Tahoe launches friendly bid for Rio Alto Mining

After a brief courtship that started at the Denver Gold Forum in September 2014, Tahoe Resources (TSX: THO; NYSE: TAHO) and Rio Alto Mining (TSX: RIO; NYSE: RIOM) are tying the knot.

It was their similarities and strengths that really brought them together, says Tahoe CEO Kevin McArthur, who founded the company after retiring at the end of 2008 as CEO of Goldcorp (TSX: G; NYSE: GG). (Goldcorp is Tahoe’s largest shareholder with a 39% stake, and has given its formal blessing to the union.)

“We have the leading return on equity in the silver space and they have the leading return on equity in the gold space,” McArthur says. “They have one of the strongest operating margins in the gold space and we have one of the strongest operating margins in the silver space, so we have similar attributes. And I think with the strong management at both companies, and the free cash flow, we are very similar, too.

“When we went to their mines in Peru and they came to ours in Guatemala, it was obvious to us that we have similar goals and skill sets, and that the culture of our teams is the same — from mining engineers and geologists to earth scientists and business people — they are very much the same,” McArthur elaborates in a telephone interview from Reno, Nev. “With the dovetailing of two similar management teams, we will have a powerful company going forward in terms of the ability to take on different assets, both underground and open-pit, in the precious metal space.”

Like many proposed couplings, timing also played a role. “We always knew we would eventually grow, but we wanted to establish our brand by building our Escobal project first,” McArthur says of Tahoe’s silver mine in Guatemala, which it first bought from Goldcorp in 2010 for US$253 million in cash and 43.7 million Tahoe shares.

Last year — its first full year of production — Escobal turned out 20.3 million oz. silver, making it the third-largest primary silver mine in the world by annual production, according to Tahoe. And with much of the hard work building Escobal behind it, Tahoe was ready for a soulmate, eventually finding it in Rio Alto.

McArthur notes that with US$78.9 million in cash at the end of the third quarter of 2014 and just US$50 million in debt, Tahoe’s robust balance sheet could support an acquisition, putting it in a unique position compared with many other mining companies, and helping it take advantage of the downturn to add to its portfolio of producing assets and exploration projects.

“It’s the strong companies that are doing things now at the low-end of the cycle that make sense,” McArthur says. “It’s the companies that blew their brains out at the top end of the cycle that can’t react, companies that are saddled with immense amounts of debt. I think that, once again, at this end of the cycle, this is the time to do these types of transactions.”

If shareholders approve the deal, Tahoe will secure a foothold in Peru with Rio Alto’s La Arena gold mine, a low-risk, simple heap-leach gold operation with an attractive cost profile, and Shahuindo, a low-capital (US$70-million), heap-leach gold project that could produce its first metal in early 2016. (Shahuindo is 30 km from La Arena.)

La Arena produced 222,000 oz. gold last year and is forecast to produce between 210,000 and 220,000 oz. gold in 2015 at net cash costs of US$570 to US$600 per oz., and all-in sustaining costs of US$730 to $765 per oz.

Tahoe’s high-grade Escobal mine, meanwhile, is forecast to produce between 18 million and 21 million oz. silver in 2015 at total cash costs of US$6.35 to US$8.25 per oz., and all-in sustaining costs of US$9.75 to US$11.50 per oz.

A business combination would create a strong and diversified precious metals producer with industry-leading free cash flow generation and a balance sheet with zero net debt, the management teams of both companies argue. And there is much room for growth, the companies say, with the planned mine expansion at Escobal from 3,500 tonnes per day to 4,500 tonnes per day, in addition to exploration upside in both Guatemala and Peru.

Combined, the new company would have a US$3.3-billion market cap that the two companies say would “appeal to a broader institutional shareholder base,” generate greater analyst coverage and improve share trading liquidity.

Under the terms of the proposed merger, all of Rio Alto’s existing and issued common shares would be exchanged on the basis of 0.227 of a Tahoe common share and $0.001 in cash per Rio Alto share, implying a value of $4 per Rio Alto share, or a 22.1% premium to Rio Alto’s closing share price on the TSX of $3.28 on Feb. 6 and a 20.3% premium based on the volume-weighted average prices of each company for the 20-day trading period ended Feb. 6.

If the deal goes ahead, McArthur will serve as executive chairman of the combined entity, while Rio Alto CEO Alex Black will become the new CEO. Black did not respond to a request for comment on the merger before press time.

When asked if he thought Tahoe might have to contend with another bidder for Rio Alto, McArthur said, “We don’t believe there’s a high likelihood that you could have another company come in with a higher price.

“I’ve been in this business for some time, so you never say ‘never’ — but we have a strong deal and the backing of the largest gold miner on the planet, being our shareholder, Goldcorp, so I would handicap someone coming in and winning this, at a low rate.”

Matthew O’Keefe and Scott Morrison of Dundee Capital Markets commented in a research note that the acquisition “diversifies Tahoe away from Guatemala (a previous goal of management) and adds two gold assets in Peru,” and that the pro-forma company could become “a leading intermediate precious metals producer, with material free cash-flow generation and a strong net cash position.” They noted that “of intermediate producers under coverage, only Randgold is forecast to exit 2015 with net cash at spot prices,” and pointed out that Tahoe would pay a US2¢ per month dividend if the transaction closed.

Kerry Smith of Haywood Securities, however, voiced concern that Tahoe’s offer does not offer a big enough premium for Rio Alto. 

“Any premium bid in the current market should be viewed positively,” the analyst wrote in a client note. “However in our opinion the [offer] … is a bit low for Rio Alto shareholders, given the increased country risk that will be assumed by operating in Guatemala.

“As a result, Rio Alto goes from a Peruvian focused gold producer with a low political risk profile to a gold and silver producer with a large operation in Guatemala (which would have at best modest corporate synergy with Peru), a country with a distinct negative bias towards mining.”