Saturday, June 30, 2007

Yamana, Northern Orion, and Meridian Gold Merger

Northern Orion first got my attention last fall when it was trading at about $4 Canadian at the beginning of October 2006, and given its under valuation, the upward march in October made sense. Then it gradually declined, again touching just under the $4 mark at the beginning of January.

It was during that descent that I started to contrast how it was being valued relatively in the market to ensure my perspective was reasonable and because of the joint ownership of the Alumbrera mine, Goldcorp was the most logical company to contrast relative valuations. The result was How I discovered the Gold Bubble and I came to the conclusion that Northern OrionLoading... was a buy to $7 based on its property holdings.

Wednesday’s joint news release announces a proposal to merger between Yamana Gold, and Northern OrionLoading... with an offer for Meridian Gold to be a part of the deal. The effective price for Northern OrionLoading... is $7.07 per share, a 21.3% premium over the day’s closing price, the same valuation that I came up with for Northern OrionLoading... without development of the Auga Rica property.

Northern Orion also has two types of warrants. The regular warrant holders closed at $4/share on Wednesday, so with an exercise price of $2, they have a 27% premium on the close, and still have until May 29, 2008 to exercise their warrants. The A warrants were not “in the money” warrants. They are exercisable until February 17, 2010. If Northern Orion managed to get their Auga Rica property developed in time for the A warrants, the roughly 600% growth in production meant that those out of the money warrants had a potentially very nice risk-reward ratio. The A warrants transfer to buy 0.543 of a Yamana share for $6. It means that Yamana’s share value must increase to $14.42, or $1.40 over the $13.02 close, in order for the A warrants to be in the money at their $1.83 price. Without this offer Northern Orion’s share price would have to increase $2 to $7.83 for the A warrants to be in the money. Relatively speaking, before the deal Northern Orion’s shares had to increase 34% to break even and at the time of the press release Yamana’s shares have to increase by 11% to break even.

But, that was before today’s Yamana’s share price declined. With the decline to $11.83 the take-over price works out to $6.42 for Northern Orion, and for the A warrants the Yamana share price needs to increase 23% to $14.54 to be in the money from today’s $1.90 close.

Before any merger fully diluted Yamana Gold has 381.9 million shares. The merge adds 309.4 million shares for shares and if all Northern Orion warrants and options were exercised, another 37.5 million. A real plus for Meridan Gold is they state they’ve only had 36% stock dilution compared to an average of 417% among their peers since 2000. There appears to be only an extra 820,830 options, so very little dilution. If all options were exercised there would be an additional 1.8 million shares, for a total of 730.6 million shares. Going with Wednesday’s close of $13.02, that would give a fully diluted market cap of $9.5 billion, which has declined to $8.6 billion with today’s price decline.


So, putting together the total of the three company’s production, and you have:

Northern Orion

  • Alumbrera, Argentina, about 50 million pounds of copper, 75,000 oz gold
Northern Orion can expect about $160 million of gross revenue, Q1 gross sales were $34.8 million. The royalty that kicked last year is costing 96c/lb of copper for Q1.

Meridian Gold
  • Rossi/Storm JV, Nevada, 25,000 oz gold for 2007, 30-40,000 oz for 2008
  • El Penon, Chili, 230,000 oz gold, 6 million oz silver
  • Minera Florida, Chili, 70,000 oz gold
  • Zinc production, 8 million pounds, my estimate from Q1 financial report
Meridian Gold can expect about $300 million gross revenue, Q1 gross sales were $66.4 million.
  • 600,000 oz gold, 140 million pounds of copper.
Yamana can expect about $840 million gross revenue, Q1’s gross were $145.1 million.
Combined production is about 1 million ounces gold, 6 million ounces silver, 8 million pounds zinc and 190 million pounds of copper. At $650/oz for gold, $12.50/oz for silver, $1.50/lb for zinc and $3.20/lb for copper it gives about $1.3 billion in gross sales without hedges.
Q1 earnings were $27.4 million for Yamana, $9.5 million for Northern Orion, and $18.9 million for Meridian Gold, or $55.8 million.
Quality of Reserves
Grade quality of reserves and resources must also be considered.
At December 2006 Yamana had 6.9 million ounces of gold at 0.49 g/ton, or metal values of $10/ton. Additionally there is 2.3 billion pounds of copper at 0.35% or about $25/ton. As some of the copper metal values overlap with the gold, weighted average metal values of copper and gold combined work out to $28/ton. The 13.7 million ounce of gold and 2.8 billion pounds of copper in the mineral resource has smaller average metal values, about $23/ton.
If you could master 100% recovery, at these grades you need to mine over 63 tonnes of ore to produce a single ounce of gold with 0.49 g/ton. Chances are they have higher grade veins to mine first, but the sheer magnitude of the amount of ore per ounce of gold suggests high production costs, or grossly increasing production costs as the grade mined declines.
To put it into perspective, the Chapada property has both the copper and gold and its metal values work out to $37/ton in the proven reserves and $30/ton in the probable reserves, essentially a 20% decline in metal values as the mine life proceeds and they move from mining the proven reserves to the probable reserves. At 0.34 g/ton 92 tonnes of ore must be mined for an ounce of gold. Take the grade down to the 0.26 g/ton and you need 120 tonnes of ore. Compounding this problem is that recovery rates also tend to decline as the grade declines, so where you might have had 90% recovery, you now have 80 or 85% recovery, the 92 tonnes required becomes 102 tonnes required at 90% recovery and the 120 tonnes required becomes 142 tonnes at 85% recovery.
You can take copper production and take those dollars and apply them to gold production and give the appearance of low cost gold production, but what you’ve essentially done is allow copper production to trade at gold multiples. With Q1/07 dilute earnings of 7c/share multiplied forward by 4 quarters you get 28c/share. That gives a P/E of 46, so copper sales are trading at a P/E multiple of 46.
Looking further, for Q1 the Chapada mine produced 38,954 oz gold and 27.5 million pounds of copper. That is about 32% of the gold production. Chapada was responsible for 60.6% of the net revenue, which leveraged to 87.4% of the operating earnings. That detail screams that the other mines are not making much money. For Q1 the grade mined at Chapada was 0.57 g/ton gold and 0.47% copper, the metal values per tonne mined were $45/ton, way more than the $37/ton metal values for the remainder of the proven reserves, and the $30/ton of the probable reserves.
Northern Orion
Alumbrera has a life of mine until 2016 and has 0.45% copper, 0.014% molybdenum and 0.47g/ton of gold for metal values of about $51/ton. Alumbrera has a 20% royalty that kicked in last year.
Agua Rica has reserves of 0.50% copper, 0.033% molybdenum and 0.23g/ton gold for metal values of about $61/ton. The Agua reserve has 8 billion pounds contained copper, 531 million pounds molybdenum and 5.4 million ounces of gold.
Meridian Gold
Meridian’s El Penon is stellar, 6.6 g/ton of gold and 275 g/ton of silver in the proven and probable reserves. At $640/oz for gold and $12/oz for silver, that’s a very nice $242/ton in metal values.
Minera Florida has 1.5% zinc, 27 g/ton silver and 5.3 g/ton gold for $169/ton metal values.
Rossi has a resource grade of 15.4 g/ton of gold for $317/ton, but the deposit is very small.
Esquel is has a stellar grade of 23g/ton of silver and 15g/ton of gold for $317/ton.
Of the three, Meridian Gold has the smallest reserve/resource contribution, but it has more profitable grades, even for the more costly underground mining.
The Growth Profile
Checking out their presentation, the two-year plan is to move from 1 million ounces of production this year to 1.5 million ounce by 2009, or a 50% increase in gold production. Say gold is $650/oz, that’s an extra $325 million/year of gross revenue. A move from 1 million ounces to 1.5 million ounces would only increase the gross revenue by about 25% as about half the revenue is from the zinc, copper and silver. There may be plans to increase production of these metals, but that information was not included in their presentation.
The increased production plan does not include developing Agua Rica, or Esquel. Agua Rica has a feasibility study to produce 365 million pounds of copper, 125,000 oz of gold and 16 million pounds of molybdenum. Say copper was $2/lb and molybdenum was $15/lb and gold $700/oz, that would give $1 billion of gross revenue. There would be no outrageous 96c/lb royalty on this production. There could also be the option of partnering with Alumbrera for some other kind of production arrangements as they are close together.
Just because you label a company a gold producer or a base metal producer is not justification to accept different valuations for producing an identical product, such as copper, silver and zinc and for Yamana the market is grossly overvaluing production from producing these metals in comparison to if they’d been produced by say, Quadra.
Also, the market tends to fail to adjust valuation for reserves based on the quality of the reserves. The low metal values per ton for Yamana suggest that the reserves should be valued at a significant discount when you consider that the mining costs per ton tend to be fairly fixed costs. When grades are $50/ton, $10 processing per ton is 20%. At $25/ton it is 40%.
The gold grades are low and the actual production costs without metals credits are high. When Chapada’s costs are fairly allocated between copper and gold you get 66c/lb production costs for copper and $187/oz for gold.
Yamana is sufficiently overvalued that the “premium” offered to Northern Orionand Meridian is completely fiat.
Do your own due diligence, these are strictly my opinions. For the record, I owned Northern Orion until I realized it could very well be taken over by some bubble-valued gold producer.

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