Primero snaps up Cerro del Gallo

VANCOUVER — Toronto-based gold producer Primero Mining (P-T, PPP-N) has waded into the merger-and-acquisition waters with a definitive agreement to acquire Australian explorer Cerro Resources (CJO-V, CJO-A) in an all-stock deal worth roughly US$120 million.

Under terms of the agreement Cerro shareholders will receive 0.023 of a Primero share for each Cerro share held, which represents a 62% premium on Cerro’s 20-day volume-weighted average price and a 77% premium on Cerro’s spot closing price of A8.6¢ on Dec. 12.

Primero’s primary target in the deal is the Cerro del Gallo gold-silver project located in Mexico’s Guanajuato state, roughly 270 km northwest of Mexico City. The agreement states that Cerro’s remaining project and equity interests will be transferred into a spin-out company where Cerro’s existing shareholders will maintain an 80% stake, while Primero has agreed to purchase the remaining 20% interest.

According to Primero’s president and CEO Joseph Conway, the company has been reviewing acquisition opportunities over the past two years. Primero attempted to buy the Young-Davidson gold property in Ontario from Northgate Minerals in mid-2011, but was outbid by Toronto-based AuRico Gold (AUQ-T, AUQ-N).

“We believe that [the Cerro Del Gallo project] offers our existing and new shareholders immediate improved leverage to gold with a significantly larger reserve and resource base, production and cash flow profile,” Conway commented. He pointed out that though Cerro will represent 15% of Primero’s market capitalization, the project could deliver in excess of 55% of the company’s total gold equivalent production.

“In our view, Cerro Del Gallo is a very promising, undeveloped, large resource base opportunity in Mexico. Primero has the operational and financial strength to advance the project on a timely basis which will be beneficial for all stakeholders involved,” he added.

Primero’s sole production asset is the San Dimas gold-silver mine located along the Durango-Sinaloa border in Mexico. The company purchased the project for US$500 million from major Goldcorp (G-T, GG-N) in 2010, and has enjoyed success over the second half of the year ramping up its gold production. Primero bumped its annual production guidance at San Dimas following the second quarter, and now expects the mine to churn out between 110,000 and 120,000 gold equivalent oz. at an average cash cost of roughly US$630 per oz.

With the Cerro del Gallo acquisition, Primero will continue its relationship with Goldcorp, which currently owns a 32% stake in Primero stemming from the San Dimas acquisition. Goldcorp holds a 31% interest in Cerro del Gallo.

Cerro filed a feasibility study on Cerro del Gallo in early July. The company modelled a two-tiered development strategy that involves an initial heap-leach stage followed by the installation of a carbon-in-leach processing facility after roughly seven years of operation.

Cerro’s heap-leach stage focuses on oxidized and weathered material totalling 32 million proven-and-probable tonnes grading 0.69 gram gold per tonne and 14.8 grams silver per tonne for 712,000 oz. contained gold and 15 million oz. contained silver at 0.3 gram gold equivalent cut-off grade.

The US$136-million project is expected to produce an average of 95,000 oz. of gold per year at average cash costs around US$515 per gold equivalent oz. Annual mill throughput is pegged at 4.5 million tonnes with recoveries clocking in at 68.5% gold and 50.1% silver. The operation is modelled to hit its highest annual production levels by its third year, when output would total 99,000 oz. of gold equivalent.

Assuming a gold price of US$1,341 per oz. and a silver price of US$25.58 per oz., Cerro del Gallo’s initial stage carries a US$181 million pre-tax net present value and a 30.5% internal rate of return at a 6% discount rate. The project is expected to generate US$280 million in undiscounted cash flows and carry a 2.7 year pay-back period.

A second stage involving hybrid heap-leach and carbon-in-leach circuits could extend mine life to 14 years. Cerro’s expansion model focuses on in-pit resources totalling 45 million measured-and-indicated tonnes grading 0.66 gram gold and 14 grams silver for 951,000 contained oz. gold and 20 million oz. contained silver at a 0.35 gram gold cut-off for fresh rock material. Capital costs for the expansion are estimated at US$85 million.

The acquisition is expected to boost Primero’s annual gold equivalent production to 260,000 oz. by 2016.

“[Primero] appears to have paid a fair price for Cerro Resources, to enhance its longer-term growth profile while strengthening its presence in Mexico,” writes Bank of Montreal (BMO) Capital Markets analyst David Haughton in a Dec. 13 research report. “On a pro-forma basis, the combined balance sheet is forecast to provide sufficient cash to fund the assumed development plans for San Dimas and Cerro del Gallo.”

Primero estimates five-year operating cash flows at roughly US$120 million, and reported a US$133 million cash balance at the end of November. Haughton maintains a $9 price target on Primero, as well as an industry “outperform” rating.

Primero’s shares dropped to a mid-day low of C$6.04 during trading on Dec. 13, but rebounded to close out the session at C$6.61 per share on above-average 728,500 share trade volumes. The company has 97 million shares outstanding and a C$639 million market capitalization at time of writing. The transaction, which is expected to close by May 2013, will increase Primero’s shares outstanding to roughly 115 million.

Cerro’s share price jumped 45% or A3.7¢ following the news en route to a A12¢ close on the Australia Stock Exchange. The company has 782 million shares outstanding and a A$93 million press-time market capitalization.