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Peter Grosskopf, CEO of Sprott, joins Catherine Murray, Host of BNN Bloomberg's The Close for a look at M&A activity within the Canadian gold sector. Grosskopf says that while big-name gold miners like Barrick and Newmont have gone through notable acquisitions this year, we are likely to see a significant number of junior miner acquisitions in 2020.
Murray: 2019 saw major merger and acquisition activity in the gold sector for some of the big names like Barrick and Newmont. One investor is putting his attention toward smaller-cap companies. Sprott's CEO Peter Grosskopf joins us.
Peter, let me have your take, big picture, in terms of what you saw for merger and acquisition activity in the gold sector in 2019. It feels as if things are just being moved around.
Grosskopf: The year started with a bang with those large-cap deals, and now at the end of the year, we’ve had some of the intermediate gold mining companies getting acquired. I do think that activity is steadily increasing.
Murray: What is the driver here?
Grosskopf: There is a considerable gap in the health of and the cost of capital for big companies compared to smaller companies. The smaller gold mining companies are still suffering, and no one wants to cover a single mine company. As a result, the smaller miners’ cost of capital is about three times the cost of capital for the major miners. This creates opportunity.
Murray: Can you give us a little granularity in terms of what this means for the smaller gold mining companies?
Grosskopf: For smaller companies running a single project that is still under development, they need to raise and spend money, and investors don’t like that. There is not enough coverage for these smaller names. They are not in an index, and their cost of capital is about 15%. This is a tough hurdle to overcome.
Murray: This is playing into the M&A activity?
Grosskopf: Yes, these smaller gold mining companies are just very inexpensive.
Murray: What are the larger-cap miners looking for in these deals?
Grosskopf: They are looking for high-quality assets that have been in development for a long time, and are close to being production ready. The larger miners are looking to buy these assets at the right prices so that they are accretive. But most importantly, these assets need to have a long life because the majors are hurting for reserve growth.
Murray: The majors are hurting for reserve growth, but we have seen them change their corporate structures over the past decade. After having spent too much money on acquisitions in the past, give us their mindset today on how will they do it better this time?
Grosskopf: There was a period of pain, no question. Many of the CEO suites have changed within gold mining companies. At first, these new CEOs talked about spending less money, instituting more capital discipline and said that they were not going to engage in mergers. But eventually, every pendulum swings and those big companies are in great shape right now. They are experiencing healthy margins, strong cash flows and their stock prices are up. They now have the currency and rather than buy growth for growth’s sake, they are looking to purchase world-class assets that are hard to discover.
Murray: You have talked about the lack of research on the smaller mining companies. How are you and your Sprott team researching which companies have the best assets?
Grosskopf: It is not easy and it requires quite a bit of homework. We have an investment team of more than 40 professionals, from geologists to technical analysts, and they sort through individual mine plans and then create their own models. They perform detailed due diligence to figure out which assets are attractive, which ones should be cut and which ones should be bought.
Murray: Where are we in terms of further M&A activity? Are we still in the beginning stages for the smaller-cap companies?
Grosskopf: I would be surprised if we surpass the dollar totals of the mega-cap deals earlier in 2019, but I think that the number of deals is going to keep increasing. I would look for a trickle-down effect. The majors are still selling non-core assets but they may also buy occasionally. The juniors are going to get purchased and merge as well.
Murray: Where do you see some of the more significant opportunities geographically?
Grosskopf: We see them all around the world, but safer jurisdictions are definitely preferred. There has been trouble in Africa, and right now safer assets attract better multiples.
Murray: What kind of prices are companies willing to offer?
Grosskopf: Against market, the average premium has been in the 30% range, but this year a no-premium merger has been favored.
Murray: How do you have a no-premium merger?
Grosskopf: Some of the big players said that their mergers were strategic deals and that neither shareholder base deserved a premium right now but will benefit from a premium over time through cost savings. For junior companies, a 30% to 40% premium has been the average.
Murray: Is that where Sprott is spending the most time?
Grosskopf: We always spend the bulk of our time in the junior sector. It is tough to add value to the big-cap mining companies. The Sprott team is the most successful in making quality picks in the $2 to $200 billion range of market capitalization.
Murray: Can you give a sense of what the mid-cap, listed landscape looks like here in Canada?
Grosskopf: The universe is still quite vast. There were hundreds of companies that started in the 2000s bull market. The field has narrowed a bit, but there are still dozens of high-quality candidates ripe for acquisition. I would say possibly 30 companies in Canada, 20 in Australia and another 20 globally.
Murray: In terms of potential buyers, are we talking about the large-cap, senior mining companies, or is private equity involved?
Grosskopf: Yes, private equity has been active, and mostly via takeunders through private placements. I would say the larger companies Kirkland Lake Gold would get into the action. Chinese companies will get into the action, like China’s Zijin Mining offer to buy Canadian miner Continental Gold. There will likely be in-market mergers among the juniors themselves, just so that they can grow and add some muscle to their project development.
Murray: Do you think that investors have been missing this opportunity?
Grosskopf: Definitely. Retail flows to the sector have been anemic, and have just started to turn positive.
Murray: Where are the hedge funds in this activity?
Grosskopf: They are opportunistic. I have not seen much hedge fund traffic given that the gold mining sector is too illiquid and it has commodity risk. Hedge funds like to arbitrage rather than taking on that risk.
Murray: Where do you see the price of gold?
Grosskopf: We see it higher. Gold is hanging in there. We think that the recent U.S.-China trade announcement may be a bit of a red herring. The real issue is the level of debt in the global economy at the government level. Governments have to keep interest rates low, and rates need to stay low to help spur inflation, and that is a good environment for gold. I think gold is being held right now as an insurance asset, and it's being accumulated slowly and steadily by a broad audience. I think the outlook is excellent for 2020, and that gold is going to be an asset that outperforms again.
Murray: Looking out over the next five years, investors are not focused on government debt levels. How long will it take for this to play out?
Grosskopf: I don’t think it is going to take five years. Look at what the Federal Reserve does, rather than what it says. They are priming the markets; printing money through a program that helps to supplement overnight repos (repurchase agreements). All of the central banks globally are printing money because they have to. It’s not just good rhetoric; they need to keep rates low because deficits are high and the global debt-to-GDP (gross domestic product) ratio is at record levels. Gold acts as an insurance policy; it's the real money.
Murray: Thank you, Peter.
Grosskopf: My pleasure.
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