Nickel frenzy continues with Sherritt takeover of Dynatec

As nickel prices surge to new levels, Sherritt International (S-T, SHERF-O) has agreed to buy Dynatec (DY-T, DYTCF-O), 40% owner of the massive Ambatovy nickel project in Madagascar, for $1.6 billion.

Over the long term, annual production from both companies’ operating mines is expected to average 109,000 tonnes of nickel and 10,600 tonnes of cobalt. Sherritt’s share will be 49,000 tonnes of nickel — more than three times what it produces now — and 4,740 tonnes of cobalt.

Nickel prices have recently risen to more than US$22 per lb. from less than US$10 per lb. a year ago, giving Sherritt a positive outlook for the future.

“Our view is that nickel prices will be significantly in excess of six dollars (US) per pound in the long run,” said Sherritt president and CEO Jowdat Waheed during a conference call. “We make our decisions based on the long run and when you flow through the cycle ups and downs, it is our view that this will benefit our shareholders significantly.”

Under the deal, Dynatec shareholders will receive 0.19 of a Sherritt share and about 0.0635 of an FNX Mining (FNX-T, FNXMF-O) share.

Dynatec has a 24.5% interest in FNX to explore five mineral properties near Sudbury, Ont. — the McCreedy West, Levack, Podolsky, Victoria and Kirkwood properties. Dynatec also has a coalbed-methane project covering about 170 sq. km in West Virginia.

In a separate but related agreement, FNX has the right to buy Dynatec’s Mining Services division from Sherritt for a cash price to be based on an independent assessment. Dynatec and FNX already had a deal in place for the Mining Services division to do mine development, construction and production work at the Sudbury properties until the end of this year.

Sherritt shares closed at $17.15 and FNX closed at $25.46 per share on April 19, valuing Dynatec at $4.88 per share — a 29% premium over Dynatec’s closing price that day.

“This transaction provides an immediate and attractive premium to Dynatec’s shareholders,” said Dynatec president and CEO Bruce Walter in a statement.

But after the takeover announcement, Dynatec shares increased 63 — almost 17% — on the TSX to $4.41 on a trading volume of 120.8 million shares and FNX shares rose $1.20 to $26.66 on nearly 6 million shares traded.

Meanwhile, Sherritt shares dropped $2.12, or 12%, to $15.03 on trading volume of almost 15 million.

Analyst Jay Turner of Nesbitt Burns BMO Capital Markets, who covers both Sherritt and Dynatec, says that there will be more volatility in the market until the deal is completed.

Turner says the deal created “natural arbitrage” in Dynatec and Sherritt, with Sherritt being the down stock and Dynatec being the up stock.

“It’s a temporary situation that will not last longer than the completion of the deal,” Turner says. “The reality is, fundamental events that affect FNX’s value will have some play in the arbitrage action, using Dynatec and Sherritt as surrogate.”

Turner says the takeover is good for Dynatec shareholders because although Dynatec had its mining services and metallurgical technologies divisions, and the coalbed methane project, it was really a one-asset company — a risky position.

“The single asset that Dynatec was embarking on isn’t going to generate revenue until 2010,” Turner says.

Adding Ambatovy to Sherritt’s portfolio makes it a less risky project because of its experience in dealing with nickel laterite in Cuba, Turner says, but notes that the project still involves risk because of its location.

“The Malagasy economy has never had anything this big put in there, so the risk is that you end up with a situation like the Goro project in New Caledonia,” says Turner, adding that New Caledonia and Madagascar have entirely different economies. “I just know that when large projects get put into Third World or emerging economies, it has a disproportionate effect.”

Companhia Vale do Rio Doce’s (RIO-N) Goro nickel-laterite project, of similar size to Ambatovy, has been a long-delayed and locally contentious project. Protestors caused $10 million in damage at Goro last year.

“But at the end of the day, the takeover diversifies Sherritt away from Cuba and should lower their overall cost of nickel production,” Turner says.

Ambatovy, which has a mine life of 27 years, is projected to produce 60,000 tonnes of nickel per year when it comes on-line in about three years. Construction is expected to begin in mid-2007. A year ago, Dynatec estimated the project would cost US$2.5 billion to build, but Waheed says the project could run over US$3 billion, once the new estimates are done.

“That’s higher than some people would’ve expected but I think the market was ready for something with a three-handle on it,” says Turner, who has already incorporated the higher number in his analysis of Sherritt.

Sherritt has 25 years worth of reserves at its existing metals operations. The company has a 50% joint venture in Cuba with the Cuban government for mining operations and associated processing facilities as well as refining facilities in Fort Saskatchewan, Alta. Sherritt is also involved in the production of oil, electricity, and the development of coal as an energy resource.

The remaining 60% of Ambatovy is owned by Sumitomo Corp. (ssumy-o) (27.5%) and Korea Resources Corp. (27.5%); SNC-Lavalin Group (snc-t, sncaf-o) has agreed to acquire a 5% interest in the project with the closing of project debt financing.