Kinross gets taste for Ecuadorian fruta

Count Kinross Gold (K-T, KGC-N) amongst the believers in Ecuador.

The Toronto-based company has made a bold move to acquire Aurelian Resources (ARU-T) and its massive Fruta del Norte gold project in the midst of continuing political uncertainty there.

And while the bid comes well before the country’s new mining law is to be ratified the latest estimates put that date in the fourth quarter it secures for Kinross a world-class deposit at a bargain price.

The deal, which has been unanimously approved by Aurelian’s board, would see Kinross give 0.317 of its common share along with 0.1429 of a warrant, for each Aurelian share. That values Aurelian shares at $8.20 and the entire company at $1.2 billion.

And while the sum represents a 63% premium on Aurelian’s 20-day share price average, investors with longer memories know Aurelian shares had been trading above the $10 mark as recently as the end of last year.

But political turmoil has a way of throwing shares off of a cliff and that was just the case for Aurelian when the Ecuadorian government suspended all mining activities in April until a new mining law was drafted.

Rumours swirled about forced joint ventures with the government, tight limits on the number of concessions a company could hold and veto powers for nearby communities over projects.

But recent comments, from both President Rafael Correa and the ministry of mines, sought to soothe investor worry. Such comments have gone a long ways towards winning Kinross’ confidence, even if many on the Street openly wonder if the company shouldn’t have waited until the political climate was more stable.

“Timing is always in the eye of the beholder,” Tye Burt, Kinross’ chief executive said on a conference call. “We could have sat on our hands I suppose but it didn’t feel right for either of us. It might be early on the political stuff, but our judgement was that on the whole we are positive in our view and fundamentally positive on the ore body.”

Burt also emphasized Kinross’ focus on responsible mining and its experience in bringing mines into production in difficult countries like Russia as being keys to its future success in Ecuador.

Thankfully for Kinross, on the geology side of the deal, it has a greater measure of certainty.

While Fruta del Norte’s resource estimate is still only in the inferred stage, Kinross is very familiar with the deposit.

Aurelian’s president and chief executive Patrick Anderson noted that a Kinross geologist was on the site at the time that the first discovery hole was drilled, and Burt underscored the point by saying the company has had a presence in Ecuador since 2006.

For their part, Aurelian shareholders may well be wondering if they’re getting full value for their shares.

The market has been known to over-react to the type of political news that came from Ecuador in April. If that was the case, and fears over the new mining law were over-stated, then Aurelian shareholders could well have seen their shares returning to their pre-suspension levels as the country moved closer to finishing the new mining law.

Aurelian shares’ recent movement seemed to point towards healthier days ahead. While its shares closed at a low of $3.24 on April 24 they closed as high as $5.64 by the end of June.

And according to Thomson One Analytics, the average analyst target price for Aurelian is $8.74, or nearly 50 higher than Kinross’ offer.

Burt says the subjective nature of estimating when the new mining legislation will come and what details it will contain has made it difficult to say there is a consensus amongst analysts.

“There is a wide range of target prices amongst analysts. It’s rare you see that broad of a spectrum,” he says. “There might be a wide range of target prices but the price we are offering today is a 63% premium with a warrant.”

Beyond the financial elements of the deal Aurelian’s Anderson says the decision to back the offer took Kinross’ reputation into account.

“A big consideration for us was Kinross’ corporate and social responsibility,” he says. “We believe they’ll do the right thing in Ecuador and, in return for that, Ecuador will do the right thing for Kinross.”

But in the world of Ecuadorian politics such reciprocity between government and foreign investment isn’t a given.

It was only in the fall of last year that Correa announced a windfall tax of 99% on all revenue above a set price on a barrel of oil. When the decision resulted in an investment freeze and oil output began to fall, Correa decided in April to lower the tax to 70% for companies that maintained output levels.

Michael Curran, an analyst with RBC Capital Markets, says tighter margins in the mining industry compared to the oil and gas industry mean governments can’t get away with such heavy tax burdens on miners.

“Fundamentally oil and gas and mining are different,” Curran says. “The billions of dollars associated with oil lead governments to have a higher level of involvement, whereas mining has lower margins because they are by comparison smaller endeavours in the tens of hundreds of millions of dollars.”

Burt says Kinross valued Aurelian assuming a total tax burden — which includes corporate tax, potential windfall taxes and a net smelter royalty — of between 45 and 55%.

One analyst called that estimate reasonable.

The deal also contains a sweetener for Aurelian shareholders in the form of a partial warrant. A full warrant entitles the holder to acquire one Kinross common share at a strike price of $32.00 per share, and Anderson says it was a key component to the deal as it will allow Aurelian shareholders to partake in any future upside of Kinross.

Recently Kinross has shown an ability to gather positive momentum. When Burt took the reins in March 2005 the company’s share price was trading in the $8 range. It has since made a steady climb into the low-to-mid $20 range before the Aurelian offer was announced.

Kinross says it will issue roughly 47 million shares for the transaction, which amounts to 8% of its current outstanding common shares. Burt says the acquisition will be accretive once mine construction begins.

Aurelian has agreed to a $42-million termination fee to be paid to Kinross should it get a superior offer and Kinross has the right to match any such offer.

Kinross is also buying 15 million Aurelian common shares through a private placement at a price of $4.75 per share for a total of $71 million. Burt says the money is a testament to the Kinross’s commitment to the project, as funds would be used to develop of the project even if the acquisition doesn’t go through.

Fruta del Norte’s resource stands at 58.9 million tonnes grading 7.23 grams gold for 13.7 million oz. of contained gold and 22.4 million oz. of silver.