Pan American to buy Tahoe for US$1B in controversial offer

Pan American Silver’s (TSX: PAAS; NASDAQ: PAAS) friendly acquisition of Tahoe Resources (TSX: THO; NYSE: TAHO) in a cash-and-share deal valued at US$1.07 billion will double the company’s silver reserves and create the largest publicly traded silver mining company by free float.

Tahoe Resources owns and operates the Escobal silver mine in Guatemala (now on care and maintenance), the La Arena and Shahuindo gold mines in Peru, and the Timmins West-Bell Creek complex in Canada, as well as a number of exploration and development projects.

Pan American — already the world’s second-largest primary silver producer — owns and operates six mines in Mexico, Peru, Argentina and Bolivia, and its wholly owned Navidad project in Argentina’s Chubut province is one of the world’s largest undeveloped silver deposits.

Michael Steinmann, Pan American Silver’s president and CEO, told analysts and investors on a conference call that with Escobal’s 264 million oz. silver in reserves, the mine “has significant long-term production potential,” and with the possible addition of Navidad, the new Pan American Silver would “eclipse Fresnillo as the world’s largest silver producer.”

Escobal is a well-built operation with minimal capital outlay and development risk, he notes. Before its suspension in mid-2017, and over its last four quarters of undisturbed production, the mine produced 21 million oz. silver at all-in sustaining costs of US$8.63 per oz. silver.

“Pan American is gaining exposure to one of the most attractive silver mines in the world through Escobal,” Steinmann declared. “With over $500 million invested in development and infrastructure, this is a well-built turnkey operation, capable of restarting production rapidly once social acceptancy is re-established in Guatemala.”

Escobal, which started commercial production in January 2014, has been shut down for more than a year by the country’s courts after an organization called CALAS accused Guatemala’s Ministry of Energy and Mines of not consulting sufficiently with the Xinka, a local indigenous group, before awarding the licence to Tahoe.

Tahoe Resources’ Escobal silver mine in Guatemala, which has been on care and maintenance since mid-2017. Credit: Tahoe Resources.

Steinmann said Pan American’s history of success in Latin America over a quarter of a century was “one of the key attributes for Tahoe in pursuing this predominantly share-based transaction.”

“With a long-standing track record for responsible mining in Latin America, Pan America is committed to being fully engaged in the process of consultation with the Xinka community and to establish a long-term relationship of trust and partnership with all of Escobal’s stakeholders,” he said.

Under the terms of the definitive agreement announced on Nov. 14, Tahoe shareholders may elect to receive $3.40 in cash — or 0.2403 Pan American shares for each Tahoe share held — up to a maximum cash consideration of US$275 million, and a maximum of 56 million Pan American shares. The base purchase price of $3.40 per share represents a 34.9% premium to Tahoe’s volume-weighted average price (VWAP) for the 20-day period ended on Nov. 13.

In addition, Tahoe shareholders will receive a contingent consideration of 70¢ per Tahoe share payable upon first commercial shipment of concentrate from Escobal, representing another 27.9% premium. The contingent value rights (CVRs) will automatically convert into 0.0497 Pan American share for each Tahoe share held. The CVRs will be transferable and have a 10-year term.

The total consideration for the base purchase price and the contingent purchase price adds up to $4.10 per share, a 62.8% premium to Tahoe’s VWAP.

If the deal is approved, shareholders of Pan American and Tahoe will own 73% and 27% of the combined company.

Steinmann notes that while the transaction positions Pan American “as the world’s premier silver miner,” Tahoe’s gold assets are also significant. “Shahuindo, La Arena and the Timmins mines are well-built, well-run modern operations in favourable jurisdictions, with significant-scale production of over 400,000 oz.,” he said. “The recent capital programs at Shahuindo and Timmins position these assets well to deliver low-cost production in the future, bolstering the new Pan American cash flow potential.”

The gold assets are “highly marketable,” he adds, “which provides Pan American with additional liquidity options to foster investment in the future.”

Kevin McArthur, Tahoe’s founder, president and CEO, said Tahoe shareholders benefit from the upfront premium and from diversification of production with Pan American’s operations across the Americas, and its “robust growth profile, with potential expansion at La Colorado and development of Navidad.” They will also benefit from an improved balance sheet and exposure to the Escobal mine, he added.

McArthur acquired the Escobal project in 2010 from his former employer, Goldcorp (TSX: G; NYSE: GG), for US$505 million in cash and shares. McArthur retired as Goldcorp’s president and CEO in 2008 and negotiated the deal with the company’s then CEO, Chuck Jeannes.

The proposed acquisition has mixed reviews from analysts and investors.

“The transaction is worse than it looks,” John Tumazos, a shareholder in both companies and the New Jersey-based founder of Very Independent Research, told The Northern Miner. “Tahoe picked a bad time to sell and sold out at a very poor price … they deserve to be sued for this.” Tumazos notes that the company’s shares on the New York Stock Exchange are trading down over 90% from their peak of US$27.55 per share in mid-2014.

“The terms of the deal are inadequate and Tahoe had other alternatives, like selling a gold stream,” he says. “They didn’t have to sell the whole company at all, and they certainly didn’t have to sell at this time.”

Tumazos calculates that on top of the US$505 million in cash and shares Tahoe paid Goldcorp to acquire Escobal in 2010, it spent another US$1 billion to build the mine.

In addition, Tahoe paid US$1.12 billion in 2015 for Rio Alto, which owned the La Arena gold mine and the Shahuindo gold project in Peru, and spent another US$680 million in 2016 to acquire Lakeshore Gold and its Timmins West and Bell Creek mines in Timmins, Ontario. Tumazos estimates that Tahoe then invested US$600 million in capex to expand the four gold assets.

“The transaction appears very nice for Pan American,” he says. “If you compare what the cost of Tahoe’s assets were, they’re getting an awful lot for free.”

Tahoe Resources’ Escobal silver mine in Guatemala, located 70 km by road from Guatemala City. Credit: Tahoe Resources.

Michael Gray of Macquarie Group poses the question whether the sale “is a good exit strategy for Tahoe, given the free cash flow inflection point was right around the corner.”

Tahoe’s ($90 million) Bell Creek shaft extension and the ($180 million) crushing expansion at Shahuindo should be complete in the first half of 2019, he writes in a Nov. 15 research note.

“By accepting an offer now instead of waiting until 2020, when the company becomes free cash flow positive, suggests to us that Tahoe may not have confidence in the gold assets.

“While Tahoe was able to withstand the blow of Escobal being shut down, the reality is that the cost structure of the gold assets will remain high (AISC + $1,000) out to at least 2024, based on our model,” Gray says. “The potential for gold to drop to $1,100 and wipe out the margin might have rattled Tahoe management and helped catalyze the transaction.”

The analyst also points out that while Tahoe’s acquisition of Lakeshore Gold and Rio Alto diversified country risk and precious metal exposure, “the assets were ‘tough’ to execute on at various levels,” including corporate social responsiblity (CSR), timing, exploration, mining and metallurgy.

“There is a fatigue factor setting in with Tahoe management, and they may be dealing with a ‘what else can go wrong’ mindset.”

As evidence, Gray points to West Timmins, where “grades have been lower than expected [and controls suggest high risk], and exploration potential has disappointed,” as well as high sustaining capital expense requirements at Timmins of $40 million to $50 million a year. In South America, meanwhile, Tahoe has faced a labour dispute and strike at La Arena, and CSR issues at Shahuindo.

Other analysts are more enthusiastic about the deal.

Geordie Mark of Haywood Securities recommends Tahoe shareholders tender to the premium price offer.

“The plan of arrangement outlines a favourable avenue for Tahoe shareholders to participate in an upfront premium, and the potential for further upside contingent on Escobal, which offsets the share price underperformance associated with the sustained hiatus at Escobal,” he says in a research note.

Matthew O’Keefe of Cantor Fitzgerald argues the deal is positive for Tahoe.

“The transaction offers Tahoe shareholders a healthy premium; brings in a stronger balance sheet; a new management team, with a long-term track record of responsibly developing and operating silver mines in Latin America; and maintains upside participation to an Escobal restart,” he argues. “The overwhelming support by Tahoe management and board also suggests that Pan American Silver is in a better position to see Escobal through a restart.”