Gold M&A

2019.03.08

On Monday Newmont Mining rejected a $17.8 billion hostile takeover by Canada’s Barrick Gold. Speculation has been running wild over whether the two major gold miners would combine to make a $42-billion gold goliath three times the market cap of the nearest competitor, Australia’s Newcrest Mining.

We now know that deal is kaput. Newmont’s board of directors unanimously spurned the unsolicited, all-stock proposal at no premium, instead offering a joint venture with Barrick in Nevada where the two companies have extensive, and profitable operations. Under the proposal Barrick would hold a 55% interest and “Newmont-Goldcorp” would own 45%.

“Newmont says its proposal would enable the companies to realize the available synergies while avoiding the risks and complexities associated with Barrick’s unsolicited proposal,” according to Canadian Press. Newmont estimates that by merging with Vancouver-based Goldcorp, it can save US$100 million per year in general and administrative costs. By forming a JV with Barrick the merged company says it could save $365 million a year.

However, Mark Bristow, Barrick’s new CEO after combining with South Africa’s Randgold, downplayed the idea of a joint venture, saying it was “based on the stale and convoluted process that foundered previously”. But he also said Barrick might be open to a JV if Barrick runs the operation. Canadian Press reports:

“Nevada, with a combined 76 million ounces, will be worth a whole lot more if it is run by one operator,” he said.

“We know we can do that more efficiently than Newmont, and that it will be worth a lot more to both Newmont and Barrick shareholders under that scenario.”

Despite the failure of a Barrick-Newmont deal, the industry is abuzz with the prospect of more mergers to add to the shake-up at the top of the gold food chain. This past September Barrick agreed to buy Randgold for $5.4 billion and then three months later Newmont announced its plan to purchase Goldcorp for $10 billion. While the latter deal hasn’t yet been approved by shareholders, it is expected to go ahead, thus putting the combined entity ahead of Barrick as the number one gold producer.

The gold mega-deals have grabbed the limelight, but other less high-profile mining merger and acquisition activity has been ramping up. In 2018 there were 1,349 mining deals valued at $86.3 billion, up 60% from 2017 according to Bloomberg data – a five-year high. The industry saw a steep drop in M&A after the mining downturn post-2012, as large mining corporations were forced to focus on cost-cutting and shareholder returns rather than the “production at all cost” mantra that put miners in so much trouble – that’s because it was all spend, spend, spend at the height of the cycle, paying top dollar for ill-advised acquisitions then having to write these assets off when commodities prices slumped.

Other examples of mining M&A last year include:

• Zijin Mining’s acquisition of Nevsun Resources for US$1.4 billion.
• Zijin also made an $81 million investment in Pretium’s Brucejack mine in BC, giving the largest Chinese gold miner a 9.9% stake.
• Pan American Silver’s billion-dollar cash and stock takeover of Tahoe Resources to control Guatemala’s Escobar, the second largest silver mine.
• Orion’s $407 million takeover of Dalradian Resources, developing a gold deposit in Northern Ireland.
• Leagold’s friendly takeover of Brio Gold, backed by Yamana Gold, Brio’s largest shareholder.

At Ahead of the Herd we’re well aware of the consolidation going on in the gold space, but we’re less interested in what it means for the big-cap miners, and more in what effect it could have on the juniors. This article will examine that question.

What’s with all the M&A?

Nearly a decade of slumping prices, shareholder revolts demanding CEOs step down after billions in lost market capitalizations, and write-offs of gold mines purchased at the top of the gold price run, all pushed miners to slash debt and lower costs in order to become more efficient. Merging is the next step.

“Mining companies are starting to realize that they have cut as much of the cost as they can and the next step is to bring assets and companies together. What the industry really needed was a couple of the big players to start,” says Dean Braunsteiner, national mining leader with PricewaterhouseCooper in Toronto, quoted in The Globe and Mail.

On top of that, the top gold miners are running out of reserves, and are looking to replace them with high-margin projects that have the right combination of grade, size and infrastructure.

The concept of “peak gold” should be familiar to most gold investors. Like peak oil, it refers to the point when gold production is no longer growing, as it has been, by 1.8% a year, for over 100 years. It’s stopped growing because existing mines are getting depleted without enough new gold deposits to replace them.

Since reaching “peak gold” in the mid-2000s, six major gold miners have experienced declines in production up until 2017. According to Bloomberg Intelligence data on the big producers, combined gold reserves shrank by almost half in 2018, to 406 million ounces, due to exploration budget cuts.

Just yesterday, Kitco reported on findings by BMO Capital Markets that global gold production is expected to drop for the next two years; with 2018’s numbers now out, last year was the second in a row that gold production fell.

The main problem is the lack of significant deposits to replace dwindling reserves.  

“When we look out over the next five years, there are very few large scale new gold projects earmarked to come on-stream,” the BMO analysts said. “The only large-scale gold projects that we see as probable to enter the top 10 producing gold mining operations by 2025 are the Donlin Creek project, owned by Barrick and Novagold, and Sukoi Log owned by Polyus Gold.”

Another interesting stat: The 10 largest gold mines operating since 2009 will produce 54% of the gold as a decade ago – 226 tonnes versus 419 tonnes.

No wonder, then, that for gold miners to grow, they need to “eat each other”. They require big gold mines, and the only options out there are existing mines run by their competition. If you can’t beat ‘em, join ‘em.

We should expect more

What will happen next? How is consolidation going to affect the smaller producers and the junior gold explorers that are more needed than ever to discover the next major gold deposits?

As we wrote after the Goldcorp-Newmont deal, there are likely two trends to emerge: more gold mines will be going on the block, as companies try to dispose of non-core assets in order to get more competitive (as the sector consolidates, economies of scale take over making it even harder for the mid-tiers and smaller producers to compete on costs per ounce vs the big guys); and major gold companies will try to acquire large, preferably high-grade deposits, due to the ever-present problem of depleting mine reserves, as extraction costs become more expensive and profit margins squeezed without a significant rise in the gold price.

Falling gold production will of course support the price but one analyst quoted by The Globe thinks that a combination of supply drop and price rise will spur more M&A.

“We will start to see commodity prices rise because companies have cut their assets and haven’t put any money in the ground, and the supply starts to drop,” says Bob Thompson, vice-president and portfolio manager at Raymond James in Vancouver. “When the supply drop’s they panic to take out other producers and prices go up.”

He adds that “more cash deals will occur as mid-tier miners either merge or get swallowed.”

The bigger the better

A less-reported but very interesting cause of all this gold M&A relates to financing. Gold majors sought to grow their portfolios when they were making money hand over fist in the late 2000s, with gold perking along at $1,500 – $1,600 an ounce. Cost control was an afterthought in the rush to out-grow the competition.

That all changed when the gold price plummeted post-2012, with these same companies pulling in the sails and concentrating more on their bottom lines, free cash flow, actually treating gold mining like a real business. Now we’re seeing a throwback to the “bigger is better” mindset. Part of this has to do with who is investing in gold companies. Back then it was easy enough to find institutional investors to backstop projects. Nowadays, money managers who remember how gold miners took huge write-downs amid the gold price collapse, are shying away.

Instead, gold stocks are bought and sold by passive index funds by algorithmic trading. Also, the biggest shareholders in large-cap gold miners are ETFs.

“The large-cap gold companies recognize this,” Jon Case, precious metals portfolio manager with Sentry Investments, told The Globe. “As they get bigger, they’re going to get more and more of a disproportionate share of the investors’ dollars, because most of the indexes are market-cap weighted.”

The juniors

The gold juniors’ place in the mining food chain is to provide ounces for larger gold companies whose reserves are running low. As stated above this is becoming a growing problem as all the low-hanging, high-grade gold deposit fruit has been picked.

Finding the kind of grades at amounts that will make a mine profitable usually requires going farther afield or deeper – greatly adding to costs per ounce.

Here’s the problem juniors have been facing: At the same time as investment capital has been pulled out of the mining majors and mid-tiers – by investors tired of seeing falling or stagnant stock prices/ red ink balance sheets – there’s been a dearth of speculative capital flowing into exploration companies.

According to a recent report by PDAC – the association that puts on the mining show going on in Toronto right now – and Oreinc, a junior financing tracker, equity financing in 2018 was 35% less than in 2017 – a decade-low $4.1 billion.

A good chunk of that cash went to marijuana stocks, as dozens of companies emerged to take advantage of the pot legalization bill passed by the Canadian federal government. Whereas weed stock IPOs attracted $491.1 million in investment dollars in 2018, mining IPOs only accounted for $51.6 million, a startling drop from the $830 million in 2017.

That’s a lot of speculative capital pulled out of resource stocks. However it’s not all gloom and doom, according to “TD Securities mining investment bankers, who say current market conditions and historical precedents make them optimistic generalist investors will return in greater numbers to mining stocks,” Bloomberg reported:

“The current market is reminiscent of the late 90’s and early 2000’s, [TD Securities’ Deputy Chairman Rick] McCreary says. At the time, investors had low interest in mining, and companies found it hard to raise capital. That was followed by waves of consolidation and a mining bull run, he says. A similar trend may be building as this ‘period of consolidation’ rolls on.”

We don’t know what will happen with gold mining M&A, but what we do know is that all gold companies are looking for top-notch development projects in this era of peak gold, and that the sector will likely see more shake-ups as gold mines and properties are unloaded.

Richard (Rick) Mills

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