the mine. In a conference call in February, Palmiere said driving an exploration adit into Lalor from the nearby Chisel Lake mine would be too expensive and time-consuming. He said his b
oard envisioned production from Lalor in roughly 2015.

The challenger board disagreed: “I think a rapid access adit can be made into Lalor that doesn’t involve committing hundreds of millions of dollars,” Jones has said. “One thing this board will look at is a quick in to Lalor that could provide a pay-as- you-go style of mine development — that will be a high priority.”

The new slate has also said it would re-examine cuts to HudBay’s exploration spending. The company recently reduced its 2009 exploration budget by 50% to conserve funds. But Jones called exploration spending the “lifeblood of HudBay for many years” and said the new board would reassess that decision.

Finally, both boards had planned to seek out acquisition opportunities — HudBay has $686 million in the bank at a time when many other companies cannot afford to keep drills turning.

“We will emphasize high-quality assets being sold by senior mining companies. . . and I will certainly be disappointed it we can’t identify good targets within six months,” Jones said.

In fact, Jones said he would consider buying one of Lundin’s properties — the failed merger left Hud- Bay with the right of first offer on anything Lundin decides to sell within six months as well as a 19.9% stake in the company — arguing that the price for Lundin was the issue, not the quality of its properties.

The now-departed board, though, criticized Jones’s acquisition record: “A key part of HudBay’s strategy during Mr. Jones’s previous tenure as CEO was to grow the company by acquisition, and the Hud- Bay board’s opinion is that Mr. Jones was unsuccessful in carrying out that strategy.” Jones did not complete any significant acquisitions in his three years at the HudBay helm.

Benner had said his board would certainly continue to look for acquisitions, but he had stressed no one knows how long base metals prices will remain depressed and that means prudence is key.

Both sides were endorsed by independent advisers. Risk-assessment firm RiskMetrics sided with SRM, advising HudBay shareholders to oust the incumbent board. The company is primarily concerned with the way HudBay negotiated the merger deal with Lundin.

“We are concerned that on the one hand, the board did not try very hard to renegotiate the transaction, while on the other hand, they appear to have tried very hard to avoid a shareholder vote,” the company wrote. “The OSC has made clear their view with regard to the incumbent board’s lack of recognition and concern for shareholder rights to the extent that their actions appear to have been for the purpose of preventing the exercise of shareholder rights.”

RiskMetrics also said it believed the SRM nominees have significant shareholder support, estimating 36- 39% of shareholders were already behind SRM in early March.

Benner pointed out, though, that even in its endorsement of the SRM nominees, RiskMetrics expressed concern over the choice for chairman. Wesley Voorheis, a lawyer, is a paid consultant for SRM.

“A consultant who is paid by the dissidents should not automatically be installed in such an influential leadership role,” RiskMetrics wrote.

Benner and the now-departed board found support in Glass Lewis, another independent advisory firm. Glass Lewis was concerned that replacing the entire board could deprive the company of much-needed leadership during a major financial downturn. The firm was also unconvinced that the dissidents’ plan, which requires a comprehensive review of operations, would yield better results than the former management’s strategy.

HudBay’s share price hovered just under $6 for the first half of March, and gained about 60¢ in response to the news of the directors’ resignations to trade at $6.18 at presstime. The company has a 52-week trading range of $2.70-20.49 and 153 million shares outstanding.