Yamana hoping three’s company

Analysts see merit in a plan Yamana Gold (YRI-T, AUY-N, YAU-L) has hatched with Northern Orion Resources (NNO-T, NTO-A) to merge and take over Meridian Gold (MNG-T, MDG-N). But whether the new company would deserve a premium gold rating in the market — as Yamana predicts it would — has yet to be determined.

Traditionally, the market has been willing to pay much more for gold stocks than the companies are actually worth, a figure analysts often refer to as a “rating” or “multiple.”

During a June 28 conference call, analysts said that Yamana, a gold company that produces copper, trades around 1.3 times its asset value, while Meridian, a gold-silver company, has a rating 1.7 times its value.

That’s why the merger deal is conditional on Yamana acquiring at least two-thirds of Meridian’s shares — because a takeover of Northern Orion alone would increase Yamana’s base metal ratio, leading to a lower valuation in the market compared to gold companies.

“This transaction does not increase our base metal exposure,” says Yamana chairman and CEO Peter Marrone. “It will be static for now and reduce over time.”

Marrone says the new Yamana could look forward to improved market multiples based on its company’s scale of operations — but that’s not his only aim with the deal.

Growth for the purpose of chasing a rating would be a mistake, Marrone says.

He points out that if the proposal goes his way, Yamana would have five high-quality, company-making assets.

“Why wouldn’t we deserve a higher multiple?” Marrone asks.

Yamana’s growth has been aggressive since the company formed through a reverse-takeover of a shell company in 2003. It brought the Chapada copper-gold and Sao Francisco gold mines, in Brazil, into production in 2006, with production forecast at 600,000 oz. gold for this year. The company has also grown by acquisition, buying RNC Gold, Desert Mining Corp. and Viceroy Exploration last year.

Yamana’s mission is to become a dominant intermediate gold company, with plans to reach the 1-million-oz.-per-year mark by 2009.

The 3-way transaction would see the new Yamana increase its annual gold production to more than 1.4 million oz. gold by 2009 from a combined base in 2006 of about 660,000 oz. The combined company would have nine operating mines and a pipeline of six development projects.

Under the deal, Meridian shareholders would receive 2.235 of a Yamana share plus $3.15 in cash, based on Yamana’s June 27 closing share price of $13.02, for total consideration of $32.25 per share — a 23% premium over Meridian’s closing share price on June 27.

Northern Orion shareholders would receive 0.543 of a Yamana share, for a value of $7.07 per share — a 21.3% premium over Northern Orion’s closing share price on June 27.

Northern Orion has agreed to contribute US$200 million of the US$300-million cash component of the Meridian offer.

Michael Curran, a mining analyst with RBC Capital Markets, says he sees the value in putting the three companies together, but doesn’t see eye to eye with Yamana on the company’s stock goals.

“We disagree with Yamana management’s view that the new Yamana would deserve premium multiples,” Curran says. “Their base metal exposure will be similar after the deal.”

Part of Yamana’s growth strategy has been to acquire new companies, but until now, friendly has been the name of the game. Marrone says he wouldn’t call Yamana’s move to acquire Meridian hostile, but instead, “unsolicited.”

“We can make this very friendly,” Marrone says. “I’m more than happy to engage in discussions with Meridian.”

Marrone says he has communicated with Meridian about the proposal, but a formal offer has not been delivered to the company. Yamana has 30 days to make the offer.

The deal is good for Meridian, according to Curran, because the company’s growth has been stagnant.

“Joining Yamana would increase Meridian’s exposure to growth but would also increase its exposure to base metals,” Curran says. “It’s a trade-off.”

Curran says the bid for Meridian is at a premium compared to recent transactions in the industry, though he sees a little room for a higher bid.

Regulatory problems or a second bidder could throw off a hostile bid. Catherine Gignac, a mining analyst with Wellington West Capital Markets, gives hostile takeovers a 50-50 success rate.

“Anything could happen,” she says.

Gignac says the transaction would cause dilution for shareholders, as the company will add 309.4 million new common shares, but would also add value for exploration.

Meridian’s main asset is its El Peon underground mine in Chile, which produced 230,100 oz. gold in 2006 at a cash cost of US$68 per oz., net of silver byproduct credits.

Meridian also has the Esquel gold property in southern Argentina, which could be worth a lot to Yamana if it can get the necessary mining permits. Local opposition has prevented Meridian from doing so, despite a 2002 mineral resource of 3 million oz. with an average grade of 8.5 grams gold per tonne.

Gignac says Yamana is basically getting Esquel for free.

“They might be able to use their clout to get the Esquel project off the ground,” Gignac says.

Marrone says that in the absence of permitting, the project holds no value for Yamana at the moment, but with the possible synergies of the combination, he might have better luck than Meridian.

Yamana’s Guacamayo project in Argentina is expected to begin production by mid-2008 at a rate of 200,000 oz. gold per year.

Yamana’s other main asset is the Jacobina underground gold mine in Brazil, which produced 62,000 oz. in 2006, and will rise to more than 200,000 oz. in 2008.

By acquiring Northern Orion, Yamana would gain its 12.5% interest in the Alumbrera copper-gold-molybdenum mine in Argentina, which produces about 190,000 tonnes of copper, 500,000 oz. gold and 2,200 tonnes of molybdenum per year. Xstrata (xraf-o, xta-l), the operator, holds 50% and Goldcorp (G-T, GG-N), the remainder.

Northern Orion also owns the Agua Rica project, located 34 km northeast of Alumbrera. Agua Rica is at the feasibility stage and is projected to produce 136,000 tonnes of copper, 130,000 oz. gold and 7 million tonnes molybdenum per year.