Barrick Gold Corporation (NYSE:ABX) is in preliminary talks with China National Gold Group to sell some or all of its 74% stake in the African Barrick Gold (ABG) business. A bid for over 30% of the company would trigger an open market offer for the whole of ABG. China National Gold claims to be the largest gold miner in China by production. It mined 1 million ounces of gold in 2011, compared to the 688,000 ounces produced by African Barrick. Its reserves stood at 1,565 tonnes, or 50.3 million ounces as of June this year. ABG’s gold reserves stand at roughly 17 million ounces. The sheer size of its asset base and as well as its sizable position in Tanzania would be attractive to any miner in Africa looking for diversification. ((China National Gold considers big push into Africa, Reuters))
Why Barrick Would Be Interested In A Deal
Gold mining company shares have been taking a beating despite rising bullion prices, largely due to rising input costs and production delays which have affected the rates of return. James Sokalsky, after taking over as CEO, announced that Barrick would do a review of its portfolio and give priority to projects which provide decent rates of return, rather than those which result in the largest production by volume. African Barrick Gold has struggled to meet production targets owing to operational setbacks and is forecasting the lowest annual output since the stock began trading in London. ABG’s shares have fallen 26% since its IPO in March 2010, while Barrick’s shares have declined by 12% over the same period. In addition, S&P downgraded Barrick’s rating to BBB+ from A- with a negative outlook on July 30 2012, citing the higher spending forecasts for the next two years which would reduce its ability to reduce debt. We think that Barrick may thus be looking to strengthen its balance sheet through this deal. Barrick’s shares have risen by 8% from the time when the talks were confirmed which, we believe, shows that the market is in favor of a deal. ((Barrick Africa Talks Signal Start Of Austerity: Corporate, Bloomberg))
Why China National Gold Would Be Interested In A Deal
China is the world’s top gold producing country. Its gold demand in the first half of the year rose by 2.8% on an annual basis to 400 tonnes, or 12.8 million ounces, despite a drop of 7% in demand in the second quarter. China is expected to become the world’s top gold consumer on an annual basis this year with demand touching 850 tonnes, according to the World Gold Council. The demand for gold is being driven by two factors. One is China’s increasing affluence, which leads to higher demand for jewellery and as a hedge against inflation by Chinese investors.
However, we believe that there may be other dimensions to this deal. Chinese gold companies may be on the hunt for external resources because the quality of domestic gold isn’t very good, and also because they want access to superior gold-mining technology. China may also be looking to shore up its official gold reserves. We believe that such deals are a way to boost the official gold reserves without attracting too much attention by buying on the open market. The fact that this deal comes at a time when gold demand and prices are falling in China as a result of the broad slowdown strengthens our belief. ((China’s Hunt for Gold Goes Overseas, WSJ))
How The Deal Might Benefit Barrick
For one, the deal may reduce capital spending requirements for Barrick to the tune of $2 billion from 2012 through 2016. This may also relieve pressure on free cash flows for the company which should help in paring down its debt of $13.9 billion.
The African mines have been facing problems due to security issues and power blackouts, leading to production shortfalls. The government in Tanzania has not been very responsive to Barrick’s concerns either. A sell-off, we believe, would make Barrick’s portfolio more stable and result in higher valuations owing to a reduction in risk premiums. These risk factors, on the other hand, make it less likely that Barrick would be able to command any premium over the market price for its stake in ABG. We believe that the overall effect would be to provide an upward boost to Barrick’s share price and market valuations. ((Barrick looks to walk from Africa, The Province))
We will be keeping a watch on any developments on this front and factor them in our price estimates going forward.