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.