Saturday, January 10, 2009 4 comments ++[ CLICK TO COMMENT ]++

Special situation: Unwinding of Sprott Molybdenum Participation Corp

A Canadian listed fund, Sprott Molybdenum Participation Corporation (TSX: MLY), which set up a fund two years ago to invest in molybdenum assets is being wound down (official press release here.) There is an opportunity for investors to make some money from the liquidation but it may be a bit too late right now, given how the stock has run up. Nevertheless, it is worth watching.

Note that this is a Canadian-listed security and it is unlikely to be worth it for foreigners unless they can hedge the Canadian dollar exposure. The currency fluctuation may wipe out any potential return.

The Globe & Mail has a summary of the situation:

Sprott Molybdenum Participation Corp. said Friday that following a strategic review announced last month, its board of directors has determined that distributing its assets to shareholders would be in their and the company's best interests.

The company, which went public at $5 a share in April, 2007 – raising $189-million in its IPO – said its net asset value was $1.75 a share as of this Wednesday, with $1.51 of that held in cash and short term securities, net of liabilities.

...

Mr. Sprott, who also heads Sprott Asset Management Inc. in Toronto, created the molybdenum company to invest both in companies that explore for, mine or process the stuff and in the physical metal itself.

At the time, the price of molybdenum oxide had stabilized at about $25 (U.S.) a pound, according to the prospectus for the firm's IPO. The price had begun rising in 2002 and peaked at about $40 a pound in mid-2005, well above the historical 5- and 10-year average of $17 and $10, respectively.

Sprott was banking on prices rising again, based on increased demand and under-supply.

However, despite initial gains, the price was swept away in the commodity sell-off last fall, plunging by about 27 per cent to $23.25 a pound during October alone, and averaging only $9.63 a pound last month.


You can see how brutal the commodities sell-off has been in some areas. It also shows the massive size of the bubble. Here we have molybdenum rising up to $40 before collapsing to the $10 range. Incidentally, the historical average is around $10 so you can see the widely-held view that commodities should trade at the marginal cost of production being illustrated.

The stock rose and closed Friday at C$1.57.

You are looking at a 11.5% return if the NAV stays the same and liquidation costs were zero. However, the non-cash portion of the NAV may decline if the holdings get hit (given how the stock market is wobbly, it would not surprise me if those holdings decline.)

Given how $1.51 of the fund is cash, a conservative purchase would be to buy below that. You are essentially guaranteed profit, after deducting for liquidation costs, if you buy below that.

I'm not sure how much the liquidation costs will end up being. There are 39.433 million shares outstanding so if you assume liquidation will cost $2 million then you are looking at around 3% of NAV being lost to liquidation costs.

I would only consider buying below the cash value--unless I became bullish on the rest of the holdings and felt that they would not decline. I'll add it to my watch list and see if the price drops below the cash value. If it falls to around $1.2, it would be worth buying.

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4 Response to Special situation: Unwinding of Sprott Molybdenum Participation Corp

contrariandutch
January 12, 2009 at 3:50 PM

Are you bearish on the canadian dollar that you stress the currency exposure so much?

January 12, 2009 at 4:31 PM

Yes, I would have to say that I'm bullish on the US$ and hence am bearish on C$. But I don't have a strongly negative opinion of the C$ (I'm more bearish on Euro.)

I keep stressing the currency, not because I expect to see the C$ decline, but rather because I don't want to see the currency wiping out the gain. This is especially a concern for risk arbitrage where your potential gain is finite within a short period of time. You just can't wait to see the currency reverse, as you can with a long-term long/short position. Currencies, if not hedged, are a big problem for risk arbitrage.

For example, Americans who took a risk arbitrage position in BCE is down almost 50% versus around 30% in C$ terms. Even if the deal had closed, they would have lost 20% in the C$ decline and ended up posting close to zero or slightly negative return (depending on purchase price.)

I am not as concerned with currencies for long-term investments...

contrariandutch
January 13, 2009 at 2:22 PM

I am moderately bullish on USD as well, although more from concern over euro weakness then USD atractiveness. Anything in particular that makes you bearish on C$?

January 13, 2009 at 3:14 PM

It's not a strong feeling but the problem for the C$ is that it is a commodity currency of late. I am not sold on commodities and if they weaken the C$ may come under further pressure.

Furthermore, a big chunk of Canada depends on exports to the US. The slowdown in the US will hurt Canada and pressure the C$.


Having said all that, a lot of people seem to be betting on the re-flation trade... so if you are bullish on commodities, C$ will strengthen...

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