Western Africa is one of the most active regions in the world as far as the precious metals mining industry is concerned. Yesterday, Teranga Gold (OTC:TGCDF), operating in Senegal, announced the acquisition of Gryphon Minerals (OTCPK:GPHYF), an exploration company developing its flagship project called Banfora, located in Burkina Faso.
This acquisition is another example of increased activity in the region. To remind my readers, most recently, Endeavour Mining (OTCQX:EDVMF) acquired True Gold, a company owning the Karma project, located in Burkina Faso.
On June 20, in response to the acquisition announcement, Teranga's share prices went strongly down (it lost 6.72% on the Toronto Stock Exchange). It was a classic stock market reaction for this kind of transaction - "Sell on the acquisition news, think it over... later."
In my opinion, Teranga is going to make a good deal, so any drop in share prices should be perceived as a buying opportunity. Let me discuss this deal in detail.
Teranga runs the Sabodala mine, located in Senegal. It is a medium-sized operation, delivering around 200 thousand ounces of gold in annual production. At the end of 2015, Sabodala was holding 4.44 million ounces of gold classified as measured and indicated resources (of which 2.63 million were mineral reserves).
Not everything is going smoothly at Sabodala. For example, due to a number of problems (for example, the artisanal mining), the company did not meet its 2015 production guidance. In theory, mining at Sabodala is simple - it is mainly an open-pit operation where the company uses two cut-off grades for production assumptions. Then:
"The higher cut-off grade is used to define material that can be treated economically in the plant at the time of production, whereas the material above the incremental cut-off grade will be mined and stockpiled and, depending on the economics of production at the time, will be treated at the end of the mine life."
However, there is quite a large logistic project standing behind this simplicity. First of all, Sabodala comprises seven pits. The production is a multi-phase process where individual pits are switched on/off depending on the mine plan. To complicate things even further, the company plans to start underground mining in 2021. Apart from that, Teranga is also investigating the economic viability of heap leaching the low-grade oxide and transitional ores (to process part of the previously stockpiled ore).
The chart below shows the planned Sabodala production starting from 2016:
Source: Simple Digressions
Well, the chart looks quite chaotic (for me, it looks like an electrocardiograph). Between 2017 and 2021, production should go down from 229 thousand ounces to 128 thousand ounces of gold. Then, after a sharp increase to 263 thousand ounces in 2024, it should level off at around 110 thousand ounces. Such high fluctuations in production increase risks associated with the Sabodala operations. And higher risk means lower multiples applied to value the company's shares (for example, lower multiple of EV/EBITDA). As a result, the company's shares are valued lower than its peers.
That is why I think that Teranga's management should have been interested in adding another asset/assets to the company's portfolio. Adding a decent mine could have a positive, de-risking effect on the entire company.
Gryphon Minerals is an Australian-listed company with 90% ownership in the Banfora Gold Project, located in Burkina Faso. Banfora holds 2.98 million ounces of gold classified as measured and indicated resources (of which 1.05 million are mineral reserves). It means that the combined (Teranga plus Gryphon) mineral resources would comprise 7.42 million ounces of gold (and 3.68 million ounces of gold in mineral reserves). In this way, Teranga would have become one of the largest mid-tier African miners as far as the mineral base is concerned.
Source: Teranga's presentation (slide 17)
According to Gryphon, the Banfora's construction is fully permitted. The main economic measures are listed below:
Source: Simple Digressions
In my opinion, the project presents very decent economics. First, all figures were calculated using the long-term gold price of $1,250 per ounce, which is close to the price the gold is trading today. Next, the Teranga and Gryphon managements set the acquisition price at C$63 million (US$49.1 million). It means that Teranga is acquiring the following assets:
Banfora: Valued at US$158 million, of which 90% (US$142.2 million) belongs to Gryphon (on conversion to a mining permit) Cash: US$8 million (using the exchange rate between the Australian dollar and the US dollar of 0.75:1), as of the end of March 31, 2016. Liabilities of the estimated value of US$2.2 million (as of the end of 2015). Other properties of undisclosed value (apart from Banfora, Gryphon holds also a 51% stake in the Golden Hill Project in Burkina Faso and a few other projects).
I value the above listed assets at US$148 million, at least (Banfora, plus cash, less liabilities). Note that the Golden Hill Project and other deposits are not included in this calculation, so there may be a significant upside to the Gryphon value.
All these assets, worth US$148 million, are to be acquired for a mere US$49.1 million, which means that Teranga's management is doing a very good deal (it is paying US$49.1 million for the assets worth US$148 million). In my opinion, Teranga's shareholders should be very satisfied with this transaction because it brings value for them. Therefore, the yesterday's drop in Teranga's share prices should be perceived as an example of market inefficiency and an excellent buying opportunity (or, alternatively, nobody believes that this deal will be done).
Well, there is only one thing that needs to be clarified. It is the value of the current Teranga's business. To find this value, I prepared the following calculation, based on the company's 2016 outlook (assuming the 2016 average price of gold of $1,250 per ounce):
Source: Simple Digressions
To find the value of Teranga's shares, I am using an EV/EBITDA multiple of 4.51. This figure is the average of EV/EBITDA multiples at which West African miners are currently trading (details are here; section titled "Valuation") and a historical EV/EBITDA multiple at which Teranga's shares were trading between 2012 and 1Q 2016.
The table discloses that the fair price of Teranga's shares should stand at $0.76 a piece, which is a little bit higher than the yesterday's price of $0.86. So it looks like Teranga's shares are more or less fairly valued today.
Due to the fact that the current Teranga business is fairly valued, the acquisition of Gryphon should have a huge positive impact on the market value of combined companies. However, I would not be surprised to see another, competitive offer to acquire Gryphon. I think that the Gryphon management may face opposition from some of the company's shareholders - simply put, in my opinion, Gryphon is worth much more than Teranga offers.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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