New Gold Mining Sector Mega-Merger Not Without Potential Problems

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Includes: GG, GOLD, NEM
by: Lawrence Williams
Summary

The World's no 2, and No. 4 gold miners have announced that they will merge subject to regulatory and shareholder approvals.

Newmont Mining is to acquire Goldcorp in a deal valued at around $10 billion - the largest ever in the gold mining sector.

Newmont Goldcorp would retain Newmont's Colorado head office but manage operations through regional offices in Vancouver, Miami, Perth and Accra.

The new regional office structure may diminish the combined company's opportunity to make management efficiency cuts.

No sooner had Barrick (NYSE: GOLD) regained top dog world gold producer position among the big gold majors through its merger with Randgold, usurping the position recently gained by principal rival Newmont (NYSE: NEM), than the latter has struck back by announcing a US$10 billion proposed acquisition of Goldcorp (NYSE: GG), the fourth biggest global gold miner by production.

Under the proposed terms of the merger Newmont would acquire all outstanding Goldcorp equity at an exchange ratio of 0.3280 of a Newmont share and $0.02 for each Goldcorp share. This represents a 17 percent premium based on Newmont’s and Goldcorp’s 20-day VWAP share prices as of January 11, 2019. Newmont and Goldcorp shareholders would own approximately 65 percent and 35 percent of the combined entity, respectively.

Newmont Goldcorp, as the combined company would be named, assuming all the regulatory hurdles are overcome, will be a behemoth in the gold sector with a combined annual gold output of around seven to eight million ounces of gold a year based on current gold output from the two companies. However, this could be reduced by some forced property disposals to meet regulatory demands. The combined company, it is claimed, will also pay the highest dividend (a targeted $0.56 a share) among the senior gold producers, although whether this continues to be the case longer term remains to be seen.

But perhaps the similarities with the Barrick Randgold merger end there. The Barrick/Randgold combination is in effect a reverse management takeover with the much smaller company (Randgold) management team, led by Mark Bristow - the new Barrick CEO - calling the shots in the merged company. This point is perhaps symbolically emphasized by the new company adopting the old Randgold stock ticker of GOLD for its quote on the NYSE.

Newmont Goldcorp, on the other hand, will continue to trade under the Newmont NEM ticker, while top management also remains in Newmont’s hands. Current Newmont CEO Gary Goldberg stays in post to oversee the transition, while senior Newmont executive - Tom Palmer (currently President and Chief Operating Officer - will take over the CEO reins once the acquisition is finalized - anticipated as being during Q4 of the current year.

While the changes at Barrick are already leading to a slimming down of the management structure and tighter controls on the likely profitability of new project development in the Randgold mould, Newmont Goldcorp looks like the offering will be ‘same old, same old’. At least it has the propensity to be such, although it should be noted that Newmont’s performance among the mega gold miners had arguably been industry-leading over the past couple of years - but still pretty depressing for shareholders. Its stock price, although having fallen back sharply like all the others in the sector, had largely held up better than that of Barrick - and far better than that of Goldcorp which has had a couple of pretty dismal years in particular.

The acquisition statement notes that Newmont Goldcorp’s Reserves and Resources would represent the largest in the gold sector and would be located in favorable mining jurisdictions in the Americas, Australia and Ghana, representing approximately 75 percent, 15 percent and 10 percent, respectively. Newmont Goldcorp will also prioritize project development by returns and risk, while targeting $1.0 to 1.5 billion in divestitures over the next two years to optimize gold production at a sustainable, steady-state level of six to seven million ounces annually. Supported by stable, profitable long-term production and an investment-grade balance sheet, the statement notes that Newmont Goldcorp will generate robust free cash flow and have the financial flexibility to fund project development and exploration in the decades ahead.

It is worth noting here that targeted longer term gold output is around a million ounces below the current combined output of the two companies, so divestitures - either planned or perhaps forced by regulatory issues - are very much part of the plan. These will continue the patterns of debt reduction already in process at Newmont in particular.

The 'favorable' mining jurisdictions note is perhaps a dig at new Barrick where the merger with Randgold has brought in a number of big gold mining operations in areas traditionally considered 'risky' by North American investors. However, as we've noted in previous articles, operations in these nations have so far proved no more risky than those in some so-called 'safe' jurisdictions.

It could be argued that Newmont has timed the deal particularly well with Goldcorp stock at around a 10-year low. Goldcorp stock rose on the deal announcement which suggests the market sees the proposed deal as positive for the company, particularly as, unlike the Barrick Randgold merger, there was a premium involved for Goldcorp shareholders. Newmont’s stock fell though.

Many analysts feel that the gold price is likely to rise this year and in the years ahead also which should be positive for the merged company regardless. However we still anticipate that the Bristow-led Barrick will do better than the other gold majors (including Newmont Goldcorp) as the likely disciplines imposed under a tighter management and project development structure, should begin to bear fruit.

As to dividends, Randgold used to pay a far higher dividend than Barrick - or Newmont for that matter - and we suspect that one of the changes Bristow will make is to up Barrick’s dividend payments in part out of loyalty to former Randgold shareholders. This may well mean that Newmont Goldcorp’s claim to be the highest dividend payer among the gold majors may be shortlived.

The other thing we should mention is that it may prove to be far more difficult for Newmont Goldcorp to achieve all the necessary merger approvals given that there is much more of a clash of potential jurisdictional issues due to parallel mine and project locations. This was not an issue in the Barrick Randgold deal with all the latter's mines in nations where Barrick had no involvement.

The proposed post-merger management structure looks as though it has been cobbled together to avoid some of these potential issues, but this will come at the expense of management efficiency. The merged company, if the approvals are received, will retain Newmont’s existing corporate head office in Colorado (Denver presumably) but manage operations through a series of regional offices - Vancouver, BC for all North American operations including those in the USA, Miami for Latin America, Perth for Australia and Accra for Africa.

The proposed merger announcement carried a whole section on the advantages to Canada, with the North American regional office located there which looked to be an attempt to avoid potential jurisdictional problems which may, or may not, carry weight. There could also be difficulties in other areas where there are overlapping projects.

Overall we feel the proposed merger, if it gets through without too many forced concessions, is a positive one long term for the merged company, and for the gold mining industry in general, given a rising gold price scenario. However we still feel the Barrick Randgold merger offers more for shareholders in terms of likely operational benefits. But, in the past institutional investors which felt compelled to invest in gold miners as a diversification hedge had tended to plump for Barrick as the world's No.1 gold producer. They may now go for Newmont Goldcorp given that it will comfortably achieve the No. 1 gold producer position assuming the merger goes ahead.

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.