Afferro Mining - Takeover Nears Completion

It finally looks like the end is sight for shareholders of AIM-listed mining firm Afferro Mining (LSE:AFF). The site has covered the shares on two occasions, back in February, and then again in April, both time suggesting the shares were undervalued and prone to a takeover - a scenario that had surrounded the company for many months beforehand. In the April review I commented: "Although the mining sector is still poor and iron ore prices are still expected to weaken further, there are simple measures of how cheap a company is and the very high cash:market cap ratio should limit the downside here to around 52p in the short term. Time for the other 70%." That brought the sites average 'buy' price down to 65.5p, a move that now looks to have been a very good move. Following a takeover offer from International Mining and Infrastructure Corporation (LSE:IMIC), the shares have moved higher to 85.50p. However, that does not reflect the entirety of the takeover offer. Nonetheless, the trade idea has already returned 30.5% of profit through share price appreciation and looks set to deliver up to 92% in total returns.

This article is a follow-on from the below post. For full context and information, read these articles first:

The formal and confirmed takeover of Afferro was announced in May following weeks of speculation within the market. The deal involved a smaller firm IMIC (LSE:IMIC) who had been placed associated with the company through a shareholding plus through takeover rumours. The deal includes a payment to Afferro shareholders of 80p in cash plus a 40p convertible loan note. In simple terms, the loan note carries an interest rate coupon of 8% per year that is paid at the end of a 2 year period. That means that, assuming the 2 years is completed, the loan notes will have accrued an additional ~6p of interest, taking the total to 46p. The loan note can be redeemed early at the discretion of IMIC. Furthermore, at the end of the 2 years, the notes can be either converted to shares or cash at IMIC's discretion. What does that mean in total? Well, investors willing to wait 2 years(assuming that IMIC does not become insolvent) can then see a total return in cash/shares of circa 126p. The notes will be listed on the Irish Stock Exchange. Compare that to the current share price and you are probably wondering, why the disparity then between the current share price and the full takeover price?

As you can see above, the share price did initially jump to just short of 80p in May. The market was clearly underwhelmed by the offer. However, it has since drifted upwards upon the confirmation of various agreements that IMIC have obtained. These agreements effectively mean that the whole project is less risky. Therefore it makes sense for the share price to move up - it is less likely that the whole Cameroon project will be unsuccessful under IMIC control. The result is that the ~46p rolled up loan notes are currently priced at just 5.5p.

That would seem like a bargain in anyones eyes, however there are quite a few risks. The obvious one is that investors would have to wait two years for payment. Being realistic, some investors simply don't have enough money set aside for the stock market and thus they don't want to risk having to wait for two years. During that period the market could rally, or equally fall - in both cases market opportunities could present themselves. Having the money stashed in loan notes is not particularly convenient. Furthermore, there is no certainty that IMIC will be around in two years time. Chances are they will, but their plan to develop Afferro's assets is based extensively on debt agreements, some of which were required to actually get the deal off the ground. Should the development not go to plan, they could default. In my opinion, the likelihood is that Afferro shareholders will see there loan notes converted to shares, rather than cash.

On the other hand, Afferro shareholders are safeguarded in the case of any of major dilutions over the period as the conversion occurs at the end of the period (unless IMIC do so beforehand). There is the possibility that selling pressure at the conversion date will damage and put an overhang on IMIC's share price, but considering many shareholders are institutions, that is unlikely - there may be an overhang but it is unlikely too lead to an immediate IMIC share price collapse. IMIC itself also holds just under 20% of Afferro's shares, which means the deal works out better for them as they are not forced into paying the loan note at all.

David Netherway, Chairman of Afferro, commented: "We have developed a world class asset in the Nkout Project, which, along with our other iron ore projects, is in a substantial new iron ore corridor running through Cameroon. It has been of the foremost importance for the Board of Afferro to come back to shareholders with a revised and simplified offer to best optimise their returns. The Board believes that the 120p per share proposal offers good value and the ability for further upside with the exposure to the strong relationships built by IMIC with the key consumer that is China."

The ultimate question is whether it is still worth buying Afferro's shares in order to capitalise on the disparity. At an 8% interest rate, there is clear upside and considering that Bank interest rates are only a fraction of that sum, it is not really a bad deal. However, there are risks involved. Holders who can spare the money are likely to be better off holding Afferro's shares towards the close of the takeover in order to take advantage of the loan notes. Considering that the share price remains a full 40p off the potential full price, there is still scope for the disparity to narrow closer to the takeover finalisation in late September. There is a very small chance that a takeover offer could be placed, but the fact that this has not yet come, means that it is highly unlikely.

Personally I don't think the deal values Afferro particularly well at all. Ideally the loan notes would have been cash and payable up front, but the insecure financial position of IMIC (prior to takeover initiation) reflects the deal. Furthermore, IMIC capitalised on Afferro's share price weakness in respect of its offer. After all, at the turn of the year, the shares touched 100p. Anyone who held an average over 80p has therefore pretty much been forced to either take a loss now, or wait two years. They will see no immediate return on their investment, and that has left a sour taste in the mouths of some investors. A much fairer deal would have seen IMIC offering 100p in cash up front, and a 20p loan note, but of course that would mean IMIC would have to raise more cash through bonds. The view of the takeover was also indicated by broker Panmure Gordon who stated that the IMIC offer "considerably undervalues" Afferro.

Looking back at the raw, and now updated resource and reserve figures makes Afferro look even more undervalued, especially since it has that large cash component (£49.4m as at the end of June 2013). If we take the 126p share price, at 105m shares, that gives the company an all-in market capitalisation of £132.35m.

As you can see from the above, the total indicated and inferred iron totals 2619.3MT. If we divide the market capitalisation by the total, a value of £0.0505 is retrieved. That figure is the (£/t) value. Compared to the wider market, that figure is low, especially since the poor performance of the mining market has been offset against upgraded Afferro resource estimates. Strip out 60% of the cash and that value drops down to £0.0430. That discounts the potential for Ntem's resource to be upgraded as well (SRK estimated that a further 50Mt to 150Mt could lie beneath the pit shell). Based on the raw resource/reserves figures alone, the takeover price is definitely cheap. Would Afferro have been able to take the projects into production themselves? No-one will know the answer to that question. large amounts of CAPEX would no doubt have been required to complete infrastructure construction and it is likely that Afferro's cash pile would have diminished very quickly.

Taking everything into account though, investors can only help but feel like they have been sold out on the cheap. The huge Afferro cash pile almost rubs salt into the wounds as the actual assets are being valued at a fraction of their potential worth. One unanswered question that remains is why Afferro actually refuted an approach by Jindal prior to IMIC's deal as they believed it 'significantly undervalued' the company. Looking at the share price at the time, any decent deal will likely have been more favourable to investors compared to the IMIC offer, especially since the latter does not offer investors much in the way of flexibility. In fact, it gives investors uncertainty regarding when they should expect to receive their loan note. A significant hurdle that remains is whether IMIC really can develop Afferro's projects. They have not yet established a track record of doing so, but with the backing of the Chinese, plus some decent deal-making abilities, you would expect they should be able to do so.

To end, it's worth mulling over this: If the takeover bid undervalues Afferro significantly, why have other parties not come forward? The deal is not in the bag yet, but a counter-offer looks ever more unlikely. The sector weakness have clearly taken it's toll on Afferro, albeit not in the same way as other miners. The weakness has diminished appetite for M&A's and this has actually allowed IMIC to pick up Afferro at a cheaper valuation. That was even admitted by CEO Luis Da Silva who noted a changing sector environment. The deal won't please many investors, but for the site, the maximum upside is around 92% assuming that the deal goes through as planned, with the loan note paid with the accrued interest. Possibly a very good return. I will update the Review Results page as of when the takeover is finalised, and adjust in the future according to what IMIC decides upon (in terms of payback).

UPDATE (21/11/13): Having reconsidered Afferro's position I have moved the company from Buy to No Rating. The IMIC takeover continues to be protracted and the market is now only valuing the loan notes at 1.5p which is a vote of no confidence in the merged entity. Take 24.4% profit


  1. Well done el1te making money against a nervy backdrop!

    92% return is amazing! Going to watch some Rugby videos now.


  2. Add another to the tally I guess!

  3. I can't wait for this Saga to end. I liken it to an episode of Eastenders with all the takeover offers and IMIC nonsense. PLUS theres all the nonsense of dealing with a bond. Many account providers don't have a first clue what to do.

    For our health, let the takeover please complete without any more extensions!

  4. Da Silva still has the Aureus iron in the fire (rather ingot). First pour late next year. That's where the BoD hot money will go, especially given Aureus' current knock down price.

    Great if you could give us your opinions El1te. Eco