SolGold announced plans to launch an offer for Cornerstone Capital Resources, which indirectly owns almost 23% of the Cascabel copper-gold project in Ecuador.

The offer was rejected in less than three hours by Cornerstone, but SolGold plans to proceed with it anyway.

I think that it’s unlikely that SolGold will back out and that it could improve its offer for the company if it doesn’t manage to get enough support.

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SolGold (OTCPK:SLGGF) owns 85% of the world-class copper-gold project in Ecuador, while Cornerstone Capital Resources (OTCPK:CTNXF) holds the remaining 15% in the property as well as a 9.2% interest in SolGold.

Flush with cash from recent deals with Newcrest (OTCPK:NCMGF) and BHP (BHP), SolGold announced plans to launch an offer to acquire Cornerstone on 31 January. Under the offer, the shareholders of the latter would get SolGold shares at an immediate premium of around 20%. It seemed like a good offer on the surface, yet, it was rejected by Cornerstone in less than three hours and that was just the beginning of the saga.

The offer

SolGold plans to offer 0.55 shares for every Cornerstone share and it said that it had felt, for some time, that the consolidation of ownership of Cascabel into a single listed entity made “eminent sense” to simplify the structure and to remove the risk of dilution for Cornerstone shareholders. SolGold added that it had approached the company in 2017 and in 2018, but that the latter had asked for too much in return as it wanted half of the seats on the board of directors of the combined entity and the removal of Nick Mather as CEO and Brian Moller as Chairman.

Cornerstone replied that its shareholders will reject the takeover offer as it’s underwhelming. It added that owners of over 50% of its shares will not support the terms of the proposed offer, which led SolGold to doubt how the company managed to contact major shareholders so quickly.

Cornerstone did leave the door open though by stating that it’s open to discussing with SolGold and any other potential bidders any value-enhancing transaction that would garner the support of its shareholders.

Does Cornerstone really have the backing of the holders of more than 50% of its shares? We’ll soon find out as SolGold plans to proceed with its original offer. The company used a very harsh language in its response to Cornerstone, targeting mainly its management. It said the latter had been disingenuous in promoting its stake in Cascabel without making it clear that the company would need to cover its share of exploration financing at some point.

The Cascabel project

Source: SolGold

Cascabel is located on the northern part of the Andean Copper belt around 180 km north of Ecuador’s capital Quito and is one of the most significant discoveries in the copper and gold sector over the past 10 years. On 20 November, SolGold updated the mineral resource estimate for the project, which more than doubled its resource to 15.4 Mt CuEq:

Source: SolGold

The grades don’t look great, but the size of the project is amazing and SolGold believes it can grow a lot more. The company is targeting a mineral resource of 10 million tonnes of copper and 25 million ounces of gold, and it currently has 12 active rigs on the property. It has so far completed over 160,000 meters of diamond drilling on and it currently produces around 10,500 meters of core per month. Over the past year, SolGold has been focused on making the resources, particularly the high-grade portion, larger and higher in grade.

Cascabel has produced some of the best drill hole intercepts in porphyry copper-gold exploration history. For example, hole CSD-16-012 returned 1,560m grading 0.59% copper and 0.54 g/t gold.

There’s a preliminary economic assessment underway for the project, so we’ll know more about its economics soon.

Ecuador itself has managed to attract a lot of interest from mining companies over the past several years, mainly due to a revised regulatory framework and an investor engagement campaign which has already attracted over 400 applications for concessions.

Likely scenarios and investor takeaway

It seems that SolGold plans to proceed with its takeover offer for Cornerstone despite the opposition of the latter. Given the company’s size, it’s unrealistic for Cornerstone’s management to expect to get half of the seats on the board of the combined entity, not to mention its demand that SolGold’s CEO and Chairman step down.

SolGold is right that Cornerstone has to raise a lot of funds for the development of Cascabel, which might prove difficult. To the extent that either Cornerstone or SolGold fail to fund their proportionate interest in Cascabel after the delivery of the feasibility study, that company will have its interest in the project diluted.

The big question is whether the 0.55 exchange ratio fair? Well, Cornerstone bought its stake in SolGold 2017. In June and July of that year, the company acquired a total of 170,156,414 SolGold shares in exchange for 261,778,875 of its own shares, which is equal to a ratio of 0.65. Clearly, Cornerstone shareholders got a better deal less than two years ago.

Cornerstone has other projects besides Cascabel such as Vetas Grandes, Bella Maria, and Cana Brava, but it’s hard to put a value of those as they are early-stage and it seems the market is valuing them at close to zero at the moment. If we take only Cascabel into account, Cornerstone owns 15% of the project directly and another 9.2% of SolGold, which would give it an indirect interest of 22.8%. In other words, excluding any cash and other projects and focusing solely on Cascabel, Cornerstone should be worth around C$305.5 million based on SolGold’s most recent share price on the TSX. This would translate into a share price of C$0.48, which is over 40% more than what SolGold is offering at the moment.

Overall, the offer looks outstanding for SolGold shareholders, but I completely understand why Cornerstone investors could be against it. If the offer is rejected, I think that the most likely response of SolGold would be to increase the offered price, maybe offer a 0.65 ratio.

I don’t think there’s anything impending SolGold from purchasing Cornerstone shares on the open market, so it’s possible the company could go that route to put pressure on Cornerstone’s management. Although I doubt that such a move will put the company’s price over the amount that SolGold plans to offer under a takeover bid.

Even though Cornerstone mentions third parties in its response to SolGold, I don’t think that another company would try to outbid SolGold. Newcrest and BHP immediately come to mind, but I don’t think they would risk damaging their relations with SolGold.

Regarding risk, I think the most obvious one is that SolGold could decide to scrap its offer, which would probably send Cornerstone’s shares down to or below the levels of the planned offer. Still, this seems unlikely. Would SolGold try to play hardball and maybe push Cornerstone’s shareholders to change the board? Seems complicated and also unlikely. Regarding Cornerstone’s demands, I just don’t see SolGold agreeing to give away half of its board seats or kick out its CEO and Chairman. I don’t think most Cornerstone shareholders care much about the composition of the new board and just want to get a fair price for their shares, which could be something close to C$0.40.

To summarize, I think that SolGold will try to launch an offer at the initial terms and it could improve it if it fails to gather enough support. I think that Cornerstone provides a compelling investment opportunity as SolGold is unlikely to back out and the company is still trading at a discount to the offer price.

Separately, any deal under C$0.48 per Cornerstone share should add value for SolGold shareholders as it means that the company is boosting its stake in Cascabel at a lower price than the market values the project through its own shares.

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