The Hostile Takeover of the NovaGold Empire

NovaGold Resources Inc. (NG) has been embroiled in a hostile takeover initiated by Barrick Gold (ABX) in late July. The original offer (of $14.50) represented a premium of 24% over the closing price of NovaGold. However, subsequent to the offering, NG shares opened at over $15 and traded above the HTO price for the next 30 days.

Obviously the market felt that a higher competing bid was imminent.

NovaGold responded with an “unfair and undervalued” analysis of the offer and a barrage of legal initiatives. Major shareholders dug in their heels and labeled the bid “too low”.

From the early September high at $18, NovaGold’s stock declined steadily to $15.50. Barrick extended its bid on September 26th and eventually increased its all cash offer to $16 per share on October 24th. This was termed its “best and final” offer and was contingent on Barrick receiving no less than 50.1%. Barrick supported their $1.6B offer with the fact that NG had lost every legal effort and had aggressively shopped themselves to other potential bidders/partners, to no avail.

NovaGold continued to trade under the $16 offer price causing several brokers and advisory services to recommend selling the stock. The ABX takeover appeared imminent and gold stocks were rallying off their October lows.

One service, upon exiting the stock, described the battle as “acrimonious, to put it mildly”. NovaGold clearly has some of the most devoted and zealous shareholders on the planet. Perhaps that is because management has done such a good job of delineated and promoting its two crown assets, Galore Creek, in BC and Donlin Creek in Alaska. Perhaps it is because NovaGold shares have returned an average of 70% over the last 5 years. Perhaps it is because Barrick is considered the “Black Knight” for its aggressive takeover tactics. Or perhaps it is because many gold bugs are also convinced that "The Evil Empire", including Barrick, has conspired to manipulate gold prices lower for many years.

Whatever the reasons, the NovaGold/Barrick battle has clearly taken on “Star Wars” proportions.

So what is so invaluable at NovaGold to precipitate this galactic conflict?

The first of the crown jewels is Donlin Creek. Donlin Creek, hosts one of the largest known gold deposits in North America. What is at stake has been defined as possibly 35MM ounces of gold. NovaGold and Barrick are already partners in this project. Through its Placer Dome takeover, ABX became a 30% partner and the operator. Barrick has “earn-in” rights to another 40% by meeting certain criteria. Barrick is required to expend $32MM, complete a Bankable Feasibility Study and make a positive decision to construct a mine by November 2007. Barrick has already spent the $32MM drilling the property. Novagold contends that Barrick will not be able to meet its other obligations by the deadline. The two were embroiled in renegotiations of the joint venture agreement when the takeover battle began.

How is NovaGold so sure that Barrick cannot meet its obligations?

One only needs to read the Preliminary Economic Assessment [PEA], updated September 2006, to understand the answer to this question. The Partnership envisions a mine that will produce 1.5MM-2MM ounces of gold annually. This will require a whopping 140MW of electricity. The current plan calls for a 350 mile 230kV power line to be constructed through the Alaskan wilderness, at a current cost of over $400MM. The power line would take at least 7 years to construct, the first 4 years in permitting alone. The line would tie into the Anchorage/Fairbanks grid supplied by Golden Valley Electric Association. The problem is GVEA does not have the extra 140MW of capacity. In fact, their entire grid only has a total capacity of about 200MW, with recent expansions. Spare capacity is currently about 30MW and GVEA is permitted to add another 60MW. The PEA indicates that potential mine closures might add another 30MW. That still leaves the grid short, if GVEA is willing to send more than half its power 350 miles into the Alaskan wilderness.

NovaGold’s “Jedi Masters” have put a very interesting spin on the power problems. On their website, they claim to have taken an “innovative look” at generating 40-60% of the power by installing wind generators at the site. According to the PEA, their “green power” wind farm could only possibly generate 20% of the needed power. And the wind does not blow 24/7, even in the Alaska. So the wind farm would still need to be tied into a power grid. NovaGold claims they can add diesel generator backup, another ridiculous claim. Generating 100MW of electricity is not “back-up”; it is a complete power plant. The fuel to power such a plant could never be shipped to Donlin Creek. The site is only accessible by barge up the Kuskokwim River. River barges are then offloaded onto low-draft, 1000 ton barges for the 480 mile round trip journey up Jungjuk Creek to the mine site. Everything except personnel and emergency supplies must make this trip. But it gets worse, the river is only accessible four months out of the year due to freeze out. Everything needed to build and operate the mine would need to be stored at the site for 8 months of the year.

The PEA calls for “construction phase” (and eventually back-up) diesel generators to provide only 15MW of power. This will require 16MM gallons of fuel to be stored onsite. This equates to 80 barge trips. Mine and mill consumables will require an additional 118 trips. This averages 1.6 barges per day working around the clock to offload. Local fishermen are already up in arms about potential barge traffic.

With barge traffic on Jungjuk Creek already at capacity, obviously the fuel to power even a downsized Donlin Creek could never be barged to the site. And it seems doubtful that permitting can begin on the transmission line when the power needed for Donlin Creek does not exist in Western Alaska. The power issue alone suggests that a first pour at Donlin Creek is doubtful before 2016, making it likely part of the “next millennia”.

Galore Creek is the second of NovaGold’s crown jewels. The updated Economic Assessment [EA], released last month, indicates very robust annual production numbers averaging more than 300,000 ounces of gold, 2.3 million ounces of silver and 370 million pounds of copper, over a 22year mine life. Clearly Galore Creek represents another “World Class” asset. However, it is primarily a copper asset as described by Roland Watson of New Era Investor. Second, the Net Present Value of $1.02B assumes a discount rate of only 5%. This is using $1.75 copper, $525 gold and $8 silver over the life of the mine. While it is doubtful many bankers will currently be comfortable using those long-term metals prices, it is even more doubtful that NovaGold will borrow the $2B current capital costs at 5%. If a more realistic discount rate of 8% is used the NPV drops to about $550MM. And although the capital costs have more than doubled since the last update, the current EA has no allowances for cost increases beyond Q2, 2006.

According to the Economic Assessment, Galore Creek sits in a valley high in the mountains of British Columbia. It is surrounded by glaciers and is only accessible, at this time, by helicopter. The current plan calls for a 135km access road in very difficult terrain that will include over 50 bridges. The road will gain access to Galore Valley via a 4.3km tunnel, beneath one of the glaciers. At this time, no one knows how deep the glacier is and no drilling has been done to determine if the geology will support a tunnel or if groundwater will negate it completely. While this may not qualify as one of the longest tunnels in the world, it will be a significant undertaking high in the Alaskan wilderness where weather is harsh and seismic activity is considered “high”.

The power lines will all have to be installed with helicopters due to difficult terrain. The 18-month time-line for road, tunnel and power construction seems a bit optimistic. The current off-site budget of $330MM seems even more tenuous. The mine site, the proposed power lines and the access road all lie in areas prone to flooding, avalanches and earthquakes. Winter temperatures typically drop to –20 degrees Celsius and snowfall is considered heavy. Yet the economics for Galore Creek are based on 20/365 operations, or essentially no downtime.

NovaGold has committed to ”Phase I” of a plan to bring in the road, the tunnel and the power. This will cost current shareholders about $400MM. The “Jedi” seem to have spun the most serious risk at Galore Creek into a purposeful galactic assault aimed at increasing asset values. While the alien races applaud management for an ingenious “two phased plan”, the bankers and/or potential partners probably won’t step up without guaranteed access to the site.

When the “Empire” describes the crown jewels of NovaGold as being from, “far, far way”, they mean just that.

Galore Creek could also have significant environmental problems. The sheer size of the project is nothing this area has ever seen before. The mine site is located at the headwaters of the Stikine River, which is a major fishery in Alaska, just a few miles downstream. The initial environmental study has been heralded by NovaGold as "groundbreaking, and has set a new industry standard”. This may also be more spin from the “Jedi”. The initial approval of the Province of BC and the Canadian Government will certainly be needed and will probably be granted. However, it is questionable that final approvals will be obtained without Alaskan consent or another galactic battle. It is Alaskan waters, wetlands and fisheries that are threatened. Potentially acid generating rock [PAG] makes up at least 41% of the ore to be mined at Galore Creek. This means that over one billion tons of waste rock must be managed in a flood/avalanche/earthquake prone area.

It would appear to be an ideal problem for Canada, all of the taxes and none of the risk. One might expect quick Provincial approval followed by significant environmental roadblocks from Alaskan and international agencies.

Barrick has muddied the environmental waters even further, at Golore Creek, by outbidding NovaGold for Pioneer Resources. Pioneer holds the mineral rights to the Grace Claims. This acreage has been condemned and is the proposed location for tailings and waste rock at Galore Creek. This issue is now in the hands of the “intergalactic magistrates”.

On November 8th, Barrick announced that they had been tendered some 22% of the outstanding shares and extended their “best and final” $16 offer until November 22nd. The next day, Barrick removed its 50.1% contingency, sending a clear message to the market. We will fight to the finish. The market sent a clear message back to Barrick as the stock traded over 4.5MM shares that day, above their offer price. NovaGold responded with more verbal assaults and claims of victory.

With very little revenue, legal and administrative costs for the battle are draining NovaGold’s precious cash reserves. In the first month alone, they spent over $4.7MM on expenses related to the takeover. And, the conflict has expanded on many fronts since then. With two very high-risk, capital-intensive projects, it would appear that NovaGold shareholders are facing substantial dilution to remain independent. Today, NovaGold announced that their financial adviser, Rothschild, had resigned. While management has tried to spin this news positive, it is doubtful that Rothschild would resign if a partner was in the wings.

So the battle rages on for the “Empire” that is NovaGold Resources, the “Jedi Masters” of spin versus the “Dark Side” of mineral imperialism. In the words of Yoda himself, “wars not make one great.”

May the Force be with You.

NG/ABX 1-yr performance comparison chart

Disclosure: the author currently has no position in NovaGold Resources or Barrick Gold.

Comments

[mike adamson:]

Interesting analysis. I've never heard of III-D Capital in connection with the gold sector...is this a new area of interest?

2006 Nov 16 11:50 AM

[Trey Wasser:]

I have just started publishing my work. I am not just involved in the gold sector, although I have been overweighted in metals for some time. I have been doing alot of work on these large in-situ metal plays, trying to find the best risk/reward scenarios.

2006 Nov 16 02:25 PM

[mike adamson:]

Thanks Trey...it's good to get viewpoints that don't necessarily jibe with the common wisdom. Nova has been a great story but I know I'd be selling at the price if I owned it. I look forward to your future commentaries.

2006 Nov 16 04:52 PM