Update: Osisko to acquire Queenston

It’s not easy these days for chief executives and their boards to strike a balance between shareholders who scream for growth and those who demand consistent free cash flow and higher dividends. 

But the management team at Osisko Mining (OSK-T) is championing growth in a friendly all-share deal to acquire Queenston Mining (QMI-T) and its Upper Beaver project along with four potential satellite deposits in Ontario’s Kirkland Lake region.

Under the $550 million deal Queenston shareholders will receive 0.611 of an Osisko share for each Queenston share they hold, which implies an offer price of $6 per share or a 45% premium to Queenston’s 30-day volume-weighted average price for the period ended Nov. 9.

Queenston shareholders will own about 12% of the pro-forma company if the deal is approved, and Osisko notes that about 30% of the outstanding shares have been locked up already.

“Queenston is an excellent strategic fit within our existing Canadian portfolio and in our view is one of the best undeveloped high-grade opportunities and significant open-pit targets in Canada,” Sean Roosen, Osisko’s chief executive, said in a prepared statement. “Osisko has always sought to be a part of camps rather than isolated assets and this transaction provides us with a highly strategic land package in another prolific Canadian gold camp.”

A preliminary economic assessment in February this year outlined an initial 10-year mine life operating at 2,000 tonnes a day. The study estimated that Upper Beaver will  produce a total of 1.1 million oz. gold at an average rate of 120,000 ounces per year at an average cash cost of US$386 per oz., net of by-product credits. At a gold price of US$1,275 per oz., the project yields an after-tax internal rate of return of 22.1% and a post-tax net present value of $233 million.

A resource update in late September boosted Upper Beaver’s total inventory by 92% to 2.17 million oz. gold. The new resource (1.46 million oz. gold in the indicated category at an average grade of 6.62 grams gold) will be incorporated into a revised PEA and a feasibility study is expected in December 2013 with production targeted in 2016.

Queenston believes its stable of four other 100%-owned deposits in the Kirkland Lake area — Upper Canada, Anoki/McBean, Bidgood and AK — will provide additional feed for a central milling facility. Altogether the company’s gold properties in the Kirkland Lake camp host 2.1 million oz. gold in the indicated category (13 million tonnes grading 5.0 grams gold per tonne) and 1.9 million oz. gold in the inferred category (13 million tonnes grading 4.5 grams gold.)

Benefits of the acquisition to Queenston shareholders include a hefty premium to their share price, exposure to current gold production from Osisko’s Canadian Malartic gold mine in northern Quebec, which went into production in May 2011, as well as upside from Osisko’s Hammond Reef project near Atikokan, Ontario. Hammond Reef is to be an open-pit bulk tonnage operation and has a global inferred resource of 10.5 million oz. (530.6 million tonnes grading 0.62 gram gold per tonne.) Queenston’s management also says that joining forces with Osisko will de-risk the financing of Upper Beaver, and brings with it a proven management team.

News of the deal elicited a wide range of comments from mining analysts.

Richard Gray of Cormark Securities views the proposed acquisition as a “prudent move” as investors “are starting to look beyond Canadian Malartic for future growth.” He argues the transaction “significantly bolsters Osisko’s presence in the Abitibi greenstone belt and provides a relatively simple, low cost mine to augment the ramping production from Canadian Malartic.” Gray has a target price on Osisko of $14 per share.

Barry Cooper at CIBC World Markets noted that the acquisition “will add new aspects (and challenges) to the Osisko story,” including copper production and underground mining at Upper Beaver, and believes the Osisko team “will have to continue to bulk-up its underground expertise in order to tackle the challenges of underground mining.” He also forecasts that capex and operating costs at the Upper Beaver project will be higher than the $240 million and US$386 per oz. estimated in the February PEA. According to his model, capex will run closer to $450 million and operating costs on a by-product basis will likely come in at US$600 per oz.  Having said that, he adds, management “can take advantage of the higher-grade porphyry zones in the earlier years to enhance payback.”

Osisko’s offer represents “a reasonable price” for Queenston, he writes in a research note, adding that the acquisition will give Osisko “one of the most prospective land packages in Canada, with long-term upside.” He calculates the acquisition is 7% accretive to Osisko’s net asset value and on a total acquisition basis (TAC), the acquisition price works out to US$982 per oz. or a 43% discount to the spot price of gold at the time of the transaction.

As for other companies that might be interested in taking a run at Queenston, Cooper lists Agnico-Eagle Mines (AEM-T, AEM-N), which already owns about 9% of the company’s outstanding shares, and Iamgold (IMG-T) and Kirkland Lake Gold (KGI-T, KGI-L), both of which have assets in the area. The mining analyst has a 12-18 month target price on Osisko of $13 per share.  

Jeff Killeen, who covers Queenston for CIBC World Markets, lists a number of the company’s attributes that in his view justify the premium offered. He expects significant resource expansion at Upper Beaver over the next 12 to 18 months and notes that Queenston’s resources “offer a mix of high-grade underground targets with low-grade open pit targets.” He also notes that all of Queenston’s assets are close to each other and “within a short distance of significant infrastructure” that includes the Trans-Canada highway, power transmission lines and skilled labour. And the $115 million on Queenston’s balance sheet is sufficient for the company to complete all of its work plans for next year and a portion of them in 2014.

After taking a broad look at the proposed transaction initially, Brad Humphrey of Raymond James, questions Osisko’s rationale. While Queenston is in a favourable geopolitical location and in an established mining camp, he concedes, the proposed transaction “appears to represent a shift in direction for Osisko from the bulk mining, low grade, (soon to be) large producing Canadian Malartic operation to now encompassing the higher grade, underground mining, smaller producing Upper Beaver project.”

“In our view the deal introduces several questions for [Osisko] shareholders regarding the long-term direction for the company with respect to the future of Hammond Reef and the company’s aspiration to be a 1 million oz. producer,” he continues in a research note. “Given Canadian Malartic is approaching a steady state level in its production, potentially generating significant cash flow, the introduction of a dividend was also (and may still be) on the cards in our view.”

“We suspect, given the current market sentiment, that once Osisko is able to get the Canadian Malartic mine up and running consistently at design rates, the market is hoping to see Hammond Reef shelved in the meantime and the company to commence paying a meaningful dividend.”

Humphrey rated the deal’s “probability of success” as “average to good,” but noted that “the potential for interlopers” is “not out of the question.”

When news of the deal was announced, Osisko shares fe
ll 8.2% or 80¢ to close at $9.02 apiece with 3.6 million shares changing hands. Queenston shares gained 74¢ or 14.8% to $5.75 with 4.8 million shares changing hands.

Daniel Earle of TD Securities has lowered his 12-month target price on Osisko from $13.50 to $11.50 per share and argues that the impact of the deal is negative. “Osisko closed down 8.2% on the day, wiping away most of the market value being acquired,” he wrote in a research note, adding that the transaction “comes at what may be a sensitive time for shareholders.”

Earle maintains that Osisko has had “a series of issues ramping up production” at its flagship Canadian Malartic mine since April 2011 when the company poured its first gold, and says that he does not believe the project will reach design rates until the first quarter of next year.

He also describes Queenston’s Upper Beaver project as being “of moderate quality” but better than Osisko’s Hammond Reef project, which he does not think will be developed. “Upper Beaver has low political risk and does provide potential production growth, which Osisko was lacking (in our view), but only in 2016,” he comments. “Resource growth could improve the picture, but only near-surface growth (rather than deep) — given the already long mine life…we see a larger mining inventory, lower grades and higher costs than the February 2012 PEA.”

“Our thesis had been that the company would continue to build production into the new year [at Malartic] and that as the challenges of its ramp up were put behind it and the market began to look forward to the significant free cash flow we forecast potentially being put toward a dividend (as management had discussed in investor presentations), the share price would appreciate,” Earle writes. “While our thesis does not change with this deal, it has been diluted somewhat.”