What Pan American's Minefinders Acquisition Means For The Sector

Includes: GDX, GDXJ, PAAS
by: Simit Patel

A big story for those focused on precious metal mining stocks is Pan American Silver's (NASDAQ:PAAS) acquisition of Minefinder (MFN) -- a deal worth over $1.5 billion. Is this the start of the much anticipated consolidation in the mining sector?

For an introduction to why many investors are anticipating consolidation in the near future in the mining sector, see this excellent Seeking Alpha article from contributor Robert Hallberg. To summarize, here are the key reasons consolidation will occur:

  1. Many of seniors (NYSEARCA:GDX) are sitting on a lot of cash. While I expect this to be used to increase dividends and pay off debts (especially as interest rates rise and the credit market contracts, which is also an event I consider to be more likely in 2012), I do think much of this cash will be used to buy up smaller companies (NYSEARCA:GDXJ). As for who the prospective buyers are, I think those with a market capitalization in excess of $5 billion is a good start.
    Notable names here include Agnico-Eagles Mines (NYSE:AEM), Barrick Gold (NYSE:ABX), GoldCorp (NYSE:GG), IAMGOLD (NYSE:IAG), Newmont (NYSE:NEM), and Yamana (NYSE:AUY) -- amongst others. Many of these firms are already shareholders in smaller explorer firms. When I see an explorer firm with operations near a senior and that senior listed as a shareholder, I'm immediately interested (Evolving Gold is one example I previously noted).
  2. 2. Seniors have appreciated more than juniors. The chart below illustrates the difference over the past twelve months.

Juniors are closing the gap, though, so the time for the seniors to strike a deal is now. Moreover, many juniors who need to raise more money in the capital markets to sustain operations will find difficulty doing so due to the ongoing sovereign debt crisis, and so they are particularly in need of support from a major. In other words, it's still a buyers market.

There is an opportunity for quick money here -- simply buy promising targets and sell them once their share price pops after the acquistion. However, this doesn't always work out perfectly; for instance, I bought Minefinders before the acquisition, but its price dropped for a good bit afterward, and so even after the acquisition pop I only netted a few percentage points. I'm grateful, although it's nothing outstanding to write home about. Short-term flipping requires an ability to interpret price action and to manage risk when doing so. Moreover, because astute seniors are looking for deals, the opportunity is finding quality juniors; struggling firms bought at a discount will only yield a corresponding return.

So ultimately, while I am a fan of buying juniors that are potential takeover targets, a good amount of due diligence to get the most out of this strategy is still needed. A short checklist would be:

  • 1. Juniors with seniors as shareholders
  • 2. Management that has hinted at being amenable to a buy out
  • 3. Juniors with operations near seniors
  • 4. Juniors operating in an environment that has a long and rich history of yielding fantastic gold outputs at excellent prices

In conclusion, I do want to note that the consolidation should bring in an onset of speculators looking for the quick flip. The onset of such short-term speculators is historically a key sign and contributor to the formation of bubble. Those who participate should understand this, for there are many opportunities in bubbles, but it is easy to get burned and learn lessons the hard way if one lets greed and irrationality take over.

Disclosure: I am long GDX, GDXJ, MFN.