Hecla to acquire Klondex for US$462M

Hecla Mining (NYSE: HL) is acquiring Klondex Mines (TSX: KDX) and its Fire Creek, Midas and Hollister mines in Nevada — three of the highest-grade gold mines in the U.S., if not the world — in a US$462-million, friendly cash-and-share deal.

“I can’t overemphasize what a rare set of assets these are in the heart of Nevada — a place where more and more discoveries have been made — and I strongly believe more are to come,” Phillips S. Baker Jr., Hecla’s president and CEO, said during a conference call. “Not only will we have about 110 sq. miles, with some of the highest-grade mineralization on the planet, but it’s along some key trends in Nevada. This is almost as much land as Hecla has in total.”

Hecla is buying the Nevada assets and the 162,000 equivalent oz. gold they produce each year using excess cash it has made and 20% of its outstanding stock.

“Instead of leaving cash sitting idle, we have put it to work buying this immediate production and long-term potential,” he said. “And we have sufficient liquidity — with the remaining cash in our revolver post-closing — that we can continue to execute our strategy.”

At the end of 2017, Hecla had US$187 million in cash and equivalents and $502 million in long-term debt.

“When it’s all said and done, we’ll still be cash positive,” Baker said during question and answer session on the conference call. “That’s one of the things that struck us, we can acquire this [and] Nevada itself will be cash flow positive for us — there are no capital outlays that we’re looking to in Nevada that are going to consume all of the cash flow that is going to be generated from the three mines.”

Klondex shareholders are being offered US$2.47 per share in cash, or 0.6272 shares of Hecla, subject to a maximum cash amount of US$157.4 million and a maximum issuance of 77.4 million shares of Hecla. The transaction represents a 59% premium to Klondex’s 30-day, volume-weighted average price.

In addition, Klondex’s Canadian assets (True North and Bison in Manitoba and Tully in Ontario) will be spun out into a separate company listed on the TSX Venture Exchange, in which Hecla will subscribe for $7 million, or a 13.5% equity stake, which values assets at US$45 million.

The boards of both companies support the acquisition, and two key shareholders in Klondex — CI Investments and Sentry Investments, which make up 24% of the junior’s outstanding shares — have entered into support agreements. The transaction should close in the second quarter and a US$21-million termination fee could apply if the deal doesn’t proceed.

Baker noted on the conference call that Hecla has 125 years of experience and is leveraging its core strengths as an operator of high-grade, narrow-vein underground mines, as well as its track record in mill optimization, and said his management team sees opportunities to improve costs, throughput and recoveries at Klondex’s operations.

He also pointed out that Hecla is well capitalized and can consistently invest in its mines, with the diversified metal exposure that it has to silver, gold, lead, zinc, and, in the future, copper.

Hecla benefits from the 162,000 equivalent oz. gold production from Klondex, but on a silver-equivalent basis, this also works out to 11.2 million oz. — a nearly 30% increase in Hecla’s production.

Hecla has four operating mines: one in Canada (Casa Berardi), two in the U.S. (Lucky Friday and Greens Creek), and one in Mexico (San Sebastian).

“The grade and the land package are truly differentiators to other acquisition opportunities that we’d seen and passed on,” Baker noted of Klondex’s assets, adding that Hecla had some of the highest grades in the business due to its Greens Creek operation, but with Klondex’s mines, grades will be even higher.

“I challenge you to name a company our size that will have our production and quality of land packages in as many prolific mining districts as Hecla,” Baker continued. “While we don’t need Nevada exposure, it seems to me that this deal with the Nevada exposure, and the fact that it’s extraordinarily high grade, is the best opportunity for Hecla to deliver value beyond what we already own, which are already in really good districts.”

The deal also increases Hecla’s doré production relative to smelter production, which helps control costs, Baker said. “We’ve actually had for a long time an objective to have more doré production versus smelter production, and it really takes a step in that direction for us.”

Paul Huet, Klondex’s president and CEO, noted that the deal is “compelling” for a lot of reasons.

“Our shareholders will benefit immediately from the premium, they get to share in the upside of the projects with Hecla running them and they will share in the ownership of Klondex Canada, the spin-out company,” he said. “We see Hecla as the right acquirer because they have a track record of delivering value from acquisitions, they are well-known for being excellent narrow-vein underground miners, and we believe they have the financial strength to further unlock the true potential and value of our Nevada mines.”

Huet also said he sees lower risk with more quality projects in the portfolio and meaningful exposure for Klondex shareholders to silver, lead and zinc. “Hecla has a track record of working with these types of mines and plans on combining know-how and capital with the skill of the miners at site to result in [assets that are] better, more profitable and longer-lived.”

Baker noted that while Klondex’s whole package of properties is important, Hecla sees Fire Creek, “the highest-grade gold mine of scale in North America, as a company making asset along the lines of Greens Creek,” but added that “it will need exploration [and] cost reductions for increased throughput to reach its full potential.

“It’s what we do,” Baker said. “The type of mining that’s done there, the type of planning that needs to be done, is exactly what we do at our other operations. The mill optimization issues are issues that we’re facing at Casa that we’re facing at Greens Creek, so we feel quite comfortable with our capacity to take these on.”

In terms of the premium, Baker noted that “depending on how you measure it, the premium is very high or very low, given the recent significant decline in Klondex’s share price,” but added that “the market has overdone the decline, so we are willing to give Klondex shareholders some of that back with our premium.”

“Just looking at the value of our Nevada assets alone, that premium is in my opinion humbly justified based on some other transactions,” Huet added. “It’s a high premium, however, having the ability to explore and consolidate a district — such as what we have in the northern Nevada rift — is unique.”

As for the US$45 million attributed to Klondex’s assets in Canada, Huet said that sum is well justified.

Klondex paid over US$30 million for True North alone, and recently acquired Bison for another US$9 million. There is a 1.7 million oz. resource at True North, and Bison on its own has another 340,000 oz. at 8 grams. The Tully project in Timmins, Huet adds, “comes at no cost … it’s in the heart of Timmins, where a lot of people have been focusing on, behind Kidd Creek for quite a while now. And don’t underestimate the value of a fully permitted mine and mill in Manitoba with the equipment that’s there.”

Huet says that when Klondex weighed making the True North acquisition and looked at risk versus reward, it had over $40 million of equipment that Klondex could have sold. Klondex took some of the equipment to Nevada early on, but he says there’s an awful lot of equipment left that could be sold. In addition, the reserve in the tails is a little north of 40,000 ounces.

For Hecla’s part, the principal driver for the deal is Fire Creek, and the 100,000 oz. gold it produces a year.

“It has a great cost profile, and it’s the highest-grade gold mine of significant scale in North America. Hecla creates value here if we can improve the consistency of the throughput and prove the over-break and under-break [and] get enough development ahead of the production, so there’s more operational flexibility, much like we had to do at Casa Berardi, and improve the planning and reconciliation.”

Baker noted that if Hecla can lower the cut-off grade (US$350 per tonne) by between 5% and 10%, or even 15%, that would either increase the mineable material or improve the margins. But even if it can’t accomplish that, he said, Hecla says it can get more consistent production out of the mine.

In terms of exploration upside, Baker noted that Klondex’s mines in the heart of Nevada are near some of the great mines in the world, adding that he started his career 32 years ago with Battle Mountain Gold, west of Fire Creek, but hasn’t been with a company with assets in Nevada for the last 17 years.

“The thing I’m struck by is how our improved exploration techniques and knowledge of geology make a district like this ever changing, with discoveries that were never discovered 30 years ago.”

While Fire Creek is driving the transaction, Hecla is also excited about the prospects for Hollister and Midas. At Hollister, it’s mostly about the prospective Hatter Graben project, with over 400 metres of veins and over 600 metres of strike. Baker said Hatter Graben has the size potential to be what Midas was 30 years ago.

At Midas, Hecla plans to add screens and other equipment so the carbon-in-leach can improve recoveries of Hollister ore and give the company more flexibility.

And while Midas has a short mine life, “there is a big resource position that gives us optionality at higher prices, and we’re going to probably continue the exploration that Klondex has started.”

Baker ended the conference call saying that during his career, there was only one other transaction he was more excited and more confident about than Klondex, and that was Hecla’s Greens Creek.

“This is the perfect marriage,” Baker says of Klondex. “It’s going to benefit both shareholders — big premiums for Klondex, big upside for Hecla, and it really fits the strategy of delivering long-term value to Hecla shareholders with these big land positions and big resource spaces that we can develop over time. And so we’re very excited and happy to be doing this transaction, and I hope you see it the same way.”

Baker also noted that one of Hecla’s goals is to become investment grade, and that he sees the Klondex transaction as helping it move in that direction.

He noted that on a pro forma basis, if Hecla had owned Klondex in 2017 and adjusted for the estimated general and administrative synergies, Hecla would have had $41 million more operating cash flow. “Our credit metrics are already pretty good and with Klondex comes more revenue and diversification, and we think moves us in that direction of investment grade.”

When asked if Hecla would consider refinancing its bonds, Baker responded: “We are always considering the opportunity to refinance the bonds, and so we’ll take everything into account as to when would be the appropriate time to do that. Or, frankly, when we look at our long-term plans, we have other ways that we can refinance the bonds. I think the key thing to realize here is that our credit metrics are going to improve dramatically as a result of the acquisition.”

“We’re going to have more earnings before interest, taxes, depreciation and amortization — we’re going to see those metrics and that improvement that we’ve seen over the last five years — and I can’t emphasize to you enough that the objective we have is to go from single B to double B and from double B to triple B, and we think this is a huge step in that direction, given the small amount of capital that these projects are going to require.”

Klondex has US$35 million in debt on its books.