The Odey Special Situations Fund fell 1.24% in January, although it outperformed its benchmark, the MSCI World USD Index, which fell 5.29%. In his January letter to investors, Adrian Courtenay of Odey outlined their arbitrage position in Western Areas, which was a sizable 9.2% of the fund’s net asset value.
Crispin Odey, founding partner of Odey Asset Management LLP, outside Hendon Magistrates’ Court … [+]
© 2021 Bloomberg Finance LP
He likes Western Areas because he believes the stage has been set for a competitive bidding process.
Background on Western Areas
Western Areas has a market capitalization of $800 million and an enterprise value of $600 million, and it’s an Australia-listed pure-play nickel miner with a sizable volume of nickel resources in the development stage. Courtenay estimates the gross value of the company’s development-stage nickel resources at more than $21.4 billion at current spot nickel prices.
He also believes that the value of those resources should be adjusted higher when considering “the cut-off grade implications of the rising nickel price.” Courtenay also pointed to the likelihood of additional exploration success based on early-stage drill results from deposits the company has already described as “massive.”
Wyloo Metals has been building a stake in Western Areas since early 2021, having built its stake up to 6.1% of the company by December. Courtenay also noted that Wyloo Metals also bid on Noront Resources in another competitive bidding arbitrage situation in another nickel mining company last year. He covered Noront extensively in past letters. In that situation, Wyloo outbid two counteroffers from BHP Billiton, and Odey realized the profits from that competitive bidding situation last year.
Western Areas agreed to a binding offer from another Australian resources firm, IGO Ltd., in December. According to Courtenay, the acceptance of that binding offer created for shareholders “an asymmetry of outcomes.” Odey’s Special Situations Fund acquired a stake in Western Areas at a 1.5% premium to the IGO offer. After the fund established that position, Wyloo Metals again increased its stake in the firm to 9.1%.
Thesis for Western Areas
The Odey portfolio manager believes that IGO’s strategy of making a “deeply discounted takeover proposal for Western Areas” without first building an anchor shareholding position is ill-advised and “precisely the variable that now will precipitate a competitive bidding trajectory.” He added that a sufficiently undervalued takeover offer incentivizes both competing bids and activism among shareholders.
At Western Areas, there are a competing corporate shareholder that’s been building a stake and “well-financed peers with neighboring assets and publicly disclosed aspirations to acquire nickel assets.” He pointed out that IGO’s offer is almost entirely below the nickel company’s entire trading range.
To value IGO’s offer against Western Areas’ nickel holdings, Courtenay considered the offer in units of nickel per share. He then compared that number to IGO’s share price history, also in kilos of nickel per share. IGO offered A$3.36 per share to acquire Western Areas, which translates to 0.107 kilos of nickel er share. That’s 14% lower than the 0.124 kilos of nickel per share that IGO’s takeover offer represented in December.
Additionally, the offer is below almost the almost entire five-year trading range of Western Areas based on kilos of nickel per share. Western Areas traded above 0.12 kilos of nickel per share last year and above 0.14 kilos per share in 2020 and 2019, representing a 30% premium to the IGO offer. Western Areas traded above 0.2 kilos of nickel per share in 2018 and 2017, a more than 85% premium to IGO’s offer.
Rising nickel prices
Nickel prices have more than doubled over the last five years. Thus, even if IGO raised its bid to the higher end of Western Areas’ trading range, it might still not reflect fair value “because the value of Western Areas is not a linearity to the rising nickel price but an amplified leverage to the rising nickel price.”
He believes that Western Areas also warrants a premium valuation because it offers additional sensitivity to the trajectory of the nickel price going forward. A significant imbalance between supply and demand for nickel, indicates that the metal’s price cold keep rising.
Research from Rystad Energy suggests that global demand for nickel will have risen from 2.5 million tons now to 3.4 million tons by 2024, significantly surpassing current supplies. The firm emphasized that battery makers and automakers will feel the supply squeeze within the two years following and that there is no obvious solution to this shortage in sight.
Courtenay also reminds investors of a remark made by Tesla
TSLA
Valuing Western Areas
Courtenay believes Western Areas is still trading at a deep discount because a summary of all this information has not yet been provided to shareholders in a “readily ascertainable format.” He also noted that since it is a mining company in transition with the vast majority of its value shifting into the development stage, the approach to valuing it must change and consider the resource value of the assets rather than current cashflow yields.
Courtenay points to a few variables that justify a higher valuation for Western Areas than what IGO has offered. For example, he noted that previous valuations of the company’s Odysseus asset date back to the 2018 feasibility study, but the price of nickel has risen significantly since then. Additionally, Western Areas holds more than five times the amount of nickel resources recorded at the Odysseus asset.
Ignoring the appreciation in the nickel price, the Odey fund manager estimates Western Areas’ worth at five times the US$313 million figure given for Odysseus, making it worth US$1.56 billion. That amounts to a more than 150% premium to the enterprise value attached by IGO, which was US$607 million.
Courtenay also notes other problems with the valuations attached to the Odysseus asset. Additionally, IGO itself has even acknowledged that Western Areas can enhance its mine plans by mining higher volumes of nickel at a higher grade upfront.
Setup for competitive bidding process in place
The undervaluation of IGO’s proposal for Western Area incentivizes both shareholder activism and competing bids at a company that already has a competing stakeholder in Wyloo and well-financed peers like BHP Billiton. He sees an “unusually high” probability of competitive bids for Western Areas emerging.
The probability of competing bids increases further when a company acts in such a way that it demands activism from shareholders, as Western Areas has. The company also has a large arbitrage shareholder base that has acquired its holdings at a premium to IGO’s initial offer, which further incentivizes them to push for a higher takeover price.
IGO can prevent additional competitive action from Wyloo and others by converting the deal structure from an arrangement scheme to a takeover offer with a lower acceptance level. He explained that an uplift in the value offered to shareholders could defeat any interference by potential interlopers.
Western Areas shareholders will have to vote on IGO’s offer in three months, and Courtenay thinks that leaves plenty of time for new developments in this arbitrage situation.
Michelle Jones of ValueWalk contributed to this report.
