Drivers of Gold-Mining Sector Consolidation and Impact on Smaller Companies
Angelos Damaskos, Manager of the JUNIOR GOLD FUND
Published: 26 June 2019 03:15
On the surface, all the typical omens of a bull rally in metals seem present: a drop in the dollar index, disappointing economic and jobs data in the US, and the escalating geopolitical tensions in key locations like Iran and Venezuela – which have pushed investors towards safe haven assets and pushed the price of gold up. The trend is likely to bolster further consolidation in the mining sector, analysts claim. But one notable M&A transaction has shaken up the industry, raising important questions about the long-term effects and consequences of that consolidation – as well as the extent to which assets like gold remain save havens, explains Angelos Damaskos, manager at Junior Gold Fund.
In September 2018, Barrick Gold Corporation, the world’s largest gold miner, announced its intention to merge with Randgold Resources, an Africa focused gold mining company, in an all-share deal. The announcement marked an important change in the company’s strategy and many saw it as effectively a reverse take-over by Randgold, led by its chief executive Mark Bristow who would assume the CEO position of the combined entity. The deal, valued at about USD6.5bn, was consummated in January 2019.
Bristow built up Randgold over some 25 years into a high-margin, Africa focused producer with good organic growth prospects in its projects, but limited by political developments in some of its countries of operation.
Barrick Gold, on the other hand, was founded by the late Peter Munk as an oil and gas company in the late 1970s. After a difficult start, and taking losses from the then-prevalent low oil prices, an advisor suggested that it would be a good idea to get into gold mining, focusing on Canadian operations – as Canadian investors could not get access to South African mining due to the Apartheid-era sanctions.
Peter Monk went on to develop the largest gold mining company in the world, but the bear-market years that ensued after the gold price peak in 2011 proved a strain on growth and profitability. After his passing in March 2018, the Board of Directors at Barrick Gold contemplated a gloomy future for the gold mining sector.
Randgold saw this as an opportunity and commenced discussions, on the basis that its own management team, led by Bristow, would fill most of the top positions, effectively taking control of strategy and operations. His first proposed deal at the helm was to threaten to takeover rival Newmont Mining, which itself had just agreed to merge with another major gold miner, Goldcorp. Newmont’s board of directors rejected the approach and, after some tense discussions, agreed to enter into a joint venture with Barrick over their neighboring Nevada operations.
Many in the market believe that the joint venture was the real goal of Barrick’s approach, as it was expected to deliver significant synergies and savings for both companies. Barrick now states its near-term strategy as concentrating on operational efficiencies, lowering debt levels by asset disposals and concentrating on organic growth within its existing portfolio. It’s also promising increased dividend payouts to disgruntled investors.
These tectonic shifts towards consolidation in mining are somewhat puzzling. In industrial terms, it often makes sense for a sector’s largest companies to merge in order to gain greater power over pricing and distribution of products, cost-efficiency in procurement of parts and raw materials as well as synergies over research & development and retention of the most competent of senior management.
Industrial mega-mergers are in most cases sold to their shareholders as improving market access, ability to finance new growth as well as expansion of profitability due to greater pricing power. They are, therefore, often scrutinized by regulators, who try to expose risks of excessive market control and monopolist tendencies.
In the gold mining sector, however, most of these arguments do not apply. Miners are price takers producing a commodity, whose price is driven by macro-economic, geopolitical and investor sentiment factors. There can be few economies of scale, such as in the Nevada joint venture, which are expected to save on marginal operating costs. Mines are typically financed as individual projects, based on their asset value and economic viability and a strong balance sheet can help in the sourcing of financing but, if they are mature and already producing, this is less of a consideration.
Finally, there is a weak argument on improving management capability if it is not intended to pursue ambitious growth. The main argument for these mining mega-mergers is, therefore, limited to the operational synergies due to senior management consolidation, pruning the asset base and cost control. This is evident as the stated strategy of the new giants to divest non-core assets, pay-down debt and only grow organically.
One has to question the real drivers of the Barrick-Randgold and Newmont-Goldcorp deals. An explanation might emerge by looking at recent market developments in the gold mining sector.
During a strong bull market over a period of eight to ten years, from 2002 when gold prices bottomed at around USD250 per ounce until the over-exuberant spike in 2011 at USD1,926/oz, most companies focused on building reserves through exploration. Investors demanded that growth in reserves would be the key determinant of value, disregarding near-term production and cash-flow.
Management teams responded by raising billions of dollars, which were mostly sunk to the ground in a wild pursuit of “blue-sky” bonanza deposits. Shares of companies with exploration success rose by several multiples and, in many cases, were sold to the mid-tier or larger companies, including Barrick and Newmont.
In an environment where some called for gold prices to reach USD5,000/oz or higher, investors found it difficult to assess value. Gold prices, nevertheless, subsequently corrected significantly, down to just over USD1,000/oz in late 2015, and with them the share prices of most gold mining companies. Investors suffered huge losses, especially as many companies without production and cash flow, or too much debt, went bankrupt.
Even the majors, such as Barrick and Newmont, suffered a collapse in profits and were under pressure from their bankers, who worried they might not be able to meet liabilities. Shareholders started blaming management teams for their irrational exuberance in the pursuit of growth in resources in what had become marginal or uneconomic deposits.
People forgot that no company had any control over the gold price, the ultimate driver of their cash flow and profits. Management teams were constantly berated and raising financing even for low-cost projects was a constant struggle.
Finally, managers were beaten into submission, agreeing to focus on capital discipline, operational cost control and lower debt levels in order to survive a possible further drop in gold prices. In an effort to sustain the downturn and keep in business, managers sought safety in size, creating grass-feeding dinosaurs.
The impact of such market sentiment on smaller companies has been severe. Financing of projects is scarce since, after all, if the mega majors are not interested in growth by acquisition, what is the point of investing in potential growth engines? Markets seem to always have the tendency to overreact, both on the way up and on the way down.
Ultimately, the master of the gold mining sector is the price of gold bullion. If, as many believe, gold’s price rises in response to the current macro-economic problems, unprecedented global debt levels and geopolitical instability, it will again be the game changer for its miners.
Investors tend to have short memories and will be encouraged to seek growth in reserves again, always in relation to the speed of the commodity price rise. At that point, the mega-majors will be forced to abandon house-keeping and look at acquisitions as these are a quicker way in obtaining growth compared to exploration drilling.
Inevitably, due to the “dinosaur inertia” large premiums will have to be paid for the prizes. Shares of smaller companies that control material reserves, either producing or close to production, will get re-rated well in advance of corporate activity as markets also have an uncanny ability to anticipate the future. Another over-reaction, this time on the up-cycle, would be the inevitable result and establishing positions early will reward the investors with foresight.
About the Author
Angelos Damaskos, – Manager of the JUNIOR GOLD FUND
A seasoned fund manager and investor with over 15 years experience directing open-ended funds and private equity investments in natural resources. Earlier 14 year career in Emerging Markets investment banking with leading financial institutions.
Founded Sector Investment Managers Ltd in 2004, a U.K., FCA-authorized and regulated company specializing in private and public companies exploring for and producing oil, gas and precious metals. In the precious metals mining segment, the Junior Gold fund which he manages invests in smaller gold and silver mining companies in safe political territories. Most of the portfolio companies have growing production, sustainable operating structures and active exploration programmes that could add materially to reserves.
Born in Athens, Greece in 1963. Graduated in 1985 from the University of Glasgow with a BSc in Mechanical Engineering. In 1990 obtained a Masters in Business Administration (MBA) from the University of Sheffield.
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