February 03, 2015 - 11:59pm EST by
2015 2016
Price: 1.43 EPS 0 0
Shares Out. (in M): 93 P/E 0 0
Market Cap (in $M): 133 P/FCF 0 0
Net Debt (in $M): -81 EBIT 0 0
TEV (in $M): 52 TEV/EBIT 0 0

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  • Special Situation
  • Canada
  • Mining
  • Lack of Coverage
  • Illiquid
  • Personal Account Idea
  • Precious Metals
  • Potential Asset Sales


Summary: A classic small-cap special situation. Eastern Platinum (TSX:ELR/ELR CN), a Candian mining company has received a sizable bid relative to its market cap for effectively all of its assets. The cash value of the bid plus the cash currently on the balance sheet is well in excess of the current share price (~C$3.43 at current FX rates vs a C$1.43 share price at close today or ~140% greater than the current share price). We believe the current share price is more a function of the company's small size (C$133mm), lack of coverage and liquidity than any abnormally high level of deal risk and so the current price represents an attractive opportunity to benefit even if the spread only closes part of the way. Even in the event that the deal falls through, there will be >C$1/shr between the cash on hand now and the break fee (assigning no value to the underlying assets) so we think there is a very attractive level of asymmetry.
Bear in Mind: this is a small (C$133mm) Canadian company with <$1mm of liquidity per day. We believe this situation is attractive but only have a modestly-sized position simply by dint of its size relative to our AUM. Because of size, liquidity and deal risk considerations, we recognize that this name cannot and should not be for everyone but we think it makes an attractive smaller-sized position for smaller or diversified funds tolerant of bets like this as well as your PAs depending on your preferences. 
We will briefly discuss the nature of the assets, followed by the deal math then lastly the risks and discussion. 
Business/Asset Overview:
ELR is a company with platinum mining assets in South Africa. Until July 2013, these were functioning, substantial platinum mines in South Africa supporting a much larger valuation for the company (C$1.6bn mkt cap as late as of Feb 2011 although almost certainly overvalued there). By 2013 however - while the asset sizes are still substantial - with South Africa becoming an especially rough place for small companies to do business (labor issues, power supply, other infrastructure challenges) plus an ongoing tough PGM price environment these assets were forced to shut down. Even now, ELRs assets are large platinum deposits with substantial attendant mine infrastructure but between high production costs and low commodity prices, the assets were put on care and maintenance (ie in a condition to be restarted in the future). 
I don't want to undersell the challenge of South Africa but for the right buyer at the right price, there is the potential for real value to be unlocked as the environment improves. To that end, there are also ~$300mm of tax loss carry forwards attached to the ELR assets being sold so the right acquirer is getting the assets themselves effectively free assuming they can wait out the cycle and the politics.
Some detail about the assets themselves: the main asset (the Crocodile River Mine) is part of the Bushveld Complex near Rustenburg (west of Pretoria) which has a number of other platinum miner working the same formation. The company also has a number of other claims near Steelpoort in Limpopo, again next to other mining companies working the play. Just on the basis of what ELR has drilled up to P&P (proven and probable) status, there are ~3.8mm ozs of platinum and PGMs to mine as well as an additional measured and indicated 174k tons of copper and 363k tons of nickel. The byproducts are just a small bonus, this very much a platinum/PGM deposit, but it is quite sizeable as PGM mines go and there is likely a lot more to discover although ELR will not be the company to do it. 
Incidentally, for those with a mining background, peak production was 130k+ oz/yr (the ore body can clearly allow for larger production), the grades were pretty nice (4+ g/t) and cash costs were in the $500-$600/oz range back in happier days for South Africa. As the operating environment got worse, cash costs spiked above $2000/oz and even at the end were >$1300/oz. This appears to be a function of the environment, not the ore body.
Again, to be clear: South Africa is a challenging operating environment right now, especially for a company without the connections or balance sheets to stick it out (re: ELR), however these assets are not at all fundamentally broken and the tax asset is a very nice sweetener. But we think this is an interesting situation not because of PGM optionality but simply because the deal is live, in-process and the share price has not adjusted properly at all- we provide the color on the assets just to affirm that sensible, longer-term players would actually want them.
The Deal:
On Nov 7th, 2014 ELR announced that Hebei Zhongbo Platinum would pay U$225mm for effectively all of ELR's assets. After minority buyout expenses, finder's fees (to a supposedly arms-length third party) and other deal fees, this will net out to ~U$175mm for ELR shareholders. Add this in to the ~U$81mm ELR has on the balance sheet already and that's ~U$256mm for ELR after the transaction. At the current exchange rate (1.24 CAD:1 USD) and current share count (92.6mm), that comes out to ~C$3.43/shr of cash on the balance sheet vs today's close of C$1.43/shr.
Hebei Zhongbo is a mainland Chinese industrial concern (really a 'group of companies') described in the information circular as 'based primarily in the Bohai New District of Cangzhou in Hebei Province, China, with operations in the specialty steel and ferrochrome business. The Hebei Group also own and operate other facilities in the heavy metal industry in other provinces of China." I have not been able to find much information on the group outside of company commentary but did get some additional color from management that Hebei Zhongbo already owns some PGM assets and finds the idea of dedicated supply (platinum has industrial uses) and the idea of diversifying from China appealing. 
So Why the Big Discount?/Risks:
Deal Risk: Does this go through? Could Hebei Zhongbo back out? Might the deal hit a snag?
           - Comments: There's no question that I take less comfort in the bid from someone I have never heard of before but there is a >U$11mm break fee in the event that Hebei Zhongbo backs out or the deal otherwise doesn't go through. The only major potential snag for the deal looks to be on the South African authorities' side as they have to approve that Hebei Zhongbo will have an appropriate local black partner under that country's BEE (black economic empowerment) rule. A ruling there should come closer to mid-year but this wait is normal and Hebei Zhongbo looks to be a preferable match for a potential BEE partner compared to ELR in terms of confidence in offtake as well as balance sheet capacity. Put more simply, Hebei Zhongbo is supposedly in a position to carry a partner whereas ELR never was - that is an obvious draw for well-connected BEE partners.
          - The share price appears to be imputing more than a reasonable amount of deal risk. Or, more likely, the stock is now sufficiently illiquid and obscure that very few people are actually aware of the sums in play relative to the current market cap. The last analysts actually covering the stock discontinued in July '14 (JP Morgan) and Oct '14 (Paradigm Capital) respectively.
Management Risk: What will management do with the cash? Could an all-cash entity lose its TSX listing?
        - Comments: These are within the standard suite of Canadian natural resource issues. Management ownership is very low (0.24%) and mining management should always be treated as guilty until proven innocent on capex. Further, the information circular (pages 12 & 13) says that management does not intend to dividend out the cash but will instead focus on acquiring a new asset. It may also temporarily lose its TSX listing if it does not have a new project in a certain time frame after the transaction closes (it has a South African JSX listing as well).
       - But we feel there are important wrinkles. Firstly, management is much more coy in actual conversation about what they will do with the cash. This has certainly been a very frustrating few years for management as this once sizeable company has been whittled down to a caretaker and management may want to be done with it. That in and of itself is quite speculative but when you consider that management all have other business interests (fairly common in the world of small cap miners) and also that both the CEO and CFO stand to receive substantial payouts (~C$2mm and ~C$700k respectively) in the event of a change of control - which this sale would qualify as (Circular, p. 13 & 14) - the idea of dividending out the cash and being done with it doesn't seem quite as far-fetched, especially if the major shareholders insist or management was allowed to receive some more equity beforehand.
        - Moreover though, we should assume that the base case is that management goes out and buys something and that we don't like the price of whatever that something is. Without question that would be sub-optimal, but it doesn't seem to warrant a discount anywhere near as large as the one currently being applied. Losing a TSX listing altogether without doing something with the cash would appear to benefit no one (and there are large shareholders who could oppose such a course of action if it were taken - it would also be a logical activist target).
Bottom Line: We appear to be buying C$3.43/shr for C$1.43/shr pending a manageable level of deal risk. The EGM to approve the deal is on Thursday, Feb 5th in Vancouver so we will know more then but, while the risks are real, we think we are being more than adequately compensated for them, especially given the substantial amount of cash the company will still have (esp post-breakup fee) in the event the deal falls apart.
Disclaimer: We are currently long ELR CN.
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.


EGM for Shareholder Approval of Deal on Feb 5th, 2015

PRC approval of money transfer expected in mid-February

South African ruling expected mid-2015

Final consummation of deal expected in CY15

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