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Barrick Bid to Buy Homestake Threat or Menace?
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(June 29, 2001) The big news in gold this week was Barrick Gold Corp’s (NYSE symbol ABX) bid to acquire via stock swap the assets of Homestake (HM), the 125 year old U.S. gold mining firm. If the deal goes through, the Canadian firm Barrick will be second in size only to South African producer AngloGold. The reactions to this merger show us that gold is a funny business…
The proposed merger announced Monday, June 25th, between Barrick and Homestake would yield a monster gold firm of $9 billion market capitalization, producing some 187 tonnes of gold yearly.

Among followers of the gold mining industry, the proposed merger partners Barrick and Homestake are considered complete opposites in their approach to the sale of their #1 product, gold.

Homestake has long been the gold investor’s favorite U.S. mining stock, because Homestake does very little selling of gold in the futures market. The stock acts as a straight gold play. When gold prices go up, so does the stock of Homestake.

Barrick, on the other hand, probably derives some 85% of its profits from its ‘hedge book,’ that is, its forward selling of gold in the futures market whenever there is a spike up in gold prices. Barrick’s profits are chiefly derived from what has been called “the most sophisticated and extensive hedge book of any gold producer.”

But with the more positive tone the gold market has taken since 1999, there is a consensus that the days of profiting from forward sales of gold is a thing of the past. Indeed, gold-bugs say that this takeover is a way for Barrick to cover its short position in gold by delivering Homestake’s unhedged production against Barrick’s extensive obligations to deliver gold in the future.

At any rate, Homestake CEO Jack Thompson is quoted as saying that this transaction is “a natural step in the process that has seen Homestake transform itself from a high-cost U.S. Company to a low-cost global producer.”

That is true enough, yet over 40% of Homestake’s current production is in Australia, and, according to The Globe & Mail, Barrick mines over 65% of its gold in the U.S.

Many longtime shareholders in Homestake are less than thrilled with the deal. Although the price represents a 31% premium to what Homestake was trading for before the announcement, it is, after all, a stock swap instead of a cash offer. And, since Homestake share prices fluctuate with the price of gold, probably a simple 10% rise in the price of gold would have lifted Homestake shares more than the 31% in ‘paper profits’ that this deal will yield for them.

"It's an unmitigated disaster," Aaron Task of TheStreet.com quotes an unnamed gold stock trader, speaking of the merger, "I see no reason to do this transaction. (Homestake) could have achieved a 30% premium in the blink of an eye if the gold market hiccups."

Of course, given gold’s price history over the past couple of decades, others may see the premium being paid by Barrick as excessive. Consolidation is taking place in the gold mining industry, but companies are wary of overpaying for gold reserves.

“Paying premiums for competitors is a thing of the past,” said Rob Edwards, head of mining research at HSBC Securities in Johannesburg, “You have to do mergers that make value sense, and this does not make value sense.”

But Homestake has solid gold reserves in the ground, and the ability to profitably mine them. Homestake is the definitive hard-asset company. And it’s being sold, essentially, for paper. All Barrick is giving up is .53 parts of a Barrick share for each share of Homestake.

“It costs them nothing!” we heard from an opinionated gold trader, “Barrick gives up paper, Homestake stockholders get shares in a highly-hedged firm, and then in six months when this is a done deal, they’ll probably go into the market and hedge all of Homestake’s production. Barrick gets Homestake for the cost of printing up new shares, and the whole deal is bearish for gold.”

Opinions of this proposed merger are all over the map. The odd thing is, it’s an event that everyone views negatively, but each for a different reason.

In most industries, a takeover at a premium price would be lauded as a testimony to the bright future of that particular sector. Other players in the field would weigh in with positive comments, if only for the public relations value. Everyone in most other industries would enjoy the reflected glory of a premium buyout, which, after all, is the pure and unambiguous compliment of big money betting on the future of their chosen sphere.

But gold is, as always, different. Take, for instance, this industry comment on the Barrick/Homestake merger by Bernard Swanepol, CEO of Harmony Gold, as quoted on Theminingweb.com:

“What you have is two overvalued entities coming together at a premium – interesting, isn’t it?”

Cheryl Strauss Einhorn, in her "Commmodities Corner" column in Barron's July 2nd edition, writes of the merger. She quotes mining analyst John Tumazos of Sanford Bernstein, who believes the merger will negatively impact Barrick earnings and was really done "for lack of better opportunities."

Einhorn writes, "As for the future of gold prices, they probably won't be aided much by this deal except in one unfortunate way: The new company will not be shuttering any capacity."

In other words, despite low gold prices, production will continue full speed ahead.

"The industry has no return-on-capital standards," she quotes Tumazos, "They are like six-years-olds, playing with their trucks and digging up the dirt."

 

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