BY MATT GEIGER | SEEKING ALPHA
Nevsun (NYSEMKT:NSU) has been a standout performer in what has been a disappointing year for the mining industry. This was long overdue for a company that has lagged its base metal peers for much of the past three years.
So far in 2018, the company has announced three major developments at its flagship Timok Project in Serbia. Positive geopolitical developments in Eritrea bode well for the company’s cash flowing Bisha Mine. And most significantly, Nevsun is now subject to a takeover battle that will likely culminate in a sale by year-end.
Starting at Timok, the company has had a productive year despite whirling takeover rumors. In late March, Nevsun released the Prefeasibility Study (“PFS”) for the company’s 100%-owned Timok Upper Zone. While the results were sensational, they were not surprising given that NSU had released an updated Preliminary Economic Assessment (“PEA”) outlining similar economics just five months before. The headline numbers improved somewhat in the PFS though it should be noted that a 5% higher copper price was assumed and the start of production slipped from 2021 to 2022.
Nevsun followed the PFS by announcing in early June that the company had broken ground on the Timok Upper Zone exploration decline. The ribbon-cutting ceremony was attended by none other than Ms. Ana Brnabić, the Prime Minister of Serbia. This development milestone is important confirmation to Nevsun shareholders (and potential buyers) that first production in 2022 is both attainable and on track.
Finally, in late June Nevsun announced an initial inferred resource at Timok’s Lower Zone. As stated by Nevsun’s CEO Peter Kukielski: “The Timok Lower Zone ranks high among world porphyry deposits by tonnage and by grade. With 1.1 billion tonnes grading 1.11% copper equivalent, the Timok Lower Zone benchmarks well against planned and operating block cave mines.”
Remember that the Lower Zone is significantly larger than the 100%-owned Upper Zone, though deeper and lower grade. It will reach production, though likely not in the next decade. The Lower Zone will ultimately be owned 54% by Freeport-McMoRan, itself a US$22b major miner, and 46% by Nevsun.
Through the second half of 2018, the company will continue to advance the Feasibility Study for the Timok Upper Zone expected in Q2 2019. Land acquisition and permitting activities will continue to advance in parallel with a significant majority of the private land required for the Timok Project expected to be purchased by year end.
Additionally, an updated PFS is expected in Q3 2018 outlining the economics of a “ramp-up scenario” (1.6m tpa initial production ramping up to 3.25m tpa over the mine’s first two years). It will be interesting to compare the results to the March 2018 Prefeasibility Study.
Let’s switch the focus to Bisha, which is Nevsun’s Eritrea-based polymetallic asset currently producing zinc and copper. Operationally it was a mixed first half of the year. In late April, the company announced Q1 results which far exceeded anything we’ve seen since Bisha transitioned to zinc production in mid-2016. Recoveries of zinc improved by 8.5% to 81.1% and recoveries of copper jumped by 34.1% to 61.5%. For a mine that has been metallurgically challenged for the past couple of years, this was reassuring as was the US$23.4m in operating cash flow.
In late July, the company announced that Bisha’s performance had regressed in Q2. This time metallurgy wasn’t the issue with copper recoveries jumping to 69.4% and zinc recoveries dropping only slightly to 77.6%. The culprits were a lower throughput, a lower zinc grade, and “reduced operating time for maintenance activities”.
Operating cash flow dropped to US$2.3m. Results should improve markedly in Q3 as the company “expects to revert to processing higher grade material through the balance of 2018” according to CEO Peter Kukielski. There is no denying however that Bisha’s Q2 was a disappointment.
That said, this operational inconsistency at Bisha was far overshadowed by the positive geopolitical developments we’ve seen in Eritrea over the past 60 days.
First, it was announced on July 9th that Eritrea and its larger neighbor Ethiopia had declared an end to their two-decade war which claimed more than 80,000 lives. This was followed nine days later by reports that the first commercial flight had been completed between the two countries since the mid-1990’s. Then came news that the two countries would be playing a soccer friendly against each other sometime in August. Most significantly, Ethiopia is now lobbying on Eritrea’s behalf for the UN to drop sanctions which have been in place against Eritrea since December 2009.
For someone who has been closely following Eritrea’s fortunes for nearly a decade, these are entirely unexpected changes that were unimaginable just earlier this year. This will positively impact Nevsun in the following ways:
1) The market perception of Bisha’s value (both cash flow and exploration upside) is set to increase significantly once UN sanctions are lifted against the country.
2) This development makes it more likely that a larger miner will buy out Nevsun, Bisha and all. It is no coincidence that Lundin Mining is now willing to acquire all of Nevsun, while just in the spring they were hesitant to take Bisha onto their books even temporarily.
3) Nevsun management can now have more confidence in investing in regional exploration as well as advancing the satellite deposit Harena to production within the next 4-5 years.
Spurred on by the developments in Eritrea, the takeover battle for Nevsun is just beginning with Lundin Mining at the front of the line. Lundin has made at least five separate attempts to acquire Timok over the years, starting with the 2016 takeover battle ultimately won by Nevsun.
After floating the idea of an ill-structured takeover of NSU involving Euro Sun Mining in the spring of this year, Lundin has gotten serious and on July 26th formally launched a hostile C$4.75 all-cash bid for Nevsun. The offer, open until Nov. 9, requires support from more than 50 percent of Nevsun shares and regulatory approvals.
Nevsun’s Board of Directors have unanimously rejected this offer as it substantially undervalues the company. Curiously, it is at discount to the C$5 takeover offer informally proposed by Lundin/Euro Sun in the spring.
There is however always a price. My view is that Nevsun should only sell this year if they can get 1.0x NAV, or ~C$6.75 per share. This is the NAV multiple paid by South 32 in their high-profile acquisition of Arizona Mining’s world-class Hermosa Project that closed just last week. If anything, Nevsun should get a higher NAV multiple given that South 32 already had a 17% strategic foothold in Arizona Mining when the deal was announced in mid-June. (Having a pre-existing strategic position generally results in a more favorable deal for the acquirer as the bidding process is less competitive.) Lundin has no current ownership of Nevsun.
If no bidder is willing to get close to C$6.75 (a 42% premium to Lundin’s most recent offer), then I’m in favor of NSU keeping the asset to themselves even if that requires bringing on a 19.9% strategic partner. Nevsun management has indicated to shareholders that at least four different parties are willing to take a strategic position in the company. The graphic below provided by Nevsun demonstrates how bringing onboard a strategic partner this year will allow the company to get to first production at Timok’s Upper Zone without any further equity dilution.
There are a few notable Nevsun shareholders who I hold in high regard that disagree with me and feel that it would be best for NSU to be acquired in next few months pretty much no matter what. These shareholders would be in favor of rejecting the current C$4.75 bid but anything above C$5 would likely be supported.
This is a legitimate opinion. One’s view on the minimum acceptable bid depends on how much you value the additional exploration upside around Timok as well as the effect of recent Eritrean geopolitical developments to the perception of Bisha’s value. Another consideration is whether you believe that one year from now this will be looked back upon as having been an opportune time to sell a world-class copper asset.
I personally would be devastated if any offer below C$6.00 is accepted. But my opinion matters little for a company of this size and I think NSU will be sold as long as there are 1-2 higher offers. Wellington and Blackrock (who own 26% of Nevsun collectively) are both bigger Lundin shareholders than NSU in total market value and would likely be onboard to accept if Lundin sweetens the bid last minute (like Nevsun did to acquire Timok originally when they offered an extra $75m in cash very late in the game).
It’s possible that the company is using the threat of a 19.9% strategic partner to facilitate a bidding war (i.e. get Lundin to increase its bid and/or bring other parties to the table). Leading candidates to lodge their own takeover bids include Rio Tinto (strong balance sheet & current JV with Nevsun elsewhere in Serbia), Freeport (owner of 54% of the Timok Lower Zone), and Chinese entity XGC (who lost out to Nevsun in the original takeover battle in mid-2016).
If no bid materializes in the coming few months that sufficiently values the company, then I’d be in favor of Nevsun taking the strategic partner route if that’s what it takes to remain in control of Timok. This asset is simply too special to give up on the cheap.
It’s clear that the most pressing issue facing Nevsun management right now is how to handle Lundin Mining’s C$4.75 hostile bid and the takeover battle that is likely to ensue. Nevsun shareholders can expect a resolution in one form or another in the next 90 days. My hope is that management refrains from immediately announcing a 19.9% strategic equity partner and instead waits to see whether additional takeover bids emerge. If the highest bid, however, does not meet or exceed C$6.75, then as a shareholder I’m perfectly happy with NSU going the strategic partner route.