Recommendation: Tender Target Price: C$0.80 Farallon Mining Ltd. (FAN-TSX) C$0.80 Cash Bid From Nyrstar Current Price C$0.78 Shares Outstanding (MM) 52 Wk High C$0.71 Basic 52 Wk Low C$0.32 Diluted Cash (MM) $23.4 Mgmt. & Dir. Total Debt (MM) $34.2 Market Cap. NAVPS C$0.79 Float P/NAV 0.99x EV Dividend C$0.00 Reserves Dividend Yield 0% Total Resource 473.5 510.9 2.1 C$369.3 C$367.7 $369.1 430 MMlb 1,541 MMlb Fiscal YE Dec. 31 2009A 2010E 2011E Zn Prod. Q1 14.1 20.0 A 27.0 (MMlb) Q2 18.0 21.8 A 28.5 Q3 18.5 18.9 A 30.0 Q4 19.6 24.3 30.0 FY 70.3 85.0 115.4 Cash Cost ($/lb) FY $0.33 $0.12 $(0.02) Diluted EPS, adj. Q1 $(0.02) $0.01 A $0.03 Q2 $(0.01) $0.00 A $0.03 Q3 $(0.01) $0.02 A $0.03 Q4 $0.00 $0.02 $0.04 FY $(0.03) $0.05 $0.13 Diluted CFPS, adj. Q1 $(0.02) $0.01 A $0.04 Q2 $0.01 $0.00 A $0.04 Q3 $0.00 $0.02 A $0.04 Q4 $(0.00) $0.03 $0.05 FY $(0.01) $0.06 $0.17 EV/Prod. 5.3x 4.3x 3.2x P/CF (73.5x) 11.7x 4.4x Unless otherwise denoted, all figures shown in US$ Investment Thesis: Farallon Mining is an emerging low-cost zinc producer which owns the zinc-rich polymetallic G-9 mine located in Guerrero State, Mexico. G-9 is part of the Campo Morado property which hosts five other distinct deposits including El Largo, El Rey, Reforma, Naranjo, and La Lucha. With only a select few equities providing exposure to zinc, Farallon Mining offers investors leverage to the strengthening metal, which shows particularly compelling fundamentals in our view. The Company has a healthy balance sheet, which should allow it to optimize Campo Morado and expand its resource base Highlights: C$0.80 All Cash Bid From Nyrstar: Farallon Mining announced that it has entered into a friendly agreement with Nyrstar NV, whereby Nyrstar will acquire 100% of the fully-diluted shares of FAN for C$0.80 in cash. The offer represents a 32% premium to the 20-day VWAP and a 23% premium to the last close. Management and the company s largest shareholder, Acuity, have entered into lock-up agreements representing 19% of the fully-diluted shares. Upside To Bid Exists, But No Competitive Suitors In The Picture: While we view the bid as a fair price (in-line with our target price), we do note that FAN could go for a higher price given the considerable exploration potential that exists and the essentially free option on the gold deposits. However, given the lack of competitive suitors in the zinc industry, mainly smaller producers, and Nyrstar s financial clout, we do not expect other competitive bids to arise. Nyrstar does have the option to match any superior proposal. Maintaining C$0.80 Target; Tender Recommendation: The cash bid from Nyrstar confirms our thesis that significant inherent value does exist at the company s G-9 mine. Given the acquisition is an all-cash friendly deal, we do expect Nyrstar to be successful in there bid. We are therefore moving to a Tender recommendation. Our C$0.80 target is unchanged.
C$0.80 All Cash Bid From Nyrstar: Yesterday, after market close, Farallon announced that it has entered into a binding support agreement (friendly transaction) with Nyrstar NV (NYR-BT), whereby Nyrstar will acquire 100% of the fully-diluted shares of FAN for C$0.80 in cash, valuing Farallon's equity at approximately C$409MM (EUR 296MM) on a fully diluted basis. The Nyrstar Offer represents a premium of 23% to Farallon's closing share price of C$0.65 and a premium of 32% to FAN s 20-day VWAP. Farallon's Board of Directors have unanimously recommended that shareholders tender their shares in favour of Nyrstar s offer. Each director and officer has entered into a lock-up agreement to tender in favour of the bid (2.6%). Lock-up agreements have also been entered into with Acuity Investment Management (16.3%), FAN s largest shareholder. In aggregate, holders approximately 18.9% of Farallon common shares have agreed to tender in favour of the transaction. The Offer will be open for acceptance for a period of not less than 35 days post the mailing of the takeover circular and will be conditional upon, among other things, approval by FAN shareholders totalling at least 66 2/3%. The transaction is conditional on a number of customary conditions including receipt of all regulatory approvals and no material adverse change in Farallon's business, and other customary conditions. The transaction is expected to close by the end of the year. Under the support agreement Farallon has agreed to pay Nyrstar a "break" fee of approximately C$12MM (3% of the transaction value). Nyrstar has agreed to pay Farallon a "break" fee of C$1.5MM in certain circumstances. Nyrstar does have the option to match any superior proposal. Who is Nyrstar? Nyrstar is a leading global multi-metals business, producing significant quantities of zinc (1.1MM tpa of zinc metal) and lead (240,000 tpa) as well as other products (including silver, gold and copper). Nyrstar is listed on NYSE Euronext Brussels under the symbol NYR. Over the past few years the company has entered into a strategy to pursue vertical integration for its zinc metallurgical business due to increased competition to secure long term supply to feed its smelters in response to the growing demand from China. Current market value is approximately EUR 1.2BB. The company has also announced a rights offering to raise EUR500 MM overnight subject to a shareholders meeting on December 14. At as June 30, 2010 Nyrstar had cash on balance sheet of EUR105MM and long term debt of EUR493MM. The company has around EUR300MM in undrawn credit available under its current credit agreements. Valuation Is There Room For More? From a valuation perspective the bid is directly in-line with our target price based upon a 4.5x 2011 CF estimate using $1.10/lb zinc price and our NAVPS of C$0.79 (down slightly due to Q3/2010 performance) using a long term zinc price of $0.70/lb. Recall, our NAV assumes a doubling of the G-9 reserves at similar grades, however, it does not reflect a value for the exploration potential of the remaining land package (several other untested anomalies exist) nor does it reflect the potential value for the ~11.0MM tonnes of gold-rich, fine grained resources defined on the property which contain 1.0MM oz of gold. Farallon is currently reviewing the metallurgical attributes of this material to determine the economic viability of processing this ore in the current mill or stand alone given the high gold values. Given the bid does not reflect a premium to our valuation we would typically suggest there is some room to the upside to support a higher bid to justify a control premium, given the prospective nature of the land package and other resources. That said, in our view, other suitors are more likely to be merger of equal candidates such as Breakwater ( BWR-T, C$10.00 Buy) or other mid tier companies. Given the cash During the past twenty-four months, Cormark Securities Inc., either on its own or as a syndicate member, participated in the underwriting of securities for these companies
nature of the bid and the financial depth of Nyrstar we do not see a competitive bid arising. That said, an outside chance of Vedanta or a Chinese bidder cannot be totally ignored. Implications for Other Canadian Listed Zinc Producers/Developers In our view this transaction supports our valuation approach for other zinc producers, most notably Breakwater, and our positive view of the zinc market as a while going forward. We continue to see the zinc market as transitioning to a structural deficit beyond 2011 due to the lack of new supply and slowing Chinese production growth at a time when demand looks set to remain firm. The bid also underscores the demand for long term supply continues to be a focus which should support smaller zinc developers such as Zincore Metals (ZNC-T, Watchlist Name, Not Rated), Firestone Ventures (FV-V, Not Rated), Selwyn Resources (SWN-V, Not Rated) and Metalline Mining (MMZ-T). Iberian Minerals (IZN-T, C$0.80 Buy) also produces a significant amount of zinc as well as copper. And Q3/10 Results Out While somewhat irrelevant, Farallon Mining also reported Q3/10 financial and operating results. For the quarter the company produced 18.9MMlbs exactly in-line with our estimates. Cash costs, however, were higher than expected coming in at $0.35/lb versus our estimate of $0.11/lb and above the $0.05/lb in Q2/10. Higher on-site operating costs and lower by-product revenue caused the higher costs in the quarter. CFPS, before working capital items, came in at $0.00 below our estimate of $0.02. The company ended the quarter with $23MM in cash and a working capital position of $22MM. Maintaining C$0.80 Target; Moving To Tender Recommendation The cash bid from Nyrstar confirms our thesis that significant inherent value does exist at the company s G-9 mine. Given the acquisition is an all-cash friendly deal, we do expect Nyrstar to be successful in there bid. We are therefore moving to a Tender recommendation. Our C$0.80 target is unchanged. During the past twenty-four months, Cormark Securities Inc., either on its own or as a syndicate member, participated in the underwriting of securities for these companies
Farallon Mining Symbol TSX:FAN Rating: Tender Share Price (C$) $0.78 Target (C$): $0.80 Market Cap (C$MM) $369.3 Return: 3% Metal Price Assumptions 2009A 2010E 2011E Company Profile Zinc (US$/lb) 0.75 0.95 1.10 Attrib. Zn Production (MMlbs) 2009A 2010E 2011E G-9 Mine 70.3 85.0 115.4 Total Production 70.3 85.0 115.4 Cliff Hale-Sanders, CFA (416) 943-4222, csanders@cormark.com Farallon Mining is an emerging low-cost zinc producer which owns the zinc-rich polymetallic G-9 mine located in Guerrero State, Mexico. G-9 is part of the Campo Morado property which hosts five other distinct deposits including El Largo, El Rey, Reforma, Naranjo, and La Lucha.With only a select few equities providing exposure to zinc, Farallon Mining offers investors leverage to the strengthening metal, which shows particularly compelling fundamentals in our view. The Company has a healthy balance sheet, which should allow it to optimize Campo Morado and expand its resource base Net Cash Costs (US$/lb) 2009A 2010E 2011E Production Profile (MMlbs) G-9 Mine 0.33 0.12-0.02 Wtd. Avg. Net Cash Costs 0.33 0.12-0.02 140.0 120.0 Inc. Statement (US$MM) 2009A 2010E 2011E Total Revenue 89.1 156.5 223.8 100.0 Operating Costs 75.2 87.7 94.7 80.0 Gross Profit 13.9 68.8 129.1 60.0 Gross Margin 16% 44% 58% EBITDA 3.9 53.3 117.0 40.0 EBIT (7.1) 39.4 98.6 20.0 Reported Net Income (15.7) 27.0 68.6 0.0 Reported EPS (US$/sh) -0.04 0.06 0.14 2009 2010 2011 2012 2013 Adjusted EPS (US$/sh) -0.03 0.05 0.13 G-9 Mine Cash Costs $0.40 $0.30 $0.20 $0.10 -- ($0.10) ($0.20) ($0.30) Cash Flow Statement (US$MM) 2009A 2010E 2011E Resource Profile Operating CF bf. ch. in WC (3.5) 39.2 88.1 Ownership Mine Zn (%) (MMlbs) CF From Operating Activities (6.2) 33.6 88.1 P&P 100% U/G 10.00% 430 CF From Financing Activities 26.4 0.7 (9.0) M&I 6.71% 889 CAPEX (11.4) (9.6) (7.0) Inferred 8.61% 222 CF From Investing Activities (11.6) (9.6) (7.0) Global Resource 7.66% 1,541 Net change in cash 8.6 24.6 72.1 CFPS bf. ch. in WC (US$/sh) -0.01 0.06 0.17 Balance Sheet Items (US$MM) 2009A 2010E 2011E NAV Breakdown (US$) ($MM) ($/share) Cash 21.6 33.0 105.1 G-9 Mine 365.7 0.72 Current Assets 39.3 49.5 121.6 Total Mining Assets 365.7 0.72 Property, Plant & Equipment 127.5 123.3 111.9 Total Assets 166.8 172.8 233.5 Cash & Cash Equivalents YE 33.0 0.06 Short-Term Debt 5.0 9.0 9.0 Total Debt YE (23.0) (0.05) Current Liabilities 24.4 20.7 20.7 Proceeds from ITM Instruments 16.6 0.03 Long-Term Debt 24.3 23.0 14.0 Total Financial Assets 26.6 0.05 Total Liabilities 123.8 112.0 103.0 Working Capital 14.9 28.9 101.0 Net Asset Value (US$) 392.2 0.77 Valuation Metrics 2009A 2010E 2011E Net Asset Value (C$) 404.4 0.79 P/E -26.0x 16.0x 5.6x P/CFPS -73.5x 11.7x 4.4x P/NAV 0.99x EV/EBITDA 93.6x 6.9x 3.2x Source: Cormark Securities
We, Cliff Hale-Sanders and Rajiv Chail hereby certify that the views expressed in this research report accurately reflect our personal views about the subject company(ies) and its (their) securities. We also certify that we have not been, and will not be receiving direct or indirect compensation in exchange for expressing the specific recommendation(s) in this report.
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