Goldcorp Bid Doesn't Impress

01/14/2014 10:30 am EST

Focus: COMMODITIES

Jim Jubak

Founder and Editor, JubakPicks.com

The market was not impressed by the recent bid from this leading gold mining company, and that may have more to do with ore grades than absolute price, writes MoneyShow's Jim Jubak, also of Jubak's Picks, who thinks companies with higher grades may reap even more rewards.

Goldcorp (GG), the world's second largest miner of gold, has made a $2.38 billion offer to buy Canada's Osisko Mining ((TSX:OSK) or (OSKFF) in New York). According to Goldcorp, the acquisition would add about ten million ounces to the company's reserves and would increase Goldcorp's annual production by about 500,000 ounces, or 18%. After the deal, about 44% of Goldcorp's production would come from geopolitically-stable Canada, versus 34% now.

The market isn't especially impressed. Goldcorp's shares closed down 0.39% yesterday, and the take seems to be that, given the depressed price of gold and gold mining stocks, Goldcorp should have offered less for Osisko. Even before the bid, shares of Osisko were up 30.3% from December 3 to January 10. The offer from Goldcorp tacks on another 15% premium. (Goldcorp is a member of my Jubak's Picks portfolio.)

I suspect that the issue isn't so much absolute price, but a sense that Goldcorp should have found a better asset to buy. In February 2011, Goldcorp actually sold a 10.1% stake in Osisko for $533 million. That valued the whole company at $5.28 billion. Looking at the $2.38 billion just offered by Goldcorp, you get a very clear sense of how badly this sector has been hit by the fall in gold prices.

The reason that Wall Street may not be very impressed may have more to do with ore grades than with absolute deal prices. Back on January 3, I wrote that gold mining companies were facing reserve write-downs in January, as a result of the falling price of gold. Gold Mining Companies May Tap Reserves. Some deposits that were worth mining at $1,400 an ounce were not worth mining at $1,200, and companies would have to remove some of those deposits from their inventory of actual reserves. In that environment, the most valuable reserves to own—or to acquire—were those with the highest ore grades, since those would be worth mining at $1,400, or $1,200, or even $1,000 an ounce.

And mines with those higher grades would be the most attractive acquisitions as well. That's why names such as Canada's Pretium Resources (PVG) and Torex Gold Resources ((TSX:TXG) or (OP:TORXF) in New York), which are seen as having high-grade ore bodies, have been showing up on analysts' lists of likely acquisitions.

Osisko doesn't make the top of that list, mostly, I think, because it's not clear how the lower price of gold will change the company's reserve figures. At the end of 2012, Osisko lowered its yearend figures for proven and probable reserves to 10.1 million ounces, from the 10.7 million ounces shown at the end of 2011. In the most recent quarter, cash costs at the company's lead Malartic mine came in slightly above analyst projections.

In a less fraught environment for gold and gold mining stocks, I doubt that these worries would matter much, given that Goldcorp has bid roughly half as much for Osisko as the February 2011 valuation. But, in the current market, everything raises a flag. (I cut my target price on Goldcorp yesterday to reflect that very negative environment—and the extreme difficulty in calling any bottom for gold or gold mining stocks—to $32 a share by January 2015 from my current $48 target.)

And frankly, investors looking to buy a gold mining stock—and there must be a few of these souls, right?—are clearly more focused on potential acquisition candidates than on acquiring companies. Pretium Resources climbed 4.8% yesterday and Torex Gold finished the day up almost 13%.

Full disclosure: I don't own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund, I liquidated all my individual stock holdings and put the money into the fund. The fund may or may not now own positions in any stock mentioned in this post. The fund did not own shares of any company mentioned in this post as of the end of December. For a full list of the stocks in the fund as of the end of June see the fund's portfolio here.

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