Kinross takeover bet appears to be a calculated winner
Rome -- ereguly@globeandmail.com
Big gold discoveries, like big oil discoveries, are becoming increasingly rare. You've heard of peak oil? Gold guys talk about peak gold. Global production has been on the wane since 2001, in spite of a 10-year run of rising prices and endless drilling.
So when a big, fat gold deposit is found, gold bosses circle it like a famished wolf circles a bleeding lamb. Reserves have to be replaced. Produce more gold than you find and you're nothing more than a slow-motion suicide.
In Toronto, the wolf with the sharpest fangs (though he looks like a high-school math teacher) is Tye Burt, the investment banker-turned-CEO of Kinross Gold . Mr. Burt is enthralled by the Tasiast mine in Mauritania, owned by Red Back Mining, because he thinks the dusty plot in the Western Saharan has enormous potential to produce more discoveries. He believes this so intensely that he is staking Kinross's future, his reputation and most of his personal wealth on the company's proposed $7-billion (U.S.) takeover of Red Back.
His enthusiasm is not shared by some analysts, investors and financial advisers and Kinross's crucial shareholder vote on the deal is now less than a week away.
The nay crowd argues that the price is rich, given the known reserves, and that the dilution from milling out 425 million new shares to pay for the beast is excessive. One adviser in particular, Institutional Shareholder Services (ISS), has triggered low-grade panic among Kinross executives. ISS recommended that shareholders reject the Red Back deal. While ISS's call will be followed by fewer than 10 per cent of Kinross's shareholder base, every vote counts when the hurdle rate is 50 per cent plus one vote. It's no exaggeration to say that ISS has the potential to wreck Mr. Burt's dream, maybe his career.
ISS is becoming a big name on Wall Street. Its job is to advise institutional shareholders on how to vote their shares in takeovers, mergers, proxy fights and corporate governance matters. Clients of ISS usually follow its advice; indeed, some are required to do so. Too bad, because the Kinross-Red Back deal is one case where ISS appears to have made a bad call.
Mining plays can be hard to value. The purchaser, of course, will know the target's proven and probable reserves. Those are the numbers you can take to the bank. But value creation in the mining world doesn't work that way. The upside is buying the theoretical reserves, the stuff - gold, diamonds, oil, potash, lithium - that the new owners think they can find after they take control of the deposit and unleash the geologists and their drilling rigs. It's a bet, in other words, though ample due diligence can tilt the odds in the buyer's favour.
Red Back's proven and probable gold reserves have been climbing impressively since 2006 and now stand at 8.1 million ounces, with another 3.2 million in the somewhat less-secure "measured and indicated" category. Those numbers were not big enough to capture ISS's imagination. ISS analyst Victor Li said: "While it remains possible there is significantly more gold in the ground than is reflected in current reserves or analyst estimates, the transaction itself would force Kinross shareholders to pay a very full price - including a market premium - for the privilege of taking on the risk of that bet."
Well, indeed. If 11 million ounces or so is the extent of it, Red Back is not worth half the $7-billion on offer. But what if the number were 20 million to 30 million ounces? Within that range, you're talking a world-class deposit, one of the biggest discoveries, perhaps the biggest discovery, since Peru's massive Yanacocha gold mine dazzled the industry 20 years ago.
Already, it looks like Red Back's public reserve figures don't reflect the real story. Kinross has been poking and prodding Red Back's two African properties (the second mine, smaller than Tasiast, is in Ghana) for six months, an exercise the company called "intensive due diligence." On Tuesday, Kinross announced a bullish "conceptual estimate" of Tasiast's potential. The implied reserve, which could not be specifically stated because of securities law reasons, is 17 million to 25 million ounces, a range now supported by some analysts. That's for Tasiast alone. The rumour in the industry is that Kinross privately believes the real figure could top 30 million as the drill results roll in, bulking up Tasiast's measured and indicated gold number.
So who is right, ISS or Kinross?
ISS is not on the ground in Africa; Kinross is. ISS lacks the technical expertise to value the Red Back deposits; Kinross doesn't. ISS does not appear to realize that no gold company is valued on proven and probable preserves alone; Kinross and other miners know those figures are only a fraction of the story. If you think Kinross is run by people who lie about gold deposit potential, then sell your shares and run. If you don't, Kinross deserves the benefit of the doubt on the Red Back deal.
