Sometimes the deal of the year actually is a long time coming.
Such was the case with Kinross Gold Corp.’s $7.1-billion mid-summer bet on Red Back Mining Inc., which, through the end of November, was the largest Canadian-led merger or acquisition in 2010.
Egizio Bianchini, the outspoken head of mining investment banking for BMO Capital Markets, lead banker for Kinross (TSX:K) on the deal, says he remembers presenting Kinross chief executive Tye Burt with the notion of taking a run at Red Back as far back as 2007. Burt, a former Barrick Gold executive, was less than two years into his tenure at Kinross at the time. And he was still determining the company’s direction.
When he’d arrived in 2005, Kinross was in disarray. Burt spent months settling accounting issues, and within a year made two decisions. The first: to move forward with the company’s mines in a remote area of Russia. The second: to get out of Africa. Now Bianchini was asking him to consider buying back in—specifically, into the isolated and politically unstable Western African country of Mauritania.
Burt said no.
“It was too much for him at the time,” says Bianchini. “He had Kinross’s Russian mines to worry about and that was enough for him. It took more than two years for us to return to it.”
“It” was a project called Tasiast. In 2007, it was a few shallow digs on a large, flat, expansive gravel plain about 160 kilometres from the coast—basically, on the western edge of the Sahara—and an uncertain volume of gold in the earth below. The mine had recently changed hands, with Rio Narcea Gold Mines Ltd. selling it to Lundin Mining for US$267.5 million, which then spun off Tasiast into Red Back.
By the time Burt decided to reconsider Red Back in late 2009, a lot had happened in the world. Kinross was running much more smoothly, yet it was seen on the Street as still lacking enough developable mines. Meanwhile, the global financial meltdown had led to a doubling of the price of gold—from US$600 per ounce in 2007 to more than US$1,200 by late 2009. At those prices, upstart mines in remote, largely unknown parts of Africa start to merit serious consideration for an executive in Burt’s position.
One other dynamic had changed, too: the size of the Tasiast deposit. By 2008, surface drilling started to show that the size of the deposit had been vastly underestimated. By mid-2009, Red Back said reserves at Tasiast totaled more than 3 million ounces, with each subsequent estimate rising significantly. It was becoming a major find. Burt knew if he wanted to buy it then, he’d be in a race. What he didn’t know was that when Kinross finally pulled the trigger on a deal, he’d also be in for a fight—thanks to the new TSX rules on takeovers and the influential U.S proxy advisory firm Institutional Shareholder Services decision to not to give the merger its blessing.
“WE TRACK the top 50 deposits all over the world all the time,” Tye Burt says, leaning forward in his chair against a boardroom table in Kinross’s new downtown office high above the Toronto lakefront. “The Tasiast deposit was growing explosively and had to be on the top of our list.”
It’s mid-November, a few days after the release of Kinross’s third quarter 2010 financials, the first to include some modest production from the Tasiast mine. With the deal now done, Burt, in an exclusive interview with Listed, can look back calmly on the decision to start seriously investigating the possibility of Kinross acquiring Red Back. But at the time, it was move fraught with unknowns. Determining the deposit’s value—and the deal’s ultimate price and structure—would require months of due diligence and a lot of creative effort.
The work began with the retaining of Bianchini and BMO as lead bankers, with GMP Securities Ltd. and Rothchilds subsequently taking on secondary investment banking roles. By the end of January 2010, Burt had signed a confidentiality agreement with Red Back that allowed Kinross’s team access to a data room compiled with Red Back’s financial news and projections.
One way or another, Kinross wanted to move quickly. But as it turned out, Red Back was skeptical, says Richard Clark, Red Back’s CEO at the time and a current board member with Kinross. “We were drilling like crazy and coming up with great results,” he says. “Their stock wasn’t that strong and they were trying to be creative. We weren’t that open to creativity.”
Clark also admits Kinross’s competitors were also knocking at his door. But Burt’s team had a slight head start. “It is really a question of who likes what deposit most and can you get an information edge,” Burt says of the timing of their move on Red Back. “Can you get a geologic edge on the competition or the market? That is what we felt we had. We thought we were a little ahead of the Street’s interpretation because we had a little more information and we felt we were ahead of the competition.”
The next critical decision point came in April, according to Burt. Based on what they knew at the time, buying Red Back was looking like at least a $5-billion proposition. “We asked ourselves whether we were ready to do about a $5-billion deal,” says Burt. “We decided we had more work to do.”
More work would cost Kinross significantly. In order to gain access to the information it was seeking, Burt and his advisors decided on a private placement, buying 9.4% of Red Back’s shares for $600 million in a deal that was announced on May 4.
The arrangement allowed Kinross to be more open about its aspirations for the project and soon after it was closed, Burt made his first trip to Mauritania to see the mine. With Kinross’s interest clear, Burt met with key political figures in the government, including the president and the mining minister. Kinross also ramped up its investigation of the site, bringing in engineering firms and consultants to do more drilling in an attempt to ascertain the size and potential of the mine.
But the placement also had a downside. It set a price tag of more than $6 billion on Red Back. Investors, worried that Kinross was at risk of overpaying if it went ahead and bought the entire company, drove down the company’s share to a 52-week low of $14.84. As the prey, on the other hand Red Back’s stock continued a steady rise. BMO’s Bianchini says the private placement was a necessary evil.
“Under different circumstances would we have liked to do it differently? Absolutely,” he explains. “The one thing about the private placement [rather than a single deal for the entire company] is it makes things cost more. We recognize that. The issue is how, in a competitive situation, do you get a leg up when you have to do due diligence. If this were Northern Ontario, it might have gone differently. But this was Mauritania. It wasn’t just new to Kinross—it was new to everyone. If Kinross hadn’t done the private placement would they have paid less? Maybe, probably even. But would they have been taking greater risks? No doubt.”
AS THE MONTHS passed, Burt liked more and more of what he saw of the Tasiast mine. But that didn’t make it any easier to strike a deal with Red Back and the aggressive mining executive who controlled it, Lukas Lundin, chair of Lundin Mining. Discussions neared a head in a July meeting in, of all places, Whistler, B.C., where Lundin has a home.
“I remember Tye coming back to our hotel after meeting with Lukas and Richard and saying the deal was over,” says Bianchini. “I remember feeling pretty awful, until he added that Lukas had invited him back for dinner that night. I thought that had to be a good sign.”
In fact, Kinross’s shareholder circular subsequently showed that the possibility of a deal remained elusive, with negotiations starting and stopping numerous times, before an agreement was finally nailed down and announced on Aug. 2. One of the main issues had been the reluctance of Lundin and Clark to take a cash deal, preferring a share swap that would give Red Back stakeholders a strong position in Kinross and strong upside if Tasiast exceeded expectations.
“We looked at it and felt with the Tasiast mine as part of their operation, we’d get a much bigger lift from being part of Kinross,” Clark says, speaking from the UK after a flight from Africa and his latest visit to the Tasiast mine. “There were various suitors out there, but we weren’t interested in a cash deal. We thought putting Red Back together with Kinross would be like taking one and one and making four.”
The deal was a stock swap sweetened with share purchase warrants that entitled Red Back shareholders to receive 1.778 Kinross common shares, plus 0.11 of a Kinross common share purchase warrant for each common share of Red Back. Each whole warrant was exercisable for a period of four years at an exercise price of US$21.30 per Kinross common share. It was the addition of the warrants—the factor that eventually encouraged Red Back to sell—that made the deal appear too rich to many analysts and a handful of outspoken fund managers.
Hallgarten & Co. analyst Christopher Ecclestone was among the more outspoken on the subject, issuing a research note prior to the close of the deal entitled, “Just say no.” He called Kinross an “indiscriminate and undiscerning buyer,” adding that buying Red Back was a “heavy reputational burden to carry and even more difficult to slough off.”
Some analysts and fund managers, not having access to the information at the fingertips of Burt’s management team, cried foul on the substantial dilution for Kinross shareholders. Burt faced a dilemma. Given the information from drilling at Tasiast, he was confident that Kinross was not overpaying for Red Back. However, given disclosure regulations, Kinross struggled to provide that information to the market without driving up Red Back’s share price further—and making the deal even more expensive.
“The conventional wisdom when we launched was that there are 5 million ounces of reserves declared at Tasiast and there might be 10- to 15-million worth of potential there,” Burt says. “To justify our premium, we knew there was more there—and our view is there is a lot more.”
However, Burt and his advisors recognized providing that information could do more harm than good, and by offering all of its thoughts on Red Back to the market, it could pique the interest of its competitors. “Now, you don’t want to share all of that immediately because that will drive the price up and bring our competitors off the bench,” he says. “So we said we’d offer a modest premium and do a friendly deal and go and get that shareholder vote.”
AH, THE VOTE. Under new TSX rules, any transaction representing more than 25% of a company’s outstanding shares needs shareholder approval. The rule was put into place after the ultimately unsuccessful 2008 merger bid between HudBay Minerals and, ironically enough, Lundin Mining. It turned the Kinross-Red Back merger was test case No. 1 for the new rules.
“This was a novel transaction to try to get done under the new TSX rules,” says Clay Horner, chair of Osler, Hoskin & Harcourt, and part of the legal team that advised Kinross on the deal. “They needed to convince their own shareholders, and get the communications out there. At the end of the day some people take shortcuts and it doesn’t matter. Here was the perfect case where the company spent an incredible amount of effort at a business and financial level, at a legal level and it all paid off because it was all necessary. All the effort put in made the difference.”
While Kinross had four positive fairness opinions from financial institutions, including an independent evaluation from Morgan Stanley, the shareholder vote, which was scheduled for Sept. 15, was complicated by skeptical media reports and the decision by proxy advisory firm ISSto recommend shareholders not vote in favour of the deal. Given that many institutional shareholders are required by their rules to vote whichever way ISS sides on a deal, it was clear the vote wouldn’t be a cakewalk (see sidebar).
In order to try to combat the perception that Kinross was overpaying for Red Back and to rebut ISS’s disapproval, Kinross disclosed some upwardly revised estimates of the total deposit. In that period, Burt also undertook upwards of an epic 150 meetings with shareholders to present Kinross’s perspective on the deal. “Once we launched the main deal, we did three rounds of marketing, specifically targeted at those who had a vote in the deal,” he says. “The first round was with Red Back and we saw our shareholders and theirs. And the second two rounds were to answer questions and comment on the press releases that we issued. Those three rounds each involved North America and Europe.”
In the end, Burt won the vote, when 66% of shareholders gave the deal the thumbs up. Horner says Kinross’s success, despite the ISS issue and skepticism by Bay Street, came because of a concerted team effort by the gold company, and its legal and financial advisors. “This, of all the transactions I’ve done in my career, is the single best example of a company that benefited from the amount of resources and time they put into pursuing and considering the opportunity,” Horner says.
VICTORY PUT a modest charge into Kinross’s shares, but as of the end of November they were still only trading in the high teens. And that becomes Burt’s biggest concern going forward. Over the past two years, shares in Canadian major competitors Barrick and Goldcorp have gone up more than 50%. Kinross stock, despite decent earnings in one of the biggest gold bulls markets in history, is flat.
If Burt and Kinross can deliver on Tasiast’s potential, the valuation problem could take care of itself. But that won’t happen overnight. The company’s current plan is to raise its total annual production to at least 3.9 million ounces, including Tasiast, up from its current 2.2 million, by 2015. (World-leader Barrick, by comparison, produced 7.4 million ounces in 2009, while Goldcorp did 2.4 million.)
“The deal moves them up to the mid-tier of the big gold companies,” says the analyst. “The Street is ultimately expecting 20 million ounces from this deal. But the results of the Tasiast acquisition won’t be fully understood for three to five years.”
For now, Burt will keep doing what he can, and that’s push forward. On November 30, he held a news conference in Mauritania’s capital, Nouakchott, to announce that Kinross was planning to invest $1.5 billion in Tasiast to boost production over the next three years. His message is much the same as it was a couple of weeks earlier in his boardroom, stressing the upside of Red Back and Tasiast and his confidence that shareholders will recognize their value—just like he knew he and his team would carry the vote on the deal.
“Because of the work we’d done,” says Burt, “we were highly confident that as the Street became familiar and as the mainstream analysts came to understand the scale that we had in mind, which is fully a six-times expansion of the processing capacity there, that they’d learned, as we did, what tremendous opportunity this is.”