Saturday, September 4, 2010

Gold Corp Eyeing "Buy or Die" - Overpays for Andean Resouces

Did you see the bids for Andean Resources (ANDPF.PK, TSX:AND) announced yesterday and today, almost within minutes of each other? First Eldorado Gold (EGO, TSX:ELD), which had been circling and watching its prey for over a year comes out with an announcement of a merger proposal valuing Andean at $3.2 billion. The offer was a whopping 62% premium to Andean’s closing price of $4.79 Cdn. Then in the early morning hours, Gold Corp (GG, TSX:G) announces a buyout of $3.4 Billion USD, that had the approval of Andean’s board. What is going on here? The frantic nature of these proposed deals make it seem like there is a dire rush to buy emerging gold properties

Buy or Die
Gold Corp is the world’s second largest gold producer by market capitalization. Gold Corp produced 2.4 million ounces in fiscal year 2009. That means these gold ounces that are produced are gone now from their reserves and they have to be replaced in order to keep the pipeline of future production coming. The author explained the credo of “Buy or Die” in a previous article about large miners needing to purchase more production ounces here as it is just not feasible to be able to replace reserve ounces by exploration.

The Magic of Accretion
Gold Corp’s last acquisition was their January 2010 friendly takeover of Canplats which owned 1.7 million ounces of gold reserves. In that purchase, Gold Corp fought off Penmont of Mexico, and ended up paying $175 per gold reserve ounce, up from the $133 in the original offer.

Gold Corp’s share price is about $44 and with 735 million shares outstanding their market capitalization is about $32 billion USD. Gold Corp lists reserves of 48 million ounces and resources of 41 million ounces. Simply put, reserve ounces are more confident estimates that are engineered to be mineable, whereas resources are just ore ounces in place. So just considering reserves, Gold Corp is valued at $670USD per reserve ounce. With the magic of accretion, Gold Corp had just purchased Canplats gold reserves for $175 per ounce, and now in Gold Corp’s pocket the gold reserves were worth almost four times more.

Cost per Gold Ounce
Andean's main project is their high grade, of 6 to 14 g/ton of gold equivalent, vein deposit of Cerro Negro in Argentina. Andean’s March 2010 NI 43-101 compliant resource for Cerro Negro was 3.1 million ounces of gold and 25 million ounces of silver. Andean only has reserves of 2.1 million ounces of gold from their feasibility study.

With the Gold Corp offer of $3.4 billion USD, this values Andean at an absolutely out of this world $1,619 per gold reserve ounce. Granted the feasibility study is predicting a cash cost of $60 per ounce due to the silver credits. However, does it make sense to pay such a world-beating price for just ore in the ground without any mine or production yet? Does Gold Corp know something else about the valuation of Andean Resources that the rest of the world does not?

Contrast the $175 per reserve ounce paid in the acquisition of Canplats to the $1,619 now offered for Andean. In the Canplats deal, Gold Corp had their Penasquito mine that was only 31 miles away. This offer for Andean is a quantum leap of almost ten times the dollar value per reserve ounce!

Gold Corp is now attempting to do the opposite of what large miners are supposed to do, buying smaller exploration companies and with the magic of accretion instantly re-valuing the reserves at the larger miner's higher price per reserve ounce. How does buying gold reserve ounces at $1,619 help with adding value to the company?

Perhaps it is the nature in the world of Gold that surprising events come to the fore. Is this Andean deal indicative of the rising costs of future Gold deals?

In acquisitions, investors typically bid down the acquirer's stock price until they can fully digest the financial details and possible impacts of the acquisition. This was the case this morning with Gold Corp as the shares were moving downwards by 3.5%. In the author’s opinion, the price paid for Andean Resources was too high and will work to put a cap on Gold Corp share prices going forward.

Disclosure: No position in the stocks discussed. Long Junior miners.

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