For the better part of a year, acquisitions of junior gold miners by their bigger competitors have been met with suspicion in the market. A quick look at recent purchases in the sector reveals a similar trend-the acquiring company's stock tanked after announcing an acquisition. This was true in the case of Pan American's (PAAS) recent purchase of Minefinders, Aurico's (AUQ) purchase of Northgate, and Kinross' (KGC) purchase of Red Back in 2010. The implication is that the big mining companies were paying too much for assets, resulting in deals that were dilutive to shareholders in the near term. One might say the action was consistent with the idea that gold was a bubble and acquisitions valued on the spot price of gold were proving very expensive.
However, the action in Yamana (AUY) stock tells a different story. With gold miners having cratered earlier in the year and mining stocks near their lowest levels since the 2008 crisis, the market cheered Yamana's acquisition of Extorre (XG). In the two days since the acquisition, Yamana has closed in the green on both occasions with a modest 3 percent gain from Friday's close. We should be careful to extrapolate too much from the price action, but the market is clearly signaling that Yamana's acquisition added a nice resource at an attractive price. In an effort to define relative value, it is interesting to take a look at the numbers behind Yamana's acquisition.
Yamana agreed to acquire Extorre for $414 million in a deal that is structured to include approximately 80 percent cash and 20 percent stock. Backing out the $40 million in cash on Extorre's balance sheet (the company has no long term debt) gives a valuation of $374 million. For this price, Yamana receives an advanced development project in Extorre's Cerro Moro property, as well as several properties that are in very junior stages of exploration and without defined resources. All of the properties are located in Argentina, where Yamana has significant experience. Now, on to Cerro Moro.
The Cerro Moro deposit contains several extremely high-grade gold veins, ranking as some of the highest grade deposits in the world. Although the mineralization is confined to narrow veins, the high grades result in lower overall cash costs when compared with most development stage mines today. The resource base at Cerro Moro includes some 2.4 million ounces of indicated and inferred gold resource, with potential for significant expansion with further exploration. Based on current resources, Yamana's acquisition values Extorre at about $155 per ounce in the ground after backing out Extorre's cash from the equation.
The mine is expected to commence production in 2014 with an initial plan to produce 250 koz per year for the first five years of production at a cash cost of around $300 per ounce. After that, production will potentially decline to around 170 koz, although further exploration would likely allow the mine to continue to produce for longer than the nine years currently planned. To get the mine fully up and running will require capex of around $210 million, although Extorre had been looking at the option of a limited startup using only open pit mining to lower capex costs to $110 million and establish positive cash flow to fund the capex required for underground mining. However, with Yamana easily able to finance the $210 million capex with existing cash flows, I would assume that Yamana is valuing Extorre based on the higher production numbers associated with full production.
Based on these numbers, it is easy to see why Yamana found Extorre to be a cheap opportunity to acquire significant resource. The Cerro Moro mine will generate about $325 million in operating cash per year once running at full production. Thus the project will repay capex in about a year, assuming a build up to full production. Moreover, as Yamana stated in its press release, the acquisition cost just 3 percent of Yamana's market cap yet it may deliver some 10 percent of Yamana's future production. Thus, Cerro Moro gives Yamana a low cost opportunity for significant near term production growth. Though not without risks (especially the political risk of operating in Argentina), Yamana's acquisition is priced right to provide a return for shareholders.
Overall, Yamana's valuation provides a good meter stick for assessing the relative value of junior miners. Based on the stock price reaction, the market certainly thinks that Yamana has gotten a deal in taking out Extorre in the wake of a huge leg down in the gold mining sector. That may have implications for a number of other junior miners that are down big over the past year. With the market giving the okay for acquisitions, it wouldn't be surprising to see a few more of the hardest hit miners get taken out.
Ultimately, it was the funding of capex that forced Extorre to succumb to acquisition. With significant capex or debt commitments on the horizon, the following gold miners might be next on the list: CGR, EGI, GBG, JAG, KBX, NG, RBY, VGZ, and XRA. I'll be compiling reports on the relative valuation of each in short order, so be sure to check back soon.
Disclosure: I am long GBG.