What is it about gold that makes people crazy? Throughout history, gold fever has been the driving force behind questionable decisions. We’re not just talking about the 49ers of California Gold Rush fame, but last week’s failed merger deal between Newmont Mining (NEM) and Barrick Gold (ABX), whose squabbles over leadership structure appeared to have skunked a deal that would have driven shareholder value for both sides.
As gold mining stocks begin a rebound from last year’s drubbing, the merger of the two mining giants reportedly could have delivered cost savings of $1 billion. Of particular note: Combining the companies’ Nevada operations alone could deliver a mining powerhouse in that state.
Instead, the deal broke down — for the third time in seven years — in large part due to a spat between Barrick Gold Co-Chairman John Thornton and the Newmont Mining board, led by Chairman Vincent Calarco.
The tipping point appears to have been last week’s remarks by retiring Barrick Gold Chairman Peter Munk that characterized Newmont Mining as “not shareholder friendly” in a newspaper interview.
Predictably, Newmont Mining was not pleased. Calarco had this to say in a letter directed to the Barrick Gold board — and Co-Chairman John Thornton in particular:
“While our team has found your management team’s engagement to be constructive and professional, the same constructive nature cannot be said of our discussions with your Co-Chairman on certain fundamental strategic and structural issues over the past two weeks.
“Our efforts to find consensus have been rejected out of hand repeatedly. And, as we contemplated further dialogue, we read in the continuing reporting of the transaction in the financial press a pointed characterization of our company as ‘extremely bureaucratic and not shareholder-friendly’ … It is, in fact, because of our deep commitment to our shareholders that we reluctantly have had to unanimously conclude that we need to put aside our attempts to resuscitate this initiative and should pursue our course as an independent company.”
ABX was quick to respond, alleging that, since the two companies agreed on a 14-member post-merger board, “Newmont has sought to renege on three foundational elements of the signed term sheet.” (The agreement was for seven Barrick, five Newmont and two new board members; current Newmont Mining CEO Gary Goldberg would be CEO, while Barrick’s Thornton would have become chairman of the combined entity.)
According to Barrick Gold, those elements were “the location of the head office of the merged company in Toronto; the identification of any specific assets that would be included in a spin-off company; and the carefully constructed governance arrangements, particularly with respect to the roles and authority of the Chairman, the Lead Director and the CEO”.
Once the mud-slinging starts, it becomes very difficult to find common ground, so don’t plan on seeing these companies revive their merger plans any time soon — despite the clear benefits to shareholders of both companies. A hostile takeover attempt of Newmont by Barrick Gold also is unlikely, because Barrick is unlikely to pay a huge premium.
So what are investors who were looking to the ABX-NEM merger as an opportunity? Here are three ways to play gold mining growth after the breakup:
#1 — Buy Barrick Gold for the Sector’s Rebound
With a market cap of $20.6 billion, Barrick Gold is the world’s largest gold producer, with mining operations on four continents. Barrick Gold is in line to benefit from this year’s rebound in mining, which is on the comeback trail after an ugly 2013.
ABX stock recently was upgraded to “Buy” by Goldman Sachs Analyst Andrew Quail, who hailed the company’s refocus on its free-cash flow generating operations as well as recent moves to divest non-strategic assets. “Following [ABX’s] equity raise in 2013, we believe the company’s financial flexibility has improved,” Quail said. ABX appears decently valued with a forward P/E of 14.5 — better than NEM’s 17.4. And ABX’s 1.1% current dividend yield is nothing to write home about, but it appears stable.
#2 – Buy Market Vectors Gold Miners ETF (GDX) for Diversification
If you’re looking for exposure to gold miners with less drama, an exchange-traded fund with holdings in several companies might be a solid bet. The Market Vectors Gold Miners ETF (GDX), which has been around since 2006, boasts $7.6 billion in total assets and a net expense ratio of 0.52%, or $52 for ever $10,000 invested.
The fund lost 37% in 2013, when the mining sector took a hit across the board, but the turnaround has delivered gains of 15% so far this year. The fund’s top two holdings are ABX and Goldcorp (GG) with about 14% each; its NEM holdings comprise about 8% of its holdings. The ETF also invests in Silver Wheaton (SLW), the largest silver streaming pure-play.
#3 — Check Out Put Options on Newmont Mining
If you have more of an appetite for risk and want a way to play the near-term challenges Newmont Mining faces, put options might be an interesting trading idea.
At the beginning of this year, the government of Indonesia banned exports of unprocessed mineral ores, and Newmont Mining is running out of space to store copper concentrates and may have to cut production in Indonesia by mid-May. Those headwinds could weigh on NEM stock, which is trading around $25 now.
If you’re bearish on NEM stock in the near term and believe the stock will retreat under these pressures, the $24.00 NEM put with a June 21 expiration is worth considering. The option price is around 75 cents now, and the open interest is 10,800, which suggests that theoretically, it will be easier to for the put buyer to trade the option at a better spread between the bid and ask prices.
As of this writing, Susan J. Aluise did not hold a position in any of the aforementioned securities.