In the last month or so, two Chinese mining companies have made overseas acquisitions that have shocked the market. Both acquisitions involved the Chinese buying gold assets in the American continent. In May, Shandong Gold announced its intention to buy TMAC in a $168 million deal. Then just last week, Zijin emerged to become the highest bidder for the highly sort after Guyana Goldfields, offering C $1.85 per share, which is equivalent to $239 million. Both are all cash deals. In this article we share some background stories of these deals after talking to different people in the mining circle, and provide our thoughts on these transactions.
By Samson Li
Chinese companies becoming ‘saviors’ of the mines that ran into trouble, buying distressed gold assets in the western world
It is well known that for more than a year TMAC has been looking for a white knight to buy them out of the mess that they found themselves in. The Hope Bay project, which is in Nunavut, Canada, was once Newmont’s hope of becoming the company’s flagship project someday, but was spun out to a new listing vehicle in TMAC Resources in 2015 (which provided some insight on how the Newmont management valued the project). A lower than expected recovery rate has seen the company’s production falling short of the management’s guidance again and again since the commencement of production in 2017. As a result, TMAC’s share price has fallen from over C $18 per share in June 16, to as low as C $0.44 at the market trough in late March 20. TMAC was losing money (reporting a C $628 million net lost in 2019) and still owe a C $152 million debt that is supposed to mature in 2020. In other words, TMAC is on the brink of bankruptcy. They have been aggressively searching for a willing buyer to bail them out, but unfortunately no western peers were willing to bite (which tells us a lot about how they value the asset).
We first heard that TMAC has been actively seeking buyers in China in February 20. Other than Shandong Gold, there were at least two more Chinese mining corporates that have signed confidential agreement and have studied TMAC’s data room, but they chose to back off. Talking to someone who is in the know, he said that ‘the Chinese companies who participated the process all liked the deposit. However, the TMAC management messed up by hiring an incompetent engineering firm to build the processing plant, which explains the sub-par gold recovery.’ In this person’s opinion, the eventual buyer of TMAC will likely have to build a new processing plant, which could possibly cost C$800m or more. The heavy capex required for the project after a buyout scared off many potential buyers. The takeout decision by Shandong Gold not only have somewhat shocked the western communities, but all those other Chinese companies who had participated the due diligence process were all equally surprised by the quick decision made by the acquirer. Indeed, there was a widely spread story within the Chinese community that people at Shandong Gold did not even do a proper site visit at Hope Bay due to Covid-19. As the travel restrictions they could only sent their representatives at the Canadian office to take some photographs and recorded videos at the mine site.
While on paper, Shandong Gold seemed to have purchased the Hope Bay project on the cheap (this is their explanation to the Chinese investment community and shareholders), buying TMAC at $28.3 per total resource ounce, however, if we factor in TMAC’s net debt position that Shandong Gold will bear, and the capex requirement for building a new processing plant, then the acquisition costs immediately could jump to an estimate of over $140 per total resource ounce. While valuation on mining companies is very complicated and actually varies a lot depending on the project , this deal could possibly ‘look cheap on paper, but totally another thing if you do the math’ type of deal. To put the valuation into context, Wesdome Gold Mines, a highly regarded and successful mining company in Canada, is currently trading at a valuation of just north of $150 per total resource ounce on a fully diluted basis. Therefore if this rough estimate can reflect how much the buyer truly pays for TMAC, then Shandong Gold has certainly bought a problematic asset, but the price that they will pay is certainly not cheap.
Guyana Goldfields – the highly sort after troubled asset
Guyana Goldfields has a long history of gold production in Guyana, but operations have experienced trouble due to various reasons, including the overestimate of both grade and resource tonnage, an increasing strip ratio at open pit operations, and running into problems transitioning from open pit to underground operations.
TABLE: Operations problems include high strip ratio, falling grade & production. Reserves suffered downgrade in 2018.
The share price of Guyana Goldfields was trading as high as C $10 in Jun 16, but was trading at only C $0.25 per share in late March 20.
In late April, a Canadian listed silver producer Silvercorp, made a bid for Guyana Goldfields, by offering 60 Canadian cents per share, which represents a 71% premium to the 20-day volume weighted average price of Guyana Goldfields. The offer was an all-cash or cash + equities deal.
Then in May, Grand Colombia Gold, a gold mining company in Colombia, offered a 3-way merger to combine itself, Guyana Goldfields and Gold X Mining Corp (a gold project developer in Colombia) into a single entity. This deal represents valuing Guyana Goldfields at ~ C 0.80 per share, but later management of the Guyana Goldfields rejected this proposed deal.
On 17th May, Silvercorp increased its offer to buyout Guyana Goldfields at an equivalent of C $1.3 per share. We heard that there was another competitor trying to buyout Guyana Goldfields, offering a C $1.1 all cash offer. The majority of the Chinese community immediately sensed that this ‘secretive’ bidder was another Chinese company.
On 3rd June, Guyana Goldfields announced that they have received a superior, all-cash offer of C $1.85 from a bidder. On the same day, Silvercorp’s Chairman & CEO Dr. Rui Feng told us that Silvercorp has no intention to further increase their bids. They are happy to take the breakup fee from Guyana Goldfields, as well as enjoying the price appreciation of the Guyana Goldfields shares that Silvercorp owns, which in total is estimated to be a C $30 million profit.
On 12nd June, Guyana Goldfields finally announced that the bidder was in fact China’s Zijin Mining, who had purchased Nevsun and Continental Gold in the previous years. They are also in the process of buying a 51% stake in a large copper project in China’s Tibet area in another deal. Investors, even within the Chinese mining community, were surprised that Zijin was the bidder because their balance sheets were already very stressed given their aggressive acquisitions in the last few years as well as the capex required in the next few years. Indeed, on the 10th June, Moody’s investors service placed on review for downgrade Zijin’s Baa3 issuer rating.
While some in the Chinese community supported Zijin’s acquisition of Guyana Goldfields, we suspect this is mostly due to incompetence or ‘it’s not my money’ mindset. Zijin’s acquisition price is three times of Silvercorp’s initial bid. While we can certainly call Silvercorp’s initial bid as opportunistic trying to scoop up a distressed asset, Zijin’s second bid at C $1.85 is not only 42% higher than Silvercorp’s second bid, but is also equivalent to $37.8 per total resource ounce.
While it looks cheap on paper, the mining operations suggested that both grade and resource tonnage are likely to have been over estimated, and in a methodical approach, more drilling (capex investments) will be needed to test the actual resource tonnage – otherwise if the actual resource does not fit the mine plan it could be financially catastrophic to the company. If we are being conservative (not counting any resources ounces) yet being optimistic in trusting the reserves numbers the management reported, at two million ounces of reserves Zijin is paying $119 per reserves ounce (not even counting the required capex required to be spent after take over), it does not seem as cheap as the deceiving $37.8 per total resource ounce again.
TABLE: Underground grade is too low and buyer bet on higher gold price
Besides, at an average gold grade of 2.75 g/t for an underground resource may be quite high in China’s standard, it most likely would not work nor be profitable in other jurisdictions. It is easy to conclude that Zijin has paid too much for a troubled asset, and possibly one of the rationales for buying this asset is to bet on a higher gold price. They probably also have full confidence in their own technical team to be able to turn this operation around.
CONCLUSION – Chinese miners may become more active in overseas gold acquisitions
To be frank, both acquisitions do not make much sense from buyers’ perspective. This is a somewhat widely shared opinion among the western mining communities. While there are some differences in tactics between Shandong Gold and Zijin, it is easy to spot some of the common trends:
1) They tend to buy assets at a cheap valuation at least on paper, more so for Shandong Gold. That means they would usually consider buying troubled assets rather than chasing quality.
2) In terms of cheap valuation, both the share prices of both TMAC and Guyana Goldfields have fallen to the ground due to operational issues. Let’s hope that their acquisitions are not simply based on looking at historical stock price performances to call an asset ‘cheap’. At the same time, they must have full confidence in their technical teams be able to turn the troubled operations around.
3) They tend to want to buy a producer or companies that are close to becoming a producer. Size matters.
As a state owned enterprise, Shandong Gold’s priority is not on profitability or efficiency or higher return on equity. Their mandate is to become a top five gold mining company in the world, both in terms of production and resources, and thus their priority at this stage is to spend a certain amount of money for purchasing assets within a time frame. This mandate indeed sounds odd to many, and this could well backfire in the long run (when gold enters a bear market again) when companies prioritise quantity over quality, and spending how much money over improving profitability.
They are also probably in a competitive position with Zijin to become the true number one in China. Based on what we know, Shandong Gold has not finished, and will likely to buy more assets this year.
In the case of Zijin, one possible explanation for the Guyana Goldfields acquisition is Zijin is very determined to expand their footprint in Latin America. Based on the several past acquisitions that Zijin has made, it has been obvious that Zijin will only consider buying projects in emerging regions over jurisdictions that have long mining histories. After getting into Colombia through the acquisition of Continental Gold last year, they probably feel that Guyana is another jurisdiction that fits their criteria – emerging regions that have rich resources but has been relatively underexplored and has been lagging behind in terms of the mining development compared to other mining jurisdictions. In fact, Zijin has invested in a small exploration company Guyana Goldstrike a few years ago (although the share price has fallen acutely).
However, does paying Guyana Goldfields such a lofty premium really justify the tactics of getting into the country? There are certainly a few other gold operations in Guyana that Zijin should have considered, but as they all are at different but earlier stages than where Guyana Goldfield is, maybe Zijin does not want to wait and wants to see an immediate impact in both production and resources. While more and more Chinese investors worry about Zijin’s leverage over the years of acquisitions, Zijin is simply implementing the way that many Chinese property developers have used in the past – try to use debt and leverage to expand as much as possible, especially in the downturn. Make yourself too big to fail then someone will have to bail you out if the situation sours.
As the gold price attracts greater market attention and the number of gold deals have surged globally this year, along with competition for overseas projects between Shandong Gold and Zijin is heating up, it is very possible that this will encourage other Chinese mining companies to speed up their footsteps on overseas acquisition. As a joke, if you have a bridge to sell, maybe you can try to call someone working in a Chinese mining company and see if he bites. Who knows?
