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

Comments are welcomed!

Friday, March 13, 2009

Capital Gold and Gammon Gold Merger Analyzed

Yesterday, Capital Gold and Gammon Gold announced a merger. I am not familiar with Gammon Gold and spent the morning analyzing the deal based on publicly available sources and my cash flow multiple valuation model.

First, Gammon Gold views itself as the consolidator for gold producers in Mexico. This information is provided in their latest corporate presentation from the BMO conference on February 22-25, 2009.

Gammon makes clear in their latest presentation that their corporate strategy is to buy up or merge with junior gold producers with mines in Mexico. So for those who follow junior gold producers with mines in Mexico, this should not be a big surprise. What has been a surprise is the relatively low premium Capital Gold shareholders are receiving from Gammon Gold.

Based on a quick visual analysis, it seems that Capital Gold shareholders may not be getting fair value for their investment in this deal.

Take a look at the following chart from page 18 of Gammon Gold's BMO presentation.



You will note that Gammon Gold lays out a very useful visual map of the relationship between market capitalization and valuation among junior producers and developers, intermediate producers, and senior producers. The chart shows, as I have written in prior articles, that the higher the market cap for gold producers the higher the valuation of a company's share price. You can visually draw, in your mind's eye, a regression line sloping upward and to the right at roughly 45 degrees. That is strong evidence in favor of the junior/intermediate/senior valuation assertion.

For comparison's sake, take a look first at the relative valuation of junior producers New Gold and Western Goldfields who last week announced a similar merger deal. New Gold's price/NAV multiple ratio is at about 0.7x and Western Goldfields is at about a 0.6x ratio. These two companies are roughly valued equally and the premium paid to Western Goldfields shareholders (about 20%) is roughly equal to the disparity in valuation between New Gold and Western Goldfields at the time the deal was announced.

Now look at the relative valuation of Gammon Gold at about 1.4x price/NAV ratio and Capital Gold at about a 0.5x price/NAV ratio. The Capital Gold premium is roughly 30% based on today's share price. In fairness, if we go back to when this presentation was made the premium is about 40% for Capital Gold shareholders.

A 40% premium on a 0.5x price/NAV ratio puts the merger valuation for Capital Gold at about a 0.7x price/NAV ratio--well roughly half of Gammon's valuation of 1.4x price/NAV ratio.

Looking at this data another way is that the new 0.7x price/NAV ratio valuation puts Capital Gold in the middle of the junior gold producer universe equal to the "new" New Gold, providing Capital Gold with an average junior gold producer valuation in this merger deal rather than a lower than average valuation.

My sense is that Capital Gold shareholders deserve a higher premium than they are getting. Using my cash flow multiple model at 10x 2009 production and 10x cash flow, Capital Gold is worth about $1.50 per share and for 2010 about $2.00 a share. Using an "in situ" valuation method, Capital Gold is likely worth more than $2 a share.

I would note that the 2009 10x cash flow multiple valuation produces a valuation similar to the price/NAV ratio valution method above using Gammon Gold's own data.

Clearly, a more thorough analyis needs to be done before Capital Gold shareholders make a decision on what to do. I don't own shares in either Capital Gold or Gammon Gold and as a result, I don't feel strongly either way. This analysis may be a good place for Capital Gold shareholders to start as they decide how to vote on the proposed merger.

As a further note, Gammon Gold's Ocampo mine operation is geographically close to two nearby mines Mulatos, owned by Alamos Gold Inc., and Delores mine owned by Minefinders. It stands to reason that Gammon Gold, with a strategy of consolidating junior gold producers in Mexico, is assessing these two companies as potential merger candidates as well.

Good luck!

Best,
Gold Stock Strategist

-----------------------------
Full disclosure: I do not own shares in Capital Gold Corp. or Gammon Gold. The information provided in this post is believed to be correct, but not guaranteed. Investing in junior gold miners entails risks. Readers are responsible for their own investment decisions

Wednesday, March 4, 2009

New Gold & Western Goldfields Merger Analyzed

For those of us who follow junior gold producers, the merger between New Gold & Western Goldfields is no surprise.

These companies are two of the larger junior producers with New Gold projected to produce about 200,000 ounces of gold and Western Goldfields projected to produce about 140,000 in 2009. This deal moves the "new" New Gold into the intermediate producer range. I plan to continue following New Gold because it is very familiar to me and remains an interesting company with a vision to become a 1 million ounce producer by 2012.

A quick look at this merger suggests this is a marginally better deal for Western Goldfields investors for two reasons.

First, on a one for one share exchange Western Goldfields (closed at US$1.48 yesterday) receives a market-based premium (about 21%) in share price because New Gold closed at US$1.79 yesterday. That said, New Gold shares may trade down today on this news, reducing the Western Goldfields premium in the short-run.

Second, Western Goldfields projected cash cost per ounce is higher in 2009 (US$540) than New Gold at about US$475. The higher cost profile will weaken free cash flow on average for New Gold shareholders.

The good news for New Gold shareholders is that the company is moving forward on New Gold President and CEO Robert Gallagher’s vision of becoming a million ounce gold producer by 2012. This is an ambitious and worthy goal that is good for the industry and good for New Gold shareholders.

The reason junior gold producing companies are merging is because the larger the company, the better the valuation in the market. The cash flow multiple model I published on February 28 shows this. New Gold and Western Goldfields have a 1.8 and 1.5 valuation compared to smaller producers that end up at the top of the ranking with higher cash flow multiple estimates in 2009. Jaguar Mining is another example with a 1.5 cash flow multiple.

As a result, I don't expect this merger to give the "new" New Gold any short-run boost in price given both companies are already valued as intermediate gold producers. In fact, with the price of gold consolidating around US$915-US$920, this deal may see some short term share price compression.

However, if the new company can reduce General & Administrative or other expenses through this merger, there should be a long-run boost to share price from the deal independent of the price of gold.

Congratulations to New Gold and Western Goldfields shareholders.

Best,
Gold Stock Strategist

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