UPDATE:Hecla goes hostile on U.S. Silver

In yet another sign that M&A continues to pick up steam Hecla Mining (HL-N) is seeking to derail a merger agreement reached last month between U.S. Silver (USA-T) and RX Gold & Silver (RXEXF-O), and scoop up U.S. Silver for itself in an all-cash hostile takeover offer.

Hecla’s $1.80 per share offer represents a 23% premium to U.S. Silver’s closing share price of $1.46 on July 24, and a premium of 30% over the company’s 20-day volume weighted average. It is also a 28% premium to the $1.41 per share imputed offer price under U.S. Silver’s proposed merger terms with RX Gold.

U.S. Silver’s board had agreed to the combination with RX Gold and Hecla’s hostile move comes less than two weeks before shareholders were expected to vote on the merger.

U.S. Silver operates the Galena mine in Idaho, which has a reserve base of 23 million oz. silver, 91.2 million lb. lead and 11.7 million lb. copper. The junior also owns the past-producing Coeur mine, which is expected to move into commercial production at the end of next year.

From a geographic point of view there is little doubt that Hecla would enjoy more synergies than RX would with U.S. Silver, and RX pegged the value of its operational synergies at $10 million per year.

That is because Hecla’s Lucky Friday mine is just 10-km east of Galena while RX Gold’s flagship project, the Drumlummon Mine, is roughly 400-km east of the mine. Galena itself sits roughly 77 km east of Coeur d’Alene.

But Hecla’s chief executive, Phil Baker, says despite such favourable geographics the acquisition offer is less about synergies and more about the exploration package that Hecla would be acquiring in Idaho’s’ Silver Valley.

“It’s a large land package,” Baker says of U.S. Silver’s exploration assets. “We think there is a chance of finding more than what is there today and that’s the sort of risk we want to take on. We’ve been there forever and we have the best chance of finding it. No-one knows how to mine that rock better than we do.”

Hecla traces its history in the Silver Valley all the way back to 1891.

While neither U.S. Silver nor RX Gold responded to The Northern Miner’s request for comment, in a release U.S. Silver emphasized that Hecla would indeed be enjoying significant synergies from the transaction and that its offer doesn’t sufficiently distribute those synergies to U.S. Silver shareholders.

“The board of directors believes that significant synergies and strategic benefits would accrue to Hecla upon the acquisition of U.S. Silver because of the proximity of the companies’ respective assets and (U.S. Silver’s) large and dominant land position in the Silver Valley,” U.S. silver wrote in a statement.

It went on to list what it believes are the key synergies of a Hecla acquisition, which included: better mill sequencing, economies of scale and greater access to labour.

Baker, however, counters that U.S. Silver is already running an efficient mine thus limiting its ability to capture such synergies.

“They’re already doing a great job at Galena,” Baker says, “and there’s not much opportunity to improve it.”

That picture is contradictory to the one painted by RX’s chief executive Darren Blasutti. Blasutti has gone on the record as saying that U.S. Silver has operational issues and would benefit from having a stronger management team run its assets.

Indeed one of the key components to RX’s case for a merger is that U.S. Silver would gain a stronger management team that would know how to unlock the company’s potential.

Blasutti spent 13 years at Barrick running their mergers and acquisition team. Indeed RX’s management is made up of former Barrick and Kinross managers that seized control of RX through a proxy fight last summer.

For Baker, the very fact that RX would take over the running of the company while not paying a premium and only holding 30% of the newly merged company, should be a bone of contention for U.S. Silver shareholders.

The RX merger calls for RX’s current management team to occupy four out of five management positions, while the board would be made up of five members chosen by RX and four members chosen by U.S. Silver.

That loss of control doesn’t seem to bother U.S. Silver’s management as it has stood steadfastly in favour of the RX proposal arguing that the Hecla offer actually lacks a premium itself when U.S. Silver’s working capital is taken into account.

U.S. Silver says it currently has $29 million in working capital (which is typically made up of a company’s cash and inventory). Often times when calculating the enterprise value of a target company its cash position is not included in the calculation. In the case of U.S. Silver its last financial statement, for the period ending March 31, showed cash of $26.8 million.

Using U.S. Silver’s own numbers, it says if the $29 million is deducted then Hecla’s offer would actually only be $1.39 per share, which was roughly the company’s share price before Hecla offer was made.

Baker counters that U.S. Silver is making a false argument.

“$30 million is barely an adequate amount of working capital to run a mine,” he says. “So that statement is not based on the realities of running a mine.”

He pegs Hecla’s own working capital for its mines at closer to $100 million.

He says that Hecla’s offer is superior to RX because only it would adequately bolster working capital to appropriate levels.

As for what the acquisition would mean, if successful, to Hecla’s bottom line, BMO Nesbitt Burns’ Andrew Kaip outlined some of the metrics in a recent research note.

“U.S. Silver 2012 production guidance for the Galena mine of 2.4 million oz. would provide a significant increase in Hecla’s production pro forma,” Kaip wrote. “Hecla looks to be making a tuck-in acquisition that provides the company long-term regional synergies and a dominant land position within the Coeur Silver District in Idaho at an acquisition cost well within the company’s capabilities.”

At the end of the first quarter Hecla had cash of US$279 million and no bank debt.

In terms of valuation, Kaip says Hecla is trading at 0.9 time the 10% nominal net present value (NPV) of US$5.23 per share, at spot metal prices versus the intermediate silver peer average of 1 time.

“While BMO research has yet to incorporate the U.S. Silver assets into the Hecla valuation,” he adds, “the offer for U.S. Silver is expected to be neutral to NPV and slightly accretive to earnings per share.”

A vote on the RX and U.S. Silver merger took place on August 2, the results have not been released.

Sprott Asset Management had signed a lock-up agreement supporting the U.S. Silver and RX merger Sprott is the largest shareholder of both companies, and as of June 7 held about 14% of U.S. Silver shares and 8% of RX shares.