The BarkerLetter

Shares of Canadian diamond explorer SouthernEra Diamonds (SDM.TSX) spiked over 40% on Friday on news of a potential stock swap with Mwana Africa plc.

The bid is reportedly worth $69.7 million Cdn, a nice premium to SDM’s pre announcement market cap of $49 million.

SouthernEra has been largely overlooked by diamond investors in recent months, and I’m not completely sure why. It has an exceptional exploration portfolio with projects in six—count ‘em—countries. Could this have something to do with the absence of former president Chris Jennings from the business pages of late? Mr. Jennings, who now sits on the board, is always in the thick of things during diamond rushes, but he’s been uncharacteristically quiet during the current one.

Mwana claims it wants SouthernEra’s expansive exploration portfolio, even though the company’s stated purpose is to build itself into Africa’s premier, low-cost diamond producer.

Hmmm…

Why would a diamond company, which describes itself as a soon to be producer, want to acquire an exploration company?

It could be one of two reasons or a mixture of both. Either Mwana thinks of SDM’s wholly-owned Hope 1 Kimberlite in South Africa or one of its many others as a potential near-term producer, or it just considers SouthernEra’s price too cheap to resist. The first reason is more bullish for SDM’s stock than the second.

Or there could be a more creative scenario afoot, involving an acquisition of SouthernEra via a reverse takeover or RTO. By swapping the shares and effecting a name change, Mwana, which currently trades on the London Stock Exchange, could have a full TSX listing and access to the lucrative Canadian capital markets. In that scenario, I would foresee a very rapid rise in the stock price since the objective would probably be to raise money.

I’m inclined to buy SDM but not today. Diamond stocks go up and down like yo-yos on news, but few of them have held onto their gains in this market, and I suspect they won’t until an earthshaking new discovery somewhere in the world occurs to fuel a sustained rally. In other words, SDM stock could probably be gotten cheaper in the days to come.

I’m also not keen on stock swaps. However, I’d feel a little more comfortable holding Mwana shares if SouthernEra recommends accepting the deal. I’m not sure when we’ll get word of that; the company has only just formed a special committee to consider the offer.