Gerard Kemp, CEO, Pamodzi Resources Fund
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» Politics taints Gold Fields bid
» Gold Fields bids $330m for Venezuelan

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The case against paper gold mergers
David McKay
Posted: Sun, 04 Dec 2005

[miningmx.com] -- THERE were some raised eyebrows when Gold Fields elected to use cash to finance its $330m takeover of Bolivar Gold, a Canadian listed firm that has gold prospects in Venezuela. The alternative would have been to use shares to fund the deal, which have gained about 50% in value this year since the rand stabilised against the US dollar and the likelihood of a takeover by Harmony Gold finally disappeared.

“It revolves around the fact that with current gold equity valuations, the cost of equity is in most cases close to zero or negative for senior companies such as Gold Fields,” said an analyst. “The cost of cash is whatever the interest rate is – in the case of South Africa, about 6% after tax.”
We wouldn’t rule out big bang deals
However, Gold Fields is to blend cash and debt in a ratio not yet finally decided. That’s not because – as some have observed – Gold Fields’ balance sheet is relatively lazy. The company had about R2.8bn in cash as at the last quarter, down from R3.4bn.

Rather, it’s a company aversion to permanently diluting shareholders in return for a finite asset. “Debt gets retired but the shares are there forever once issued,” said Ian Cockerill, Gold Fields CEO, in an interview with Miningmx. “You land up in a situation where there are shares outstanding with no production.”

“I believe cash is king,” said David Davis, an analyst at Andisa Securities. “But they’ve obviously done their sums. The cost of debt is the cheapest option, so that’s the way to go.”

But world mining is in a period of extreme excitement with a lack of new reserves underpinning vaulting demand growth from China. With production being increasingly ratcheted up in the majority of commodities the temptation to use shares for merger and acquisitions is becoming increasingly difficult to resist. Barrick Gold’s $9,.2bn bid for Placer Dome is an offer largely based on issuing new shares. The question is whether Barrick is really adding value to its shareholders by bidding for Placer Dome in that way.

“On a share for share basis, it doesn’t add up,” said John Munro, newly appointed head of Gold Fields’ corporate development. Since June 2001, Gold Fields has only issued 36 million shares despite buying mines in Ghana and Australia. Compare that to DRDGOLD, which is known for its repeated use of paper deals. It’s issued its shares 100 times in 10 years from when it had 2.5 million in outstanding shares.

But not all deals can be funded through cash. Inco’s $12bn takeover of Falconbridge and BHP Billiton’s $9.2bn bid for WMC Resources can’t be financed only through cash, though a cash element is an attractive enticement for shareholders.
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That means that Gold Fields’ cash-only approach potentially limits its expansion scope. Said Munro: “We wouldn’t rule out big bang deals or deals using large amounts of stock. But making companies bigger while not enhancing value doesn’t make sense. Shareholders are sensitive to value, especially when there are alternatives.”

“I agree with Cockerill. If you’ve got cash why dilute the shareholder?” said Gerard Kemp, who heads the resources division at Rand Merchant Bank. “By not choosing paper it also shows what Gold Fields thinks of its prospects. Why dilute yourself if the share price is going north? It suggests Gold Fields is bullish about the rand gold price.”