Untouchable Gold Stocks

Gold stocks are the most valuable asset class, and untouchable by the private equity scourge.

JOHANNESBURG - 

The world would be a very strange place without listed gold stocks. Global private equity funds, with US$300 billion burning holes in their pockets, want no listed stocks at all. The luck for investors who do not want to live in a very strange world is that listed gold stocks are unaffordable.

Unaffordable to private equity funds, that is. Listed gold stocks are only affordable to other listed gold stocks. This logic hinges on the simplicity that one gold stock can issue fresh shares when acquiring another gold stock. Sometimes, some cash is thrown in to sweeten the deal, but mostly, it's stock.

Gold stocks are demonstrably expensive. If investors apply the price:earnings (PE) multiple as a litmus test, the broad-based S&P 500 index (representing 500 US-listed stocks) is currently trading around a 16 times PE, roughly equal to its long-term average. Tier One gold stocks are trading at an average PE of 31 times, nearly twice the S&P 500. There are many reasons for this, not least the class of investors who believe that gold bullion is the anti-dollar, and that gold stocks should be regarded as, and are, royal game.

There is also the overwhelming power of the modern gold stock business model, arguably developed by Barrick from the 1980s. Investors demand not only that gold stocks produce gold, but also that they replace ounces mined out. Exploration successes are unusual, perpetuating a sustained appetite for junior gold plays. The high value of senior gold stocks feeds down the food chain.

Gold diggers are capital intensive and heavy users of cash, leaving paper-thin dividend yields. Gold stocks, in a nutshell, are rare creatures with very loyal followers that repel aliens with ease. The latter issue arose, briefly, on April 11, when Bloomberg, a wire service, baldly stated that: "U.S. financier Edward Pastorini may lead a bid for Gold Fields Ltd., the world's fourth-largest gold producer, to tap the rising price of bullion".

If just one thing, and one thing only, gave this away as a hoax, it was the statement that "the LBO [leveraged buy out] firms, corporate raiders and I ["Pastorini"] feel that gold is going to rise to over $1,000 an ounce over the next two to three years". Unless Pastorini was a gold stock, this deal was a hoax. It would be impossible to countenance a cash-purchase of a Tier One gold stock, and beyond impossible to consider the use of leverage (interest-bearing debt) in such a deal.

Without allowing the Pastorini hoax to cloy this story, consider that on October 18 2004, Harmony Gold announced a takeover deal worth R52.9bn (US$7.49 billion) for Gold Fields. Harmony's offer was pure paper: for each Gold Fields share, 1.275 new Harmony shares. Despite great theatrics and wonderful entertainment, the deal was never completed.

Just over a year later, on October 31, 2005 Barrick (then-market capitalization: US$14bn) announced the unsolicited proposed acquisition of Placer Dome (US$10bn). Here, the offer was a mixture of Barrick stock, and cash. Beyond the status of both stocks as Tier One gold diggers, the authenticity of the offer was certified by the presence of big egos that inevitably seem to set up camp in the upper echelons of gold companies.

Placer Dome unanimously recommended that shareholders reject Barrick's hostile takeover bid. Placer Dome had naturally consulted its financial advisers, among the meanest names on Wall Street: CIBC World Markets, Goldman Sachs & Co, Morgan Stanley & Co. Each adviser denounced the Barrick offer.

In the horse-trading so typical of this kind of corporate activity, Peter Tomsett, then President and CEO of Placer Dome said: "It's easy to see why Barrick needs Placer Dome, but it's difficult to understand why Placer Dome should want Barrick."

Barrick's offer was seen as rotten and not reflective of "an adequate premium for control of Placer Dome." Suddenly the invective and fireworks were over. On 22 December, Barrick and Placer Dome jointly announced agreement on "a friendly transaction" under which Barrick increased its offer to acquire Placer Dome. The revised offer was some $10.4bn, compared to the original offer of US$9.5bn. In the end, Barrick issued 322.8m fresh shares, worth $8.8bn, to Placer Dome shareholders, topped up with $1.2bn in cash.

It was a mother of a deal. Today, including a control premium of, say, 25% it would cost US$31bn to take out Barrick. That's unaffordable, unless the buyer is another gold stock, and there are none so big as Barrick.

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