In December we learned that Primero Mining (NYSE:PPP) made an offer to acquire Brigus Gold (NYSEMKT:BRD) for about $220 million worth of stock. On Tuesday, we learned that proxy advisory firms Institutional Glass Lewis & Co. and Institutional Shareholder Services Inc. made a recommendation to Brigus Gold shareholders to agree to the acquisition. Thus, barring an outside event, it is very likely that the acquisition will be completed without any issues.
The terms of the deal are as follows. First, Brigus gold shareholders will receive 0.175 Primero Mining shares. This increases the number of outstanding Primero shares from about 117 million to 159 million. Second, Brigus gold shareholders will get 0.1 share of a new company (aka “SpinCo”) that consists of the Brigus’ secondary properties. Primero Mining will also own 10 percent of the outstanding shares of SpinCo.
There are many things to like about the new Primero Mining. First, the company nearly doubles its production by adding the Black Fox mine to its portfolio. The Black Fox mine is located in Ontario and it is expected to produce 120,000 ounces of gold at $1,100 per ounce, making the project economical. Sandstorm Gold (NYSEMKT:SAND) owns a royalty on the Black Fox property, entitling it to 8 percent of the gold produced there at $500 per ounce. While the current mine plan indicates seven years of production, the company predicts that it will be able to extend this by at least another seven years.
Second, Primero diversifies its holdings outside of Mexico. Before the deal, the company’s two main projects — San Dimas and Cerro del Gallo — were located in Mexico. With the addition of the Black Fox property, the company now has exposure to a Canadian mine. Investors who have been concerned that the Mexican government might raise taxes on mining profits again as they did in October can now be more comfortable owning Primero Mining, as the tax hike will not hit the company’s entire portfolio.
Third, the company now has more leverage to a rising gold price. The Black Fox property has higher production costs than San Dimas, and therefore its value will rise faster with a rising gold price. Of course, this comes with the corollary that if the gold price falls, Primero Mining is now more vulnerable to reduced profits or even losses.
While there is a lot to like about the deal from the perspective of a gold bull, there are also some drawbacks to the deal.
First, one of the appeals of Primero Mining was its strong balance sheet that contained a lot of cash with a little bit of debt. Brigus Gold’s balance sheet is just the opposite. The new company will have $147 million in cash but $107 million in debt. If we couple this with the company’s heightened leverage to the gold price, it follows that Primero Mining has lost that safety appeal. Primero Mining will do better in a rising gold price environment, but it also doesn’t have the downside cushion that made it a low-risk investment.
Second, it follows that in a weak gold price environment, Primero’s capital position can be jeopardized. This in turn could mean that the company might have trouble raising the funds to develop its next mine, Cerro del Gallo. This mine should cost the company $136 million. While it currently has $147 million, it could potentially lose some of this if the gold price falls. Furthermore, given the company’s newly acquired debt load, its borrowing capacity is constrained. This, too, can potentially delay construction of the Cerro del Gallo mine in a weak gold price environment.
Ultimately, the new Primero Mining is a riskier proposition than the old Primero Mining. Investors who like higher risk gold miners will find this appealing, as the shares will rise faster should the gold price rise. We have already seen this in the shares’ strong performance over the past several weeks in response to a rising gold price. But this leverage works both ways, and if the gold price falls, Primero Mining no longer has the low production costs and strong cash position to withstand this.