Golden Valley Mines (GZZ.V) – Merger Arbitrage – 28% Upside

Current Price: C$10.85

Offer Price: C$13.88

Upside: 28%

Expected Closing: Q4 2021

Presentation and press release

 

Less than two weeks after we successfully closed the Ely Gold merger arbitrage case, Gold Royalty announced two more similar acquisitions - Abitibi Royalties and Golden Valley Mines. Both transactions are a "package deal" as Abitibi is a 2011 spin-off of Golden Valley and the parent still owns a 45% stake in Abitibi. Quick idea on Abitibi's takeover is posted here.

On the 6th of September, Gold Royalty announced a definitive acquisition of Golden Valley in an all-stock transaction coming in at 2.1417 GROY shares for each share of Golden Valley. GROY seems like a credible buyer with an accelerating acquisition spree to grow its royalties’ portfolio and is unlikely to withdraw the offer. Conditions include consent from 2/3rds of Abitibi shareholders and also approval from the majority of the target's minority shareholders. Management owns 29% and so far it's not clear if any of these shares will be excluded from the minority vote. More information will be detailed in the upcoming circular. Nonetheless, given the initial support and all-time high price, I expect that shareholder approval to pass easily. The meeting date is set for the 29th of October. The downside to the pre-announcement price is 34%. Borrow for hedging is available at 24% but is limited. Closing is estimated in Q4'21 (likely early November), so even with these borrow costs ample upside on the trade remains.

The remaining 44% stake in Abitibi is the most valuable asset of Golden Valley due to Abitibi's exposure to several Canadian Malartic Mine's (largest open-pit mine in Canada with an annual production of 700k oz and AISC of C$800-C$900/oz) royalties. The key royalty Odyssey is already in the construction phase and is expected to have at least 18 years of mine life. Overall, GROY should be highly incentivized to add these assets to its portfolio amidst the consolidating gold royalties industry. On top of that, Golden Valley also has smaller stakes in two junior miners Val-d’Or Mining (38%), International Prospect Ventures (11%), both of which were also spun-out from the company, and a few NSR's in early-stage projects.

Some more info on GROY and its targets can be found on Abitibi Royalties merger arbitrage write-up.

Gold royalties market is consolidating and as put by ELY.V CEO (previous GROY acquisition) it is getting substantially more difficult, even for larger players, to find quality assets. Hence, GROY is highly incentivized to get their hands on Abitibi's core assets - royalties in Canadian Malartic Mine, which it says "will become a significant cash flow generator for the combined company" (PR):

The acquisition of Golden Valley and Abitibi Royalties represents a very compelling extension of our strategy by adding royalties over the world class Canadian Malartic mine – a generational asset that will continue to deliver gold production for decades to come.

The Canadian Malartic Mine is a pure-play on gold with an annual production of ~700k oz and ASIC (all-in sustaining costs) well below the industry average ($800-$900/oz). The key royalty is a 3% NSR (net smelting return) over the Odyssey Underground project, which is already in the construction phase. The Odyssey mine is expected to become Canada’s largest underground mine with an 18-year mine life with the potential of beyond that. As confirmed in the recent update, the construction seems to be ahead of schedule and below budget.

A full list of royalties/projects/properties for sale can be viewed on the company’s website.

 

GROY

The company has started the acquisition spree after its IPO in March and aims to re-rate with the increased scale. Worth noting that unlike most micro-cap royalty players the company seems to have a heavyweight management team - GROY's CEO is the former CEO of Goldcorp ($10bn market cap) and Hudbay Minerals ($2bn market cap).

The combined company (including both Golden Valley and Abitibi Royalties) will have 191 royalties including in 6 cash flowing and 7 near-term cash flow and 14 development stage projects.

9 COMMENTS

  1. dt

    Very interested in hearing other opinions on why the spreads are so large on RZZ and GZZ deals, when ELY/GROY just closed successfully

    Is this just a matter of gold mining Canadian small-caps listed on Venture exchange and cross-border all-stock mergers with expensive borrow for hedging or are we missing something else here?

    (when I wrote this down, it looks like plenty of caveats already, however, ELY case was quite similar)

    1. snowball

      Looking at the smaller spread in the RZZ (18%) deal vs GZZ (28%) , I speculate that target shareholder approval risk and whether management shares will be excluded from the minority vote might explain the wide spreads in both deals.

      The spread for RZZ is smaller because the risks mentioned above are relatively smaller, with 65% of shareholders already supporting the deal.

      My view is that management shares will not be excluded in the minority vote. So I think the release of Circular can be an catalyst for spread narrowing.

      1. hta

        Actually I believe these risks are the same for the two deals because approval of both deals is a condition precedent for each of them.

        1
      2. Vinn

        The spread for GZZ is higher mostly because there is a lot more downside if the deal fail. GZZ traded at a large discount to RZZ before the merger announcement.

    2. hta

      Borrow cost on GROY exploded higher towards the end of the ELY deal. Got up to around 80 or 90% as I recall. I managed to make money, but after that experience I am not rushing into these deals. Of course these Canadian mining stocks don’t seem like the kind of thing I would like to be unhedged on.

  2. rc99ar

    GROY was up 20%+ on very heavy volume two days after the announcement and has stayed up. This had the effect of widening the spread further. GROY/GZZ has traded at a wider spread than GROY/RZZ announced at the same time. I have/had short $2.50 January calls on GROY that have been getting assigned to me. I can’t see what could be missing but the spread and stock behaviour does seem atypical.

  3. Zulu Investor

    The spread isnt as large as it appears IMO. The stock has gone up since the write up. It’s about a 7% spread for RZZ (after adjusting for borrowing costs, which is 6% if we assume this transaction closes in 3 months and its 15-17% for GZZ likewise after adjusting for costs and depending on when it closes.)

  4. hta

    The trade I like best here is long GZZ short RZZ in a ratio of 2.15 GZZ to each share of RZZ. Borrowing cost for RZZ is under 1% and I believe is less likely to blow out and destroy your economics than hedging with GROY. Ive been getting about a 7% spread. If the deal fails then of course there is farther to fall for GZZ based on the pre-deal prices.

    2
  5. Vinn

    I like this trade a lot as I think GZZ and RZZ both have very trustworthy management a very good sense of what their shareholders are going to vote.

    In general though, I’m doubting whether it makes a lot of sense to hedge these kind of mergers. Mainly because adding a short leg:
    1. Increases the margin requirement at least 2x, basiscally reducing your IRR by at least half.
    2. Adds borrowing costs of currently 20%-30% annually
    3. Creates a risk of higher borrowing cost near the closure of the deal
    4. Creates a risk of being closed out (forced) of your short if there aren’t enough shares available

    Are these disadvantages really worth it to reduce volatlity? Does it add alpha on average? I mean does the short leg on average create a profit? I think it’s an interesting discussion, would welcome any thoughts on it.

Leave a Reply