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The Gold Stock Strategist analyzes leading junior gold producers and major gold mining companies.

Comments are welcomed!

Tuesday, April 29, 2008

Will AngloGold Exercise it's Option on Capital Gold?

Capital Gold purchased a 100% interest in 3,544 hectares of property located n Northern Mexico. Capital Gold bought the interest from a subsidiary of AngloGold Ashanti (NYSE-AU) for US$55,000 cash in 2001.

The terms of the deal included a 10% net profits interest with a $1 million cap, a 4% net smelter return royalty with a $17 million cap, and a one-time option to gain a 51% share of the property equal to payment of two-times Capital Gold’s total investment in the project. The option is estimated to cost AngloGold Ashanti $180 million if exercised.

Based on a recent buyout deal by a major where reserves were acquired at about $280 an ounce with the price of gold at $950 an ounce. With gold at $850 an ounce, the buyout valuation metric would potentially be about $250 an ounce assuming spot gold is a reasonable assumption. The AngloGold Ashanti option would be worth the equivalent of $200 an ounce if they acquired 51% of Capital Gold.

Either way, this seems like a good deal for AngloGold Ashanti buying reserves at a 20% to 30% discount to recent buyouts by majors. Capital Gold's low cost of production profile, logistical advantages in Northern Mexico, and friendly mining jurisdiction in Mexico means AngloGold would also find the deal rather sweet.

AngloGold has experienced overall declines in production over the last couple of years and has initiated a program to turn that around. Their largest production share is from South Africa which has had extensive problems providing electricity to industry. AngloGold could use a well-run operation to help boost production at the margin.

It seems like a sweet deal except for two operational considerations and a more fundamental consideration.

First, AngloGold has no operations in Mexico and is not intimately familiar with Mexican rules and culture.

Second, AngloGold has their hands full reforming the operations of their globally diverse holdings so that overall production begins to move up rather than down.

In the end, I think AngloGold’s decision hinges on their projections of the price of gold going forward. If they think gold rises above $1,000 again and beyond, they will buy back in with the 51% ownership option.

My sense is that AngloGold is bullish on the price of gold and therefore is likely to exercise the option. I'm reminded of Don Coxe's rule for investing in mining projects, "unhedged reserves in politically secure areas."

If AngloGold exercises the option, Capital Gold gets a nice chunk of change equal to about $0.95 per share. As a result, $0.95 per share should be the floor for Capital Gold given their successful record of executing their plan over the past 7 years.

But, then again, I could be wrong. Do your own due diligence.

Best,

Gold Stock Strategist

1 comment:

Gibralter said...

In a presentation last week Capital Gold's Jeff Pritchard estimated that the company's total investment in the El Chanante project since 2001 to be between $40 and $50 million. Thus, your comment that it will "cost AngloGold Ashanti $180 million" to exercise its 51% option is way off -- $90 million is closer to reality.

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