ENRC – A riddle inside an enigma right until the last with an arbitrage opportunity on the table

One of the features of the noughties mining booming was the listing in London of a number of large mineral resource companies from the former states of the USSR. State assets that were bought up in the rounds of post glasnost privatisations were packaged together to form corporate entities which could gain the cache of a senior UK if not a FTSE 100 listing. It seems that during this period the strict standards that had previously been applied to companies looking to list at the top level London’s equity markets were waived and a number of  new & exotic businesses took their place in the official list.

One of the first of these vehicles to list was ENRC which hailed from Kazakhstan in Central Asia and has interests in Ferrochrome, Iron ore and  Aluminium as well as, which we would discover, a complete lack of interest in acceptable standards of UK corporate governance. The list of faux pas made by ENRC is extensive but its attempts to buy assets from the Government of the Democratic Republic of the Congo which had previously been confiscated from rivals First Quantum made even the normally prosaic mining community blush. The poor governance standards at the company and the downturn in mining and commodity markets over the last two years prompted ENRC’s major shareholders (a group of oligarchs, or other terms some would apply) to launch a bid for the company back in late June, effectively closing the bear they had opened at 540p when the company listed in London six years ago .

However, investors hopes for a premium bid for ENRC (including our own) were dashed by the oligarchs who offered the equivalent of just 234p per share to ENRC’s external shareholders. A take under not a takeover. The oligarchs saw no reason to be generous because they accounted for 54% of the equity in the Kazakh based group and that majority would shortly be bolstered by the acceptance of the company’s other major shareholder and countrymen Kazakhmys who hold a 26% stake and whose shareholders (read senior management and major shareholder) have tacitly accepted the oligarchs offer. The deal is set to close on the 28^th of August and to all intents and purposes is a fait accompli.

However even in the death throes of its London listing ENRC remains an enigma as a look at the numbers shows us. The oligarchs bid for ENRC comprises US$2.65 cash and 0.23 Kazakhmys share for each ENRC share. The value at today’s KAZ closing price and FX rate is @ 240p. That compares to a closing price on the 27/08/13 of just 215p per share. What’s more, the ENRC price also seems to in fact be discounting the sharp rise in Kazahkmys shares since the bid was launched in late June, over which time frame Kazahkmys have rallied by 22%, and which in theory should have sweetened the deal. Although still leaving a bitter taste for many.

This is not the only quandary however because as we have already noted Kazakhmys has a 26% stake in ENRC. Based on last night’s closing price in ENRC, that stake is worth around £720 million which is more than 50% of the current market cap of Kazakhmys. If we value the stake at the bid price of 234p it’s worth another 9% or a total of £784 million pounds. Even if we apply the cash bid per ENRC share (US$2.65) only to the Kazakhmys holding at the current cable rate of $1.5544, we get a value of @ £1.70 per ENRC share which equates to a valuation of some £569 million pounds for the Kazakhmys stake. Regular readers of this blog will know that we are big fans of KAZ sub 400p and still scratch our head today at the price. We have either really missed something or the re-rating has not even begun.

With the deal closing today, investors will have to be fleet of foot to take advantage of the arbitrage opportunity however. The table below illustrates that if you are able to purchase a notional 1000 ENRC shares at last night close, for say £2150, that you should ultimately receive US$2650.00 or £1707.838 (at current exchange rates) as the cash element of the bid, plus 230 new Kazakhmys shares worth a further £694.60p, valued on last nights close of 302p.

Bringing the total value of your potential receipts to a rounded £2400. This is £250 greater than the cost of the ENRC holding – nearly a 12% uplift and one hell of an annualised return. Of course you will need to sell 0.23 Kaz shares for every 1 ENRC bought to crystallise this gain. In effect, on the completion of the bid you will close out your short KAZ by receiving the KAZ shares.

That window may not be open for long and clearly it’s dependent on the prevailing prices of both ENRC and Kazakhmys as well as the cable (£/US$) rate and above all the treatment of these items by your margin trading or spread betting provider nonetheless there would seem to be an attractive opportunity here and one that we are to take advantage of in our Titan Macro fund as we are perplexed at the size of the arb discount. But then again, ENRC & KAZ have well and truly confounded us in recent weeks and months!

R Jennings, CFA Titan Investment Partners