Primero Mining: Motivated Sellers Trashing the Stock

When Primero Mining (NYSE: PPP; P.TO) and Northgate Minerals (AMEX: NXG; NGX.TO) announced in early July 2011 a deal to combine the mining operations to form a mid-tier gold miner, the market seemed all excited in the short term about those prospects.

This was expressed in a rising share price of NXG and also rising share price of PPP, at the time traded only in Toronto. Within 4 days of deal announcement, investors had a sudden change of heart as rumors started to circulate that counter-bidders were circling around the acquirer NXG. The shares of PPP seemed to imply with a large probability that the deal would be off.

Since August 29, these market rumors got confirmed. On that date, Aurico (NYSE: AUQ) and Northgate announced a definite agreement and a superior offer that apparently Northgate directors could not reject. Primero Mining is now left with the break-up fee as a consolation prize.

Aurico shareholders did not get too excited about the prospect of combining operations with Northgate and the stock took a beating in yesterday's trading. Not so Northgate stock, which benefited nicely from the superior offer.

Primero Mining as the spurnt bride, though, took a serious shellacking. Volumes traded on day 1 of deal termination reached 6 million on both Canadian and US listings. And the stock plunged intraday by about 20% before recovering some territory during the day.

This seems to be a classical case of motivated sellers dumping the shares of Primero Mining for reasons other than operational or strategic ones.

Admittedly, Primero Mining is not a household name in the North American stock markets. In fact, its NYSE listing of shares only occurred on August 15, 2011 and whatever investors since then felt attracted to purchase PPP shares on the NYSE now must have some second thoughts about this exposure sought over the past 2 weeks. The investors who on Monday dumped PPP shares in droves hardly can be considered the committed long term investors that Primero Mining was eager to attract with its listing on the NYSE. It has to be assumed that the motivated sellers of Primero Mining shares are arbitrageurs not looking beyond the current event driven transaction, which they are well aware got terminated officially.

When a deal breaks apart for whatever reasons, the motivated sellers rarely ask questions and they should. The rush to the exit gate generally means that the baby occasionally gets tossed out with the bathwater. This appears to be the case here.

The 6 million shares trading volume of Primero Mining on Monday has no fundamental underpinning, but is a strictly fear driven, technical sell off and gut reaction by Mr. Market. The words knee-jerk come to mind. This is a best illustration of herding instincts at work.

This presents a strong buying opportunity for those investors willing to look beyond the negative short-term event. UBS, who has been providing a fairness opinion to Northgate came out with an upgrade on Primero and a $5.50 price target. Since UBS has been on the inside all along on both Northgate transaction proposals, and have had an information advantage over all other unprepared sell side analysts, the upgrade is perhaps a leading indicator of what is in store for Primero shares going forward. Granted, UBS is just acting as a banker and they are probably vying for a piece of future Primero investment banking business. I wouldn’t call them ultra-contrarian but would be surprised if their trading desk is not snapping up lots of shares from desperate, motivated sellers. They may not have that prop trading desk any more but sure are not devoid of customers that can play an occasional contrarian move. In a way, it can be argued that following the money trail here can be a possible strategy. I would reckon that UBS knows a lot more about Primero than the average run of the mill event-driven investor.

So, fundamentally speaking what is this Primero Mining story all about? Is it worth even looking at? Is that UBS informed price target even worth bothering about?

At the time when the Primero deal was announced, I happened to be a committed Northgate shareholder having acquired NXG shares during the last junior mining downturn with some mixed performance results. Not everything at NXG was all the rage operationally. Kemess and Australian mines gave rise to occasional troubles. Young-Davidson was as of yet not operational. The deal as originally announced was greeted by all shareholder factions alike as a good move. Of course, nobody will discard a superior offer just because it happens.

However, when looking back at why NXG shareholders like myself were originally excited about the Primero deal, it quickly comes to mind that Primero is lead by a world class mining CEO, Joe Conway, who had been instrumental in shaping Iamgold (IAG) and predecessors into world class mining organizations over a period of 15 years. When Joe Conway left Iamgold in January 2010, this was a surprise move to most everyone in the industry as Iamgold continued to perform well an the reasons for leaving just did not seem obvious. Today, Iamgold has $1 billion in cash on its books and it may still not seem obvious why Mr. Conway left. Is it all explained by entrepreneurial drive to excel at the next junior mining opportunity? Possibly.

Investors took some notice when Joe Conway signed on in August 2010 with little known Primero Mining, which was created as a mining spin-off from Goldcorp (NYSE: GG). Goldcorp is still a 35% shareholder in Primero and they have the right to increase share ownership to 50%. As a Goldcorp backed spinoff, Primero Mining does not have the worst corporate DNA. I have not yet met anyone so far who has dissed the accomplishments of Joe Conway. I am, thus, assuming that the managerial DNA at Primero is impeccable and worth taking some notice, particularly since it is only 12 months since Primero's San Dimas mining operations were spun off. All kinds of positive PR has circulated what the game plan at Primero was going to be. This game plan includes some occasional M&A activity. Within the context of this game plan, the original Northgate deal was probably an illustration of pretty confident dealmaking by a premier mining CEO. In its design, it would have been a pretty gutsy transaction if successfully concluded. Such are the hallmarks of visionary CEOs.

The July 2011 deal proposed between Primero and Northgate created some excitement with investors and various bloggers as Joe Conway would effectively become the CEO of the combined Northgate/Primero operations. In essence, the original deal had almost the character of a reverse merger. This didn’t sit too well with some Northgate shareholders or sell side analysts who were fretting over lost business opportunities. To use an analogy of Greek mythology, Primero was attempting to be the proverbial Icarus flying too near to the sun. Whenever the humans are full of hybris, the resenting Greek Gods are typically swift in their punishing response. Some of this is applicable to Primero and some lessons will be learnt from this no doubt. This could have gone down in history as a gutsy, transformative deal but it didn’t. It was nevertheless worth the try, as in “Nothing ventured, nothing gained.”

With the Primero fast-track M&A hopes for now puffed up in smoke, the crash to reality has been relatively benign. Primero is the proverbial spurnt bride left at the wedding altar. Not good for Primero Mining stock in the short term but over the long term it will likely be perceived as a drop of water on a hot stone. A non-event operationally speaking. Strategically speaking, it could have been a transformative event and put them on the map of more mid-tier investors.

Primero Mining will most likely recover from the insult suffered from being spurnt at the altar. Not a big deal when you also get $25 million in break up fee, and when you just turned in a nice profitable Q2 2011 quarter at the beginning of August.

On the other hand, Northgate had a losing quarter in Q2 2011 and they are already down the termination fee to Primero. Ouch. No wonder that Aurico shareholders are less than thrilled about the prospects of combining operations with a less than glamorous Northgate. After all, how bad do operations have to be managed for Q2 2011 results to be money losing, even with an unhedged book of business. This might explain why the Northgate long time CEO resigned in conjunction with the announcement of the Primero transaction. (Actually, 2 days before announcing it.) Northgate is far from a well managed organization and the ascendance of Joe Conway to become CEO of Northgate was generally viewed positively.

This will not happen now. Instead, Joe Conway will simply run the affairs of Primero capably. By all practical means from which I can judge the situation, Primero Mining is now better off than it used to be before. Its cash position has been strengthened since original deal announcement. The Q3 2011 quarter should be an unhedged blast. A literal cash flow bonanza will await shareholders. And yet, those motivated sellers cannot figure out in a lifetime what is going on at their little spurnt spinoff company.

Come on!!!

This small research note on Primero is aimed to add a few perspectives on this underfollowed Goldcorp divestiture. Something to put Primero on the radar screen of serious investors, who might disagree with me and chime in on what they know. When Goldcorp spun off this mining asset via reverse merger into an existing shellco, Primero was a $5.25 stock. After initial enthusiasm and reaching a $7 share price, Primero has lost 50% of its market value. Concurrently, the price of gold has risen by 50% during the same time period. Without going into any valuation details too deeply, this overall constellation makes for a potentially intriguing producing gold investment target. The consternation that has been settling in with Primero shareholders is not unusual in the initial seasoning period of any newly listed spin-off company. The market simply doesn’t have the benefit of a long operational history, the assets suffer from certain lack of past investments and expectations have a tendency to get frustrated along the way. Rightly or wrongly so. This offers secondary investment opportunities to astute investors.

To Recap:

Primero is a Goldcorp spin-off (12 months out of the gate)

Primero shares reflect certain frustrated expectations
Primero is lead by a top notch and gutsy CEO (Joe Conway)
Primero is improving its operations (through exploration and milling capex)
Primero has an improving balance sheet
Primero plans to improve San Dimas gold output from 100,000 oz to 200,000 oz
Primero trades at less than 1x book value and less than 3x ttm sales (2x E2011)

I can see lots of things to be liked about Primero as a long term gold allocation with a opportunistic, borderline contrarian bias.

The Negatives:
Hedge Book that is not well understood or liked but so far not proving to be problematic as Primero has delivered in the first half of the year all forward silver obligations for the entire fiscal year. Thus the second half of 2011 will be unhedged, and – ceteris paribus – a cash flow bonanza. At this point it merely looks like Primero is a company that like any spin-off is dealing with some legacy aspects in its business. The hedge contracts are a contractual obligation to be dealt with and so far they are being dealt with not to the detriment of shareholders. If anything, and painting the worst picture of future distress, these hedge obligations remain an off-balance sheet hard obligation of Goldcorp. Time will tell how Primero handles its affairs in this respect. During the last conference call, Joe Conway addressed some of the questions relating to hedge book highlighting that one possibility to address hedge book is to simply produce more volumes. This is why Primero spends some 20-25 MM per annum on exploration activities on the San Dimas property. For those who have followed Mr. Conway at Iamgold and predecessors, he is probably as close to a straight shooter as it gets and I do believe his word counts still for something in this industry. He may not be right in every corporate move he makes but it may be a bit too early to tell if targeted production volume are achievable or not. Buying Primero shares in this respect is like betting on the underdog team. The market has taken an absurd stance of expecting Primero to deliver all forward sold silver now, and right now. This is merely an illustration of the market’s bearishness on the shares. As a contrarian, I respectfully disagree with Mr. Market.

There is also a tax question that Primero hopes to resolve over the course of the current fiscal year. The market is possibly assuming that this tax question cannot be resolved in favor of the company. Time will tell. Mr. Conway is certainly a smart dealmaker and even as a spurnt bride, Primero walked away with some cash.

The next 6 months should clarify many issues. In the short term the PPP investors who have picked up shares over the past 2-6 weeks are voting with their feet. They obviously do not care about the bigger picture of this story and what makes Primero interesting to begin with.

Reinet Investments (REIN LX)

Reinet Investments is a publicly traded family office of the Rupert family of South Africa.

This investment vehicle was spun out of swiss based Compagnie Financiere Richemont in a
complicated, multi step corporate restructuring.

Reinet was endowed with cash and with shares of British American Tobacco (BATS LN).

Today, there are about 196 million REIN LX shares outstanding (or about 1960 million REI SJ depositary receipts traded in South Africa).

The assets that Reinet today holds are 406 million Euro of Cash and Investments, and 83.5 million shares of BATS LN.

The 406 million in cash and investments is comprised of approximately 350 million euros in cash and the rest in solar and optical technology companies. The venture capital allocation is fairly minimal overall. Therefore for simplicity, lets just say that 406 million Euro in cash sits within this holding company. This equates to about Euro 2.07 per outstanding REIN LX share.

The principal asset of Reinet is the BATS LN shareholding which currently amounts to 0.43 BATS LN per REIN LX. The price of BATS shares in Euro equivalents is about 18.25 Euros as of today's closing price.

Thus each REIN LX at present contains BATS share worth Euro 7.85.

There are no significant liabilities.

The cash and BATS holdings represents Net Asst Value.

NAV turns aout to be Euro 9.92 per REIN LX shares.

At present REIN LX trades at Euro 6.85, or 69% of NAV.

In other words this holding or investment company trades at 31% discount to NAV.

Reinet Investments was set up 2 months ago as an investment firm managing assets under a closed end, 1%/10% fee structure.

The company currently has about Euro 1.93 billion under management.

Today the Rupert family is a major shareholder in the entity and through an optional share placing, they will subscribe to additional shares at parity to NAV. This optional placing will be concluded on December 19 or shortly thereafter.

After this share placing, it is believed that the assets within Reinet Investments and the Reinet Fund will be approximately Euro 2.1 billion.

Why would anyone at this point consider an investment in Reinet?

1) The discount to NAV of 31% which might be deemed excessive given the quality of assets and given how recent the entity was set up. In a closed-end fund context, something has to be seriously impaired for a fund to trade at a 31% discount to NAV. There is no asset value impairment going on at Reinet, other than the Rupert family controlling their family office and owning currently about 25-30% of shares outstanding. After the option placing the Rupert family will come to own about 40% of shares outstanding.

2) The track record of the Rupert family is excellent by most standards. 2 Generations of Ruperts have shown quite exceptional business acumen turning them into billionaires (net worth estimated around 2-3 billion according to the usual wealth trackers). Sure enough there is hard work behind it all and typical financial journalists dont give proper attribution of how much of the results are due to industry and how much due to capital. We are not going at this point into details of trying to demystify the sources of Rupert family wealth. They are shrewd dealmakers. they are hard charging dealmakers. They are not known for giving away anything for free. Looking at their corporate constellations over time, the like to operate in tax-efficient jurisdictions while enjoying quality of life. So some people work hard, while others work smart.
Clearly, the Ruperts are smart, and they have not given up working hard. This assessment certainly applies to the family patriarch Johann Rupert.

Reinet Investments gives an opportunity to participate over time in this long term track record by the family. As a passive portfolio investor. We hope that at this point the portfolio of assets is sufficiently large to warrant the effort and that no additional capital structure modifications are needed to prove the family office concept.

At this point, no investments have been undertaken but 80% of assets is centered on BATS LN holding. The rest is cash. BATS LN pays a healthy dividend. And it is a defensive stock. A sin stock. So while Reinet is a bet on the track record of the Ruperts, it is also a defensive stock at this point.

At this point, REIN LX trades at a 13% discount to the value of its BATS holding alone.
This does not inclued the over 2 euros in cash per share that come as a freebie.

For any investor without tobacco scruples, this gamble is probably worth it.

If one does not like BATS LN, one can alway short out that exposure partially or in whole. and make it a call on the Rupert track record along, but such a trade would ignore that tobacco is part of what made the Ruperts so successful over time.

Enough said.

3) Reason number 3 to invest is their articulated strategy for investment.

At this point they have not allocated any money in this family office other than 55 million in venture like investment in solar and optical technologies.

Johann Rupert has expressed all along his scepticism about the current economic state of affairs. He has been critical about the growth in credit and has generally been making a bearish case about the business cycle. He has been bearish for years which has earned him the nick name of Rupert the Bear, which we find quite charming. We wholeheartedly go along with Mr. Ruperts sentiment, given that our own sentiment is defensive, conservative and capital preservation oriented. But growth oriented over long periods of time.

So, Mr. Rupert has laid out a case that there will be plenty of seizures in the financial markets over the next few years and this should create numerous investment opportunities. We generally agree with that. No indication has been given on the timing and size of future investments. We shall see if investment allocations occur in 10 MM tranches or 100 million tranches. and when. Reinet Fund is structured as a closed end fund and the organization is under no pressure to undertake any investments now. This is good.

There evidently is no rush to allocate any assets for as long as investors run up to the Treasury department and demand zero interest 4-week T-bills in 4 times oversubscribed auctions.

The current market environment is enough sickening and the flight to quality has eluded investors from the real systemic risks.

We find it very ironic that flight to quality is going to the US Dollar and to the Treasury at Zero interest rate.

Reinet at this point has an asset bias in Euros for its cash holdings and in various emerging market currencies since BATS LN essentially is an emerging market play in many jurisdictions.
It is probably a healthy diversification outside the G7 countries. At least conceptually.

Although there are some investment opportunities surfacing at this point, there are indications that asset valuations could go much lower after a snapback rally. Tobin's Q-Ratio seems to indicate so.

The current bear market isnt quite over yet.

Since no investments have been undertaken by Reinet at this point, we hold our breath on applauding any such moves.

For the record, Mr. Rupert wants to invest in opportunities created by the seizures in the financial market.

We shall see in the future what he means with that, and to the degree that such investments are disclosed to shareholders.

An investor in Reinet certainly would have to feel comfortable with that contrarian, anti-cyclical investment philosophy.

We surely are.


Thus for various above cited reasons, we recommend purchase of these heavily discounted securities as a long term investment. It would be an allocation to a closed end fund asset and a family office run by some shrewd, if not smart investors.