Kinross bids for Aurelian

Count Kinross Gold (K-T, KGC-N) amongst the believers in Ecuador.

The Toronto-based company has made a bold move to acquire Aurelian Resources (ARU-T, AUREF-O) and its massive Fruta del Norte gold deposit, part of the Condor project, in the midst of continuing political uncertainty there.

And while the bid comes well before the country’s new mining law is to be ratified — the latest estimates put that date in the fourth quarter — it secures for Kinross a world-class deposit at a bargain price.

The deal, which has been unanimously approved by Aurelian’s board, would see Kinross offer 0.317 of a common share along with 0.1429 of a warrant, for each Aurelian share. That values Aurelian shares at $8.20 and the entire company at $1.2 billion.

And while the sum represents a 63% premium to Aurelian’s 20-day share price average, investors with longer memories know Aurelian shares had been trading above the $10-mark as recently as the end of last year.

But political turmoil has a way of throwing shares off a cliff and that was just the case for Aurelian when the Ecuadorian government suspended all mining activities in April, pending the introduction of a new mining law.

Rumours swirled about forced joint ventures with the government, tight limits on the number of concessions a company could hold and veto powers for nearby communities over projects.

But recent comments, from both President Rafael Correa and the Ministry of Mines, sought to soothe investor worry. Such statements have gone a long way toward winning Kinross’s confidence, even if many on the Street openly wonder if the company shouldn’t have waited until the political climate was more stable.

“Timing is always in the eye of the beholder,” Tye Burt, Kinross’s chief executive said on a conference call. “We could have sat on our hands, I suppose, but it didn’t feel right for either of us. It might be early on the political stuff, but our judgment was that on the whole, we are positive in our view and fundamentally positive on the orebody.”

Burt also emphasized that Kinross’s focus on responsible mining and its experience bringing mines into production in difficult countries, such as Russia, are keys to its future success in Ecuador.

Thankfully for Kinross, it has a greater measure of certainty on the geology side of the deal.

While Fruta del Norte has only aninferred resource estimate — 58.9 million tonnes grading 7.23 grams gold for 13.7 million contained ounces gold and 22.4 million oz. silver– Kinross is very familiar with the deposit.

Aurelian’s president and chief executive Patrick Anderson noted that a Kinross geologist was on-site when the first discovery hole was drilled, and Burt underscored the point by noting that the company has had a presence in Ecuador since 2006.

For their part, Aurelian shareholders may well be wondering if they’re getting full value for their shares.

The market has been known to overreact to the type of political news that came from Ecuador in April. If that were the case, and fears over the new mining law were overstated, then Aurelian shareholders could well have seen their shares returning to their pre-suspension levels as the country moved closer to finishing the new mining law.

Recent movement in Aurelian’s share price seemed to point toward healthier days ahead. While its shares closed at a low of $3.24 on April 24, by the end of June they had started to bounce back, closing as high as $5.64.

And according to Thomson One Analytics, the average analyst target price for Aurelian is $8.74, or nearly 50 higher than Kinross’s offer.

Burt says the difficulty of estimating when the new mining legislation will come out and what details it will contain has made it hard to say there is a consensus amongst analysts.

“There is a wide range of target prices amongst analysts. It’s rare you see that broad of a spectrum,” he says. “There might be a wide range of target prices but the price we are offering today is a sixty-three per cent premium with a warrant.”

Beyond the financial elements of the deal, Aurelian’s Anderson says the company decided to back the offer because of Kinross’s reputation.

“A big consideration for us was Kinross’s corporate and social responsibility,” he says. “We believe they’ll do the right thing in Ecuador and, in return for that, Ecuador will do the right thing for Kinross.”

But in Ecuadorian politics, such reciprocity between government and foreign investors isn’t a given.

It was only last fall that Correa announced a windfall tax of 99% on all revenue above a set price on a barrel of oil. When the decision resulted in an investment freeze and oil output began to fall, Correa decided in April to lower the tax to 70% for companies that maintained output levels.

Michael Curran, an analyst with RBC Capital Markets, says tighter margins in the mining industry compared with the oil and gas industry mean governments can’t get away with such heavy tax burdens on miners.

“Fundamentally, oil and gas and mining are different,” Curran says. “The billions of dollars associated with oil led governments to have a higher level of involvement, whereas mining has lower margins because they are by comparison smaller endeavours in the tens or hundreds of millions of dollars.”

James Crossland, Kinross’s vice-president of government relations, says President Correa has been consistent in his support for responsible mining and has not indicated in any way that miners would face a fate similar to that of the country’s oil industry.

Crossland points out that as Ecuador’s oil supplies begin to decline, it will have to look to mining, along with agriculture and tourism, to pick up the economic slack.

Furthermore, he says anti-mining sentiment coming out of Ecuador in April was from a constitutional assembly set up and given legislative powers while a new constitution was drafted.

“It’s a unique situation there: for every comment made by the (constitutional assembly) against mining I can pull out positive quotes from the president,” he says. “What’s important to recognize is the constitutional assembly is not the government.”

The assembly is not the government — and is no longer in existence. The constitutional assembly dissolved on July 26 with the completion of the new constitution. The draft they presented will be voted on in a referendum in September.

While Crossland says there is nothing in the constitution that would be of concern to miners, what will be of interest is the tax structure that the new mining mandate will bring in. He says the government has consulted with Chile and other South American mining countries and expects the tax burden to be in line with such neighbours as Peru.

On the conference call, Burt said Kinross’s valuation of Aurelian’s assets assumed a total tax burden — including corporate tax, potential windfall taxes and a net smelter royalty — of 45-55%.

In an interview, one analyst, who did not want to be named, called that estimate reasonable.

To help further entice Aurelian shareholders, Kinross’s offer also contains a sweetener in the form of a partial warrant. A full warrant entitles the holder to acquire one Kinross common share at a strike price of $32 per share, and Anderson says it was a key component to the deal, as it will allow Aurelian shareholders to partake in any future upside of Kinross.

Recently, Kinross has gathered positive momentum. When Burt took the reins in March 2005, the company’s shares were trading in the $8-range. It has since made a steady climb into the low-to mid- $20 range before the Aurelian offer was announced.

Kinross says it will issue roughly 47 million shares for the transaction, which amounts to 8% of its current outstanding common shares. Burt says the acquisition will be accretive once mine construction begins.

Aurelian has agreed to pay Kinross a $42-million break fee should it receive a superior offer; K
inross has the right to match any such offer.

Kinross is also buying 15 million Aurelian common shares through a private placement at a price of $4.75 per share for a total of $71 million. Burt says the money is a testament to Kinross’s commitment to the project, as funds would be used to develop Fruta del Norte, even if the acquisition doesn’t go through.