Is Royal Gold a Takeout Target?
On Monday, Morgan Stanley (NYSE:MS) compiled a list of 44 companies that have a relatively high likelihood of being taken out. The company argued that companies that fit a certain profile are more likely to be takeout targets. Some of the characteristics that Morgan Stanley used in order to compile this list include the following:
- Low market capitalization: Low market cap companies are potential takeout candidates to more companies than higher market cap companies.
- Low dividend yield: Companies with lower dividends tend to be more attractive to potential acquirers. While there is no direct reason for this, I would maintain that companies with lower dividends are more likely to be reinvesting their profits in their businesses, and they likely have higher growth. This is not true of all companies with low yields, but higher growth companies tend to have this attribute.
- Low price to book value: This is fairly obvious; companies that trade at a lower price to book ratio are cheaper and inherently more attractive to potential acquirers.
- High debt to asset ratio: Companies with more leverage tend to be more likely takeout candidates. This one is less intuitive, but keep in mind that the leverage of a small company will likely be diminished when the assets and liabilities are in the hands of a larger company.
One of the companies that appeared on this list is a company that I follow and own – Royal Gold (NASDAQ:RGLD). I was somewhat surprised to see this company make the list. Many of the companies on the list are companies such as energy companies, drug companies, or consumer goods companies. This makes perfect sense. For instance, a small drug company might be the takeout target of a large drug company if it has a late stage development product that needs just a few more trials, but which the company cannot afford. A large drug company can buy the technology and then fund the trials in the hopes that the drug will be approved. Furthermore, a consumer goods company might want to expand into other products and buy out a smaller company that sells these other products.
Royal Gold is a gold royalty and streaming company. This means that it gives money to mining companies in exchange for the right to buy an agreed upon amount of that company’s production at a certain price. For example, Royal Gold’s latest deal was an agreement to pay Rubicon Minerals (NYSEMKT:RBY) $75 million in 5 $15 million tranches. In exchange, Royal Gold has the right to buy 6.3 percent of the gold produced at Rubicon Minerals’ Phoenix Mine up to 135,000 ounces at 25 percent of the gold price, and 3.15 percent of the gold produced at the Phoenix Mine after 135,000 ounces at 25 percent of the gold price. This is a win-win situation. Rubicon Minerals gets capital it needs to construct the mine, which it will do this year, and Royal Gold will get a cash-flowing asset that will give investors leverage to the gold price.
The business model works extremely well, and Royal Gold meets several of the aforementioned criteria, but it is difficult to see the company as a takeover target. The reason for this is that one would expect that the acquiring company would be another royalty and streaming company, and there are only two candidates – Franco Nevada (NYSE:FNV) and Silver Wheaton (NYSE:SLW). Furthermore, Silver Wheaton focuses primarily on silver, which makes an acquisition of Royal Gold by Silver Wheaton less likely.
Still, Franco Nevada could potentially buy out Royal Gold. Franco Nevada is a favorite investment among gold mining investors given its impeccable balance sheet, its history of growth, its monthly dividend, and its strong management team. I think Royal Gold is equally well managed, although it doesn’t get the recognition that Franco Nevada does. As a result, Royal Gold trades at a discount to Franco Nevada given its production growth. If Franco Nevada’s management recognizes this, it could rationalize making an offer to Royal Gold. I think it would be unlikely that Franco Nevada would pay a high enough premium to the current market price to convince Royal Gold shareholder’s to sell, but even if such a threshold were reached the deal would be accretive to Franco Nevada. Even if Franco Nevada didn’t like all of Royal Gold’s assets it could create a new company with those assets, capitalize it with a couple hundred million dollars, and spin if off as a new company.
While this is just speculation, the main point is that there is good value in Royal Gold shares. Investors who want a relatively low risk way of playing the gold market should consider taking a position, especially now that the shares are pulling back after rising more than 50 percent in the first couple months of 2014. If there is a takeout offer then that’s great! But buying the shares hoping for one is the wrong approach.
Disclosure: Ben is long Royal Gold and Silver Wheaton.
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