Markets & Finance

The $8.6 Billion Gold Deal


Mining company Goldcorp (GG) on Aug. 31 struck an agreement to acquire gold company Glamis (GLG) in an $8.6 billion deal, part of a wave of consolidation sweeping through the commodities sector as prices for everything from gold to copper to aluminum soar.

Goldcorp's shares tumbled as much as 12% during trading on Thursday and closed down nearly 10%, at $27.66, on fears that the company is paying too steep a price in the deal. The company's bid represents a 33% premium over Glamis' market price on Aug. 30. On top of that, Glamis Chief Executive Kevin McArthur will get to be chief executive of the combined companies.

It was the latest in a series of deals that have swept through the mining industry and the commodities sector this year. Barrick Gold (ABX) paid $10.4 billion to acquire Place Dome. Phelps Dodge (PD), the copper mining company, is in a takeover battle with Comphania Vale do Rio Doco (RIO) to buy Inco (N), the Canadian nickel company (see BusinessWeek.com, 8/15/06, "Teck Cominco Raises Offer for Inco"). And Russian aluminum producer OAO Rusal is in talks to buy Sual Group and assets of Glencore International, according to news reports.

M&A BOOM. Overall, the number of deals in the mining sector is soaring. There have been 713 mining deals this year to date, according to market researcher Dealogic. That is nearly as many as the record 763 logged during all of 2005. It is far more than the 515 recorded in all of 2004.

The deals reflect the need for consolidation in the mining and commodities sector. Rising commodity prices push up costs for producers as well as buyers. "What's driving consolidation, I have to believe, is the need for more scale," says Matt Michaelis, an investment banker at Jeff Williams & Co. in New York.

Yet investors are concerned that Goldcorp CEO Ian Telfer is overpaying to lead the way in the consolidation. The 33% premium is high by industry standards. The average premium to prior-day closing prices for deals in the global mining sector is 22%, according to Dealogic. And the premium for all global mergers and acquisitions is an average of 19.5%. "It sounds like [Telfer] believes that prices will continue to rise," says Michaelis.

DEFENDING PURCHASE. Telfer, who will be non-executive chairman of the combined company, was forced to defend the transaction during a conference call on Thursday. One investor wanted to know how the companies arrived at the acquisition price.

Telfer said he knew that the deal would be dilutive for Goldcorp shareholders in the short run, but that Glamis was worth the price. "This is a world-class company. They were not going to let Glamis go for anything close to a bargain basement price. I am telling you, you could not have gotten it cheaper," Telfer said.

Telfer described the negotiations as hard-fought and arm's-length. Glamis' resources and reserves are key to creating a new company that will be the low-cost producer in the industry, Telfer said. "That is the most important metric going forward, and on that metric, the deal is very accretive," he said.

If that bet on higher prices turns out to be wrong, investors who are nervous about the premium could be vindicated. But Glamis CEO McArthur said the new business will have a low cost structure that will make it competitive. He told investors on a conference call that the new company would have "a stunning growth profile for a mining company." He said the new Goldcorp, which would have a presence in the Americas from Canada to South America, would have a leading cash-producing profile. The new Goldcorp, he said, will generate a profit margin of more than 60%, using earnings before income taxes, depreciation, and amortization, or EBITDA, as a benchmark.

GROWTH OUTLOOK. The outlook for the new company is closely related to the global economy. Economic growth is still strong in the U.S. and many parts of Europe. Economies such as India and China are surging ahead, fueling demand for commodities from oil and gas to lumber and metals (see BusinessWeek.com, 9/4/06, "How Oil Fuels Sino-U.S. Fires").

If that global growth continues, pushing commodity prices higher, then the value of the companies that produce those goods should rise as well. Of course, rising prices could eventually spark a round of inflation that would bring the global boom to an end (see BusinessWeek.com, 7/26/06, "Would $100 Oil Slam the Global Economy?").But there's little clear sign of that happening so far.


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