Is Oz Minerals in 'play' with private equity shareholder KKR?

Given the notable drop in Oz Mineral's (ASX: OZL) mid May share price of $4.76 – on the back of a dismal commodity outlook – it's hardly surprising that a recent raid on the stock by Kohlberg Kravis Roberts (KKR), taking its stake to 10% – with an associate, Thorpe Holdings, controlling another 4.99% – is seen as a possible prelude to the private equity firm making a play for the Adelaide-based copper miner. 

While there is arguably positive market sentiment towards a potential private equity takeover bid by KKR, one of the largest private equity firms in the world, the timely arrival of other favourable dynamics – including a 4% kicker in the copper price, plus a weaker dollar – have collectively nudged the copper miner's share price up another 10% since mid July.

Arguably one of the standout investment grade miners – of which there are precious few – renewed interest in Oz Minerals by KKR is hardly surprising. Covered by no fewer than 18 analysts, OZ Minerals has an extremely tidy balance sheet, especially for mid-tier miner, strong long-term cash flow relative to reported profits, a long-term funding surplus of $496 million and is forecast to go on delivering exceptional earnings per share (EPS) growth.

Other favourable data include revelations – just days after the latest KKR share raid – that Oz Minerals could develop the company's next mine (the massive Carrapateena copper-gold project in South Australia) significantly faster and cheaper than previously expected.

After deliberating for four years over how it might develop the massive 800 million tonnes resource at Carrapateena, the most favoured of three options management is currently contemplating is to invest $1 billion on a smaller project that would mine about 3 million tonnes annually, and generate cash a lot sooner. The slower and more expensive option is to spend $2.98 billion on a block cave mine that produced 12.4 million tonnes annually for 24 years.

Management is expected to make a decision on this in the first quarter of next year. Assuming the high-grade option wins out, Oz Minerals could have a decision to mine Carrapateena by the end of 2016.

At a time when so many of its resource-stock counterparts appear uncomfortably exposed to future calls on their debt positions – especially if iron ore prices fall further – Oz Minerals has been extremely cautious and prudent with its capital. The option of being a low-cost producer at Carrapateena shows that management is focused on creating value and being prudent with cash reserves.

But despite holding net cash of $496 million, Oz Minerals management appears to like the idea of sharing a project of 'Carrapateena proportions' with a partner or other interested parties. While KKR is an obvious contender for future partner, the recent raid suggests that it may have bigger plans, which could involve a takeover offer.

It's true, a traditional private equity model – which typically doesn't like to stick around for the longer haul – and mining have traditionally made for strange bedfellows. However, KKR has both experience within this sector, and very deep pockets – with US$101.6 billion in assets under management – and KKR has a track-record of investing long term. Equally attractive to KKR – or other suitors – is OZ Minerals' decision back in May to fast-track operations at its Prominent Hill mine in South Australia so it can return 20% of generated cash to shareholders annually.

KKR also clearly likes Oz Minerals' primary focus on existing cash flows and the potential cash flows from Carrapateena, which effectively positions it as a growth company within a down resources cycle. It also likes the fact that the miner's primary play copper has some of the best longer term supply-demand fundamentals of mining commodities.

While KKR has described Oz Minerals as 'a good undervalued company', what's unclear is how much it would be prepared to pay for a resource of Carrapateena's potential, which Oz Minerals acquired for only $250 million. On the downside, there's prevailing disinterest across the sector for developing large and expensive developments like Carrapateena, and the sector has hit a multi-year low with appetite from the world's largest commodities consumer China currently waning.

Whether KKR makes a bid for Oz Minerals or not, it is expected to play an activist role on the register, and that should be a positive influence.  But assuming KKR 'low-balls' an initial offer, all it may succeed in doing is attracting other suitors to the bidding table.

There's growing market speculation that regardless of KKR's intentions, Oz Minerals is in play. With PanAust Ltd being taken out by its major shareholder Guangdong Rising Assets Management in May, there is clearly interest in mid-tier copper miners with attractively priced assets.

An Oz Minerals takeover may take time to play out, and with further weakness expected in copper prices, the chances of a re-rating for this sector anytime soon look unlikely. But given the interest in the Oz Minerals, which is clearly undervalued, and some price targets on the stock at around $5.50 – there's still sufficient upside to justify entry around current levels for those with the patience for longer term rewards.