July 9, 2001 - Do you know which company's stock has been listed on the New York Stock Exchange longer than any other? You might guess US Steel or perhaps AT&T, both of which have been around for quite awhile, but neither of these two venerable companies' stock is the longest listed.
That honor goes to Homestake Mining, but its unique position of unmatched longevity is about to change. If Homestake shareholders vote to accept a bid by Barrick Gold, Homestake will disappear before the end of this year.
Homestake was one of my top mining stock picks in Letter No. 272-10 published on October 20th 2000. The sell-off in the mining stocks that was taking place when I wrote that letter concluded in November, which proved to be an important bottom as I thought it might. Gold mining stocks climbed over the subsequent six months. Homestake in particular was one of the leaders in that rally and did exceptionally well, rising from its $3.50 low last November to a recent price around $8. But there's an interesting story in this $8 price.
After the Barrick bid was announced, Homestake climbed from $6.65 to around $8 because the Barrick bid was made at a 31% premium to HM's close the previous day. Some market observers acted as if this $8 price had never been seen before, and that the price surge in HM after the Barrick bid was some great gift from the stock-market gods. The reality is that Homestake traded at $8 only the month before when the gold price was in the $280's. Therefore, the obvious conclusion is that Barrick is buying Homestake on the cheap - a good deal for Barrick and a lousy deal for Homestake shareholders. Here are my problems with this deal:
1) Combining Homestake with Barrick is like mixing oil with water. Barrick is set apart from most other mining companies by its huge hedge book. Though Homestake has increased its hedging recently and has more hedging than I would like, HM remains basically a leveraged play to any rise in the gold price, particularly because it is a higher cost producer than Barrick. As proof of this statement that HM is leveraged, look what happened to these two stocks from their low last Fall. Homestake rose from $3.50 to $8, or in other words, it more than doubled. Barrick by contrast rose from $12.25 in October to $19, a respectable 55% gain but far less than HM's performance. Once HM is gone, so too will be another leveraged play on the gold price.
2) There is no reason for Homestake to sell. Its balance sheet is not as strong as Barrick's, but it is better than that of many other majors, such as Newmont. And HM no doubt is having a hard time making money at these low gold prices, but that is in fact what provides its leverage to the gold price. Having established above that $8 per share is not such a big deal, one can be very sympathetic to the viewpoint expressed by John Brimelow of Donald & Co. after Barrick announced its bid: "It is a mystery to me why the HM shareholders would surrender their option premium for a gain which their company would achieve in a flash should gold hiccup.” I agree. There is no apparent reason to sell.
3) I have not yet seen the details, but a number of analysts have stated that HM's CEO and a couple of other members of its top management are being given a very rich 'golden parachute'. Too bad there are no golden parachutes being offered for HM's shareholders. Nor is there any golden parachute being offered for all the HM employees who will be let go as Barrick integrates HM's operations into its own in order to achieve some cost savings. If it emerges that the HM executives are receiving excessive golden parachutes, that event would in my mind be sufficient reason to scuttle this deal. Nobody likes bribery, and if management cannot provide any good reason for selling out, an excessive golden parachute will look to many like nothing else but bribery. And so far I have seen no good reason from HM management to justify this deal.
4) HM and others have stated that this deal is being done because it provides both companies with the opportunity to merge ABX's Pascua with HM's Veladero. That may be true, but both of these projects need a $300 gold price to be economic. Combining them will not make them economic at $270. Veladero is an attractive leveraged play to a higher gold price, and one of the important reasons for owning HM stock. Those potential future benefits from Veladero, which could provide substantial future production for HM in the right gold price environment, are now lost to HM shareholders. One has to ask that if putting Veladero into Pascua is so important to Barrick, why didn't Barrick outbid Homestake to buy Argentina Gold, the company that discovered Veladero? Further, why couldn't the two companies operate the project jointly, just like mining companies often do on large projects? HM argues that they couldn't finance Veladero alone, but one has to question that statement. If gold were above $325, it is likely that a number of different alternatives would be available to HM that are not now available, including selling its stake in Veladero to Barrick or another major producer if Homestake really thought the project too big for it to handle.
5) There are no important synergies to be derived from combining these two companies. I noted above that combining Veladero/Pascua is not reason in itself to justify this merger. There are some tax benefits and operating efficiencies that will result by eliminating many Homestake employees, but these are not sufficient reason to justify the deal when taking the viewpoint of a Homestake shareholder. These efficiencies only benefit existing Barrick shareholders at the expense of existing Homestake shareholders because Homestake is being bought on the cheap when considering the future potential for both of these companies to generate cash-flow in a higher price gold environment. Also, Barrick shareholders gain an important foothold in Australia, given Homestake's major position in that country. Once again, this geographical diversification is being gained by existing Barrick shareholders at the expense of existing Homestake shareholders.
6) It is more than clear that Barrick is benefiting at the expense of HM's shareholders. I can't believe that Homestake management does not recognize this obvious fact. I noted above the significant underperformance of ABX compared to HM in this last gold price rally, but ABX actually under performed against many of the mining stocks, most notably those with little or no hedges. This relatively poor performance of ABX's stock has no doubt caused some consternation with ABX management. It is only natural and logical that they had to be asking themselves that if the market rewards those stocks with relatively little hedging, how does Barrick reduce its hedge book? Barrick is a captive of its hedge book because the outstanding hedges are too massive to try buying them back in the market, so how does Barrick solve this problem? It buys HM instead. The net effect is that Barrick's hedge book drops from 27% to 22% of reserves, and annual production for the next two years is hedged only 66% after the merger from 100% at present. A hedge book of this size is still too large to be 'my cup of tea', but it is a lot less than it had been. It's a good move by Barrick management to make its stock more palatable to investors in an attempt to perhaps change its relative underperformance, but I can't believe that HM management doesn't see this obvious conclusion. HM management are good operators, but they clearly are not 'big picture' thinkers who understand gold, corporate finance or the best interest of their shareholders.
So what should Homestake shareholders do? I have not yet spoken with one HM shareholder who likes this deal. It is a deal that just doesn't make any sense from the perspective of a Homestake shareholder.
I find it hard to accept that HM management is so out of touch with its shareholders that it doesn't recognize the fact that from their shareholders' perspective this deal stinks. Yet that seems to be the only plausible conclusion in the absence of Homestake management providing any good reason to sell out. In short, I think this deal stinks even if HM management is not walking away with golden parachutes. Therefore, it should be voted down.
What are the chances of it being voted down? Probably low, but they are not out of the question altogether. It is possible that some organized shareholder opposition may develop in the weeks ahead. If so, it is easy to see how this deal could be stopped, particularly if HM management is slated to walk away with unwarranted golden parachutes.
For now, I recommend that HM shareholders hold their shares. I don't think that another bid is likely, but one could happen, which could cause another surge in HM. However, the expectation of another bid topping the one from Barrick is not my main objective in holding the shares for now. Rather, I want to see whether any organized shareholder revolt will develop with sufficient momentum, which could in the end scuttle this deal. In that case, I want to keep holding HM because of its leverage to the gold price.
Clearly, the arbitrageurs are now involved in this deal in a big way. They probably bought much of the huge volume in HM the first day of trading after the deal was announced. So the arbs represent a formidable force that will no doubt be pushing for this deal to be done. But arbs have been whacked before (the unraveling of the GE/HON deal is good example).
In conclusion, this is a great deal for ABX shareholders, but a bad deal for HM shareholders. It is further proof that ABX has world-class management to go with their world-class mines. It's a shame that HM management does not stand as tall. They are good operators, good mining engineers, but lousy businessmen who apparently care little about their shareholders.
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