The war between Lion Selection (LST) and Indophil (IRN) is heating up. Indophil is currently urging Lion shareholders to accept its bid of a minimum of 2.5 Indophil shares for every Lion share held. Indophil’s offer closes on 12 June, however we believe it is likely that the offer will be extended.

Meanwhile, Lion is telling its shareholders to reject the offer and instead vote for Lion’s own proposal, which involves a significant restructure and return of cash. The vote will take place at Lion’s Annual General Meeting on Monday 23 June.

Throwing the proverbial spanner into the works, Xstrata Copper subsequently made a $1.00 per share cash bid for Indophil. Xstrata has yet to file a Bidder’s statement, however the bid is conditional on a number of outcomes and we’ll discuss these shortly.

So, what are Members to do? We maintain our previous advice to take no action in relation to any of the offers on the table. The situation is complex and until we have more clarity on the possible outcomes, which we hope to have in the next few weeks after discussions with the various parties, we recommend that Members do nothing.

Our take on the matter is that a poorly executed takeover attempt by Indophil has resulted in a reactionary and highly defensive strategy by Lion, which in turn has brought Xstrata into the game, making an opportunistic bid for Indophil. Let’s look at the possible scenarios for each set of shareholders.

Lion Selection

In reaction to Indophil’s bid (outlined below) Lion’s proposal is to essentially sell off their best assets and return cash to shareholders. After doing an about face on its recently articulated strategy to become a mining company rather than an investment company, Lion is now proposing to sell the 30% stake in the Cracow gold mine in Queensland, and has already committed to sell 17.76% of its Indophil stake to Xstrata for $1.00 per share.

In addition, emerging nickel producer Albidon, which Lion controls through its African Lion Funds, is up for sale. At a current price of around $4.40, any sale should generate cash of just over $40 million for Lion.

Including Lion’s current cash holding of just under $100 million, the proposed sales would lift the cash balance to over $300 million. Under Lion’s plan the majority of this cash would be returned to shareholders (equating to between $1.35 - $1.50 per share), leaving a smaller portfolio of investments and a net tangible asset backing of around 70 cents per share.

While there is nothing particularly wrong with this strategy, our frustration stems from the confused and reactionary nature of communicating this to shareholders. Instead of continuing with the previous strategy of building a portfolio of operating assets, Indophil’s offer has suddenly turned Lion bearish, or at least equivocal, on the nature of the resources boom.

In the latest quarterly report, Lion states: “We are nearing the top of the cycle and while the strong resources market could continue for some years, it could end tomorrow. The opportunity to convert major assets to cash has arrived and we plan taking it.”

However in the same report Lion says it is working on a plan to “allow shareholders to either take cash OR retain and possibly increase their investment in a new expanded Lion.”

One of the biggest disappointments from our point of view is the proposed sale of the Indophil stake to Xstrata for $1.00 per share, which values Indophil at around $425 million. Given Indophil has $100 million in cash, Xstrata is really paying $325 million for Indophil.

While there are convincing arguments that Indophil’s Tampakan gold/copper deposit holds considerable political and capital expenditure risk, we believe $1.00 is an attractive price for Xstrata to pay. On the flip side, Lion shareholders are not getting maximum value for the risk of being invested in Indophil for all these years.

We plan to meet with Lion during their investor roadshows in June and will subsequently update Members on their strategy.

Indophil

Indophil has offered 2.5 to 2.7 shares per Lion share. At current prices, this values Lion at $2.75 to $2.97, significantly above Lion’s current trading price. But Indophil’s share price has obviously been buoyed by Xstrata’s $1.00 bid, and this bid disappears if Indophil is successful in taking out Lion.

Let’s assume that Xstrata’s bid, even if it is withdrawn, places a floor under Indophil’s share price. So at $1, Indophil’s offer for Lion is worth $2.50 - $2.70. If successful, the enlarged Indophil could still negotiate a sale with Xstrata for a presumably much higher price.

This may take some time and such an outcome, if successful, would be a good result for current Lion shareholders, although we doubt that Indophil shareholders would be overly impressed. If Indophil were successful in taking over Lion, and then sold Tampakan to Xstrata, the Indophil team would end up controlling Lion’s old asset base, minus Tampakan!

While the implied value of Lion (assuming $1 per IRN share) looks attractive, the risks also increase. Lion shareholders would have full exposure to the Tampakan deposit, and the Indophil management team will be running a book of assets with which they have little experience. Moreover, we know nothing of Indophil’s plans for Lion’s assets, apart from the obligatory ‘strategic review’ as outlined in the Bidder’s Statement.

Indophil shareholders do not really have a choice in relation to the above scenario. However, they do have a say in the Xstrata offer and with the Bidder’s Statement not even released by Xstrata at this stage, we recommend Indophil shareholders do nothing.

To reiterate, we recommend that both Lion and Indophil shareholders do nothing at this stage. We anticipate that Indophil will extend their offer, which should draw a response from Xstrata, given Xstrata’s bid for Indophil is dependent on them NOT extending their offer...just to make the situation more confusing. Our aim is to try and maximise the long term outcomes for shareholders of both companies and our recommendations will reflect this intention.