A look at the merger and acquisition potential in the junior Gold Mining space...
DESPITE the rise in the Gold Price over recent years, junior Gold Mining explorers are in a predicament. Stock valuations are suffering. Many of them, even those on the heels of exciting discoveries, are faced with either rounding up the cash and teams needed to build out mines themselves or turning the projects over to companies with the money and infrastructure already in place.
In this interview with The Gold Report, David Goguen, director of institutional sales at PI Financial in Vancouver, discusses the merger and acquisition landscape.
The Gold Report: China posted its worst growth rate in more than two years during the third quarter. China is one of gold's biggest buyers and largely drives demand. Should gold bugs be concerned?
David Goguen: I don't think so. While it was the worst growth rate in two years, China still had a very respectable growth rate of 9.1%. Also adding to demand is China's growing middle class and its affinity toward gold bullion that has lasted centuries and will likely continue for centuries both as a savings vehicle (through retail investment demand) and as the central bank continues with its purchases to diversify its foreign currency reserves. According to figures released by the World Gold Council, China and India accounted for 54% of global bar and coin investment and 55% of global jewelry demand in 2010. These markets for gold have been growing at a remarkable 30% per annum.
TGR: Global markets seem confident that a plan can be reached to solve the Eurozone's sovereign debt problems. As more details about a solution emerge, how do you expect gold will react?
David Goguen: There's a possibility for a pullback in the bullion price if investors perceive that the global macroeconomic risk has been reduced or that systemic risk within capital markets has been reduced because of these measures.
I believe that the bullion price should be well supported by government policies and the entitlement programs that exist in North America and Europe are unsustainable in the long term. Until that has been dealt with, we are still going to accrue large annual fiscal deficits. In that environment people are going to question the soundness of fiat currencies.
I can see gold trading in a range of $1,500–2,000/ounce (oz) through the remainder of 2011.
TGR: Do you think that the Gold Price has established something of a floor for now?
David Goguen: I believe that we're probably within 10–15% of a floor. There is still an element of speculative risk capital in the bullion price. Some of that may exit as alternative opportunities present themselves in a more stable, "risk on" type capital market environment.
There has been a lack of big new discoveries made by junior explorers. Also, some of the larger deposits that are under development are considered "wait and see" deposits in terms of their ability to deliver name-plate production results. Having some of these single-mine, large-deposit companies come onstream successfully will derisk these potential acquisition targets and the majors will be more comfortable stepping in and buying them.
TGR: With gold above $1,500/oz, the major producers are selling their gold at somewhat unprecedented margins and have a lot of cash flow. Meanwhile, a number of the juniors have seen their share prices erode throughout 2011. These junior metal explorers have extremely cheap ounces in the ground right now and it seems like the stage is set for a fresh wave of merger and acquisition (M&A) activity.
David Goguen: I agree. Select Golds, our Latin focused, quantitative publication tracking junior gold companies has seen a lot of M&A activity. We see a number of juniors that have made important discoveries advance those projects from resource definition to pre-development. Now they find themselves in a situation where they are forced to choose between building out the mine themselves or putting the company up for sale.
It is at this decision junction that companies need to assess their ability to raise the very substantial capital and recruit the critical personnel, the "build it" personnel that allow them to credibly develop these projects on their own or to put themselves up for sale.
As a result, some takeovers reflect the idea that some junior companies are in the business of making discoveries and are not mine builders. Junior companies at the end of the day have to realize that in many instances the best way to surface and preserve shareholder value is to allow an intermediate or major mining company to develop the deposit through sale of the company. Shareholders often underestimate the execution risk and shareholder dilution required to reach production. At this stage in the mining cycle more juniors are increasingly in this position, hence our expectation of more M&A on the horizon.
TGR: Why is the market not providing full value in these equities with advanced projects?
David Goguen: Mainly because equity valuations across the board are heavily discounted. There exists at the moment a big disconnect between asset values and equity market prices. This can be seen in some of the large premiums we are seeing on announced transactions. They also reflect the market's aversion to risk.
Acquiring companies are recognizing the long-term value in specific assets. The asset in the sweet spot at the moment is one where capital expenditure (capex) budget is in the order of $150–300 million (M), is fairly defined, and is limited in its probability of unforeseen big capex blowout that would impair the acquiring company's returns.
Those attributes make a project attractive to an acquiring company. It is easily executable with respect to the capital investment required and also the complexity of project construction. An acquirer with a strong development team can develop projects in an 18-month period as opposed to a two-to-three year build.
The new sweet spot used to be considered too small for intermediates. But it is a really competitive environment for the larger deposits. Some of the better values in the marketplace are for the 2 million ounce (Moz) deposits that have an annual 100,000–150,000 oz production. Those projects are being sought after.
TGR: How do you recommend investors play these takeover targets?
David Goguen: Every company is unique. Every deposit is unique. Investors want to focus high-grade deposits that are valued exponentially higher by acquirers because of the margins they tend to generate. While these ounces in the ground appear to trade at premium valuations in the market, they are still some of the best risk-adjusted values in our Select Golds screen.
Investors should also want to be looking at situations where there's a high propensity to double or triple the existing resource that's in place. It may be that the target company is focused on engineering instead of exploration and it's leaving all that value on the table for someone else down the road. The acquiring company recognizes it as being an opportunity and is able to afford to pay a larger premium on the front end knowing that value is going to get backfilled amply with new discovery and additional ounces on that resource itself.
TGR: Thanks for sharing your thoughts with us.