Shorting Anvil Mining Provides Degree Of Comfort

Jan.20.12 | About: Anvil Mining (AVMNF)

Asymmetrical risk-reward opportunities are not always obvious, and it’s not every day that one can be certain to a high degree what can be the loss/gain generated from an investment.

Anvil Mining Ltd. (OTC:AVMNF) is an Australian (also listed on the TSX) copper miner in the Katanga province of the Democratic Republic of Congo (DRC). It owns 95% of the producing Kinsevere property (5% owned by a private local company) and 70% of the Mutoshi joint venture exploration project with Gecamines (30%), a state owned miner.

On September 30, 2011 Minmetals Resources Ltd (MMR) initiated a friendly takeover offer to buy Anvil for CAD$8/share. The offer was accepted by company insiders and Trafigura, which together own roughly 40% of the company.

On October 31, 2011 the company published a news release indicating the deal might fall apart if the company did not come to an agreement with Gecamines with regards to a complementary feasibility study on the Mutoshi project. Anvil responded that the company did submit the study in August, 2011.

The offer has since been extended 3 times with the current expiration date being February 16, 2012. That’s roughly four months to get the green light to purchase a $1B company, which is not big in relative terms. Whether the deadlock is really due to the feasibility study it is difficult to say. It is, however, difficult to understand why anyone would purchase the shares around the $7.60 levels.

From a short view, the math works:

Scenario

Deal Succeeds

Deal Fails

Deal Adjusted

Short price

$7.60

$7.60

$7.60

Purchase offer (net of arbitrage)

$7.96

Price prior to offer

$5.77

Price ex. Mutoshi project (net of arbitrage)

$7.69

Gain/(Loss)

-$0.36

$1.83

-$0.09

Return on investment

-4.74%

24.08%

-1.18%

Click to enlarge

The table above illustrates the potential gains and losses from shorting the stock and also shows the disproportionate risk investors take when buying the stock. Buying the stock can only result in a rounded 5% gain, but can also result in a 24% loss on the day the deal is announced to fail. The stock will probably continue to decline further with the passage of time.

On the flip side, shorting the stock provides a degree of comfort that the potential loss is capped around 5% and the potential gain is 24% on the day the deal is announced to fail.

The risk reward ratio is roughly 5 ($5 of potential gain for every $1 of potential loss). Excluding the chance the deal will be adjusted to exclude the Mutoshi mine, which accounts to roughly $0.31 of the bid offer, the market is factoring an 83.5% chance the deal will succeed. The exclusion of the third scenario (deal adjustment) is warranted since its not likely MMR will adjust its offer.

At $7.60 per share, the market indicates a short position is 83.5% likely to lose:

Scenario

Deal Succeeds

Deal Fails

Deal Adjusted

Total

Probability

83.50%

16.50%

0.00%

100.00%

Expected payoff

-$0.30

$0.30

$0.00

$0.00

Click to enlarge

The deal might succeed and the persistence of MMR is probably reassuring investors the deal will indeed get eventually done, and that’s why this is a speculative bet. Indeed, some say negotiations between Gecamines, Anvil and MMR were on hold until the November 28th elections in DRC were over. Joseph Kabila was declared the winner on December 9th.

Yet, the offer did get extended by a few months. To me, this is a red flag. In addition, I have yet to find the feasibility study the company originated on the Mutoshi site in the public domain (the August, 2011 study).

Granted, not all company information is made public, but it seems to me that such a document, with its ability to add value to the company’s shares, would be published for investors to evaluate. It’s also possible the company submitted to Gecamines a quick and dirty study, not fit enough to pass the NI-43-101 regulatory standards and therefore, not published. But now we are just speculating.

Disclosure: I am short Anvil Mining Limited on the TSX.