Cornerstone (CGP.V) – Merger Arbitrage – 27%-50% Upside

Current price: C$0.33

Expected merger consideration: C$0.42 - C$0.50

Upside: 27% - 50%

Expiration Date: Q3 2019

This idea was shared by Ilja.

 

This is an interesting potential merger situation between two junior miners that have joint interest in Ecuador copper-gold project Cascabel. Investment by large cap names BHP Billiton and Newcrest Mining at higher price levels adds quite a bit of confidence in the property itself as well as workout of this case.

Cornerstone Capital Resources (CGP.V) has received an indicative takeover offer from its bigger peer SolGold (SOLG.L and SOLG.TO) at 0.55 SOLG/share (235% premium to the last closing price). The offer has been rejected on the same day as apparently over 50% of the shareholders have expressed their dissatisfaction. Despite that, CGP has stated that they are open to continue talks with SolGold and any other potential buyers. In it's turn SOLG stated that they will proceed with their offer anyway.

There is a nice 8% spread to the rejected offer price and I am expecting that SOLG will eventually have to increase share exchange ratio in order to receive support from Cornerstone shareholders.

For both companies the main asset is their ownership of Cascabel (15% for CGP and 85% for SOLG) - a high potential copper-gold project in Ecuador. There is also cross-shareholding between the companies, which results in Cornerstone's 23% direct+indirect ownership in Cascabel. The remaining assets are mostly exploration licenses and their value for the purpose of analyzing this merger situation is negligible.

Since 2016 Cascabel drew the attention of the mining industry giants - Newcrest Mining (A$19bn market cap) and BHP Billiton ($187bn market cap), which currently are the largest shareholders of SOLG (15.3% and 11.2% respectively) and which have increased their stakes recently in Q4 2018. Therefore I am assuming they would be interested in CGP's Cascabel stake as well. However, currently both large cap miners are restricted until Oct 2019 and Oct 2020 by the standstill agreements. Thus SOLG seems to be under a time pressure here to buy out CGP before other players are allowed to step in.

Three largest CGP shareholders (together own 37%) have acquired main portions of their holdings in 2017 by exchanging their SOLG shares into CGP at 0.65 ratio. This should serve as a lower limit for any successful merger negotiations between the companies. The upper limit is likely around 0.77 SOLG (40% premium to the rejected offer), which is the amount that wouldn’t dilute CGP’s current stake in Cascabel adjusted for upcoming exploration debt repayments (explained below).

If the deal fails, downside to unaffected price is considerable (60% ), however CGP has hinted a few times already that are interested buyers are present.

 

Cascabel Project

In the last 40 years Cascabel had 8 owners in total, which at most made some samplings, but did not proceed further with the project. In 2011 the project was initially purchased by Cornerstone and then in 2012 SOLG has entered into the scene by acquiring 20% and then exercising the option to increase the stake to 85% in 2014. Cascabel project is currently still in early stages and should have completed the pre-feasibility assessment by the end of 2018. The most recent exploration campaign resulted in 2x larger estimation of the total resources than the previous one - 10.9Mt Cu and 23.2 Moz Au.

According to the agreement between CPG and SOLG until the completion of the feasibility studies, the financing would come 100% from SOLG (so far has spent $117m and is expected to spend another $80m). CGP will have to repay their 15% part after the commercial production starts by giving 90% (out of their current 15%) of the cash flow to SOLG. Also, after feasibility studies further development of the property will have to be done by both companies proportionally to their holdings in Cascabel and in case either party fails, their ownership will be diluted accordingly. If CGP stake gets diluted below 10%, it will be reduced to 0.5% NSR royalty, which SOLG will be able to acquire for $3.5m.

Another thing, is that Ecuador is increasingly becoming an attractive spot for mining companies due to the recent regulatory reforms. This definitely adds to the attractiveness of the project.

 

BHP Billiton and Newcrest Mining

Apparently, both Newcrest and BHP have been going over each others head since 2016 in order to acquire larger stake of Cascabel (BHP has even offered to acquire 70% of SOLG’s interest in Cascabel for US$275m, but got rejected). At the end of last year both firms have increased their stakes in SOLG at a premium to market price - BHP has increased their stake by 5% at £0.45/share (28% premium at the time), while Newcrest by 1.5% at £0.40/share (8% premium at the time). Both of these investments also were done at a higher price levels than the current £0.375 SOLG share price.

Despite that, the limiting factor is that both of the companies are currently unable to make any moves on CGP. Newcrest is bound by the subscription agreement, which until the 17th of October 2019 won’t allow them to buy any shares of CGP. At the same time BHP is restricted by the standstill agreement, which doesn’t let them buy any shares of CGP without SOLG’s consent till the 16th of October, 2020.

Given the apparent potential of Cascabel, I think motive behind SOLG's offer is clear -  to acquire as cheaply as possible the remaining 15%, while other interested parties haven’t started to move yet. Thus SolGold is likely under a time pressure as Newcrest will offer to acquire CPG as soon as their standstill expires.

Moreover, the possibility of other potential buyers have been mentioned by CGP a few times already and SOLG has also stated that they are aware that:

There may be a number of other companies interested in Cascabel, such as BHP Billiton and Newcrest Mining, both of whom have acquired substantial shareholdings in SolGold.

 

Previous Merger Attempts

Apparently this is not the first time SOLG has tried to talk with CGP about a possible merger. Although I’ve not been able to find any original announcements, in the most recent indicative offer SOLG states that they have already tried in 2017 and 2018, but nothing moved forward because CGP’s conditions of “(i) 50% of the seats on the board of directors of the combined entity were allocated to Cornerstone, (ii) the Chief Executive Officer of SolGold was replaced, and (iii) the Chairman of the board of directors of SolGold was replaced.” were seen as unrealistic given the difference in size of the companies and their stakes in Cascabel. The current offer and the responses from CGP, however, did not mention any of the conditions above, so I think this time the outcome might be different.

 

Merger Discussions

Both companies have provided numerous arguments for and against the offer, yet I don’t think any of them stand on strong ground. Overall, the discussion doesn’t seem friendly - both parties are accusing each other of making misleading or false statements and on some points arguments simply seem silly. For example, SOLG has stated that they are paying 20% premium to Cornerstone’s 2 year high price, however apparently it is false as CGP was trading at C$0.55 (60% premium to the current offer) on the 17th of July 2017.

Nevertheless, the main argument why the offer was rejected is that with the current holdings of 15% in the Cascabel + 9% stake in SOLG, Cornerstone owns 23% in the property, while in the combined company (at 0.55 share exchange ratio) they would have only 18% stake. So in order for CGP to keep their 23% stake, share swap ratio should be 0.85. Adjusting this figure for Cornerstone's 15% part that will have to be repaid for the feasibility stage investments results in 0.77 ratio, which is 40% premium to the rejected offer.

In the calculation above I have ignored other SOLG and CGP assets, which are mostly exploration licenses on the properties that have not been touched yet (at most only some initial samples have been collected) and which shouldn’t have a significant impact on the valuations of both companies. Merger discussions between the two companies also did not seem to refer strongly to any other properties besides Cascabel.

 

Cornerstone Shareholders

Cornerstone is an exploration company without any operations - SOLG described CGP’s management as passive. Since the time of its earliest filings (in 2009) the company hasn’t done much and its current value now is holding on just that 15% stake in Cascabel.

Cornerstone is largely held by the privately owned hedge fund sponsor Rosseau Asset Management (14%), CEO of Maxit Capital - Mr. Dmyant Bob Sangha (13%) and the company’s chairman Greg Chamandy (10%), who is also a co-founder and ex-CEO of Gildan Activewear (C$9bn). Apparently, all three of them have acquired the majority of their holdings by exchanging (here and here) part of their SOLG shares into CGP at 0.65 ratio. I haven’t been able to find any explanation on why did they swap the shares, except that it was done just before CGP wanted to spin off all of its other assets except for ownership in Cascabel (eventually the spin-off was cancelled). Likely these shareholders were expecting price convergence between SOLG and Cornerstone - which would mean 0.85 exchange ratio before adjustment for Cascabel exploration expense repayments.

18 COMMENTS

  1. work 22

    Note the threat from SOLG in the announcement press release, concerning CGP’s ability to raise financing to avoid dilution down to dangerous levels as Cascabel begins construction. Do the shareholders of CGP have the will and money to write more checks to avoid that dilution and hold out?
    “If Cornerstone elects to maintain its 15% ownership, SolGold believes that financing the required cash calls will present significant difficulties to Cornerstone. As noted above, Cornerstone’s interest in the Cascabel Project does not carry any operational rights whatsoever that could form the basis of a strong value proposition to potential future Cornerstone investors. Additionally, its economic exposure to the Cascabel Project will be burdened by the debt-carry repayment requirements described above. Issuers with minority interests in major mineral projects, such as Cornerstone’s in Cascabel, typically already trade at a discount to the implied asset value, but this would be compounded by the likely need to conduct an equity financing at a valuation that is significantly dilutive to existing Cornerstone shareholders. SolGold does not expect Cornerstone to be able to finance its cash call requirements through other traditional funding structures either, since Cornerstone is not permitted to sell or even to encumber its interest in Cascabel, either directly or through a pledge of its shares of ENSA. This makes debt financing, a royalty, metal stream or other similar structure a significant challenge for Cornerstone under current arrangements.

    As a result of such challenges, in SolGold’s view, there is a high likelihood that Cornerstone’s 15% interest would be significantly diluted during the construction phase. In the event Cornerstone’s ownership of ENSA is diluted below 10%, in accordance with the arrangements in place at the ENSA level referred to above, SolGold has the right to convert all of Cornerstone’s remaining ENSA shares into a 0.5% net smelter return royalty, which SolGold may then acquire for US$3.5 million. In SolGold’s view, Cornerstone shareholders should not be comfortable with any risk that this outcome may materialize”.

  2. dt

    I saw this as well and would not consider it to be a credible threat – CGP can simply sell itself to finance any further development expenses. With both Newcrest and BHP seemingly interested in Cascabel, CGP should be able to get a fair price in a competitive sale process.

    The quote above does not seem to rule out such possibility, or am I reading this incorrectly?

  3. fishwithwings

    “SolGold approached Cornerstone in 2017 and 2018 in an effort to commence the negotiation of a business combination transaction between the two corporations. Despite SolGold’s good faith attempt, Cornerstone’s management indicated that they would not engage in any negotiations towards a business combination unless (i) 50% of the seats on the board of directors of the combined entity were allocated to Cornerstone, (ii) the Chief Executive Officer of SolGold was replaced, and (iii) the Chairman of the board of directors of SolGold was replaced. The board of directors of SolGold view each of these demands as being highly unrealistic based on the relative size of the two companies and their respective ownership interests in Cascabel by the two entities.”

    Hilarious response from CGP esp. given it’s a 200m market cap company v. SOLG’s 700m market cap. Pretty much a GTFO.

  4. dt

    Any thoughts on what is causing CGP volatility (yesterday’s range $0.3-$0.4)?
    Did not managed to find any news.

    1. work 22

      Not sure. I saw rumors of the PEA coming out for SOLG. Also probably rumors of an increase in the bid from SOLG? i sold what i had yesterday on the pop

  5. over2u

    Share price lose nearly 30% for the last week. As I understand the sell off was related to the news that on 5th of June there will be a public hearings on mining in the province in which Cascabel project is located. SolGold issued a press-release where it has full support from Ecuador government. So may be an interesting though risky trade ahead of hearings on 5th of June.

  6. Ilja

    Recently there has been a lot of selling pressure for both Cascabel companies as “On May 27th, certain individuals from small communities up around the Cascabel project and other projects in NW Ecuador petitioned the Ecuadorian Constitutional Court in Quito to rule on whether they may legally hold a referendum to ask the question: “Are you in favour of mining in your communities?””. The hearing is scheduled on the 5th of June.

    The market has appearently viewed this as a threat to the project and in my opinion strongly overreacted. Both companies have issued letters explaining why the project is safe:

    CGP – https://www.globenewswire.com/news-release/2019/05/30/1859542/0/en/Cornerstone-Comments-on-Share-Price-Activity.html

    SOLG – https://finance.yahoo.com/news/solgold-plc-announces-response-share-104000307.html

  7. Ilja

    The hearing took place on the 5th of June and CGP states that: “CGP states that “the overwhelming majority of the presentations were against the proposed referendum.”.”

    The court is going to announce a decision on the 24th of June, but it really seems it won’t be in favor of the referendum.

    “In other news, Cornerstone notes that the Government announced a new Mining Policy for Ecuador earlier this week intended
    to strengthen investment in the mining sector as well as setting out a framework for environmental and social sustainability.”

    https://sedar.com/GetFile.do?lang=EN&docClass=8&issuerNo=00013027&issuerType=03&projectNo=02928623&docId=4540878

  8. Zulu Investment Partnership

    Sorry for asking a similar question but aside from tender offers, would the OTC stocks of these foreign companies (CTNXF in this case) work as well?

  9. Zulu Investment Partnership

    Hi any new updates on Cornerstone? Wondering what is causing for today to be down 6 percent?

  10. ijw

    Why exactly did they refuse?

    “Given that the Canadian takeover rules require the majority of the outstanding shares (excluding shares held by SolGold) be tendered to a formal offer before any shares can be taken up, SolGold’s proposed offer, if formalized, is incapable of being completed.”

    Why is it incapable of being completed? So SolGold should have offered to buy cgp’s solgold shares first? Is this true?

    1. Ilja

      59% of shareholders have initially refused to support the transaction. So there was no way it was going go reach the required acceptance threshold.

      “Shareholders that collectively own or exercise control of approximately 59% of the outstanding common shares of the Company have advised Cornerstone that they will not support the terms announced by SolGold.”

      1. ijw

        It looks like a reasonable price, why wouldn’t they accept it? They would still own the project afterwards, but without the overhang of having a minority stake. Still get upside from BHP buying this out at a premium etc etc.

        Were those shareholders just throwing an irrational temper tantrum? Or am I missing something here.

  11. Ilja

    Activity on the mine has been suspended due to COVID-19. This idea is already taking much longer than originally expected. With the current market situation it seems that any kind of move from buyers is very unlikely in the short term, while the prospects of an offer being made in the longer term is also not clear. All in all, this might be the time to close down this idea.

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