Description

With equities on the rich side and cash rates at zero, we’ve turned to arbitrage and other uncorrelated equity strategies as a source of alpha.  

Canada-based Ely Gold Royalties (ELY) is being acquired by Gold Royalty Corp. (GROY) for cash and stock.  Current prices imply a ~17% gross return in less than a month for a ~237% IRR.  The wrinkle: there is no borrow on GROY to hedge the equity exposure.  As a result, professional arbs are unlikely to get involved.  Further complicating things is a deal structure that pays the cash portion of the transaction in Canadian dollars (CAD) and the stock portion in US dollars (USD), possibly leading some retail investors to misprice the deal.

ELY is listed in Canada as ELY and in the U.S. as ELYGF.

Merger Agreement and Opportunity

On June 21st, 2021, Gold Royalty Corp. announced a definitive agreement to acquire Ely Gold Royalties for cash and stock.  The acquisition represents a 42% premium to ELY’s 30-day VWAP.  Each ELY shareholder has the option to receive either i) C$1.46 cash or ii) .2450 shares of GROY stock (currently worth US$1.23); however, this is subject to a maximum cash consideration of C$84MM and a maximum equity consideration of 41.5MM GROY shares. So,  

• If less than 16% of shareholders choose "all cash", those that choose "all cash" will receive all cash. Those that choose "all stock" will receive mostly stock and an increasing amount of cash (as the percentage drops).
• If between 16-28% of shareholders choose the "all cash" option, everyone will receive "all cash" and "all stock" as requested.
• If greater than 28% of shareholders choose "all cash", which is our working assumption, those that choose "all cash" will receive less cash and an increasing amount of stock (as the percentage increases). Those that choose "all stock" will receive all stock. 

If an investor chooses the cash option, they will likely receive some mix of cash & stock.  Assuming more than 28% choose all cash and the maximum cash consideration of $84MM is reached, investors that choose the cash option will receive C$.42 in cash plus 0.1742 shares of GROY stock per ELY share.  That equates to US$1.21 per ELY share vs. it’s current price of US$1.03, a 17% premium and 238% IRR.  

If an investor chooses to receive stock, they will likely receive all stock.  This is currently worth US$1.23 per ELY share, a 20% premium to today's prcice and a 271% IRR.  So, there is slightly more upside to choosing the stock option, obviously due to greater equity risk.

As you can see, the current deal spread offers a large margin of safety.  GROY would have to decline 17-21% (depending on cash/stock election) before the investor sustains a loss.  GROY’s net cash equals almost half its market cap, so a 20% decline in its stock price is an almost 40% decline in its EV, reducing the likelihood of a dramatic decline in its stock price. GROY would have to fall well below consensus NAV for ELY shareholders to sustain a loss. 

Completion of the deal requires:

• ELY shareholder approval of at least two-thirds of the votes.
• ELY shareholder approval of a simple majority, excluding votes from certain members of management and “related parties”.
• Receipt of court and stock exchange approvals.
• Customary closing conditions. 

The ELY shareholder vote is August 18th, with court approval expected a few days later.  The deal can close immediately after court approval.  Management expects the deal to close on August 21st or 22nd. 

The deadline to make an election (cash or stock) is August 12th.  If you don’t make an election, you will be defaulted to “all stock”.

The Acquiror: Gold Royalty Corp.

GROY was created by Goldmining Corp. in 2020 and came public via IPO in March 2021, at $5.00.  GROY was created as a roll-up in the highly fragmented mining royalty industry.  As a new company, GROY’s capital structure is very simple - no debt, $90MM in cash raised in the IPO, and 18 NSR royalties.  GROY has a market cap of $208MM and an EV of $118MM.  Goldmining Corp. maintains 49% ownership.  

GROY appears to have some street cred with investors, primarily via its management team.  CEO David Garofolo was previously CEO of Goldcorp where he led the largest merger in gold mining history when Goldcorp was sold to Newmont Mining in 2019 for $10B.  Ian Telfer, who started Wheaton Precious Metals when he was Chairman of Goldcorp, serves as Chairman of GROYs Advisory Board.  Leading with this pedigree, GROY went public a year after it was created, raising $90MM in their IPO, triple the planned initial raise of $30MM. They raised the offering twice and it was still over-subscribed.  

GROY owns 18 net smelter return (NSR) royalties on 12 projects in five countries.  The underlying projects are mostly very early stage and years away from production.  Royalties range from .5%-2.0%.  Measured and inferred resources equal 16.6MM and 17.0MM oz, respectively.  Eleven of the 18 NSRs are with Goldmining Corp, its prior parent company.  The two most advanced projects are Sao Jorge and Yellowknife.  Sao Jorge is expected to begin producing royalties in 2023, with a 1% royalty on 711,000 measured and 718,000 inferred oz. Yellowknife royalties are expected to begin in 2025.  While GROY on its own appears to have little meaningful revenue generating ability in the near-term, it appears to have reasonable long-term revenue generating potential via a large underlying resource base.  Regardless, GROY investors own this for the management team and the roll-up story, not the potential of its current royalties, in our opinion.  

Risks

Shareholder approval

The primary risk to the deal is ELY shareholder approval.  Despite the 42% deal premium, some ELY shareholders have expressed disappointment in the price relative to what they perceive as NAV.  Estimates of NAV vary widely. As you can see in the slide below from the merger presentation, the deal doesn’t move P/NAV (consensus) much, despite the premium.  

Source: company presentation

Some ELY shareholders do not like the deal due to the “long-term” nature of GROY’s royalties (i.e., zero current revenues and mostly early-stage projects).  ELY has 46 royalties, including four that currently produce revenue, while GROY has 18 royalties, only two of which are expected to produce revenue in the next five years.  ELY shareholders will own approximately 46% of the company post deal which rubs some investors the wrong way when considering the number of royalties, respectively, and their near-term prospects.  

Despite these concerns, we believe the deal is highly likely to be approved.  Disgruntled ELY shareholders are more likely to vote of the deal and then sell their GROY shares post-deal rather than suffer the 22% downside to the pre-deal announcement price if the deal was voted down.  In addition to the deal premium, ELY shareholders benefit from a substantial upgrade in management talent, improved liquidity via an NYSE listing and inclusion in GDXJ (the dominant junior gold miners ETF), and, importantly, the scale of a larger organization in an industry full of small, sub-scale royalty companies. Consent of ELY management (5%) an Eric Sprott (22%) increase the likelihood the deal is approved.  

GROY gaps down post-closing

Even if the deal goes through, GROYs stock could trade down immediately after closing if former ELY shareholders begrudgingly stay in to deal close to receive maximum value, but then sell GROY as soon as they receive their shares.  ELY shareholders in it for the arb like us are also natural sellers post close.  This is a risk but are comforted by the large margin-of-safety in the stock price.  GROY could trade off materially and we would still receive a healthy IRR as shown in the table presented earlier.

Hedgeless

Royalty companies are very popular today and valuations reflect this.  It’s a very competitive space.  Absent the arb, GROY is not an obvious opportunity.  Without borrow available in GROY we are taking on equity risk which we frankly don’t like, however, concerns regarding fundamentals or valuation have little relevance due to a one-month holding period in a cash & stock arb.

Resources

Merger press release:

https://elygoldinc.com/news/2021/gold-royalty-and-ely-gold-to-combine-to-create-a-leading-growth-and-americas-focused-precious-metals-royalty-company 

Merger presentation:

https://elygoldinc.com/assets/docs/presentations/Announcement-IR-Deck-(6.23.2021)[1].pdf 

ELY merger town hall webcast June 21st:

https://www.youtube.com/watch?v=kSUQY8B0qu4 

ELY merger town hall webcast July 8th:

access appears to have expired but there are transcripts (at least on Factset).

ELY letter to shareholders:

https://sedar.com/CheckCode.do 

ELY’s most recent corporate presentation:

https://elygoldinc.com/assets/docs/presentations/June-8-copy.pdf 

GROY’s most recent corporate presentation:

https://goldroyalty.com/_resources/presentations/corporate-presentation.pdf?v=0.23

Canadian mergers 101:

file:///C:/Users/iamti/Downloads/2017-03-20-Canadian-MA-Guide-8th-ed%20(1).pdf   

Merger document:

Found in ELY’s corporate filings 

DISCLAIMER: THIS IS NOT A RECOMMENDATION. The securities described are neither a recommendation nor a solicitation. There are no assurances that securities identified in this note will be profitable investments. The stated opinions are for general information only and not meant to be predictions or an offer of individual or personalized investment advice. This information and these opinions are subject to change without notice. Security information is being obtained from resources I believe to be accurate, but no warrant is made as to the accuracy or completeness of the information. Any type of investing involves risk and there are no guarantees. The author may or may not have material positions in the securities mentioned in this note and will not be obligated to give notice of any changes in their views or positioning. The author makes no representation or warranty, express or implied, regarding the accuracy, completeness, or adequacy of the information. The author accepts no duty of care to you in relation to investments. Past performance cannot be relied on as a guide to future performance.

Catalyst

Deal closing.