ABITIBI ROYALTIES INC RZZ.
September 27, 2021 - 5:10pm EST by
Fenkell
2021 2022
Price: 28.45 EPS 0 0
Shares Out. (in M): 13 P/E 0 0
Market Cap (in $M): 355 P/FCF 0 0
Net Debt (in $M): 15 EBIT 0 0
TEV ($): 340 TEV/EBIT 0 0

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  • Merger Arbitrage
 

Description

Abitibi Royalties Inc. (RZZ-T)

I believe Abitibi Royalties (RZZ) provides a unique merger arb opportunity to earn ~ 10% in ~1 month with a very high probability of the deal with Gold Royalty Corp (GROY) closing.

Features of the deal:

  1. Particularly High Probability of Closing - GROY recently went public with a high profile CEO and advisory board chairman – with an urgency (and possible limited discipline) to make acquisitions

  2. Limited Fundamental Downside from Deal Break – RZZ’s downside appears limited because:

    1. the premium does not appear that high relative to RZZ’s pre-announcement price, 

    2. RZZ seems to be a good business in the mining space, largely a function of its Malarctic/Abitibi region royalties, and a disciplined and creative management/board.

    3. RZZ’s main shareholder GZZ negotiated to be taken out by GROY as well, as a condition of the transaction. Hence, there is a more substantial premium paid to GZZ vs RZZ

  3. Spread Wide because difficult to hedge and FX risk – With Gold Mining (GOLD) holding ~50% of GROY shares, GROY’s float is tight, making it difficult to find a borrow (and costs ~35%). Further complicating matters, RZZ is Canadian listed while GROY is US listed, introducing another element of FX risk

Terms of Deal

For GROY’s proposed acquisition of RZZ, RZZ shareholders will receive 4.6119 GROY shares per RZZ share. RZZ will conduct a meeting and shareholder vote by November 8, 2021, with the transaction expected to be completed a few days after obtaining the vote. 

Details:

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Brief Background on RZZ

RZZ is essentially a spinoff of GZZ when its CEO & Chairman Glenn Mullan staked land in Canadian Malarctic that proved to be valuable. In 2005, GZZ entered into a JV with Osisko mining to develop the area in the hopes of proving up potential gold resources. GZZ shrewdly negotiated itself to maintain a 30% “free participating interest” in the JV, meaning it will retain a 30% interest without the need for capital contributions (and would not otherwise be diluted either). In 2011, GZZ spun out RZZ to hold this JV interest. By 2014, RZZ ultimately benefited from the JV being acquired by Yamana Gold (YRI) and Agnico Eagle (AEM). RZZ ended up receiving both YRI and AEM shares and converting its JV interest into royalty interests. 

Currently, RZZ has just under $50 mln in YRI and AEM shares, and cash on its balance sheet. Annual revenues from royalties and dividends are at a ~$2 mln run rate which more than covers its operating expenses. At a current market cap of $350 mln (no debt), RZZ doesn’t look that interesting until one considers:

  1. As the miners expand, RZZ expects to have exposure to 200-300k oz of annual gold production for its royalties by 2025. Therefore, steady state royalties cashflow should be in the ~$15 mln+ range. At a 20-25x cashflow multiple that royalty companies typically get, the market’s valuation of RZZ prior to the deal announcement was not entirely unreasonable

  2. Shrewd owner operator with good capital allocation

    1. No options issued since 2014, specifically to avoid diluting shareholder’s ownership/returns

    2. Engages in share buybacks when shares appear undervalued 

    3. Outside the box thinking on value creation – RZZ writes covered calls (and if called away) and naked puts related to its YRI and AEM holdings. Since starting this strategy, RZZ collected ~$4 mln in tax advantaged option premiums – as this income helps offset the depreciation taken on the royalty assets

 

Bottom line, there is reasonable fundamental support for RZZ even in the remote chance the deal with GROY breaks.

Brief Background on GROY

GROY recently went public this year and is essentially a creation of Gold Mining (GOLD). While I can’t vouch for the quality of GOLD’s assets, here is my understanding of GOLD’s CEO Amir Adnani: 

  1. Involved with UEC, a uranium company that have not reached production for over a decade, 

  2. Particularly skilled in marketing, as evident in 

    1. choice of ticker for Gold Mining, 

    2. his brother (Arash Adnani) running Blender Media that helps other mining companies create “digital experiences” 

    3. extending his marketing skills by creating GROY and involving the previous Goldcorp CEO and the precious metal streaming innovator Ian Telfer (Wheaton River Minerals that merged with Goldcorp, and then creating Silver Wheaton). 

I believe when you combine marketing prowess and veterans accustomed to running large enterprises, chances are high that some empire building and undisciplined acquisitions will occur. 

Incidentally, it appears the chances of the deal closing is a virtual certainty, especially when considering how the deal is communicated on LinkedIn:

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Why This Opportunity Exists

I believe there are various reasons why this merger arb opportunity for RZZ looks interesting:

  1. Trading Liquidity – RZZ’s volumes are generally light, making it unappealing for larger professional arb players

  2. Difficult to Hedge – Half of GROY shares are held by GOLD. As a results, the borrow pool on GROY is small and the borrow cost is around 35%. Brokers are also mentioning “recall noise” perhaps that’s why we are seeing some “random” spikes in the GROY share price

  3. FX Risk – RZZ is Canadian listed in C$ and GROY is US listed in US$. The incremental FX risk makes this deal even more unappealing to professional arbs.

  4. Some of the Premium in GZZ – Even looking at the chart, it appears RZZ’s downside is limited when looking at how RZZ traded prior to deal announcement. I believe part of the reason for this is the Chairman/CEO is also involved in GZZ and negotiated with GROY to have them acquire GZZ as well as part of the transaction at a healthy premium. This indirectly limits the RZZ downside on a deal break (although chances of that are already slim to begin with)

 

 

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.

Catalyst

Deal closing in early November

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