Goldcorp & Rubicon - It looks like the perfect marriage, doesn't it?

Check original post on my website at http://valuations.webs.com

As I indicated in this post, Goldcorp will be spending $330 million of the $840 raised to pay a revolving facility and the remaining $510 for CAPEX and general corporate purposes. Personally, the $510 million looked like a big number for CAPEX so most of it may be going towards 'general corporate purposes'.

But what is 'general corporate purposes'?

The only plausable explanation I have is that general corporate purposes = merger or acquisition

So I started looking for potential acquisitions. In finding this small fish, three factors guided my search:

1. The enterprise value of the company target company should be no more than $600. My reasoning is that GG has $510 million extra from the debt issue and has some cash on hand.
2. A junior gold company with significant reserves and exploration.
3. A junior gold company that is close to GG's current gold operations. This will drive costs down for GG

After countless searching, I believe I found GG's next acquision to be Rubicon Minerals (AMEX: RBY). Rubicon Minerals Corporation is a Canada-based mineral exploration-stage company that explores for commercially viable gold and base metal deposits. The reasoning behind my conclusion:

1. Its enterprise value is around $460 million ($516 million market cap - $56 million cash, no debt, no prefered equity and no minorty interest). So if GG bids for $510, it would be offering a 10.9% acquisition premium.
2. RBY has just discovered excellent grade ores close to Red Lake.
3. RBY operates very close to GG's operations in Red Lake, Ontario. If GG would acquire RBY, there would not be any significant incremental costs from the larger operation, in fact, there would be potential savings due to synergies.

Since 10.9% is not an enough premium, I believe that GG needs to offer around $600 million (30% premium) to RBY for a successfull acquisiotn. Therefore, I am including RBY in my buy list with a target of $4.

Keep reading my blog for updates.

Iyad Atuan

keywords: iyad atuan talent, iyad atuan program, iyad atuan finance, iyad atuan electrical, iyad atuan corporate finance, iyad atuan capital markets, iyad atuan efficiency, iyad atuan operations, iyad atuan professional, iyad atuan ms excel, iyad atuan keyword, iyad atuan fraud, iyad atuan marketing, iyad atuan onlne, iyad atuan msn, iyad atuan rcm, iyad atuan tpm, iyad atuan jit, iyad atuan wacc, iyad atuan capital structure, iyad atuan secure debt, iyad atuan acquisition, iyad atuan merger, iyad atuan showiyad atuan, iyad atuan valuations, iyad atuan mining, iyad atuan gold, iyad atuan goldcorp, iyad atuan barrick, iyad atuan profile, iyad atuan links, iyad atuan mba, iyad atuan cfa, iyad atuan engineer, iyad atuan mechanical, iyad atuan schulich, iyad atuan university of toronto, iyad atuan scam, iyad atuan draft, iyad atuan equity research

Gold

Download this report here.

Gold

While gold is widely used as jewellery for its appearance and rarity, its metallurgical properties makes gold an excellent commodity used in electronics and dentistry. Furthermore, gold is used as an investment vehicle by central banks and investors. Gold tends to appreciate in value in higher inflation environments as investors believe gold to be an excellent inflation hedge.

Properties

Gold is one of the rarest metals on the globe with more than 2,500 tonnes of gold mined annually. It is virtually indestructible making it one of the strongest metals. Recycled gold maintains the same properties as newly mined gold. Gold is very recyclable. In fact, a significant portion of the gold supply is provided by recycled gold. It is very ductile making it easily shaped for wire and sheet products. Since gold does not react with oxygen, it is an excellent conductor of heat and electricity and resistant to corrosion. Even though, it is not feasible to use in common wiring, gold is extensively used in electronics. Gold is a soft material in its pure form; therefore it is usually mixed with a harder metal to improve its durability.

Uses

Three main uses of gold are in (1) jewellery, (2) investment vehicle and (3) electronics. Almost two thirds of the global usage of gold is in jewellery, arts and sculptures. A quarter of gold is used as investment vehicle, especially against inflation. Gold ETFs are becoming very popular since they are easier to buy than physical gold bullions. Currently, approximately a third of investment vehicles are in the form of ETFs while the rest are bars and coins kept by investors such as hedge funds and central banks. Thanks to gold?s conductivity and noncorrosive property, gold is largely used in electronics. On a smaller scale gold is used in dentistry, however, lately it is being substituted with ceramic fillings for their properties and aesthetics.

Production process

Depending on the depth of the gold reserves and the geology of the deposits, the reserves are mined by open pit mining or underground mining. While the former costs less, the grades for the latter are higher. Then, the ore is crushed and sorted for different processes depending on composition to maximize gold recovery. The next step is called leaching, in which the crushed ore is submerged in a cyanide solution until the gold ore is dissolved. Gold is extracted from this solution, chemically stripped and melted into bars called dore bars. Dore bars are 90% composed of gold and are sent to further refining. The refining process is divided into two steps. Firstly, the bars are melted and are further purified by adding chloride. Finally, an electrolytic cell is composed of the gold which results in 99.99% pure gold.

Global gold supply

Approximately, two thirds of the global gold supply is provided by mining activities. Two thirds of the remaining supply is provided by recycled gold and the rest is provided by the reserves of central bank. Gold is virtually indestructible; therefore no gold is lost in recycling. Most of the known gold reserves are located in South Africa and to smaller degree in Australia and Peru. As a percent of global production, the biggest three gold producers are Barrick Gold, Newmont Mining and Anglogold. As gold prices increases, the rate of recycled gold increases as more individuals like to profit from the scenario. The same situation is encountered in times of economic distress where individuals sell their gold for liquidity.

Inflation

It has been well documented that gold is the investment of choice in high inflation environments. Therefore, understanding where inflation is trending is valuable. Inflation is a rise in the general level of prices of goods and services in an economy over a period of time. In April 2009, the U.S. economy experienced deflation (-0.74%) as the U.S. dollar devalues. The current U.S. policies will further devalue the dollar as new money is printed constantly to cover President Obama?s bailout program and the war in Iraq. Therefore, I predict deflation to reach somewhere between -1.50% to -2.00% before starting recovery towards 2.00% inflation by the first quarter of 2010.

Gross domestic product (GDP)

The current economic slowdown is causing a decline in consumer spending which is hurting the bottom line for large corporations and as a result their stock price. Therefore, investors are moving their money away from the depressed stock market and into the gold market boosting the demand for gold. As investors return to the stock market, gold demand will return to its natural level.

Oil price

Oil price works as a double edged sword, while an increase in oil price boosts the price of gold, it also increases costs. It should be mentioned that the correlation between gold and oil prices is not perfect as there are several factors affecting the price of gold as previously demonstrated. Oil producers such as Saudi Arabia encounter a boost in revenues whenever oil prices increases. Since gold plays a big role in the region?s traditions and cultures, an increase in money supply automatically translates to an increase in the demand of gold in the region.

While gold companies enjoy the larger revenues from higher gold prices, they encounter larger costs due to higher fuel costs. As described earlier in this report, gold production is an energy intensive operation in all the stages.

Production & demand

The demand for gold is steadily increasing for three reasons. Firstly, as the globe?s population is growing, the metal will be demanded by more individuals. Secondly, studies have shown that there is more money available per person now compared to decades ago. The more money a person has, the more the demand for gold. In fact, the ounces of gold available per person now are much higher than those available in the past. Finally, Chinese people tend to be cautious about their finances and save for the future by investing in physical assets such as gold. Thus, as China?s population becomes more productive and starts earning higher salaries, the demand for gold will increase.

In contrast, gold producers have not been able to match production to demand, in fact production has been declining and more of the demand has been met with recycled gold or gold provided by central banks; both supplies have declined substantially and cannot support this demand for much longer. Turning a gold reserve into a productive gold mine is time intensive and can take up to ten years. Since producers did not invest significantly in exploration in the 1990s due to the low gold prices, gold producers may be facing a production shortage for the short-term. However, this obstacle should be overcome in the long term as gold companies are heavily investing in exploration at the moment.

Reserves

As the amount of gold in the world is finite, global gold reserves plays a big factor on the price of gold. Currently, there is an 18-year reserve of gold, that is, after 18 years all the proven and probable reserves of gold would be exhausted. Therefore, finding the next gold reserve in the ever shrinking world of today will be the key success factor for gold companies. Unfortunately, most of the feasible gold mines have been exploited. However, as reserves for this metal declines, gold prices will increase making reserves that cannot be mined at today?s prices feasible leading to an increase in global gold reserves.

Conclusion

Several factors go in the pricing of gold. Inflation, GDP and oil prices play a factor on the short term pricing of gold while gold production and global gold reserves play a role on the long term pricing of gold. Gold prices will further increase during this year due to deflation and reach a price between $975-$1025; however, gold prices will pull back as inflation returns to its natural level of 2% and gold privet will hover around $900-$925. In the long term, gold prices will increase due to higher demand and a limited supply.

iyad Atuan

Money raised going to pay debt, capex and general corporate purposes

As promised in this post, I found out where the money raised by GG is going. According to this report, $330 million is going towards paying its outstanding indebtedness under its revolving credit facility. The remaining $530 million is going towards CAPEX and general corporate purposes.

I think this was a great move by GG. First of all, they are taking advantage of the current market conditions to get competitive rates on its debt; these convertible notes only bear a 2% interest. Secondly, GG is ensuring that they have enough cash on hand for capital expenditures required by promising mines in their early development stage.

Iyad Atuan

Goldcorp Announces $750 Million Offering of Convertible Senior Notes

Today GG annouced $750 in convertible bonds. I was surprised at this announcement as I thought GG's strategy was to be delevered for the duration of this slowdown. I have not read as to specifics where GG wants to use the money but I am assuming that they are facing some budget overruns in Eleonore and Cerro Blanco. Regardless, GG continues to be the less delevered senior gold company at 4.6%. The market did not like this move as GG's price retracted 7.10%.

What I would like to find out is where the money is going to be invested. The interest on the bonds is only 2% which is very low. I cannot see any projects that would have a return on equity (ROE) less than 2%; making this move most likely a value adding proposition.

As soon as I get more details about this issue, I will post it on here.

---

Iyad Atuan

valuations.webs.com

Buy Goldcorp, target 44.40

Posted by Iyad Atuan at 03:53 PM on May 31, 2009

delete edit comments (0)

Current price (May 29): $39.73

Target 12-month price: $44.40

For downloadable vrsion click here.

Summary

GG is a rapidly growing senior mining company. Having the lowest cash cost of $305/oz among its main competitors, GG has more profitable ventures providing more free cash flow to invest in new promising projects such as Penasquito and Pueblo Viejo. Additionally, GG is quickly reacting to the current economic times. As one of its main measures, it has very minimal debt making its balance sheet one of the strongest in the industry. Also, GG has decided to consolidate geographically in order to minimize its country-related risk. Currently, Alumbrera is the only mine outside of NAFTA region. By developing new mines, GG is expecting to increase its gold production by 50% in the next five years making it one of the most aggressive large-cap gold companies.

Industry attractiveness

Current appreciation of gold price makes it attractive to new junior companies to enter the market. However, there are several barriers such as lack of economies of scale, high capital intensity, difficulty of finding new untapped reserves. Even if reserves are found, those are in remote locations that are not close to an electric grid. The threat of substitutes depends on the market segmentation. While the threat of substitute in the jewellery market can be considered high, this threat is considered very low in other industries such as in the computer hardware production.

Why is GG a good investment?

Aggressive growth strategy: GG is planning to increase production by 50% in the following 5years. This growth will be driven by Penasquito and Pueblo Viejo.Penasquito is one of the largest new mines in the world. It is 100% owned by GG. The mine consists of two open pits that are expected to produce 500,00 oz annually for the life of the mine. Pueblo Viejo is 40% owned by GG and 60% owned by Barrick. GG?s gold production is expected to be 400,000 oz for the first five years. Currently, drilling is being performed in Eleonore to define and understand its deposits. Definition drilling is scheduled for 2009 at Cerro Blanco ? another promising project.

Lowest total cash cost among senior gold companies: One of the biggest drives of GG?s success is its low cash cost compared to other competitors. GG?s total cash cost was $353/oz for 09Q1 compared to $379/oz, $404/oz, $419/oz and $435/oz for AUY, ABX, KCG and NEM respectively.

Geographical consolidation: While GG is consolidating its mines to lower-risk NAFTA regions, none of the major competitors are following the same strategy. Barrick Gold (ABX) is still highly dependable on gold production in higher-risk locations. Currently more than 50% of ABX?s gold production and 65% of its gold reserves are located outside of North America. Furthermore, ABX?s development of the Pascua-Lama mine implies that ABX has no intention of geographical consolidation. Kinross Gold (KCG) and Newmont Mining (NEM) depend on a considerable portion of its gold production in higher-risk regions but Yamana Gold (AUY) has all its operations the Americas.

Low financial risk: In the current economic times, cash flow volatility increases. GG has responded to this situation by deleveraging substantially increasing its safety cushion. The other three major competitors have kept their leverage unchanged as shown below.

Risks faced by GG

Gold price fluctuation: The main risk is fluctuation in the price of gold. However, this risk is not specific to GG as none of the senior gold companies hedges its gold production. The table below demonstrates the sensitivity of the NAV-derived price to gold price fluctuations.

Unexpected project expenses: One of GG?s main advantages is its low cash cost. Therefore, unexpected project expenditure especially regarding Eleonore and Cerro Blanco will increase the average total cash cost.

Failure to find new gold reserves: With the recent increase in the gold price, more junior gold companies and new entrants have an incentive to explore for new reserves. However, this risk is somehow limited since most of the remaining gold reserves are in remote locations that require large capital investments.

Fuel cost and fluctuation in exchange rates: Since energy is the main input and the gold business is truly global, the cost of fuel and exchange rates have a significant impact on the profitability of GG. GG hedges most of its exposure to fluctuations in fuel cost and exchange rates through several derivative instruments dampening this risk substantially.

As more of these risks occur, the NAV multiple will decrease to industry average or even lower. The above table illustrates the effects of fluctuations in the gold price and in the P/NAV utilized on the NAV derived stock price.

Valuation

GG was valued using a NAV approach and comp analysis. The final target price is the weighted average of the two prices (75% NAV and 25% comps).

For the NAV approach, earnings from each mine were forecasted for the lifetime of the mine, then discounted at a discount rate that reflects the risks incurred due to geographical location, currency and success probability of the project. Then, several items were added to the Value of Operational Assets to reflect items that are not accounted for such as reclamation costs, long-term debt and working capital.

Using Tier I gold suppliers as the universe, the average NAV was calculated to be 1.65x. Three premiums were added to reflect the advantage GG has over its competitors due to having the lowest cash cost, lowest debt ratio and lowest risk due to geographical consolidation in NAFTA region. Using this P/NAV multiple of 2.40x, the target price is $48.90.

The weighted average of three comps was utilized. Those comps were EV/ 2009 production estimate, EV/reserves (P&P) and EV/ forecasted 2009 EBITDA. The universe used was only Tier I gold companies while premiums were added for GG?s low financial risk, aggressive growth approach and low geographical risk. The comps fair price was calculated as $31.10 leading to a 75%NAV-25%comps target value of $44.40.

The risk related to the comps approach is embedded in the fact that comp averages where obtained using market information for competitors. Therefore, if the whole sector is being undervalued or overvalued, the price attained could be misleading.