Canada Gold: The Midas Touch

Peter Munk's Barrick Gold Corp. (TSX: ABX) has never been one to settle for second best. The Toronto-based company, which has grown from a tiny miner into Canada's largest gold firm, is now looking to become the biggest in the world. In an audacious move, Barrick is partnering with Vancouver-based Goldcorp Inc. (TSX: G) to launch a US$9.2-billion hostile takeover of Placer Dome Inc. (TSX: PDG). The combination of what are now the third- and fifth-largest gold producers in the world will create a powerhouse, Barrick CEO Greg Wilkins told reporters shortly after making the bid public. “Barrick will be able to compete on the international stage more effectively than either Barrick or Placer could do independently.”

Should Barrick be successful, the deal would be the largest hostile takeover in Canadian mining history–and could spur another gold rush as major gold companies look to snap up their weaker rivals. Barrick is no stranger to multibillion-dollar deals. The company burst onto the international scene in 2001 with its US$2.3-billion buyout of Nevada-based Homestake Mining Co. Barrick, however, may soon face competition. Vancouver-based Placer Dome has not accepted the bid and announced it has formed a special committee to review the offer and consider alternatives. Analysts and market watchers are already speculating that Denver-based Newmont Mining Corp. (NYSE: NEM), Barrick's longtime international rival and currently the world's largest gold producer, could either spoil the party and try to trump the bid for Placer or seek another merger to keep its No. 1 spot secure. Being the biggest carries more than just bragging rights in the gold market; many investors and mutual fund managers make room for only one gold company in their portfolio–and that's the largest one.

Placer Dome investors seem to be expecting a rival bid. At the time of the announcement, Barrick's offer was worth about US$20.50 per share, representing a healthy premium on the US$16.51 price at which Placer shares were trading. (Placer and Barrick trade on both the New York and Toronto stock exchanges.) In the days following the bid, however, Barrick shares have dropped while Placer shares have moved up to trade above US$19–all but erasing that premium.

If Newmont were to launch its own bid for Placer Dome, it would likely follow Barrick's strategy and partner with another gold company to divvy up Placer's diverse assets. A likely partner would by Toronto-based Kinross Gold Corp. (TSX: K), says Barry Allan, mining analyst with Toronto-based Research Capital Corp. “Placer Dome has so many assets all over the world that it is really not a good fit for any one company,” he says.

Newmont wouldn't necessarily need to outbid Barrick to retain its title as the world's largest gold miner. The company could choose to launch its own hostile takeover of South Africa-based AngloGold Ashanti Ltd., currently the world's second-largest gold producer, says John Tumazos, a gold analyst with Prudential Equity Group LLC in New York. AngloGold is vulnerable to a takeover after its majority shareholder, U.K.-based Anglo American PLC, announced in October it was looking to reduce its stake in the firm.

The gold industry is in dire need of more consolidation, says Tumazos. Investors would be better served if four major gold companies–Barrick, Placer, AngloGold and Newmont–merged into one single entity. “None [of the four gold producers] are strong,” he wrote in a note to investors. “The top four gold producers…should be merged into one or two companies, as one large enterprise would be better able to rank the best investment projects [and] cancel the worst.”

Shares of many major gold companies have failed to keep pace with the rising price of gold, which has moved up to as high as US$475 an ounce last month from US$413 in February. Placer Dome, for instance, has seen its stock drop from a high of nearly US$24 last November to a low of US$12.10 in May as the company struggles with higher energy and production costs, hedging losses as well as cost overruns and delays at several mining operations. Less than a week before Barrick's hostile takeover was announced, Placer reported a decline in profits for the fourth straight quarter. The company was further weakened by the recent cancellation of the huge Cerro Casale gold project high in the Andes Mountains of Chile. Its lacklustre stock performance, coupled with ongoing production problems, made Placer a ripe takeover target.

As is the case with many gold companies, Barrick stock has been relatively flat over the past two years, even though the firm's operations have been on a roll. Just one day after Placer announced its rather disappointing results, Barrick announced third-quarter profits of US$113 million, more than three times the US$32 million it produced a year earlier. As well, the firm boasted that its new Lagunas Norte mine in Peru had opened in June, ahead of schedule and under budget, and that its Veladero mine in Argentina poured its first gold bars ahead of schedule.

Even with Placer Dome's production problems, it has what every major mining company desperately needs: proven reserves to replace the metal being mined today. As every gold company CEO knows, it's often easier to buy those reserves on Bay Street than it is to try to find them through exploration. Placer has world-class operations in Canada, the United States and Chile. Some of those operations are relatively close to Barrick's own mines, which would help the merged entity save more than US$240 million in annual production costs.

Barrick managers will need to work overtime to solve production problems that have plagued Placer Dome for years, says analyst Allan. “This is not a typical mining merger where a company buys a well-operating mine and tacks it onto its existing operation,” he explains. “Placer's costs are creeping up, and there will be some serious challenges for whoever takes over those assets.” Even with no additional production problems, costs at a combined Barrick-Placer Dome would be about US$246 per ounce of gold, higher than Barrick's current costs of US$225, but still lower than many competitors'.

While a post-merger Barrick would have the most gold production in the world, it would also have one of the largest hedge books. Back in the late '90s, when the gold price was less than US$300 per ounce, investors loved Barrick's strategy of selling its future production. That all changed in 2002, when gold prices started to rally and Barrick was forced to sell a good portion of its gold at below-market prices. The firm has spent the past three years reducing those hedging commitments. But if the merger goes through, Barrick will have to cut the hedging positions of Placer Dome, which has commitments to sell about 7.6 million ounces of gold at prices around US$383 per ounce.

In the end, the biggest winner in the deal could be Goldcorp and its shareholders. Goldcorp is providing most of the cash for Barrick through an agreement that will see the company pay about US$1.35 billion for Placer Dome's assets in Northern Ontario, Chile and the Dominican Republic. That's a lot of money, but included in the deal is Placer's Campbell Mine in Ontario–a site right next door to Goldcorp's Red Lake Mine. Combining the operations of the two mines should save Goldcorp about US$40 million annually. The move also catapults Goldcorp into the big leagues by increasing its annual gold production by 50%, to about two million ounces, and nearly doubling its reserves.

Whether Barrick's bid for Placer Dome is ultimately successful or not, there is little doubt that there will be more consolidation in Canada's gold sector. After all, with gold prices continuing to rally, few mining companies can afford not to get in on the gold rush.