As long-term shareholders of Pan American Silver (PAAS), who've held it for more than a decade, we were surprised to hear that its management has decided to purchase Minefinders (MFN) - whose PE ratio is roughly twice that of PAAS. We've taken a closer look at the proposed financials, and the deal does not add up.
On August 26, 2011, PAAS shares were low enough that the company initiated a stock repurchase program for up to 5 percent of the stock. At the time it was stated that "in the opinion of its board of directors, the market price of its common shares, from time to time, may not fully reflect the underlying value of its mining operations, properties and future growth prospects." The price of PAAS closed that day at $31.72. It's rather dubious that a stock price, which was considered cheap at $31.72, is now considered well priced to use as buying collateral at $23.
Generally, acquisitions are accretive when a company with a large cash balance uses it to purchase a profitable business in cash, or when a fair- to highly-priced company trading near the highs of its PE range uses its stock as collateral to purchase a business with a lower price and higher growth rate. In the case of PAAS buying MFN, neither of these conditions apply. PAAS has proposed to make a stock purchase using its shares with a PE in the 7-8 range of MFN, whose PE is in the 15-16 range. Furthermore PAAS earnings are projected to grow faster than MFN.
|total shares MM||107.3||96.3||160.265|
|2011 total e, MM||$246.79||$82.818||$329.608|
|2012 total e, MM||$305.805||$91.485||$397.29|
Based on the data above, we estimate that due to the proposed acquisition of MFN, PAAS shareholders will suffer an immediate loss of $1.11 per share for the cash payout, and an additional 15 percent dilution in earnings. We estimate that instead of trading at $23.18 today, PAAS would be trading at $27.77, implying a total dilutive loss of 20 percent. It is worth noting that Pan American Silver's massive Navidad project in Argentina is not currently priced into either the earnings projections or price of its stock. As a result, Navidad is an effective call option, which could potentially double the production from roughly 22 to 44 million ounces of silver per year. Since this isn't priced into the stock, the dilution of current shares could prove to be even more folly pending approval of Navidad by the Argentinean government.
At the end of 2011, Bill Fleckenstein resigned from the board. While we don't know the reason for sure, we now know that this directly preceded PAAS' dilutive bid of MFN. Perhaps Mr. Fleckenstein opposed the dilutive action.
It's difficult to buy and hold a stock that is underpriced by the market. It's even more difficult to learn that management of the company attempts to justify the low price by diluting the company's value. We expect PAAS to underperform its peers going forward as it consolidates the dilutive loss.
The largest winners of this deal will be the management teams of PAAS and MFN. The largest losers will be PAAS shareholders. One year ago, MFN stock was trading in the $11 range and PAAS was above $40. Had it purchased MFN then, it would have been far less dilutive. Now, PAAS shareholders are paying almost twice the price for the same acquisition. We plan on voting against the acquisition, and would support an effort to replace current board management.