Drivers of gold-mining sector consolidation and impact on smaller companies
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 $6.5 billion, was consummated in January 2019.
Mr. 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 certain of its countries of operation. Barrick Gold, on the other side, started life by the late Peter Munk as an oil and gas company in the late seventies. After a difficult start and suffering losses from the then prevailing low oil prices, his friend and adviser, Jim Slater, 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 Munk 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 the passing of Mr. Munk in March 2018, the Board of Directors at Barrick Gold contemplated the future in a gloomy gold mining sector. Randgold saw the opportunity and commenced discussions, on the basis that its own management team, led by Mr. Bristow, would fill most of the top positions, effectively taking control of strategy and operations. His first proposed deal on the helm was to threaten taking over 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 fraught discussions, agreed to enter into a joint venture with Barrick over their neighbouring Nevada operations. Many in the market believe that the joint venture was the real goal of Barrick’s approach as it is 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 also promises increased dividend payouts to disgruntled investors.
These massive mining consolidation moves 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 and 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 focus on cost control. This is evident as the stated strategy of the new giants is 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 $250 per ounce until the over-exuberant spike in 2011 at $1,926/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 billion 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 get to $5,000/oz or higher, investors found it difficult to assess value. Gold prices, nevertheless, subsequently corrected significantly, down to just over $1,000/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 to 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 over-react 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 the reward of investors with foresight.
This post was originally published on Miners & Investors and has been republished here with permission.