Eric Sprott explains what investors are getting wrong about Kirkland’s all-stock Detour Gold deal
Toronto-based Kirkland Lake Gold Ltd. on Monday announced a multibillion dollar acquisition of Detour Gold Corp., a deal that would elevate it into a major gold miner and could attract new institutional investors.
But investors weren’t impressed, with the stock declining 16 per cent by mid-afternoon to $40 on the Toronto Stock Exchange. Detour rose 3.6 per cent to $23.
The combination marries two near opposites: Kirkland Lake operates two high grade underground mines at some of the lowest cash costs in the sector, whereas Detour operates a single, low grade bulk tonnage open pit mine at comparatively higher costs.
The acquisition would boost Kirkland’s annual gold production by about one-third to more than 1.5 million announces per year, but its costs are also expected to rise.
The value of the all-stock deal was somewhat uncertain as of Monday, initially pegged at $4.9 billion but falling with Kirkland’s stock. If some investors expressed initial skepticism, one of the biggest and perhaps most important investors in Kirkland, billionaire Eric Sprott, who stepped down as chairman earlier this year, said he would support the deal.
“The more I reflect on Detour, I think we’re ‘stealing value’ — value that the market’s not seeing,” Sprott told the Financial Post.
Detour reported all-in sustaining costs of $1,198 in the third quarter whereas Kirkland reported all-in sustaining costs of $562, about half of that.
Nonetheless, Sprott said he had been studying Detour: With gold prices rising — about 15 per cent since June to US$1467 per ounce — higher cost producers can catch momentum more quickly than lower cost producers because they’re starting from a lower profit base.
For example, Detour reported revenue from mining operations of US$59.8 million in the third quarter — compared to about US$15 million in the same quarter one year earlier. It said in its report that it had sold its gold for US$222 per ounce more on average during the quarter than the prior period.
Sprott also said he was encouraged by signs that Detour looks like it’s bringing costs down to around US$1,100 per ounce, and that could increase its gold production beyond the 621,000 ounces produced in 2018.
“I think we’re on the cusp of something really special,” he said. “I think a lot of good things will happen at that property.”
Tony Makuch, chief executive of Kirkland Lake, said his company was attracted to Detour Lake by its sheer size. It provides the company with 15.4 million ounces of proven reserves, roughly triple what the company holds between its two underground mines, with Fosterville in Australia at about 2.7 million ounces, and Macassa, in Ontario at 2.2 million ounces.
I think we’re on the cusp of something really special
Plus, he said Detour is already lowering its costs, and its production has been rising on track to produce more than 600,000 ounces for a second straight year.
“You can see potential to get this up to well over 800,000 ounces per year production,” he said, adding that the company had spent only about $40 million on exploration during the past five years — which Kirkland will look to increase.
A spokesman for Paulson & Co. declined to comment on the proposed merger.
He said initial discussions began in August, but didn’t really pick up speed until last Thursday.
“It came together fairly quickly,” said Makuch.
Both Detour’s Lake mine and Kirkland’s Macassa underground mine are located on Ontario’s Abitibi Greenstone belt, about several hundred kilometres away from each other, and Kirkland Lake said it expects about $75 to $100 million in pre-tax synergies.
The management of both companies declined to provide any details of how that would be achieved during a conference call on Monday morning.
Kerry Smith, an analyst at Haywood Securities who covers Detour, said he thinks the combined company, which would have a market valuation of around US$14 billion, could attract new institutional investors who want a gold stock in their portfolio, but who viewed Kirkland and Detour as too small or lacking in liquidity.
“All of a sudden you’re getting another company that could be a name these investors gravitate to,” he said.
David Neuhauser, managing director of a Illinois-based hedge fund, Livermore Partners, was ecstatic about the deal: In 2018, during the activist campaign launched by Paulson, he bought into Detour at around $11 per share.
In recent months, he had started to sell down his position as Detour’s stock soared above $24.
He predicted more consolidation in the gold space. Since 2018, there have been at least two other megamergers, with Barrick Gold Corp. swallowing Randgold Resources Ltd. in a US$6-billion deal and Newmont Gold Corp. merging with Goldcorp Inc. in a US$10-billion deal.
Under the deal, Kirkland agreed to exchange 0.43 of its shares for each Detour share, which give Detour shareholders approximately 27 per cent of the newly combined entity.
Before the deal was announced, Kirkland had been trading at $63.33, one of the best performing stocks on the TSX during the past two years, rising 228.5 per cent in that time.
Having dropped 16 per cent, to $53.24, that meant the deal still valued Detour’s shares at approximately $22.89 apiece — slightly less than the $27.50 announced by the companies.
Smith noted Kirkland trades at 12 times its cash flow whereas Detour trades at 8 times. The difference in the trading multiple of their net asset value is more stark, he added, calculating Kirkland trades at 2.1 times whereas Detour is 0.9.
“Undoubtedly, (Detour) is higher cost, so investors are wondering what’s going to happen to the multiple,” Smith said.
Kirkland was smart to move while its stock had a high valuation, and could be used as a currency, Smith noted.
It was a point that Sprott, who owns approximately 14 million shares of Kirkland, according to one recent estimate, raised too: Kirkland is not taking any debt to complete the deal.
He compared the market reaction to Kirkland Lake’s acquisition of the Fosterville mine in 2016, which Sprott helped engineer, and which the market initially disliked. Yet after more exploration, Fosterville emerged as one of the highest grade gold mines in the world and helped give Kirkland one of the highest trading multiples of any of its peers.
“When Kirkland bought Fostervile, everyone hated it, well, the market did,” Sprott said. “And the market was wrong.”
Makuch said given the exploration potential at Detour Gold’s property it was similar to Fosterville in that it has the potential to provide a big contribution to Kirkland Lake’s bottom line.
“We got to recognize that Fosterville is a special asset, and we may not find another of those in the world, even though we keep looking,” said Makuch. “And Detour is a very special asset too.”
The deal must be approved by two-thirds of shareholders and is not expected to close until next year.