Why A Barrick-Newmont Merger Makes Sense

Barrick Gold Corporation (NYSE:ABX) and Newmont Mining’s (NYSE:NEM) recent attempt to merge collapsed acrimoniously. Though the proposed merger between the world’s top two gold producers fell apart, it may not be dead and buried. There are plenty of reasons why mergers between gold mining companies in general, and Barrick and Newmont in particular, make sense. ^[1]

The depletion of gold mines globally has resulted in higher extraction costs. Moreover, the number of new discoveries has fallen drastically. In addition to these factors, gold prices have plummeted over the last year due to a strengthening U.S. economy and Quantitative Easing (QE) tapering by the Federal Reserve.

In an environment of rising costs and falling gold prices, gold mining companies have sought to rationalize costs in order to remain competitive. Both Barrick and Newmont have divested a number of high-cost, non-core assets to free up capital for better allocation and debt repayment. A merger between the two would result in significant cost synergies. In this article we take a closer look at why a merger between the two companies makes sense.

Gold Prices

Gold prices have corrected significantly over the last year. These have been reacting to cues regarding QE tapering by the Federal Reserve. London PM Fix gold prices have fallen from average levels of $1,650 per ounce in Q1 2013 to $1,300 per ounce in Q1 2014. Going forward, the expected strengthening of the U.S. economy is likely to result in further QE tapering and continued pressure on gold prices. ^[2]

The adverse gold pricing environment has affected the fortunes of both Barrick and Newmont. Average realized gold prices for Barrick have fallen consistently. These stood at $1,669 per ounce, $1,407 per ounce and $1,285 per ounce in 2012, 2013 and Q1 2014. Similarly for Newmont the corresponding figures stood at $1,662 per ounce, $1,393 per ounce and $1,293 per ounce in 2012, 2013 and Q1 2014, respectively. Falling realized prices have affected margins, especially in the context of rising costs. ((Barrick Gold’s 2013 40-F, SEC))

Costs

Discoveries of new gold deposits have dropped drastically over the years. In 1995, 22 gold deposits with at least 2 million ounces of gold each were discovered. The corresponding numbers of such discoveries dropped to 6 in 2010, 1 in 2011 and none in 2012. Though the number of discoveries is a function of a number of factors, including how much companies are willing to spend on exploration, the falling number of new discoveries may point to limited availability of gold ore. According to data from the U.S. Geological Survey, global gold production was 5.1% of the 54,000 tonnes in reserves in 2013. This would mean it would take 19.5 years to exhaust gold reserves. This compares unfavorably with 38.5 years for copper and 28 years for iron ore.

There has been a 35% decline in the grade of gold mined by gold mining companies from 2001 to 2012. Lower grades of gold are more expensive to mine. The cost of mining an average ounce of gold has risen to $745 in 2012 from $280 in 2005. There are two reasons for the decline in the grade of ore mined. It is more economical to mine lower grade ore in an environment of higher gold prices. With London PM Fix gold prices having risen from levels of around $280 per ounce to levels of around $1,700 per ounce between 2001 and 2012, companies found mining lower grades of gold economically viable. Secondly, the limited number of new discoveries has meant that lower grades had to be mined. ^[3]

However, with gold prices having corrected significantly over the last year, it is becoming less economical and in some cases unsustainable to mine high-cost, low-grade ore. Companies are looking to divest such assets in order to reduce costs.

Divestments

Both Newmont and Barrick have been divesting non-core assets to lower their average costs of mining gold and repay debt. Newmont has raised around $800 million from divesting non-core assets over the last 12 months. Barrick has raised around $1 billion from non-core asset sales since mid-2013 as part of its portfolio optimization efforts. ((Newmont Signs Agreement To Sell Jundee Underground Gold Mine In Australia, Newmont Mining News Release))

These divestments along with measures to enhance productivity have lowered all in sustaining costs (AISC) for Barrick from $1014 per ounce in 2012 to $915 per ounce in 2013. The corresponding figure for Newmont fell from $1,192 per ounce in 2012 to $1,105 per ounce in 2013. The AISC metric includes the total cash cost, sustaining capital expenditures, general and administrative costs, mine site exploration and evaluation costs, mine development expenditures and environmental rehabilitation costs. It provides a comprehensive view of costs related to a company’s current mining operations. ^[4]

In addition to lowering costs through divesting non-core assets, consolidating low-cost gold mining operations under a merged entity is another option for Barrick and Newmont to remain competitive.

Possible Merger

In a business environment characterized by low gold prices and higher mining costs, rationalizing costs is important for both Barrick and Newmont. A possible merger between the two could result in $1 billion in cost synergies from the two companies combining their low cost gold operations in Nevada and spinning off non-core assets. ^[5]

Newmont’s Nevada gold mining operations accounted for 1.8 million ounces out of 5.065 million ounces or nearly 35% of the gold produced by the company in 2013.  Barrick’s Nevada gold mining operations accounted for 2.791 million out of 7.166 million ounces or nearly 39% of the gold produced by the company in 2013. A merger between the two companies would help the merged entity consolidate these operations. The geographical proximity and  low cost of production of the two companies’ Nevada operations would enable the realization of significant economies of scale.

As per a statement released by Barrick Gold, the reasons for the break down of the proposed merger include disagreements between the two companies on the location of the head office of the merged company and identification of assets to be spun off. It seems the reasons for a breakdown in merger talks are mostly to do with disagreements in the boardroom. We believe that in an environment of depressed gold prices and depleting gold assets, there is a clear business case for this merger. The deal is off the table for now, but it may not be dead and buried. ^[6]

See More at Trefis | View Interactive Institutional Research (Powered by Trefis)| Get Trefis Technology

1. Newmont Terminates Merger Discussions With Barrick, Barrick Gold News Release [↩]
2. Gold Price Chart, Kitco [↩]
3. Gold Deals Remain Likely Despite Barrick-Newmont Merger’s Collapse, Wall Street Journal [↩]
4. Nemont Mining’s 2013 10-K, SEC [↩]
5. Barrick Gold Chief Hails Benefits of Newmont Merger, Financial Times [↩]
6. Barrick Clarifies Merger Discussions With Newmont, Barrick Gold News Release [↩]