As we break into summer, a lot is concentrating our minds at GBN.
Precious Metal Mergers and Future Challenges
Anyone involved in the finance industry says that the second half of 2018 was eventful: tech stocks were under pressure and correcting heavily, volatility spiked, and liquidity was scarce. Macro-economical trends where far from stable either. Sino-American relations remain tense and can still deteriorate into a full-blown trade war. In Europe, social tension threatened even the largest economies.
While the world was busy dealing with other issues, the precious metal mining industry was rocked by two large mergers.
Firstly, Barrick Gold and Randgold Resources merged in September and this year Newmonttook over Goldcorp. These mergers will create two gold mining industry behemoths. (Barrack moved to take over Newmont in a hostile takeover couple of days after the interview was done.)
Apart from a few articles in the specialized press, these mergers went almost completely unnoticed.
To help us understand the issues surrounding these recent takeovers, I had the pleasure of interviewing Joe Mazundar, co-editor of exploration insights, a weekly newsletter focused on the junior mining industry.
Karim Achibane: Joe, you have been involved in the mining industry for more than two decades. What do you make of these recent mergers? Do you see the timing of the Newmont takeover as a coincidence or is it partially in reaction to Barrick and Randgold merging?
Mazundar: Although we discussed seven M&A transactions in 2018, the mega-mergers are the ones that get everyone’s attention because they show how the large companies are both adapting to and altering the ecosystem of the precious metals sector.
In its conference call following the transaction announcement, Newmont CEO Gary Goldberg emphasized that the acquisition of Goldcorp was not a deal he had to do. He may have been suggesting that he was not compelled by history to correct a past omission.
The background for his confession may lie in Newmont’s failure, rightly or wrongly, to keep pace with its Toronto-based rival over the decade following Barrick Gold’s acquisition of Placer Dome in October 2005 for US$9.2 billion.
Although the Denver-based gold producer has performed well over the past few years, the company appeared to have hit a wall regarding growth while trying to maintain a discipline of only executing projects that generate a 15 percent internal rate of return. Prior to the merger announcement, Newmont guided its investors to near term production of 4.9 – 5.2 million ounces and a long term profile of between 4.4 to 4.9 million ounces.
Part of Mr. Goldberg’s desire to execute the transaction may be simply hubris to leave Newmont as the largest gold mining company in the world. He was scheduled to retire as CEO in the latter part of 2018 but will remain until the transition and integration of Goldcorp is complete for the some 20,000 combined employees.
In summary, these types of transactions take more than a few months to organize, however, it may be that some of Newmont’s desire to execute the deal may have been accelerated somewhat by the Barrick Randgold merger.
Achibane: What is the rationale for these two mergers? Barrick et Randgold can benefit from synergies, but that can hardly be said of Newmont and Goldcorp.
Mazundar: Barrick’s rationale appears to be have been related to adding a few ‘tier-one’ gold assets that still generate free cash flow at low gold prices combined with a more lean management team led by Mark Bristow, whose philosophy is more in line with the current Chairman, John Thornton. The New Barrick’s asset portfolio will still be weighed to the old Barrick Gold however the senior management will be led by Randgold executives. The synergies are obviously mostly in Africa and Barrick’s chairman is hoping Randgold’s experience in Africa can resolve its issues on the continent.
Part of Newmont’s rationale may be tied to the high rate of growth of passive funds, like the GDX and GDXJ ETFs, that attract generalist investors to the gold sector. The combined Newmont-Goldcorp would create a formidable S&P 500 gold company with dividend-paying industry-leading liquidity, treasury and debt capacity with the majority of its assets in safe jurisdictions. The new company with a combined market capitalization of some US$25 billion may be able to compete directly with the ETFs. The combination would increase its relevance in the larger market for those who want exposure to gold. Its focus is on combining the assets to generate a sustainable production profile, not necessarily growth, that generates free cash flow.
The Newmont-Goldcorp combination proposed US$100 million in pre-tax savings; however, given the limited overlap between the companies’ operating bases, savings may be focused on corporate G&A expenses—Goldcorp alone was spending some US$20 million a quarter (or US$120 million on an annual basis).
Achibane: After years of cost cuts and lack of budget dedicated to exploration in the mining industry, shouldn’t resources depletion be the main focus?
Mazundar: Depletion is a focus however there is a lack of large gold deposits that would ‘move the needle’ for a large company. Gold companies had made a number of less than accretive transactions over the past decade or so and also overran their capital budgets on a number of large development projects to generate higher production profiles.
After shaking off the impact of enduring billions of dollars of write-downs from these strategies, majors have had to right their respective ships by creating companies that can sustain themselves on a steady production profile at low gold prices – US$1200 per ounce. They need to run their companies like a business that would attract more generalist investors and not just gold bugs.
The mergers allow the new mega gold companies to rationalize the portfolio of the combined entities and deliver a better asset portfolio and divest the remainder.
Achibane: The process from grassroots exploration to actually building a mine on a mineral deposit takes at least 10 years and that’s the best case scenario. Shouldn’t we see the majors focusing on acquiring quality junior companies (late exploration/pre-production) instead of merging between themselves?
Mazundar: As opposed to more acquisitions of development plays, over the next year or so, the new mega gold companies will focus on rationalizing their portfolios generated from the combined entities and deliver a better asset portfolio and divest the remainder. The divestitures will take place over the next 12-18 months and hopefully generate US$1.5-2.0 billion for the two companies in total.
Achibane: Speaking of the junior mining sector, regulation is far from optimal. And quality companies with competent management teams are mixed with companies with highly questionable business models. How can the average investor distinguish who is who?
Mazundar: Management teams, especially in the junior mining sector where the risk is particularly high, are an important part of the investment thesis for putting money into a country. At Exploration Insights, we look for the comparative advantage that a company’s management team has in executing their specific strategy.
There are numerous risks – technical, execution, geopolitical and financing to name a few- in executing a strategy that generates value for a shareholder. The management’s job is to mitigate these risks. Competent management teams are not legion in the junior mining sector, therefore, are one of the best filters to deciding among the 1,000 plus mining-related companies on the TSX Venture exchange.
Seeing how the price of gold has risen these past few months and how aggressive the major seems to be in their strategy we can further consolidation in the mining sector.
Geneva BusinessNnews would like to thank Joe Mazundar for taking the time for this interview. For readers who would like to know more about the mining industry, we recommend exploration insights, which covers the mining sector and its potential evolution over the coming years.