Kennady Diamonds (KDI.CVE) – Merger Arbitrage – 7% upside

Current Price – C$3.00

Merger Consideration - C$3.22 (in stock)

Upside – 7.2%

Expiration Date – April 9, 2018

Merger Announcement

This idea was shared by Michael.

 

Kennady Diamonds (TSXV:KDI)(OTC:KDIAF) is a junior diamond explorer that has had some fairly material exploration success. The outcome of that success has been interest from bigger players. They have agreed to a takeover offer from Mountain Province Diamonds (TSX:MPVD), which owns an interest in a producing diamond mine, also in Canada. The deal is likely win-win, as Kennady would have a hard time raising money to build mines at their two significant diamond discoveries, while Mountain Province’s existing mine will eventually run out and MPVD doesn’t have any other significant assets. MPVD can raise the money to build the mines (including by using its significant cash flow). See here for more detailed outline of the benefits.

The offer is 0.975 MPVD for every KDI share. With MPVD at C$3.30 and KDI at C$3.00 that is a 7.2% spread. MPVD is shortable in both Canada and the US, although the cost of the short is relatively high (approximately 10% per year at Interactive Brokers). There could be a case for an unhedged long here, as MPVD is ramping up their mine and has been producing significant cash flow. Based on their reported mining results, their next few quarters should be quite good.

Friendly junior mining deals almost always close quickly, because there are relatively few regulatory barriers to contend with. In this case, the companies have the same major shareholder, as Dermot Desmond has a 24% stake in MPVD and a 28% stake in KDI. That alone makes it very likely the deal will gain shareholder approval, although I think the strategic rationale is sound as well. The votes of both companies are scheduled for April 9th , and I would expect the deal to close directly following. If the deal closes in a month or less, that is a net spread of over 6% on a relatively low risk short time frame deal that can be fully hedged, which I believe to be attractive. For some further colour on the deal see here.

11 COMMENTS

  1. dt

    Thanks for idea.

    You mention: “The outcome of that success has been interest from bigger players” – did you mean to say there were other parties besides MPVD interested in acquisition of KDI? Also what do you consider the downside risk here?

    It is worth noting that merger discussions have already been suspended before due to unfavorable market conditions (from the circular):
    “Throughout April and May 2017, discussions continued and the Kennady Special Committee met frequently to receive updates from management until the end of May 2017, when Kennady and Mountain Province determined that, because of market and industry conditions, it was impractical to continue discussions regarding a transaction. Discussions regarding a possible transaction were halted. ”

    However, on a positive side, MPVD already agreed to invest C$10m in KDI (in exchange for 4m KDI shares) irrespective of the outcome of the merger.

    1. Michaelx

      I had heard there was other interest as a piece of scuttlebutt, but realistically with the blocking stake held by Dermot Desmond I don’t think a higher bid is likely. I do wonder if feelers around a third party KDI were the catalyst for this.

      I don’t think the fact the two boards couldn’t agree on a ratio last year matters much given they have already agreed this year. I wonder if previously the KDI board was insisting on at least some cash, which would have made market conditions more relevant. Given this is all shares/no financing, and no new shares will be sold, I don’t think the market conditions matter that much.

  2. work 22

    FYI Dermot Desmond cannot vote his stake due to minority protection rules in Canada; but still probably likely vote goes through. Also Mountain Province shareholders must vote yes on the deal as well, not just Kennady. No borrow available when i checked from my broker last

  3. Michaelx

    Good point about the vote. I do still think it’s likely it goes through, because the strategic rationale is pretty strong, with KDI’s land being directly adjacent to the Mountain Province mine. These companies actually were formerly a single entity, and KDI was spun off prior to them building the mine, presumably because they didn’t think they’d get much value for the exploration properties when they were raising capital for the mine.

    I checked at Interactive Brokers prior to sending this in, and there was borrow there in both Canada and the US from multiple sources. I filled the short on the TSX because it had a lower cost of borrow, and bought my KDI position there as well. KDI is more liquid in Canada, although it does trade OTC and have a bit of volume there.

  4. over2u

    Thanks for the write-up. I have also been following this situation. My view that even Desmond can’t vote himself a lot of friends of him have been also invested in MPVD (at least that what I’ve heard). The same guys are in KDI, so my estimation of the merger going through is pretty high.
    Also, some time ago spread was even higher (c.10%), so given relatively low liquidity of KDI spread may again widen a bit. So it is worth monitor it closely.

    1. Michael Bumstead

      Definitely agree that it is worth watching the spread. My initial position here is actually on at a 11% spread, but as mentioned it has come in some. One potential factor that might push the spread out is if some brokers have run out of Mountain Province shares to lend out, as mentioned in a previous comment.

  5. Michaelx

    Any source on Desmond’s friends having a stake or is that more of a scuttlebutt thing? The votes are the biggest potential impediment here, and I would size it bigger with more information on the certainty of closing. The spread was higher in the past, but as the time to close has declined the spread has declined as well, which I think makes sense.

    1. over2u

      No hard evidence unfortunately. Only based on elevator talks with bankers. I just recalled the situation when potential take out of MPVD was considered and it was rumored that though Desmond doesn’t have a 50%+ majority in shareholder register, but with his friends he actually has.
      Anyway, the BoD is chaired by the same person, Jonathan Comerford, who works for the Desmond International Investment and Underwriting vehicle in Dublin. I guess, indirectly you can come up to the conclusion that both companies under total control of Desmond.

  6. over2u

    Toronto and New York, March 16, 2018 – Mountain Province Diamonds Inc. (“Mountain Province”, the “Company”) (TSX and NASDAQ: MPVD) today announces it has signed a non-binding memorandum of understanding (“MoU”) with its partner in the Gahcho Kué mine, De Beers Canada Inc. (“De Beers”).

    The MoU contemplates incorporating properties owned by Kennady Diamonds Inc. (“Kennady Diamonds”) into the Gahcho Kué joint venture, in the event that Mountain Province’s proposed acquisition of Kennady Diamonds is approved. Mountain Province and De Beers will now work towards a definitive agreement based on the MoU.

  7. over2u

    Mountain Province and Kennady Shareholders Overwhelmingly Approve Business Combination

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