HudBay-Lundin Merger Draws Fire

Vancouver — What was supposed to be a friendly merger between HudBay Minerals (HBM-T, HBMFF-O) and Lundin Mining (LUN-T, LMC-N) is turning into a nasty battle, as groups of HudBay shareholders demand the right to vote on what they see as an overpriced takeover of a marginal company without concern for shareholder value.

The deal, announced Nov. 21, calls for HudBay to issue 0.3913 of a share for each Lundin share, transforming Lundin into a wholly-owned subsidiary. The share ratio values Lundin shares at $2.08 apiece, representing a 32% premium. The agreement also commits HudBay to loan Lundin $135.8 million, which it will recoup in the form of some 97 million Lundin shares.

When the companies announced their merger plans, HudBay investors were not impressed. News of the plan drove the major’s share price down 40% in one day, closing at $3.16. Within hours, one merchant bank announced plans to try and abort the merger by wresting control of HudBay from its current board. Within days, another fund challenged HudBay to respond to charges the deal constitutes gross mismanagement and offers no possible benefits to HudBay or its shareholders.

The main bone of contention is that HudBay has $900 million in the bank and operates profitable mines in stable jurisdictions — primarily in Manitoba, where it has three mines and a concentrator-smelter complex — whereas Lundin is weighed down by almost $300 million in debt, has mines that are now barely profitable, and is facing liquidity problems. And despite Lundin’s troubles, HudBay is still paying a considerable premium in the deal.

Lundin may have found a partial solution to its debt problems: the company has just announced a nonbinding agreement to sell its Aljustrel zinc mine in Portugal to private company MTO. Lundin recently put Aljustrel on care and maintenance because it could not find a way to operate the mine profitably.

In the meantime, HudBay CEO Allan Palmiere continues to defend the deal vigorously, arguing that market valuations are currently irrational. He points out that the merger more than triples HudBay’s zinc reserves and doubles its copper reserves and that the new Hud- Bay will be the third-largest diversified mining company on the Toronto Stock Exchange. Palmiere argues the company will have the finances to navigate the turbulent markets, and will own a truly global portfolio of producing assets with a strong pipeline of development projects.

Another key issue is that Hud- Bay shareholders have no say in the decision. Since Lundin is being acquired, its shareholders have to approve the plan. As the purchaser, however, there is no such requirement for HudBay, even though the company will be more than doubling the number of shares it has outstanding.

That’s one of the reasons merchant bank Jaguar Financial (JFC-V), which owns roughly 1% of HudBay, is trying to intervene to stop the merger.

“Call it what you will — call it a merger, call it an acquisition — the reality is it’s a major transaction and to do it without shareholder approval is frankly mind-boggling,” said Jaguar CEO Vic Alboini in an interview.

Alboini thinks the Toronto Stock Exchange should mandate shareholder approval for large share issuances, calling the current situation “incredulous.”

Moreover, Jaguar does not believe it is legal for the merger to go ahead without the green light from shareholders. The bank argues that the 97-million-share private placement, which will leave HudBay as the largest Lundin shareholder at 19.9%, makes HudBay an insider of Lundin before the merger. In addition, two men sit on the boards of both Lundin and HudBay. The end result, according to Jaguar, is that the deal is a related-party transaction that does require approval from HudBay shareholders.

Jaguar contends the related-party nature of the deal is deeper, and darker, than that. First, Alboini points out that the merger would leave Lundin shareholders owning slightly more shares of HudBay than current HudBay shareholders. To that end, Jaguar says the deal should more properly be called a reverse takeover of HudBay by Lundin; it also means the transaction would result in a material change of control of HudBay, which should necessitate shareholder approval.

Second, Jaguar takes issue with the history of deal-making between key members of the two companies and the profits both have seen from those agreements. Alboini says the deal would be the third time Colin Benner, one of the men who sits on both the Lundin and HudBay boards, and HudBay’s Palmiere have acquired each other’s companies.

Benner was CEO of EuroZinc Mining until it merged with Lundin in 2006. He then took on the role of vice-chairman of Lundin, where he stayed until receiving $2.25 million for resigning in January. Benner then became CEO of Skye Resources, HudBay’s previous takeover target. After four months of work, Benner received $4 million for his termination when HudBay took over Skye, plus a transaction bonus close to $3 million.

Jaguar also takes issue with Hud- Bay’s use of GMP Securities to give a fairness opinion on the deal because GMP, having worked with Lundin and Hudbay, is “clearly conflicted.” And Jaguar points out that the deal gives management at Lundin and HudBay the chance to reset the prices on their options, which are dramatically out of the money at present.

“It appears the same parties that benefited from the Skye acquisition — Messrs. Palmiere, Benner, and GMP — also stand to benefit from the Lundin transaction, at the expense of HudBay shareholders,” Alboini concludes in a recent news release.

Jaguar is working on two possible solutions. First, the bank — along with other HudBay shareholders that collectively account for about 4% of HudBay’s shares — has begun a proxy battle. The group has requisitioned a shareholder meeting where it plans to try and replace the current HudBay board with eight “completely independent nominees,” one of whom would come from Jaguar. Second, it is preparing a takeover bid for the company. If it succeeds on either front, its first order of business would be to share out a significant portion of HudBay’s $900 million in cash through a dividend issuance.

If it succeeds with its takeover bid, Jaguar no longer plans on selling HudBay’s assets and dissolving the company, which was its initial stance. Alboini says after talking to shareholders, his group is considering maintaining the company as an operational unit, but would of course not go ahead with the Lundin deal. It is important to note, however, that the deal is a binding contract and it is unclear how, or if, Jaguar would be able to get out of the agreement without the prospect of being sued by Lundin.

“You’ve got to listen to your shareholders and that somehow was totally forgotten here,” Alboini says. “It’s incredulous that anybody would agree to this transaction when Lundin is out of money. To rush out and bail out any company and pay a premium — it is absolutely preposterous.”

In a recent conference call, Palmiere responded to Jaguar’s allegations and plans.

“First and foremost, the Jaguar proposal, however presented, is designed to strip the company of its cash. . . In this environment cash is king and in our business combination, the cash remains inside the company, providing a secure foundation from which we can grow as and when markets improve,” he said.

Palmiere also defended the men who sit on both boards: “Contrary to Jaguar’s implications, neither of the directors they named participated in or attended any meet-