Primero snapping up Cerro del Gallo

Toronto-based gold producer Primero Mining (P-T, PPP-N) has waded into merger-and-acquisition waters with a friendly offer to buy Australian gold explorer Cerro Resources (CJO-V, CJO-A) in an all-stock deal worth US$120 million.

Cerro shareholders would receive 0.023 of a Primero share for each Cerro share held, which represents a 62% premium on Cerro’s 20-day, volume-weighted average price, and a 77% premium on Cerro’s closing price of A8.6¢ on Dec. 12.

Cerro’s primary asset is its 69% stake in the Cerro del Gallo gold-silver project in Mexico’s Guanajuato state, 270 km northwest of Mexico City. The agreement states that Cerro’s remaining projects and equity interests would be spun out into a company that would be 80% owned by Cerro’s existing shareholders, with the remaining 20% being purchased by Primero.

Primero’s president and CEO Joseph Conway says his company has been reviewing acquisition opportunities over the past two years. Primero attempted to buy Northgate Minerals and its Young-Davidson gold mine in Ontario in mid-2011, but was outbid by Toronto-based AuRico Gold (AUQ-T, AUQ-N).

“We believe [the Cerro del Gallo project] offers our existing and new shareholders immediate improved leverage to gold with a significantly larger reserve and resource base, production and cash-flow profile,” Conway says. He points out that though Cerro would represent 15% of Primero’s market capitalization, the project could deliver in excess of 55% of the company’s total gold-equivalent production.

“In our view, Cerro del Gallo is a promising, undeveloped, large resource base opportunity in Mexico. Primero has the operational and financial strength to advance the project on a timely basis, which would be beneficial for all stakeholders involved,” Conway says.

Primero’s sole production asset is the San Dimas gold-silver mine located along the Durango-Sinaloa border in Mexico. The company bought the project for US$500 million from Goldcorp (G-T, GG-N) in 2010, and has ramped up gold production at the mine over the second half of the year. Primero bumped its annual production guidance at San Dimas following the second quarter, and expects the mine to churn out between 110,000 and 120,000 equivalent oz. gold at an average cash cost of US$630 per oz. gold.

With the Cerro del Gallo acquisition, Primero will deepen its relationship with Goldcorp, which already owns a 32% stake in Primero from the San Dimas acquisition. Goldcorp holds a 31% interest in Cerro del Gallo.

Cerro filed a feasibility study on Cerro del Gallo in early July. The company modelled a two-tiered development with heap-leach stage followed by the installation of a carbon-in-leach processing facility after several years of operation.

Cerro’s heap-leach stage would target oxidized and weathered material totalling 32 million proven and probable tonnes grading 0.69 gram gold per tonne and 14.8 grams silver per tonne for 712,000 contained oz. gold and 15 million contained oz. silver, at a 0.3 gram gold equivalent cut-off grade.

The US$136-million project is expected to produce 95,000 oz. gold per year at average cash costs around US$515 per equivalent oz. gold. Annual mill throughput is pegged at 4.5 million tonnes, with recoveries clocking in at 69% gold and 50% silver.

The operation’s annual production would peak by its third year, when output would total 99,000 equivalent oz. gold.

Assuming prices of US$1,341 per oz. gold and US$25.58 per oz. silver, Cerro del Gallo’s initial stage carries a US$181-million pre-tax net present value and a 30.5% internal rate of return at a 6% discount rate. The project is expected to generate US$280 million in undiscounted cash flows, and boast a 2.7-year payback period.

The second stage involving hybrid heap-leach and carbon-in-leach circuits could extend the mine’s life to 14 years.

Cerro’s expansion would target in-pit resources totalling 45 million measured and indicated tonnes grading 0.66 gram gold and 14 grams silver for 951,000 contained oz. gold and 20 million contained oz. silver, at a 0.35 gram gold cut-off for fresh-rock material.

Capital costs for the expansion are estimated at US$85 million.

The acquisition is expected to boost Primero’s annual equivalent-gold production to 260,000 oz. by 2016.

“[Primero] appears to have paid a fair price for Cerro Resources, to enhance its longer-term growth profile while strengthening its presence in Mexico,” BMO Capital Markets analyst David Haughton writes in a Dec. 13 research report. “On a pro-forma basis, the combined balance sheet is forecast to provide sufficient cash to fund the assumed development plans for San Dimas and Cerro del Gallo.”

Primero estimates five-year operating cash flows at US$120 million, and reported a US$133-million cash balance at the end of November. Haughton maintains a $9 price target on Primero, as well as an “industry outperform” rating.

Primero’s shares dropped to a midday low of $6.04 during trading on Dec. 13, but rebounded to close out the session at $6.61 per share on above-average, 728,500 share-trade volumes.

The company had 97 million shares outstanding and a C$639-million market capitalization at press time. The transaction, which is expected to close by May, would increase Primero’s outstanding shares to 115 million.

Following the news, Cerro’s share price jumped 45%, or A3.7¢, en route to a A12¢ close on the Australia Stock Exchange. 
The company has 782 million shares outstanding and a A$93-million press time market capitalization.