The golden chop shop

It’s been speculated for so long that nobody can really say he was surprised by someone making a takeover bid for Placer Dome. The company has looked for years as if it could be sold for parts; all that was wanting was a bidder. The bidder has now appeared.

Three Barrick for four Placer, with a little cash. So is it a good deal for Placer shareholders?

Hardly, if the conventional wisdom that Placer was less than the sum of its parts was correct. Taking that view, Placer would have made more for its shareholders by selling its own assets and returning that cash. Best of all, the shareholders wouldn’t have to take paper today. (Determined gold investors might not agree, but getting a cheque rather than a share certificate can be a very pleasant experience.)

Then is it a good deal for Barrick? If it is, then it might have been a better deal a few years ago, when Barrick paper could have bought Placer at a much lower exchange ratio — maybe two for three instead of three for four. Placer hasn’t changed a great deal since, except for the Cortez discovery. (But maybe there’s a lesson in there for growth-by-acquisition enthusiasts.)

Barrick’s own view is that it can wring out some new cost savings once it owns the Placer operations, through operating efficiencies and economies of scale in places like Nevada and the Kalgoorlie camp, where both companies have a large presence. Our view on that hasn’t changed: the buyer had better find cost savings, just to whittle back the premium you pay in a takeover deal.

The daily press has concentrated on how Canada will boast the world’s largest gold producer. But Barrick — with both Hemlo and Eskay Creek nearing scheduled closure — is getting out of Canada entirely, eschewing smaller-scale (but usually highly profitable) underground mining for big-pit earthmoving. If this merger really is a bet on Barrick’s cost-cutting abilities, its choice of energy- and capital-intensive open pits looks like a very long shot.

Barrick is also buying Placer’s money pit, South Deep, where total costs for the first nine months of 2005 averaged US$454 per oz. Here, there are none of those vaunted “synergies” for Barrick to exploit; just a rising rand and a difficult mine. Too, there is the problem of making an empowerment deal by 2012, and South Deep hasn’t done that so far. The longer the owner waits, the more expensive that deal will be.

Unwinding hedge books is costly, too, and anyone buying Placer inherits a big one, whose mark-to-market value was reported to be US$1 billion underwater at the end of the third quarter. When the gold price turned, Barrick took to eliminating its hedge book, even though it had said for years that its book was loss-proof. Considering that Barrick’s hedge position has taken most of the blame for Barrick shares’ underperformance in the gold sector, this merger would undo some good work.

One other development relevant to share prices, one that has so far flown below the radar, is that Barrick will give up its claim to being a pure gold play. Placer produced about 188,000 tonnes of copper in 2004, chiefly from the Zaldivar mine in Chile. In the first nine months of this year — admittedly, one when copper prices went sky-high — the operating earnings of Placer’s copper mines were only a million dollars behind those of its gold mines.

This doesn’t square with the old Barrick, which made its money and name in gold and very much wanted the street to see it as a gold company. The market has been paying a higher multiple on gold producers for a long time; that was one of the selling points of the Glamis bid for Goldcorp in early 2005. But as we pointed out then, high multiples are great only if you’re a seller. We think diversifying is shrewd. The street, for years, has disagreed.

Is acquiring Placer the right strategy for Barrick, or for another company that might come in as a white knight? Analyst George Albino correctly pointed out that “all large-cap gold companies have grown principally by acquisition.” True, but how many have made big money for their shareholders that way? The lesson of recent years, since gold prices began to turn up in early 2001, is threefold: first, gold equities still rise faster than the gold price; second, the big market gains are made in the middle tier and the juniors, not in the large-capitalization companies. Last, being taken over is the way to make your shareholders rich.

Try it yourself. Placer was up 62% from its 2001 low the Friday before Barrick announced its bid; it’s now up 89%. Would you rather have held Placer or Meridian Gold (up 156% from its 2001 low)? Barrick (up 39%) or Iamgold (up 284%)? Newmont (up 204%) or Goldcorp (up 466%)?

Which brings us to a likely winner in this deal. Goldcorp gets ownership of the Campbell mine, unifying the biggest orebody in the Red Lake camp, and with that comes the opportunity to turn its best moneymaker into a bigger moneymaker. As the old Dickenson mine has prospered in recent years, so has the Campbell declined — with tough ground conditions and falling grades. Bringing two mines on one orebody under one umbrella offers the obvious cost savings, but better still, it vaults over the principal block to good mine planning in the Red Lake camp, and maybe gives Campbell a new lease on life. (We won’t hold our breath for it to happen at Hemlo.)

Goldcorp gets the rest of Placer’s Canadian assets including Musselwhite and the upper bunk in the Porcupine Joint Venture. Yes, Goldcorp is buying exposure to the strong Canadian dollar, which has hurt Placer’s cost performance. But Goldcorp is also buying assets where scale is the operator’s friend, rather than his enemy — where incremental savings by the ton turn into much wider margins by the ounce. And Barrick’s terms are straight cash, which Goldcorp’s lenders seem enthusiastic about dishing out.

But shareholders of Barrick and Placer could reasonably be disappointed with this bid. Consolidation might have cured a lot in the weakened gold industry of 1999. In the vastly stronger industry of 2005, it just chews up cash, at least in the short term. Gold producers must be thinking long-term. We hope they’re right.