Vancouver-based New Gold Inc. (USA) (NYSEMKT:NGD) recently announced that it would acquire upstart Canadian gold miner Rainy River Resources Limited (NASDAQOTH:RRFFF) for about C$370 million. At current exchange rates, this translates to a purchase price of about $355 million. Due to the corporate structure and asset portfolio of Rainy River Resources Limited (NASDAQOTH:RRFFF), this deal is quite straightforward. Since the smaller company owns just one production-ready asset, New Gold Inc. (USA) (NYSEMKT:NGD) is effectively buying a ready-to-go gold mine that has been managed well during the course of its relatively short lifespan.
New Gold Inc. (USA) (NYSEMKT:NGD) competes directly with a number of Canadian mining companies that exploit copper, gold, silver, molybdenum and other minerals. Since the bulk of the company’s leases lie on Canadian soil, it would make sense to compare it to a firm that deals with a similar basket of assets. Although plenty of candidates fit this bill, Taseko Mines Limited (USA) (NYSEMKT:TGB) offers a solid comparison.
In 2012, Rainy River Resources Limited (NASDAQOTH:RRFFF) reported a loss of about $65 million and little in the way of revenues. This is largely due to the fact that exploration work continues at Rainy River Resources Limited (NASDAQOTH:RRFFF)’s eponymous gold-mining project in northwestern Ontario. For comparison, New Gold Inc. (USA) (NYSEMKT:NGD) reported 2012 income of about $202 million on revenues of around $824 million. Taseko Mines Limited (USA) (NYSEMKT:TGB) notched a narrow loss of about $20 million on revenues of just under $230 million. Meanwhile, Taseko Mines Limited (USA) (NYSEMKT:TGB) reported a cash hoard of about $87 million and total balance sheet liabilities of around $268 million. New Gold Inc. (USA) (NYSEMKT:NGD) had debts of just over $850 million and cash equivalents of $672 million, and Rainy River Resources Limited (NASDAQOTH:RRFFF)reported a debt load of just $7 million against a cash hoard of nearly $100 million.
How the Deal Is Structured
Under the terms of this deal, New Gold Inc. (USA) (NYSEMKT:NGD) will issue payments of cash and stock to current Rainy River Resources Limited (NASDAQOTH:RRFFF) shareholders. Although the exact ratio will depend on Rainy River’s stock price in the days leading up to the deal’s completion, the transaction is defined by a cash cap of C$198 million and a share cap of just under 26 million New Gold shares. As it currently stands, each of these shares is equivalent to two Rainy River shares. Relative to Rainy River’s current share price of C$3.68, New Gold’s cash offer of C$3.83 per share represents a premium of about 4 percent. In light of the deal’s inherent risk, most market-watchers view this as an acceptable but not stellar arbitrage premium.
Complications and Legal Issues
At this point, there are no significant legal issues that could delay or derail this deal. However, there are plenty of logistical hurdles and risks. Although the Rainy River Gold Project is nearing the end of its exploratory phase and contains ample proven reserves of gold and silver, it has not yet produced significant revenues for the company. As a result, this deal carries more risk than a production-stage asset sale.
According to Rainy River’s most recent annual report, certain environmental hurdles continue to impede the final stages of development at the Rainy River site. Since this property lies in an environmentally sensitive wetland region within the Hudson Bay watershed, it has the potential to cause significant water pollution. Although it seems likely that these worries will not derail this project, investors should consider the possibility of additional delays. Although the project is wholly located in Canada, its proximity to U.S. waters raises the possibility of the involvement of U.S. environmental regulators as well.
Potential Synergies
New Gold brings a tremendous amount of operational experience to the table, and its consistent profitability suggests that it has the wherewithal to develop complex gold projects. Although this project is still shrouded in uncertainty, it appears likely that it will ultimately reach the production phase and begin producing gold on a sustained basis. With about 4 million ounces of proven gold reserves and over 10 million ounces of proven silver reserves, the Rainy River site could throw off income for many years to come. In addition, New Gold’s ample cash flow will permit it to absorb whatever short-term losses might accompany this deal.
Will It Work Out for Investors?
Conservative investors who seek predictable yields from the mining companies in which they invest may wish to steer clear of this deal. In the unlikely event that the Rainy River Gold Project falls through, New Gold’s balance sheet will take a major hit. At the same time, this merger’s potential potential to create value-enhancing synergies is undeniable. With the added incentive of a small arbitrage premium, investors who do not mind shouldering some risk should take a close look at this situation.
In sum, New Gold’s acquisition of Rainy River Resources has tremendous upside potential and significant downside risks. On balance, experienced traders and investors should deem the risks associated with this deal to be acceptable. Although it might take several years for the Rainy River Gold Project to get up and running, it could turn out to be quite lucrative.
The article Premiums and Potential Profit From This Gold Acquisition originally appeared on Fool.com.
Mike Thiessen has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Mike is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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