If you believe as I do that uranium is a good long-term investment, Denison Mines (NYSEMKT:DNN) offers investors an interesting investment opportunity right now. At current prices you are actually acquiring ownership in two companies, Denison and its Canadian and global uranium assets and Energy Fuels Inc. (EFRFF.PK), which has agreed to acquire Denison's U.S. uranium assets including its White Mesa Mill. Denison's stock has fallen significantly since the announcement of this transaction on April 16, 2012. There may be an opportunity to benefit from a bit of arbitrage when the transaction is completed. Beyond that short term opportunity, the two resulting companies appear to offer compelling exposure to favorable long term trends for uranium.
Source: Yahoo Finance
On April 16, 2012 Denison and Energy Fuels announced this agreement:
Energy Fuels Inc. and Denison Mines Corp. today announced that they have entered into a Letter Agreement to complete a transaction (the "transaction") whereby EFR will acquire all of Denison's mining assets and operations located in the United States (the "US Mining Division") from Denison in exchange for 425,441,494 common shares of EFR (the "EFR Share Consideration"). Immediately following the closing of the Transaction, Denison will complete a Plan of Arrangement (the "Denison Arrangement") whereby Denison will complete a reorganization of its capital and will distribute the EFR Share Consideration to DML shareholders on a pro rata basis as a return of capital in the course of that reorganization. Upon completion of the Denison Arrangement, Denison shareholders will receive approximately 1.106 common shares of EFR for each common share of DML owned and will in aggregate own approximately 66.5% of the issued and outstanding common shares of EFR.
Management of the two companies believe that separating the assets will result in greater realization of shareholder value and I concur. Once the reorganization is complete, EFR will become the largest 100% U.S. pure-play uranium producer as well as one of the largest holders of National Instrument 43-101 compliant U.S. based uranium. 2012 production forecasts for the company total more than 25% of U.S. total production estimates. In addition to Denison's U.S. mining assets, EFR will also operate the White Mesa Uranium Mill, the only operating conventional uranium mill in the U.S. Management of EFR also indicated in the press release that this transaction is intended as a platform for further consolidation of uranium assets in the U.S. Adding assets should increase output significantly at White Mesa which has historically operated at far less than capacity.
Looking at comparisons in the sector the new Energy Fuels looks to trade at a significant discount to its peers. In its investor presentation on the merger, management indicates U.S. based uranium producers trade at average Price/Net Asset Values of over .50, while companies with U.S. based production like Cameco (NYSE:CCJ) and Uranium Energy (NYSEMKT:UEC) trade between .85 and over 1x NAV. According to the company presentation on a post transaction pro-forma basis, EFR trades at a price of roughly .25 of its NAV. This supports management's assertion that once the markets better understand the new EFR, it will garner a higher valuation commensurate with other leading U.S. based developer/producers. Based on those comparisons it has the potential to trade 2-4x higher than today's prices or between $.50-1.00/share. The fact that analysts like RBC's Adam Schtzker believe that Denison sold its U.S. assets below net asset value further reinforces mine and management's belief that the newly formed EFR.TO is dramatically undervalued.
Mr. Schatzker does note, however, that the sale price is significantly lower than RBC's net asset value estimate of $312-million.
Denison After The Distribution
After the merger is complete and Denison and the assets are divvied up, Denison shareholders will be left with 1 share of DNN and roughly 1.1 shares of EFR for each share of DNN they currently hold. If it happened today for my hypothetical 1,000 shares of DNN, I would end up with 1,000 shares of DNN and roughly 1,100 shares of EFRFF.PK. You would expect that the value of this transaction is reflected in the current price of DNN, but that isn't necessarily a valid assumption. First, there is some discount applied to account for the likelihood that the transaction does not end up coming to fruition. This is a possibility and each investor must make assumptions about the probability of each outcome and how that outcome will potentially impact the shares of DNN. I believe the likelihood of this transaction being completed is very high.
I also believe that even if it doesn't go through DNN is priced attractively on its own and remains a good long term investment. Perhaps as some analysts believe it is even a potential acquisition target for a larger company like Cameco. The chart below from the World Nuclear Association depicts only one scenario where there is ample production to satisfy demand for uranium after the year 2013 and there are very few companies with Canadian assets as attractive as Denison. Canada is the world's second largest uranium miner accounting for approximately 22% of the world's supply. BMO Capital Markets analyst Edward Sterck noted that "the trimmed-down Denison may be more attractive as an acquisition target (after) the transaction." RBC Capital Markets analyst Adam Schatzker also believes Denison Mine's remaining Canadian properties are attractive to potential buyers:
"We think that senior uranium producers will be very interested in the strategic value of the McLean Lake mill, the Wheeler River exploration project, and potential for relatively near-term production from McLean North Underground," he said in a note.
Given that I feel comfortable owning Denison regardless of the outcome of the EFR transaction (I owned DNN before this announcement) the pending transaction only improves the current investment profile of DNN. I believe the current price of DNN offers the opportunity for a measure of arbitrage, or money for nothing. If I buy 1,000 shares of DNN today and pay $1,550 I will receive an additional 1,106 shares of Energy Fuels when the deal is completed. If I receive 1,106 shares of EFRRF.PK at current prices of .26/share at conclusion of the merger, I don't believe DNN will trade down to $1.30 to reflect the distribution.
I believe as we get closer to the deal's approval, scheduled for the end of June, DNN will trade back up to where it was after the deal was announced or roughly $1.80 and EFR will stay between today's quote of .26 and .30. That means when the deal is concluded and shares are distributed I will end up with over $1,800 in stock (1,000 DNN at 1.50-155 post distribution of EFR and 1,100 EFR.TO at .26-.30). That is a 16% gain from today's levels and after the transaction investors will still hold two companies that remain undervalued and offer significant upside.