Should New Gold Buy Bayfield Ventures?

Gold, Money

New Gold (NYSEMKT:NGD) is a company I follow closely as I think it offers a unique and intriguing risk/reward potential for gold bulls. On the one hand, it offers investors awesome leverage to the gold price insofar as it owns two very large projects — Rainy River and Blackwater — that have high initial capital expenses, but also a lot of production potential. At the same time, the company has four low-cost producing mines that give it cash-flow even in a low gold price environment. This somewhat mitigates the upside leverage but at the same time provides the company with appeal to more risk-averse investors as well as the cash flow needed to fund the two aforementioned large development projects.

Given this, there is one element of New Gold’s business that I find somewhat unappealing — it has $862 million in debt versus just $668 million in current liabilities. This limits the company’s ability to take on more debt to construct its two development properties, and this also means that it is not in a position to expand where the opportunity arises.

One such opportunity that has been staring management in the face ever since it acquired Rainy River Resources is Bayfield Ventures (OTCMKTS:BYVVF). Bayfield Ventures has a market capitalization of just $24 million. It owns an exploration property with incredible potential right next to the Rainy River mine that New Gold is going to be developing. Before I discuss the logistics of an acquisition, let us briefly look at Bayfield’s Rainy River property.

The property consists of three zones — the Burns Block, the B-Block, and the C-Block — all of which are adjacent to or surrounded by New Gold’s Rainy River property, which contains over 5 million ounces of gold and is expected to produce over 300,000 ounces of gold annually for more than a decade once it is in production.

Bayfield has done a lot of exploratory drilling and it has discovered several very promising drill holes containing gold occurrences that are almost uncanny; in some cases, over 50 grams of gold per tonne. To give you a reference point, there are above ground open pit gold mines that operate profitably at 0.5 grams per tonne, and there are underground gold mines that operate profitably at 5 grams per tonne.  Given how promising these drill holes are and given the proximity of this land to New Gold’s multi-million ounce gold deposit, it seems as though there is a very good chance that Bayfield will find a highly profitable mine. In fact, it has already found a small defined resource at the Burns Block of just over 200,000 ounces of gold and just over 2 million ounces of silver.

In light of this, Bayfield shares have performed very well. While the stock is up just 12 percent for the year [versus the Market Vectors Junior Gold Miner ETF (NYSEARCA:GDXJ), which is up 35 percent] it is up 28 percent over the past year versus the GDXJ, which is down 30 percent. This is likely due to the impressive drill holes that I have discussed, and speculation that New Gold might buy the company out.

Investors interested in Bayfield Ventures should bear in mind that the company has only a small defined resource, no mine plan and no likelihood of developing one for several years, and no revenues. Therefore, the shares are extremely difficult to value and they are highly speculative.

But New Gold is not an individual retail investor, or even a typical institutional investor. It is a company that owns a lot of land and a future mine that surrounds, and is bordered by Bayfield’s Rainy River property. Again, while the property is virtually impossible to value, New Gold can get more potential upside from Bayfield as it may be able to incorporate Bayfield’s property into its own Rainy River project and perhaps build a bigger mine.

The trouble is, as I have suggested above, New Gold is not really in a position to be aggressive like this. True, New Gold could buy Bayfield and end up spending about $40 million if it pays a premium to the current market price plus transaction expenses. However, New Gold would then be in a position where it would have to find additional capital to explore the Bayfield Rainy River property, revise its newly updated mine plan for its own Rainy River project so that Bayfield’s is incorporated, and then it would likely have to develop a larger mine than that which is planned. If it doesn’t do this, New Gold can still buy out Bayfield, but it is then just going to sit on this property as it gathers dust.

Ultimately, New Gold has a decision to make. It can focus all of its resources on the Rainy River project and ignore the Black River project. If it does this, it should buy Bayfield and try to build a more valuable Rainy River mine. It could also wait for Bayfield to expand the resource. While this would eliminate uncertainty it may also mean that New Gold will pay far more for Bayfield than it would today assuming that Bayfield’s team can dramatically expand its resource. Finally, New Gold can just put blinders on and move forward with its Rainy River project “as-is.” As I already mentioned, New Gold has excellent assets and a unique risk/reward profile that makes it an appealing addition to any gold mining portfolio, and not buying Bayfield wouldn’t change this. However, New Gold’s restrained capital position forces its management to be less aggressive than it could be, and I find this to be somewhat disappointing, especially in a depressed gold price environment where it pays to be aggressive from the standpoint of a gold bull.

New Gold may want to just bite the bullet and issue some stock in order to pay down debt or to buy Bayfield and to fund an exploration program. I know that the stock is down from $15/share to $6/share, but the opportunity here seems to be too good to pass up.

Investors who watch or own New Gold should add Bayfield to their “watch lists” and those who like to gamble with some money should consider a small position in Bayfield shares given its exploration potential and given that it is a takeout target. Investors may also want to buy New Gold should it decide to purchase Bayfield — especially if it is a stock transaction — as this would be a sign that the company is continuing its growth agenda in a strategic fashion. If New Gold uses cash to buy Bayfield, I would become somewhat concerned that management is not being careful enough with its balance sheet. I would also be somewhat concerned if New Gold went after acquisition targets elsewhere with Bayfield staring it in the face as an obvious choice.

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