Consolidation revisited

Whatever we may have been told, consolidation in the gold industry isn’t finished. Placer Dome’s A$2-billion offer to take over Aurion Gold is proof enough of that.

But the scale of that bid, following the expensive battle over Normandy Mining, Franco-Nevada’s lucrative chess game, and Barrick Gold’s absorption of Homestake, illustrates how important the early moves were. What remains, especially for the second rank of big producers, is more like a conventional growth-by-acquisition story than a sweeping business combination.

Few people are surprised to see Aurion as a target; the merger that created it out of Goldfields and Delta Gold was widely seen as a way of making a company that was big enough to be a worthy takeover target for the big producers. The large stake held by South African house Harmony Gold was sometimes seen as the start of a creeping takeover, more often as a side bet; and last year the industry had one ear cocked to the whispers that Gold Fields would make a bid for one or both of Aurion’s founding companies.

There is one respect in which this takeover could be a very good deal for Placer Dome: with a large investment in the South Deeps mine in South Africa, Placer is now seen as a company with significant South African exposure. Gold investors, by nature, are sensitive to political risk and most would choose Australia, Canada and the United States as the lowest-risk gold-mining countries. Aurion’s production is largely first-world, with the exception of the Porgera mine in Papua New Guinea, and brings that stability gold investors love.

There are other ways it could be a rather bad deal. The first concern most analysts raised was the large Aurion hedge book. Placer Dome was supposed to be trimming its own hedge position, with a target of getting hedged ounces down to a fifth of reserves. Buying a company with 5.2 million oz. hedged, and a book that is currently US$224 million under water, sets that strategy back by 5.2 million oz., give or take.

Placer Dome’s own hedge book is generally believed to have a negative mark-to-market value when gold is at US$325 per oz. Assets with a negative value can be carried for some time without penalty, but sooner or later the market notices.

Bringing Placer Dome up the scale of major gold producers is broadly thought to be a plus; but size, in itself, is a poor reason to launch a takeover. It is true that larger companies have better access to capital, and consequently cheaper capital. It is not true that larger companies take full advantage of that lower cost of capital to be more profitable. To chase the presumed higher rating that comes with being near the top of an industry’s behemoth table may mean a few extra dollars in short-term shareholder value, but to do that at the expense of operating competence and financial discipline will, in the end, erode the business and cost the shareholders money.

So, also, is moving on your quarry when the price is high in the belief that you may be left behind. For almost two years, gold mining shares have been the star performers on exchanges around the world, first because of investors’ belief that consolidation was on its way, and now because of the rising price of gold. For about the same length of time, commentators have chided Placer Dome for being late to the party, for not being part of the blockbuster deal, for not making the blockbuster deal itself. Yet the real money, for shareholders anyway, consists not in being the predator but in being the prey. Paying a premium to market value — an indispensable condition of getting the deal in an industry where everyone is looking for, and pricing in, consolidation — is not a good way to make your shareholders rich.

But in a takeover, some shareholders always get rich. Harmony’s block, converted to cash, would neatly wipe out the company’s debt, and — having been made in a down market — looks like a shrewd buy today.

A Placer-Aurion deal would not rub out too many of the question marks still hanging over gold-industry consolidation. Gold Fields — which was ready to slug it out in the early stages but was forced to the sidelines by the South African government’s unwillingness to approve the deal with Franco-Nevada that would have moved Gold Fields’ nominal head office to Toronto — may still look for acquisitions, but it will likely find that non-hedging producers that fit its philosophy are fewer and farther between after the Newmont-Franco deal. AngloGold will still be hunting, in a bid to come back to the top of the producer tables.

What it means for mid-tier Canadian gold companies is harder to guess. All have ridden the wave of higher bullion prices to share valuations that could scare off bidders. Perhaps they might combine with each other in share swaps, but it might just be that the market is ready for the idea of mid-tier producers once more. Small is not always beautiful, but profitable sure looks good after a long period of low prices and tough times.