SDL 0.00% 0.6¢ sundance resources limited

jpmorgan coverage on sdl

  1. 3,394 Posts.
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    JPM Aust: BUY SDL - Spread Trading Too Wide
    By Sujit Dey

    BUY SDL - Spread Trading Too Wide

    The share price action in SDL surprises me. On 3 October, the stock was trading at 43c which represented a 16% gross spread. At the time, the markets were looking extremely shaky, iron ore comps were falling heavily and the market was pricing in a large chance of no deal, let alone a bump. Since that date, we have seen Hanlong come back with a formal, 57c revised offer price (14% bump), the ASX 200 has rallied 9%, iron ore comps have rallied 10% and the Cameroon government looks like it will get re-appointed. But despite all of this the SDL share price is basically at the same point as where it was before all of these events took place.

    SDL is now trading at a 31% gross spread which equates to ~56% annualised. The market is placing only a ~60% chance of the deal getting completed. The amount of risk being priced in confuses me considering when you look at the EXT situation, the stock is implying a ~28% annualised return. In that deal, you don't even have an "intention to make an offer". The two parties are merely in talks and yet the spread is so much tighter than the SDL deal (although it should widen today on the back of the KAH announcement last night which showed that no price has been agreed yet).

    Some may argue that the KAH/EXT deal has counter bidding optionality because RIO may get involved. Personally, based on our conversations with RIO, it doesn't look like RIO is focussing on uranium right now. I think the more likely scenario is that RIO will attempt to form a partnership with CGNPC once the takeover is complete. Therefore, I think SDL has a higher chance of a counter bid than EXT. West Africa is the only region in the world where all the global majors are competing head to head in iron ore. As you can you see in the map below, BHP, RIO, Vale and Xstrata all have projects in this region. In fact, BHP recently told us at their site visit that West Africa is the most prospective region outside of WA and Brazil.

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    Originally when the revised proposal was announced, I thought potential counter bidders must have chosen not to bid. But now I've changed my view. I can't see a Western major making a bid when the mining conventions have not been agreed yet. RIO has learnt first hand about what can happen in developing countries with regards to nationalisation / larger government ownership threats. It has had recent experience in Guinea, Mongolia and Zimbabwe on this front. Therefore, I'd expect these majors to wait for the project to get de-risked through the mining convention agreements. Once these agreements get signed, then the majors will know exactly what they are bidding for and I wouldn't be surprised if we see a counter bid. SDL's Mbalam project is a large, world-class, tier 1 asset that could easily attract a counter bid.

    Despite SDL looking much more attractive now compared to last week, why is the stock trading at roughly the same price? Market conditions are much better now and we have a bid on the table at a much higher price. There is only one explanation for this unusual trading, in my opinion. I checked the market share stats and since the revised proposal, Commsec has had the no 1 market share (20%) followed by D2MX (9%). Therefore, ~30% of the trading in this stock was done by retail brokers. Retail shareholders seem to be using the revised proposal as a "get out of jail" card and are selling out. Many of these shareholders have been hurting due to the market's major sell-off and I'm sure retail shareholder deleveraging has been a big theme in recent months. But overall, I don't think this share price reflects the right level that SDL should be trading at and once the retail selling finishes, the spread should tighten.

    One piece of news that came out this morning however is that the FIRB will not progress its decision on the bid until it has a fuller picture of the ASIC findings of the insider trading investigation. This story, reported by the SMH, seems extremely unusual to me. Why would the FIRB have any issues with this deal when the asset is located in Africa? The FIRB has never rejected a deal involving an overseas asset and I don't think it will reject this one. There is no national interest issues in this case. Therefore, I question how accurate this story is.

    But assuming the story is accurate, there is one reason I can think of for why the FIRB has decided to hold off its decision. It could be part of a new process that the FIRB is undertaking which involves always having the last say on deals. This is a similar approach that the NDRC has been taking. We recently saw the FIRB decide to defer its decision on Foxtel's acquisition of AUN until after the ACCC decision, despite Foxtel being majority Australian owned. While the news snippet may lead to some weakness in the share price, I doubt the ASIC investigation will impact the deal.

    Overall, I continue to like the SDL situation. It is clearly not the cleanest deal around due to the mining conventions risk and the background noise around the insider trading allegations, but the spread is more than reflecting this. The stock is trading at a massive 31% gross spread which annualises a return of 56%! I'm not concerned if the FIRB is waiting for the ASIC findings because SDL has allowed ~7 months to complete this deal. The FIRB should not impact this timeline because there is ample time for the ASIC findings. Once the mining conventions are out of the way, I think there is a reasonable possibility around a counter bid and the market doesn't seem to be factoring this in either.

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