Barrick bids for Equinox (April 25, 2011)

The board of Equinox Minerals (eqn-t, eqn-a) is withdrawing its bid for Lundin Mining (lun-t) and endorsing instead an all-cash takeover bid of $8.15 per share from Barrick Gold (abx-t, abx-n), which values the company at about $7.3 billon. The friendly agreement with Barrick follows a hostile bid made earlier this month for Equinox by Chinese-owned Minmetals Resources valued at $6.3 billion, or $7 per share.

Barrick’s offer for Equinox is a 16% premium to the value of Minmetals’ bid and represents a 30% premium to Equinox’s closing share price on the Toronto Stock Exchange on Feb. 25, 2011, the last trading day before the announcement of Equinox’s bid for Lundin.

Aaron Regent, Barrick’s president and chief executive, said on a conference call that the proposed transaction gave it an entry point into the highly prospective Zambian copper belt and “a rare chance to acquire one of the world’s larger copper producers.”

Last year Equinox’s Lumwana copper mine in Zambia produced 323 million pounds of copper, and its Jabal Sayid project, currently under construction in Saudi Arabia, is expected to start producing over 100 million pounds of copper starting in late 2012, Regent said.

If approved the acquisition would give Barrick 5.7 billion pounds of copper reserves, including 4.5 billion pounds of copper reserves from the Lumwana mine and 1.2 billion pounds of copper reserves from Jabal Sayid. In addition Lumwana has a further 5.5 billion pounds of inferred copper resources.

“These types of assets rarely become available in the market,” Regent told analysts and investors on the conference call. “Further we were able to work with Equinox to complete due diligence, including a site visit to Lumwana, and finalize an agreement which is fully supported by Equinox’s board.”

“Most major copper mines tend to be tied up by major producers,” he added. “If you look at the top twenty copper producing mines in the world, this is probably one of the only ones that is actually available.”

In a press release outlining the terms of the offer, Barrick said that the proposed acquisition is “consistent with its strategy of increasing gold and copper reserves through exploration and acquisitions” and was also cash flow and earnings accretive for its shareholders. 

Barrick will pay for Equinox with cash on hand and $5 billion in financing consisting of a bridge loan ($3.5 billion) and a five-year revolver ($1.5 billion). The transaction, said Regent, would not only utilize its balance sheet but also comes at a time of historically low interest rates. At the end of 2010 Barrick held about $4 billion in cash and $1.5 billion in undrawn credit.   

Regent noted that the acquisition would position Barrick in Africa and South America, two of the most prolific copper producing regions in the world. (Barrick currently owns Zaldivar, an open pit heap-leach copper mine in northern Chile. Last year Zaldivar produced 318 million pounds of copper at total cash costs of US$1.09 per lb.)

“Seventy percent of committed mine production growth over the next five years is attributed to Latin America and Africa and this is a product of geology,” he explained.

“In Zambia renewed exploration and research has been finding new deposits and new geology that has completely renewed the prospectivity of the region,” he said. “There have been some fantastic new finds recently. While we are excited about Lumwana, we are equally positive about the prospects within this region and the platform it provides for future exploration and development opportunities.” 

Regent pointed out that the region is under-explored and that no significant drilling has been conducted on property targets outside the resource areas for at least the last fifteen years. He also described Zambia as an “attractive country” in which to operate, “with political stability and maturity and a long mining tradition.”

“It is one of the most stable countries in Africa,” he asserted, where “decision making is largely transparent and the legal framework around mining is considered to be well conceived and structured.”

Zambia’s tax regime includes a corporate tax rate of 30%, a mineral royalty of 3%, and a variable profit tax. There is also an export levy of 15% on exported copper concentrate. But Barrick estimates its total tax rate, including the profit tax, will fall somewhere in the range of 30% and 40%. It also said the 15% export tax won’t apply if concentrates are processed in the country.

In terms of Saudi Arabia, Regent said Equinox’s Jabal Sayid project contained a high-grade underground deposit grading about 2.2% copper plus gold by-product credits. Good infrastructure exists around the project, fuel and power costs are anticipated to be relatively low, and the deposit is open at depth, he said.

“There is a high likelihood of resource expansion at lodes 1 and 4,” Regent added, noting that Equinox has a high-quality portfolio of gold and polymetalic properties in the Arabian Shield, which is a highly prospective area for moderate sized, high-grade gold and polymetalic deposits.

“From a historical perspective the Arabian Shield has over 1,000 ancient copper and gold mines and over 6,000 targets and it is a fairly sparsely explored region,” he said, adding that the government of Saudi Arabia “has been keen to promote industrial development by expanding and diversifying industrial output, particularly in the mining sector.”

Saudi Arabia has been a member of the World Trade Organization since 2005, he noted, and “is regarded by multilateral organizations as a favorable investment destination.”

In terms of the fundamentals for copper, Regent said they continue to look “very strong for the foreseeable future.”

Demand is forecast to grow by in excess of 3% per year, he reasoned, which when combined with the impact of lower grades and mine depletion will require over one million tonnes of new mine supply annually.

When asked about long-term copper prices, however, Regent would only say that “most of the long-term copper assumptions being used right now are understating what’s going to happen,” and pointed to cost pressures across the board that are likely to continue and eventually translate into the need to have higher long-term copper prices to incentivize production.

And when queried about Barrick’s future direction and how many non-gold assets it would be willing to own, Regent said that if one looked at the impact of the transaction on Barrick’s pro forma basis to 2010, its revenues would still be about 80% gold and 20% non-gold.

“I think that compares well with the other producers out there,” he said. “I think Newmont is in the same range, Goldcorp is a bit less than that, Agnico is probably a little less than that. So the revenue mix is pretty consistent with our peer group. That’s a ratio that will probably be more or less maintained.”

In response to a question from an analyst about whether Barrick might end up putting Lumwana into African Barrick Gold (abg-l),Regent said no. “We had specific reasons why we took that unit public but it wasn’t a position or an indication of an exit strategy,” he explained. (In March 2010 Barrick offered about 25% of the equity in African Barrick in an initial public offering on the London Stock Exchange. It currently owns about 73.9% in the company, which holds Barrick’s previously held African gold mines and exploration properties.)

“I don’t think there is any logic to combining the two entities,” Regent said. “African Barrick has a specific mandate to grow in gold and part of the reason we took it public was to enable it to pursue some of the smaller gold opportunities that wouldn’t be material to us but would be quite significant to them…Lumwana is a big asset and is material to Barrick and strategic to Barrick and gets us into a very attractive region and if you are a global m
ining company you need to have a presence in this part of the world.”

Barrick’s offer for Equinox surprises many and worries some. “Management emphasized its financial capacity and its ability to get low-cost financing as rational for the transaction,” Adam Graf of Dahlman Rose & Co. wrote in a research note to clients. “We can’t help but worry why a gold company is looking to lever up their balance sheet to acquire copper assets. Further, we view ABX’s core competencies as its ability to finance and execute large mining projects. Therefore, we are puzzled by the company’s purchase of an operating copper asset at full price (in our view), using up much of its spare financial capacity. On a positive note, the $250 million break fee could be a boon to ABX should Minmetal try and top them for this asset.”

Kerry Smith of Haywood Securities was equally negative about the proposed acquisition. “While we accept this was an opportunistic bid for a company already in play, we believe this bid sends a negative view on Barrick’s longer term strategy, the availability of gold assets in the industry and Barrick’s ability to grow their gold cash flow per share,” he wrote in a note to clients.

“We are concerned that over time Barrick will be faced with the “problem” of how to invest their excess cash to grow CFPS (cash flow per share) – with acquisitions slanted towards copper – suggesting that over time Barrick would move towards being a more diversified miner – which would also lead to declining multiples as the diversified miners today trade at 6x 2012 consensus CFPS while the senior gold producers trade at 10x.”

Meanwhile, Onno Rutten of UBS Investment Research, believes there is a 60% probability of a counteroffer from Minmetals, “with a 5-10% bump over Barrick’s offer.”

“China Minmetals has similarly low funding costs and conceivably can apply a lower country risk discount to Zambia,” he wrote in a note. “Moreover, China should be more motivated to get access to physical copper supplies.”

Rutten also pointed out that Lumwana’s first quarter (2011) copper production was 9% below his estimate due to a worse-than-expected grade decline and equipment issues. “At a copper ore grade of 0.66%, cash operating costs were US$1.93 per lb (21% above the UBS estimate). Moreover, copper concentrate inventories continue to rise due to Zambian smelter bottleneck issues. These trends challenge the long-term economics of Lumwana’s ‘Chimi’ expansion.”

In Toronto, Barrick’s shares closed down $3.57 or 6.73% at $49.50 per share after the deal was announced. In New York they lost US$3.77 or 6.78% to finish at US$51.86 per share.