Joe Conway to lead combined Northgate and Primero

Only a year after Joe Conway took the helm at Primero Mining (P-T), the former Iamgold (IMG-T, IAG-N) president and CEO is set for another big change.

This time, he’ll be the president and CEO of Northgate Minerals (NGX-T, NXG-X), which has announced a $409-million friendly offer for the precious metals producer.

Under the all-share deal, Primero shareholders will receive 1.5 Northgate shares for every Primero share held. The offer values Primero shares at $4.22 apiece, a premium of 13.9% based on closing share prices on June 12, a day before the deal was announced. If the merger goes ahead, Northgate will issue 130 million shares for a total of 424 million shares outstanding. Current Northgate shareholders would own 69% of the company, with Primero shareholders at 31%.

The merger would create a diversified mid-tier gold producer with a market cap of $1.2 billion and operations in Canada, Australia and Mexico. The combined company will have more than 13 million gold-equivalent oz. in reserves and resources, with production reaching around 550,000 gold-equivalent oz. – an increase of 72% – by 2013.

“In terms of the intermediate peer group that we see, there’s only one that has a larger reserve and resource base than the combined entity going forward,” Conway said on a June 13 conference call with analysts.

At the same time, cash costs will decrease, settling in 2013 “below the average cost structure,” he said.

While Northgate chairman Terry Lyons was also on the line, Conway has already taken the reins and spoke for most of the 40-minute call. There was some indication that the deal didn’t have the support of former Northgate president and CEO Ken Stowe, who announced his retirement in May. The concept for the deal came up about three months ago, with both companies feeling a merger would mitigate the issues that kept their share prices from going higher – which Conway described as tax issues in Primero’s case and transition issues for Northgate, as it moves toward production at its Young-Davidson mine in Ontario.

“Ken was really waiting for the rerating that would come by the building of Young-Davidson, and we were just on a little different page,” Lyons said, in response to a question about Stowe’s stance on the merger. “We felt that this opportunity was an important one for Northgate, and that we needed to move the company forward.”

Lyons said that Northgate’s new president and CEO, Richard Hall, was appointed a few days before the transaction was made public to help steer the company through the merger. Hall has been a director of Northgate since 2008, and will retain a spot on the board of the new company.

To go through, the deal requires 66.6% of Primero shares to be tendered, and approval from a majority of Northgate shareholders. Goldcorp (G-T, GG-N), which owns 35.5% of Primero, will vote its shares in favour of the merger. The companies are shooting for a September closing.

Outlining the improved market presence the new company would enjoy because of its size, production, reserve base and cash flow base, Conway said: “Our sense is that the market is actually looking for a company in that sort of intermediate space that has a lot of upside to it still to come.”

If Conway can repeat his performance with Iamgold, where he presided over the company’s growth from a market cap of $400 million to more than $6 billion, upside is a given.

“I think you can assume pretty safely we’re going to grow this thing through acquisitions, no question – either development plays, near production, etc.,” he said.

Conway will have the cash to do it. The combined company’s cash position would be $400 million. While it would also have $300 million in debt, Conway pointed out that 80% of that amount isn’t due until 2015 or later. And over the next five years, the combined company will see $1 billion in cash flow,
according to consensus estimates.

The new company’s market cap of $1.2 billion would also make it easier to fund acquisitions. “That is an important feature as well, because it gets us into a critical mass in terms of where we need to be in the marketplace . . . We’re certainly going to attract more attention and more access to capital going forward.”

Conway and Lyons touted the combined company’s focus on “safe” jurisdictions, its producing assets as well its development and exploration pipeline, and the complementary fit of Northgate’s strong technical team with Primero management’s corporate development skills.

Northgate owns two gold mines in Australia and Young-Davidson in Ontario – which will begin production in the first quarter of 2012. Life-of-mine production at Young-Davidson is expected to average 180,000 oz. gold a year over 15 years.

Primero owns the San Dimas gold-silver mine, which it purchased from Goldcorp last year. Production at San Dimas is expected to double to 200,000 gold-equivalent oz. a year by 2013. San Dimas has a mine life of more than 20 years.

Conway argued that the merger offers a rerating opportunity, and that by any metrics used – cash flow per share, price to net asset value (NAV), enterprise value to resources – the combined company could be expected to double its share price or more.

While there are no synergies to be had from combining nearby properties, Conway said there are synergies in combining management teams.

“What I’m excited about is really leveraging the operating teams to optimize San Dimas, Fosterville, Stawell – all of these mines could use some optimization.”

‘Problem children’

The merger won’t directly address Primero’s tax issues, which stem from an inherited silver purchase agreement Goldcorp had with Silver Wheaton (SLW-T, SLW-N). While more favourable terms were secured as part of Primero’s purchase of San Dimas, on its silver production, it still pays tax based on spot prices while receiving only US$4.04 an oz. for much of the silver produced.

In a May research report on the company, Canaccord Genuity analysts pointed out the problem.

“Evidence of the punitive impact of the silver stream deal in Q1/11 was taxes of $12.9 million on pre-tax earnings of only $5 million.”

Conway says the company is working on the inequity between the taxation structure and the amount of money received from silver production. Aside from an accelerated tax depreciation plan announced in May that will allow it to defer some taxes, it’s also looking at “transfer pricing scenarios under OECD law and regulations” that could mean $40 million in incremental cash flow. However, that process will take some time, and there’s only a fifty-fifty chance that it will work, Conway said.

Under the silver stream agreement, Primero sells the first 3.5 million oz. of annual production at US$4.04, as well as 50% of the remainder. Only half of its silver production above 3.5 million oz. is sold at spot. For 2011, San Dimas production is forecast at 90,000 to 100,000 oz. gold, and 4.5 to 5 million oz. silver. While 500,000 to 750,000 of the silver will be sold at spot prices, the average price Primero will receive is estimated at US$6.63 per oz.

As for Northgate’s Australian assets, the Fosterville and Stawell mines, CIBC World Markets analyst Barry Cooper pressed Conway on whether he would address them as the “problem children” they have become for Northgate, draining the company’s cash rather than producing it.

“We are expecting certain things to happen during the second half here that will improve the operation,” Conway said. “If that happens, great. If not, then we obviously have to look at where we are at that time.”

Both are shorter-life, high-cost mines (cash costs for 2011 are forecast at between US$800-930 an oz.), but Northgate is doing 18,000 metres of exploration drilling at Fosterville this year, and 24,000 metres at Stawell to enhance resources.

Lastly, al
though no one is paying much attention to Northgate’s Kemess Underground gold-copper project in north-central B.C. these days, Conway believes it represents a huge opportunity for the company.

“From our look at it, if you were to use the forward curve on commodity prices, for example, this project is a zinger,” he said.

Kemess Underground holds 2.6 million oz. gold and 861 million lbs. copper in measured and indicated resources. Northgate previously tried to advance the project as an open-pit mine, but native opposition to its tailings disposal plan killed the permitting process. Conway says the underground version of the project has a much smaller footprint, and environmental permitting should be easier. A preliminary economic study for Kemess Underground is due out this summer.

Cormark Securities analyst Richard Gray is upbeat on the merger for both companies.

“This deal provides Northgate with a quality asset in Mexico and an injection of energy into the management team and overall story,” write Gray and associate Joshua Perelman in a note on the merger. “Primero shareholders will benefit through an enhanced growth profile and a dilution of the problematic tax burden from its silver stream sales.”

While Gray has maintained his “market perform” target for Northgate at $3.75 (based on 1 time NAV and 7.5 times cash flow), once the deal is done, he writes that the combined company could be eligible for a rerating to the $5.75 to $6 range using the more aggressive multiples that are applicable to the larger peer group (1.25 times NAV and 10 times cash flow).

The markets reacted positively to the merger news. At presstime, Northgate shares had jumped 13.5% since the announcement, to $3.12, while Primero shares were up 11.5% to $4.52.

Northgate traded in a 52-week range of $2.42-$3.62, and has 292 million shares outstanding. Primero traded between $3.03 and $6.73, with 87.9 million shares outstanding.