Sprott acquisition bolsters balance sheet in tough time

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Just over a year after the idea was first floated, struggling asset manager Sprott Inc. has secured shareholder approval for its acquisition of Sprott Resource Lending Corp.

In exchange for adding repayment risk to its balance sheet, Sprott will get roughly $225-million of desperately needed capital that it can use to seed new funds.

Historically, Sprott's balance sheet has been relatively risk-free because the bulk of the asset manager's revenues came from performance fees earned on its natural resource portfolios. But with junior resource stocks in the gutter, even Peter Grosskopf, Sprott's chief executive officer, admitted in May that "it's not a realistic model for the future."

So over the past year the two companies held negotiations, and Sprott determined that the risks stemming from adding mining loans to its balance sheet were worth the risk. Because junior resource stocks are in a free fall, Sprott has barely earned any performance fees from its portfolios, and that's limited how much cash it has on hand to diversify the business.

However, acquiring Sprott Resource Lending won't offer up cash right away. The bulk of the target's assets are deployed in existing loans, yet these will eventually come due.

The bigger question mark is what the target's investors get out of the transaction. At first glance, you could argue that the offer wasn't very appealing. Only a fragment of the $242-million takeover price will be paid in cash – the rest comes in the form of Sprott shares. If you haven't heard, they aren't exactly hot commodities.

But there's more to the story. Murray Sinclair, one of the target's co-founders, acknowledged in May that he didn't have many options available to grow the lending business. Banks aren't enthusiastic about lending to a company that will then lend it to high-risk miners, and it's practically impossible to raise equity in this market.

And while Sprott Resource Lending could have simply run off its loan portfolio, management figured that doing so wouldn't get them any value for their goodwill or tax losses. Suddenly a Sprott acquisition seemed more appealing.

Plus, while it may seem like a long shot, obtaining Sprott shares offers the target's investors the potential to participate in any resource rebound.

Proxy adviser Glass Lewis & Co. more or less came to the same conclusion. While the adviser didn't support the deal with much enthusiasm, it did argue that "in the absence of a more compelling alternative, we consider the proposed transaction provides SRL shareholders with an attractive opportunity to capture any market rebound by swapping into a Sprott investment at prices approaching three-year lows."

Until now, Sprott hasn't said much publicly about what it will do with the new capital on hand, but in a recent interview with The Globe and Mail, Mr. Grosskopf suggested his company may launch an income-oriented fund and seed it with Sprott's own cash.

(Tim Kiladze is a Globe and Mail banking reporter.)

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