In January, Goldcorp (NYSE:GG) made an offer to buy out Osisko Mining (MKTS:OSKFF.PK). Osisko’s management responded by saying that Goldcorp’s offer was inadequate and that it didn’t reflect the full value of Osisko shares. While the offer expired, Goldcorp recently announced that it is extending it in hopes that it will be able to forego Osisko’s management and take the offer directly to Osisko shareholders for a vote.
Let us look at the details of the offer. Goldcorp offered Osisko shareholders 0.149 shares of Goldcorp plus $2.26 Canadian (about $2.) With Goldcorp trading at $27.60 as of the end of Friday’s trading, this comes to roughly $6.11 versus Osisko’s closing price on Friday of $6.29, or $2.8 billion. Still, when the offer was made, Goldcorp’s bid exceeded Osisko’s price. Osisko shares climbed on January 11 when the offer was made, reflecting the 15 percent premium that Goldcorp offered. When Osisko rejected the offer, saying that the premium was too small, Goldcorp’s management remarked that the premium offered was considerably higher — 28 percent — than the average trading price for Osisko shares over the past 20 days.
Why does Goldcorp’s management want to buy Osisko and why is Osisko’s management so reluctant to sell? Osisko owns the Canadian Malartic mine, which has a large resource base — over 10 million ounces of gold. The mine produced nearly 500,000 ounces in 2013 and production is expected to produce between 500,000 and 600,000 ounces. Furthermore, production costs have been falling so that it is reasonable to assume that it will cost Osisko just $950/ounce to produce an ounce of gold going forward. This means that at $1,325/ounce gold, the mine can generate $225 million in pre-tax cash-flow. Assuming a 22.9 percent tax rate with the company, this comes to $173 million. This is a lot of cash flow and the mine has a long life ahead of it with low production costs and a lot of ounces produced.
But even at the current price-tag of $2.8 billion, Osisko shares are no bargain. It currently trades at just over 16-times cash flow. This isn’t necessarily expensive, but production might not reach 600,000 ounces — this is the high end of a range. If production averages toward the lower end of the range — say 520,000 ounces per year — then cash flow falls to $150 million per year, and the stock suddenly trades at 19-times cash flow.
Furthermore, while the company has other resources such as extensive exploration property in Mexico and the currently uneconomical Hammond Reef project in Canada, Osisko doesn’t have the extensive resources needed to explore this land in Mexico or to build the Hammond Reef mine once the gold price rises. For instance, where is Osisko going to come up with the $1.8 billion needed to build the Hammond Reef mine when it generated just $190 million in gross profits last year and less than $100 million in adjusted net income? The company only has $161 million in cash and $317 million in debt.
This is why the deal makes sense for both Goldcorp and Osisko. Goldcorp has the extensive resources needed to bring out the value of these assets. Therefore, it is okay for Goldcorp to pay a little extra for the cash flow from Canadian Malartic. On the other hand, since Osisko doesn’t have the resources that Goldcorp has, it makes sense for it to find a partner such as Goldcorp to bring out the value in its undeveloped assets. Otherwise, I think the company’s shares are somewhat expensive at the current valuation.
Therefore, I think Osisko shareholders should consider selling at this valuation, or they should vote for the deal and encourage management to do the same.