Roxgold (ROXG.TO) – Merger Arbitrage – 6% Upside

Current Price: C$2.14

Offer Price: C$2.26

Upside: 6%

Expected Closing: early July 2021

Issuer bid circular

 

This is a somewhat risky arbitrage trade on the merger of small/mid cap precious metal miners.

Gold miner Roxgold is subject to an acquisition by gold/silver miner Fortuna Silver Mines for 0.283 FSM per each Roxgold share (US$690m in total). FSM is listed both on TSX/NYSE, however, borrow is available only on the US exchange – 3m shares at 1.4% annual fee. Conditions include approval from 2/3rds of ROXG votes cast and majority of FSM shareholders. ROXG directors (own 3.5%) and its largest shareholder Appian Natural Resources fund (owns 13.2%) have agreed to support the transaction. FSM directors own 1.6% of Fortuna. Meeting dates are set for the 28th of June and the transaction is expected to close in early July.

At current prices this situation offers an opportunity to capture a 5.6% spread in 1 month. The situation provides an attractive IRR opportunity (67% annualized upside), however, in case things go south, you could get burned on both sides of a hedged trade (potential downside could be 20%+).

The spread is most likely explained by the shareholder approval risk. The market looks especially skeptical regarding FSM shareholder approval, as evident by FSM share price deterioration vs. Gold and Silver mining indexes since the acquisition announcement. Discussions on the retail investor forums indicate that some investors are worried that FSM is overpaying for ROXG and the lack of any significant cost synergies for this merger. FSM assets are in the Americas, while ROXG in Africa.

I am not a mining expert, however, there are a few important positive aspects to consider here, which, in my opinion, indicate that this special situation is worth a trade:

• FSM is a credible buyer with a US$1.5bn market cap and 3 gold producing mines in the Americas. Fortuna has already done 1 similar all-stock acquisition in 2016 – GoldRock (Lindero mine) for US$129m. The risk of offer withdrawal is minimal.
• I don’t think FSM is overpaying here and the market is most likely underplaying the chance of the eventual shareholder approval. Roxgold shareholders are expected to own 36% of the combined company, while the acquisition is expected to be 34% accretive to FSM NAV. Although it may look like ROXG is getting a better deal here, from the cash flow perspective FSM is getting a bargain if, as expected, ROXG prospective ultra high grade gold mine Seguela launches production in 2023.  ROXG assets are expected to generate 48% of the pro-forma FCF and 46% of the pro-forma EBITDA in 2023. Seguela’s construction phase is going to start later on this year.
• FSM directors seem to agree that the market has overreacted with FSM sell-off. Based on SEDI.CA data, 5 senior insiders bought FSM right after the acquisition announcement (mostly on the 28th-29th of April), when its share price fell from C$9.34/share to around C$7.60/share. The total sum of the purchases stands at over C$750k. CEO and CFO alone bought 33k shares each at around C$7.35-$7.43/share (C$244k each).
• It’s likely that FSM is rushing to diversify its assets due to an increased risk to its Peru operations. The country is currently in the process of presidential elections with one of the top candidates vowing to stop foreign firms from “looting” the country’s mining resources. Peru operations generated 15% of the total operating profit in 2020.
• Time to expected closing is only 1 month, so it’s not like your money will get frozen for a long period of time.

 

FSM and ROXG

Fortuna Silver Mines operates:

• San Jose silver/gold mine in Mexico. The mine is expected to produce 40 koz of gold and 5.8-6.5 Moz of silver in 2021.
• Cayllome silver, zinc and lead mine in Peru. Expected to produce 1.0–1.1 Moz Ag of silver in 2021.
• Lindero gold mine in Argentina. Expected to produce 140-160 koz in 2021.

Roxgold:

• Yaramoko gold mine in Burkina Faso (Africa). The mine has 7-8 years of mine remaining with 710 koz of proven and probable reserves left.
• Seguela – advanced development project in Cote D’Ivore (Africa). ROXG has 90% interest in the project. The most recent feasibility study expects 9 years of mine life with 120k of annual production. Construction phase is going to start later on this year with production to begin in 2023.
• Also owns Boussoura gold exploration project in Burkina Faso.