Deal of the year: Cash flow is colour-blind

After Barrick’s US$7.7-billion purchase of Equinox Minerals, 20% of the world’s largest gold miner’s revenue comes from copper. The CEO and chairman say that’s right where they should be
By Robert Thompson

PETER MUNK’S YEARLY address to Barrick Gold Corp. shareholders at the company’s annual meeting always has the tone and atmosphere of a preacher speaking to his congregation. He leans on the podium, speaking slowly in unscripted passages, his glasses dipping dangerously down his nose as he regales his flock with discussion of the nuances of the mining business and the gold company he founded that has grown to become the largest in the world.

This past April, the 84-year-old founder and chairman of Barrick (TSX:ABX) appeared a little different when he reached the stage and began to address the room. Only two days previous, on April 25, Barrick, led by president and CEO Aaron Regent, caught many off-guard when it announced it would spend US$7.7 billion (C$7.3 billion at the time) to acquire Equinox Minerals Ltd., a large copper producer with loose ties to Canada. “Gold companies historically don’t have any cash, but given the prices of gold, suddenly they do,” says one Bay Street analyst. “The question is what they do with that money.”

Despite the price tag, the real surprise was the metal. With gold prices nearing $1,500 an ounce at the time of the deal, critics argued Barrick was paying a premium for a copper company when they should be showing more focus on what made its business great. Some analysts worried about whether Barrick was moving away from gold by acquiring Equinox; its primary copper mines, in Zambia and Saudi Arabia, would immediately double Barrick’s current copper production, taking it close to 20% of total company revenue.

The low-key CEO Regent used his turn at the AGM microphone to defend the friendly purchase. He said the deal would provide Barrick with another “major earnings and cash flow generator,” assuring investors that “multiples [should not] be affected.”

But when it was time for the chairman to speak, Munk went on the offensive. Gold was the foundation of Barrick, he said confidently, and would remain such regardless of the latest deal. “Hear me loud and clear—this company has been built on creating the greatest gold company ever,” Munk said. “Who is so idiotic to kill the goose that laid that golden egg? And some golden egg this is so you’re not going to give it up. Hardly.”

The gold preacher then moved onto the topic of copper. It and gold were regularly linked, he pointed out. Given these particular assets and the favourable financing options available, the company would be foolish not to make a play for Equinox, Munk said. “When you have the opportunity like Equinox where you can appear as a white knight and you can acquire it in today’s monetary conditions,” he said, “you’d have to be counter-intuitive not to take advantage of it. That is the kind of free cash flow for any company, it provides the lifeblood for any company that is aggressively determined to grow.”

IF A CHAIRMAN’S SPIRITED defence is grounds to name any deal the deal of the year, Munk’s speech was it. But when Listed picked the Equinox buy as the No. 1 Canadian M&A transaction in 2011, there were a few other factors in play. First, size counts: at US$7.7 billion (at the time of the deal), it ranks just ahead of Toronto-Dominion Bank’s US$7.5-billion purchase of MBNA Canada (closing in TD’s fiscal 2012 Q1) as the year’s largest Canadian-led deal, period (through late November). Second, as Regent’s first major acquisition since he took over as Barrick’s president and CEO in 2009, it’s a milestone achievement. Third, is the execution: in terms of technical efficiency, of a company being ready to move quickly and seize an opportunity, the purchase was textbook.

Only a few weeks before Munk’s address, none of it was foreseeable. Instead, Equinox was in the midst of its own $4.9-billion bid for Canadian copper and zinc producer Lundin Mining Corp. That deal was announced on Feb. 28; then, unexpectedly, on April 3, Minmetals Resources Ltd., the large, Chinese state-backed mining operator, made an unsolicited takeover offer for Equinox at $6.3 billion, or $7 per share.

The bold move energized the market, but there was also immediate speculation that Equinox might seek a white knight who’d pay more for its “quality assets.” And two days later, Rob Franklin, former chairman of Placer Dome, which Barrick acquired in 2006, reached out to Equinox, contacting the company’s chair, Peter Tomsett. Three weeks after that, Barrick and Equinox had a deal.

To some, the suddenness of the move, and the fact that it was for a copper miner, smacked of an impulsive buy. Although it’s since recovered, Barrick’s share price took a 10% hit after the announcement, a clear indication many investors weren’t as enthusiastic as either Regent or Munk. “It needs explaining and raises concerns about what their strategy is,” says one Toronto-based analyst who asked to remain anonymous. “When you read the background of the transaction you recognize this wasn’t a strategic deal—it was totally reactive. It begs the question of do they have a strategy and what is it?”

Those closer to the process see it differently. Jamie Anderson, deputy chair of RBC Capital Markets, lead banker on the deal, says Barrick is always on top of opportunities. Anderson knows—he’s been working with Barrick as an investment banker for 15 years, helping advise the mining giant on such acquisitions as the $10.5-billion takeout of Placer. “Barrick has an excellent handle on things. They have a very strong corporate development department,” Anderson says.

That was lead lawyer Terry Dobbin’s perspective as well, although initially the Norton Rose partner had no idea he’d be involved in the acquisition. Dobbin started the year as a partner at Ogilvy Renault, which had announced in late 2010 it would be merging with Norton Rose, an international firm with significant mining experience, in June. Dobbin had a routine meeting with Barrick’s legal department last February. Nothing immediately came of it as Barrick had a longstanding relationship with the firm Davies Ward Phillips & Vineberg as its outside legal adviser on M&A transactions. However, when the time came for Barrick to jump into the fray with Equinox, Davies was already representing rival Minmetals in its bid. So Barrick called Dobbin and hired his firm to assist.

Dobbin, who previously represented CHC Helicopter in its $3.7-billion sale to First Reserve, was impressed by the preparation Barrick put into the acquisition. “They are a very seasoned issuer that acts that way,” Dobbin explains. “They have a large in-house legal department with a lot of expertise that adds a different element to it. Their deal execution capability is superb. One of the best we’ve worked with.”

BARRICK’S DECISION TO buy Equinox came down to its two key assets—a mine in Lumwana, Zambia, that Barrick expects to produce 155 million pounds of copper on its behalf in the second half of 2011, and a second in Jabal Sayid, Saudi Arabia, that Barrick says will produce 100 million pounds in 2012. Barrick’s annual copper output has been effectively doubled, to more than 600 million pounds a year, and has the potential to reach one billion.

On a conference call the day of the announcement, Regent told analysts that three primary factors drove the acquisition. First, Equinox was a “world-class asset,” the kind of prized company—with great mines, providing immediate cash flow—that can rarely be acquired through a friendly transaction. Secondly, his team was able to do due diligence on the deal, sending people to see the mine in Zambia. And finally, the financing terms, given historically low interest rates, made it very attractive, especially with copper prices soaring to around $4 a pound in the months before the deal was announced.

“We believe the fundamentals for copper are very strong for the foreseeable future,” Regent said. “This is a unique opportunity to acquire a large copper producing company with the endorsement of its board. It provides us entry into the highly prospective Zambian copper belt.”

As to the financing, Regent said that the “all in” cost of the acquisition was 3.5% on a pre-tax basis, tapping into Barrick’s $4 billion in cash, credit facilities of $1.5 billion and financing of $5 billion. RBC, as the lead, and Morgan Stanley put up the bridge loans for the deal.

“We utilize the strength of our balance sheet and that allows us to deploy a portion of our cash balances which are earning very little at higher rates of return,” Regent said. “By using cash and dilutive debt we will not be diluting our shareholder’s interest in our current production base.”

Looking back now, RBC’s Anderson says the quality of the Equinox mines was the lure. “Barrick has a stable of great world-class assets and it wasn’t interesting to them to pick up a marginal copper asset—that would have just been a waste of time, money and effort,” he explains. “If you look at the world’s top copper deposits, most are contained in companies that have no intent of letting them go. And there is a very short list that might be available and have upside. So when it became clear Equinox was going to do a transaction and transform, it focused us on whether it was something we wanted to do because we wouldn’t be able to do it later.”

The deal was priced at $8.15 per share. “I’m sure the Equinox board were grinding their teeth a bit. We want to make them sign, we didn’t want to make them ecstatic,” Anderson says. It was also enough of an increase that Minmetals immediately pulled the chute and announced the next day, also prior to the AGM, it would withdraw from the bidding. “The price offered by Barrick is above our most optimistic assessment of value,” Andrew Michelmore, CEO of Minmetals, said at the time. “Competing with Barrick at these prices would, in our view, be value destructive.”

Anderson says Minmetal’s hasty decision to withdraw its bid was unexpected. “I was a little surprised by it, but I wasn’t in their boardroom,” he says. “They appear to have had a view that this is more than they wanted to do. Alternatively they might not have wanted to get in a fight with a Canadian icon over a nominally Canadian asset. They probably thought there were other things they could do and their shareholders were not enamoured of the proposition at the start. We were pleased to see them vamoose.”

With Minmetals out of the picture, the deal went on to receive minority shareholder approval a month later, and a final thumbs-up from regulators in early summer. Regent, the former CEO of Falconbridge Ltd., and then president of Noranda after it acquired Falconbridge, who came to Barrick in 2009 after former CEO Greg Wilkins stepped down to fight a battle with cancer, had completed his first big deal for the company.

It wasn’t his first signature move at Barrick, however. That came shortly after he arrived in late 2009, when Barrick opted to wind down its gold hedge. For years Barrick had engaged in a hedging program that put fixed prices on much of production at pre-determined rates. But with gold soaring, Regent and Munk determined in September that year that the policy had to change. It was a big bet—Barrick took a $5.6-billion charge as a result of the change, and raised $3 billion to chart a new course.

“Aaron and Barrick’s board were exactly right,” says Anderson, noting gold pricing was around $1,000 per ounce at the time, a fraction of the price it’s soared to since. “That was the first big event for him.”

That move alone solidified his place in the gold miner. Munk regularly refers to the 45-year-old CEO as a “visionary,” while Anderson says Regent is a “very smart, very smart, very down-to-earth guy who keeps his eye on what matters.”

In an industry filled with characters with incredible self-affinity and belief in their own legends, Anderson says Regent is slightly understated, and sharp when it comes to a balance sheet, not surprising considering he’s an accountant by trade. “Aaron has a great affinity for numbers, and a de minimis ego, which isn’t that common in mining,” he says.

IN OCTOBER, BARRICK announced its third-quarter results. The company’s share price has rebounded to pre-Equinox-deal levels, after bottoming out 20% lower in June. Gold, of course, is still the company driver, and continued strength there prompted Barrick to announce a 25% hike in its dividend, to 15 cents a share.

The latest results also include the first full quarter of copper production from the Lumwana mine in Zambia. Barrick says it’s continuing to make operational improvements at the site and conducting exploration to expand the resource. However, it’s also had to ride out a significant (great than 25%) decline in copper prices in the second half of 2011. That hasn’t been great in terms of short-term optics for the Equinox transaction; and company-wide, lower copper prices in the third quarter cost Barrick $58 million in provisional pricing adjustments on sales made earlier this year but pegged to prices one to six months out.

Barrick declined Listed’s request for an interview with CEO Regent to discuss the Equinox deal in detail. Spokesperson Andy Lloyd said Regent has nothing to add to his earlier statements at this time. In an e-mail, Lloyd added: “We have not been actively seeking media coverage because there is still much work to be done, and the ultimate verdict on the deal will rest on the value we are adding now.”

While some pro-gold pundits—or “gold bugs” as Anderson calls them—remain critical of Barrick’s increased exposure to copper, most shareholders thus far seem to recognize the arrangement as a pragmatic necessity at a time when gold prices make deals for developing mines a pricey challenge.

“I think it was okay on the pure financials perspective,” says Andrew Martyn, president of Toronto-based Falcon Asset Management and a Barrick shareholder. “I’ve seen Barrick as one of the great builders of wealth. But if there was a disappointment, it was the realignment. It is difficult to be a pure gold company when gold is at $1,900. And people will have to adjust to the fact they’ve dropped down to a significant portion of copper. I was okay with that because I didn’t think in the long term it would contaminate the multiple. I think everyone has recalibrated to a future of an 80/20 gold-to-copper split.”

While his speech wasn’t the only factor in that recalibration, it’s certainly what Peter Munk had in mind at the annual meeting when he reaffirmed Barrick’s commitment to gold, but then added: “On the other hand, it would be equally foolish of many companies that are riding high [to] refuse to change, refuse to have their eyes opened.”

Barrick’s now running with its eyes open. Time will tell if the market likes what it sees.


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