Kinross, Red Back set to merge

In a US$7.1-billion deal that would give Kinross Gold (K-T, KGC-N) a foothold in West Africa, the boards of Kinross and Red Back Mining (RBI-T) have agreed to a friendly merger that values the intermediate, unhedged gold producer with operations in Ghana and Mauritania at about $30.50 per share.

That works out to a 21% premium based on the preceding 20-day volume- weighted average price of Red Back Mining shares on the Toronto Stock Exchange and the July 30 closing price of Kinross shares on the TSX.

If another suitor doesn’t derail the offer, Red Back Mining share-h olders would receive 1.778 Kinross shares plus 0.11 of a Kinross warrant for each share they hold in Red Back.

The warrants will be exercisable over a four-year period at a price of US$21.30 — or about a 30% premium to the closing price of Kinross shares on July 30 of US$16.39.

Kinross currently owns 9.3% of Red Back Mining.

The transaction would leave Kinross shareholders with 63% of the combined company and Red Back shareholders with about 37%.

Pro forma gold equivalent production of the combined company would be about 3.9 million oz. in 2015.

The merged company would have 10 mines and four development projects in eight countries. If the deal is sealed, Kinross would have reserves of 53.2 million oz. gold equivalent and resources of 19.5 million oz. gold equivalent.

In a research note to clients, mining analyst Brian MacArthur of UBS Investment Research in Toronto argued that Red Back Mining’s Tasiast gold mine has “world-class exploration potential, a robust growth profile and relatively low cash costs.”

He reasoned that while Tasiast has been in production for two years already, “further upside is highly likely given exploration continues to highlight the potential to deliver incremental value through both brownfield and greenfield targets, development of a heap-leach operation and an expanded milling facility.”

He also noted that Tasiast’s published reserves are about 5 million oz. but estimates life-of-mine reserves of 16.2 million oz.

“Our preliminary analysis, using US$1,250 per oz. gold, indicates that to make the deal immediately accretive, Tasiast’s mill production profile would have to be doubled and reserves would have to be about 28 million oz.,” MacArthur wrote, adding that Kinross has “diluted itself in the near term to add the potential for significant future growth.” (Kinross expects to issue about 425 million shares and 26 million warrants.)

“Based on our estimates and using US$1,250 per oz. gold, Kinross would be paying about 1.3 times net asset value for Red Back,” MacArthur concluded.

MacArthur’s colleague at UBS Investment Research, Dan Rollins, who covers Red Back, notes that the company’s expansion efforts at its two gold operations, Chirano (Ghana) and Tasiast (Mauritania) are expected to surpass 500,000 oz. by 2012, higher than the 261,000 oz. produced in 2008. He also points out that in addition, Red Back has exploration projects in Ghana, Mauritania and Cte d’voire.

Red Back Mining’s president and chief executive, Richard Clark, described the merger in a press release as an “exciting and unique combination” based on Kinross Gold’s “record of successful project development and delivery” and the “world-class prospects of Tasiast.”

Clark added that Red Back shareholders would benefit by “participating in a large and well-diversified major gold producer with a core stable of high-quality producing assets, significant expansion opportunities and an exciting exploration portfolio.”

Shareholders will vote on the deal next month. Under the plan of arrangement, the merger would require the approval of two-thirds of Red Back shareholders’ votes and the go-ahead of a majority of Kinross shareholders.

If Red Back terminates the deal, it will have to pay a break fee to Kinross of $217 million; if Kinross breaks the deal it will owe Red Back $250 million.

Markets were closed in Toronto for a civic holiday on Aug. 2 — the day the merger announcement was made. When the TSX re-opened on Aug. 3, Red Back shares climbed $1.43 or 5.5% to $27.45, with 17.7 million shares changing hands.

The company has traded in a 52- week range of $9.65-$28.94.

In Toronto, Kinross shares fell $1.08 or 6.4% to $15.79. The gold major has a 52-week trading range of $16.08-$25.22.