Recently Goldcorp (NYSE:GG) made an unsolicited hostile bid for Osisko Mining (OTCPK:OSKFF) for C$2.6 billion in cash and stock. Osisko's management seemed less than thrilled given the meager 15% premium offered by Goldcorp. Osisko's press release stuck to formalities; the company plans on bringing the offer to shareholders, but management expressed no enthusiasm for the deal or for the opportunity to work with Goldcorp or its management.
Interestingly enough, Osisko shares traded at a premium to the take-out price, closing the day with a valuation of C$2.74 billion. This is indicative of a market assumption that Goldcorp will have some competition as this deal pans out, and furthermore, this implied competition tentatively leads one to the conclusion that Osisko shares are still undervalued, as this would be the only motivation of a rival bidder should one get involved.
But I'm not sure that a rival bidder will show any interest for Osisko. True, Goldcorp has a lot of competitors that are presumably looking to grow production and resource, but many of them have high debt loads and sloppy balance sheets (e.g. Barrick Gold (NYSE:ABX), Newmont Mining (NYSE:NEM)) which makes competition for a deal of this magnitude unlikely.
Furthermore, despite Goldcorp's vote of confidence, and despite the fact that the Osisko deal will be accretive to Goldcorp on a per share basis according to several metrics, the fact remains that Osisko's portfolio consists predominantly of one project, which doesn't justify the acquisition. Osisko has properties other than its flagship, Canadian Malartic, but they are either of little value (e.g. Kirkland Lake), or out of commission until we see higher gold prices (e.g. Hammond Reef). While these properties give Osisko exploration potential and optionality, respectively, the fact remains that a lot has to go right for the C$2.6 billion price tag to make sense. Goldcorp, being a large diversified company can take such a risk, especially since it is getting immediate cash-flow from Canadian Malartic. But for investors to justify paying C$2.74 billion (aka $2.52 billion U.S.) it has to be viewed largely as a speculative stock at the current gold price.
Therefore I believe that investors should take advantage of the recent rise in the share price and sell - the risk/reward in the stock favors doing so. This is the case because one of three things will take place:
- The deal goes through and Osisko shares fall to reflect the C$2.6 billion takeover price from C$2.74.
- The deal doesn't go through, in which case Osisko shares do not offer good value to investors except from a speculative standpoint. While this may not bother some investors, I do not see the advantages to speculating in Osisko over a plethora of other small gold mining companies.
- Goldcorp is outbid, in which case holding onto the shares is a winning proposition.
The first possibility needs no explanation. The second requires a closer look at the value proposition found in Osisko shares regardless of the company's relationship with Goldcorp. We will see that the company's properties do not have a high enough objective value to merit the C$2.6 million price-tag. However, I will gladly acknowledge that there is value in the Hammond Reef property and value beyond the expected 16 year mine life of Canadian Malartic that I cannot quantify, and which may turn out to, in conjunction with the company's quantifiable value, surpass this threshold even at the current depressed gold price. Having established Osisko's value, it should become evident that the third possibility is unlikely as a result.
From this it follows that investors in Osisko shares should feel lucky that they are being given the opportunity to unload their stock to optimists betting on the third possibility, or to speculators. Let us take a closer look at Osisko's properties to see why this is the case.
Canadain Malartic is one of the largest gold mines in Canada. It has an estimated 10.1 million ounces of proven and probable reserves at 1.01 grams per tonne. It also has 11.7 million ounces of measured and indicated resources at 1.05 grams per tonne, and 1.2 million ounces of inferred resources at 0.75 grams per tonne.
In addition to this expansive resource base Canadian Malartic has excellent production metrics with rising producing and declining costs.
In the most recent quarter the company produced just over 120,000 ounces of gold (480,000 ounces annualized) with cash-costs of just $726/ounce. Furthermore, production is expected to rise further to between 500,000 and 600,000 ounces per year, and the mine life has 16 years remaining. Furthermore, even at 600,000 ounces per year the mine has sufficient resources to operate well beyond the 16-year mark.
This is impressive, but I'm not sure that it merits such a high price tag. Let us see why.
In all the mine generated $39 million in profits last quarter, which means that the company made $325 per ounce of gold mined, which puts its all-in cost at $1,000/ounce (the company's realized gold price was $1,326/ounce).
Now let's give Osisko shareholders the benefit of the doubt and assume the following:
- Costs continue to come down somewhat, so that all-in cost of production is $950/ounce.
- Production is 600,000 ounces per year, which is the high end of the company's guidance.
- Production takes place for 20 years instead of 16, which is a definite possibility considering the size of the resource at Canadian Malartic.
Now let's look at an NPV matrix using various gold prices and discount rates. I will also factor in a 20% tax rate. Note that in the company's financial statement it says that it will have a maximum effective tax rate of 22.9%.
|Discount Rate/Gold Price||$1,250||$1,500||$1,750|
|5%||$1,884 million||$3,454 million||$5025 million|
|8%||$1,527 million||$2,799 million||$4,072 million|
|12%||$1,205 million||$2,209 million||$3,213 million|
We see that at the current gold price, even using our optimistic scenario and a generous 5% discount rate that we need to justify nearly $500 million (U.S.) in value from Osisko's other projects.
Let us do the calculation two more times only with less optimistic assumptions in place. The first will look at an "average" scenario.
- 550,000 ounces of annual production.
- $1,000/ounce production cost
- 16 years of production
|Discount Rate/Gold Price||$1,250||$1,500||$1,750|
|5%||$1,252 million||$2,504 million||$3,756 million|
|8%||$1,051 million||$2,102 million||$3,153 million|
|12%||$859 million||$1,718 million||$2,577 million|
The second uses more pessimistic assumptions:
- 500,000 ounces of production
- $1,050/ounce production cost
- 16 years of production.
- The maximum 22.9% tax rate
|Discount Rate/Gold Price||$1,250||$1,500||$1,750|
|5%||$877 million||$1,973 million||$3,103million|
|8%||$737 million||$1,658 million||$2,607 million|
|12%||$608 million||$1,369 million||$2,130 million|
While we like to be optimistic as investors, it is prudent to made investment decisions based on conservative estimates, and judging from these more conservative estimates Canadian Malartic is worth nowhere near the C$2.6 billion price-tag ascribed to it by Goldcorp unless we assume a higher gold price.
Of course Osisko has other projects and other assets/liabilities on its balance sheet, so before jumping to any conclusions let's look at those first.
The Hammond Reef project in northwestern Ontario is essentially an out of the money call option on gold. This isn't bad in itself, but it doesn't add much value to the company.
Hammond Reef has just over 7 million ounces of gold: 5.43 million ounces of measured and indicated resources at 0.86 grams per tonne and 1.75 million ounces of inferred resources at 0.72 grams per tonne.
The company conduced a feasibility study in which it estimated that it would produce roughly 400,000 ounces annually and that it would have cash costs of roughly $800 - $850 per ounce. Unfortunately the same study estimated that the capex requirement would be between $1.5 and $1.8 billion. This means that the mine is not feasible at the current gold price. If the mine produces for 10 years then using an 8% discount rate the mine would have to generate $250 million per year for the NPV to be $0. This would means that the company needs to generate $625/ounce. In order for the project to generate an IRR of just 10% it would need to generate annual profits of $650 million per year after taxes, or $812.5 million before taxes at a 20% tax rate. This is over $2,000/ounce of gold, which would require a gold price of nearly $3,000/ounce!
Thus, as I claimed, Hammond Reef has optionality value, but little else.
Upper Beaver (Kirkland Lake)
Osisko's last major project is the newly acquired Upper Beaver gold and copper project in the Kirkland Lake mining district. The property's former owner--Queenston Mining--was bought out by Osisko in December, 2012.
This is actually a great property with a lot of potential value, especially given its exploration potential. Yet the planned mine simply doesn't have that much value relative to Canadian Malartic or the C$2.6 billion that Goldcorp is offering for Osisko. The property has a little more than 2 million ounces of indicated and inferred gold, as well as nearly 90 million pounds of copper.
Once in production the mine will produce about 120,000 gold equivalent ounces for 9.5 years. Initial capex will be about C$240 million. using a $1,275/ounce gold price and a $3/lb copper price the project has an estimated NPV of C$183 at a 7% discount rate, or less than 10% of Osisko's valuation. Even if we use a higher gold price of $1,520/ounce (+20%) and a 5% discount rate the NPV only doubles to C$367 million.
Osisko's Balance Sheet
Osisko's balance sheet is a drag on the company's overall valuation. The company has just C$73 million in working capital and C$235 million in long-term debt. If we add in the C$73 million in deferred income tax and "other liabilities" the company's balance sheet subtracts about C$235 million in value.
Looking at Osisko's quantifiable assets we find that the value doesn't even come close to C$2.6 billion. Using our relatively optimistic scenario for Canadian Malartic and an 8% discount rate we arrived at a valuation of $1,527 million. Upper Beaver, using a 7% discount rate and a gold price of $1,275/ounce only has a value of $167 million using an exchange rate of I USD = 1.0948 CAD giving us a total of $1,694 million. If we subtract out the companies net liabilities we get a figure of $1,479 million, which is well below the C$2.6 billion (aka $2.375 billion) price tag. While there is still exploration potential and the optionality value of Hammond Reef it is very difficult to argue that these assets are worth $900 million, and betting that they are is speculation.
Now this sort of speculation might not be such a bad thing. Goldcorp, with its vast arsenal of assets at different stages of development is in a position to make such a bet. Furthermore a lot of Osisko shareholders seem less than thrilled about this deal. Fellow author Steve Nicastro wrote an article on the Osisko/Goldcorp deal, and if you take a look at the comments at the bottom you will see several from shareholders who are unhappy with the deal. I suspect that in response to my "Osisko is overvalued" argument they would respond in large part by saying that management has done an excellent job of building the company and that this justifies the built-in premium.
But keep in mind that I have been very generous in my assumptions and yet investors and Goldcorp are still granting Osisko a 60% premium to NAV. As we saw with the more pessimistic valuations of Canadian Malartic one could easily argue that the NAV is significantly less than $1.479 billion.
This being the case let's re-examine the three scenarios that Osisko could face. The first--the Goldcorp deal goes through--means that the shares have about 5% downside from here.
The second--the deal falls through--means that we need to make a stand-alone judgment regarding Osisko's valuation, and as I have argued above I believe the shares are overvalued. While we may be able to justify paying a premium for management's competence, the possibility that Canadian Malartic's life is extended, the optionality value of Hammond Reef, or the exploration potential at the company's properties, it is very difficult to justify paying $900 million for this when we don't even factor in the possible downside risk that Canadian Malartic is less valuable than my "generous" scenario.
Finally, in the third scenario -- in which there is another take-out bid that exceeds that which is already in place -- there is upside, but we don't really know how much. Furthermore, as my analysis of the company's valuation reveals, a higher take-out bid probably won't come.
That being the case Osisko shareholders have the odds stacked against them, and I think the currently elevated price presents an excellent selling opportunity.