Rival royalty firms to merge (December 14, 2010)

Franco-Nevada (FNV-T), the world’s largest resource royalty company with interests in gold, oil and gas, is beefing up its precious metals portfolio through a friendly takeover of Gold Wheaton Gold Corp. (GLW-T), a royalty company set up just two-and-a-half years ago.

Franco-Nevada will acquire Gold Wheaton for $830 million in cash and shares. Under the plan of arrangement, Gold Wheaton shareholders will receive $5.20 per share payable 60% in shares and 40% in cash.

Each Gold Wheaton share will be exchanged for 0.0934 of a share in Franco-Nevada and $2.08 in cash. The deal represents a premium of about 19% to Gold Wheaton’s closing share price on Dec. 10, a 23% premium to its 20-day volume-weighted average trading price, and a 42% premium to its 60-day volume-weighted average trading price.

David Cohen, chairman and chief executive of Gold Wheaton, notes the company will generate more than $110 million in cash flow in 2011.

“It became apparent to us that the royalty business and streaming business, as competitive as it is and as difficult as it is in the current market, would be better served if we put the two companies together,” Cohen remarked on a conference call, adding that Gold Wheaton’s management was “very comfortable taking more shares than cash in Franco-Nevada.”

“As acquisitions become more difficult to finalize and close on and have become more expensive as metal prices have increased…the organic profile of Franco-Nevada…is a big benefit to us,” Cohen said. “What we’ve created by putting them together is a new company with unbelievably strong cash flow generation. That’s not easy to put together in any business and it has the opportunity to execute substantial deals going forward.”

Gold Wheaton’s gold royalties/streams include production from Quadra FNX‘s (QUX-T) Sudbury properties, production from First Uranium‘s (FIU-T) Mine Waste Solutions in South Africa, as well as production from First Quantum Minerals‘ (FM-T, FQM-L) Ezulwini operations, also in South Africa.

The acquisition is subject to approval by two-thirds of Gold Wheaton’s shareholders. No shareholder vote is required by shareholders in Franco-Nevada.

The deal came together over the weekend, after Franco-Nevada agreed to acquire a block of Gold Wheaton shares owned by Quadra FNX  for $4.65 per share in cash on Friday Dec. 10. That transaction is expected to close on Dec. 16 and will lift Franco’s holdings in Gold Wheaton to 36.9%.

Pierre Lassonde, Franco-Nevada’s chairman, said the combination was “compelling” because it increases immediate cash flow in terms of precious metals by over $100 million and noted it also “gives us more torque, more leverage and more exposure to increasing precious metal prices.”

Following the transaction, 85% of the combined company’s revenues will stem from precious metals, Lassonde said, adding that Franco-Nevada will be “the only precious metal royalty company with almost a 20% exposure of its precious metals portfolio to platinum.”

Franco-Nevada’s president and chief executive, David Harquail, outlined that following the transaction the company will still have roughly $170-190 million in cash on its balance sheet and therefore has a lot of capacity to do further transactions. “We are seeing quite a few things in the pipeline and we are going to be aggressive in further developing this company,” Harquail elaborated on the conference call. “The company has got tremendous free cash flow margins of over 90%; we pay significant dividends; and we have some amazing new discoveries. We’ve got an impressive PGM portfolio…we like to call ourselves a gold ETF on steroids.”

UBS Investment Research mining analyst Brian MacArthur says “the deal makes sense” and “accelerates” Franco-Nevada’s cash flow generation. “When combined with its existing growth portfolio (e.g. Detour and Tasiast), [this acquisition] should allow Franco to double its cash flow over the next few years,” he wrote in a research note to clients.

MacArthur argues the deal is accretive on earnings per share, cash flow per share and net asset value metrics, and also allows Franco-Nevada to “redeploy some of its cash balance efficiently.” In addition the acquisition “increases leverage to gold prices via the stream structure and adds further platinum and palladium exposure.”

Stephen Walker of RBC Capital Markets agrees that the transaction appears accretive in terms of NAV, EPS and CFPS. He also notes that Gold Wheaton’s revenues are about a 50/50 split between Canada and South Africa. While he points out that Quadra FNX’s assets are “high quality in a low-risk Canadian jurisdiction with significant upside,” he also reiterates RBC’s view that First Uranium’s assets in South Africa “have struggled to meet the market’s expectations.”

Harquail noted that South Africa will still be a small percentage of the combined company’s revenues, which will continue to be dominated by assets in Canada, the United States, and Mexico.