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A Quest for Scale: Why Newmont Bought Goldcorp

Evan D'Silva, The Motley Fool


On January 14, 2019, Newmont Goldcorp (NYSE: NEM) formed via a stock-for-stock transaction that joined together major gold miners Newmont and Goldcorp. Newmont paid a 17% premium above Goldcorp's trading price at the time of the merger.  In 2018, the pre-merger Newmont produced 5.1 million ounces of gold with a cost of $909 per ounce.  Goldcorp produced 2.3 million ounces of gold in 2018  with the costs at around $800 an ounce and expects to maintain these levels of production and costs in 2019. In addition to great production volume, Newmont Goldcorp has a large portfolio of reserves and resources for future development, making it less likely that its production will taper off as its current mines are exhausted. The combined production of these two companies exceeded the 2018 production of Barrick , which was the largest gold producer of 2018 though the average costs were higher. However, many investors objected to the premium that Newmont paid for Goldcorp and it takes lots of time and money to turn reserves and resources into mines. The acquisition sets Newmont Goldcorp up to be the largest gold producer in the world and also allows it to sustain its production into the future as reserves and resources are turned into mines. 

Image of bars of gold

Image source: Getty Images.

Merger Controversy 

Investors did not react positively to news of the acquisition. Newmont shares fell when the merger was announced in January, and it suffered a 13.2% decline in April. In response, Newmont offered an $0.88 dividend to shareholders contingent upon the merger being approved to bolster support for the merger.

Hedge fund billionaire John Paulson was among the shareholders objecting to the deal, stating that the 17% premium Newmont was paying for Goldcorp was too high.   The stock-for-stock merger left former Goldcorp shareholders owning 35% of Newmont Goldcorp. Paulson expressed the concerns of many investors, observing that 35% of the cost savings of Newmont's partnership with Barrick would accrue to former Goldcorp shareholders. This, combined with the 17% premium made the price that Newmont paid for Goldcorp unattractive. However, Paulson would not have objected to the merger if the 17% premium had not been paid. 

Basically, John Paulson and many Newmont investors felt that Newmont's management was giving Goldcorp shareholders too sweet of a deal. Goldcorp did not contribute any of the properties that are part of a massive cost-saving joint venture between Newmont and Barrick. However, former Goldcorp shareholders will benefit from this joint venture through their shares in Newmont Goldcorp, thereby diluting the benefit of this joint venture for those who had originally held Newmont shares.

The assets 

While John Paulson's concerns are valid for those who held Newmont shares prior since before the merger, they shouldn't affect how new shareholders view the company. New investors are buying the entire portfolio of assets of the new combined Newmont Goldcorp, receiving shares in a company producing much more gold each year and possessing a much larger portfolio of active mines and properties that have potential for development. 


However, that portfolio could be a mixed blessing. The company now claims to have the largest collection of reserves and resources . These two terms refer to very specific types of properties. Reserves are economically, legally, and technically feasible to extract, while resources are potentially valuable and are reasonably likely to be extracted. This is a good thing because it indicates that Newmont Goldcorp has properties that can replace its current mines when they are exhausted .

However, developing these properties is both expensive and risky. If gold prices increase, these reserves and resources could greatly appreciate in value, even if Newmont Goldcorp does not develop them. Furthermore, successful development of these mines can help Newmont Goldcorp maintain or increase the amount of gold it produces each year, likely improving its profits whether or not gold prices increase.

An unsuccessful development project, however, can quickly turn into a cash drain. Newmont Goldcorp's peer Barrick spent $5 billion to develop a gold mine in South America and never got a single ounce of gold out of it. Nothing is foolproof in the mining industry. 

Is Newmont Goldcorp a buy?

Newmont Goldcorp shares are not "undervalued" or an obvious buy. Investors are right to be somewhat wary about the costs of developing reserves and resources into mines and if the 17% premium was worth paying or not. The merger was also approved despite stiff shareholder opposition, which raises questions about how responsive management is to shareholders. Investors may be concerned that Newmont is more focused on growing its size even at the expense of shareholder value. 

However, Newmont Goldcorp has scale in gold mining that few other companies can match. It has both the largest (projected) production and the largest collection of properties that can be developed into mines. Its costs are well below the current price of gold, so it can stay profitable even if the gold price decline . Should the price of gold rise, Newmont Goldcorp's profitability will also rise. Many investors like to have exposure to gold since it tends to do well when the rest of the market is doing badly. Newmont Goldcorp is a good way to get that

The 17% premium that Newmont paid for Goldcorp probably won't matter much if gold enters a bull market. Those who originally held Newmont shares now find themselves owning a much larger gold production business. This should allow them to experience larger gains than they would have previously. Goldcorp shareholders did get a very good deal but there should be plenty of gains for everyone if gold appreciates. That is probably why Newmont management was so eager to get the deal approved that they offered shareholders a special dividend contingent upon approval of the deal. However, there is plenty of opportunity for Newmont Goldcorp to get into trouble in development projects and there is no certainty that a strong gold bull market will materialize anytime soon. Shareholders should be vigilant for signs of trouble. However, given Newmont's size and profitability, development issues most likely won't be fatal to the company or its share price. 

The issues surrounding the merger are largely irrelevant to new investors and are not significant enough to make it necessary for shareholders in the pre-merger Newmont to sell their shares. Goldcorp did get a very good deal in this merger but Newmont's management clearly saw value in the increasing annual gold production and increasing its portfolio of properties for future development. Shareholders of both Newmont and Goldcorp can continue to hold shares of a profitable gold business that has the potential for tremendous appreciation in a gold bull market. New investors also get a robust business that is likely to stay profitable even if some issues do arise. 

Conclusion 

Newmont Goldcorp's status as the largest producer of gold and the owner of the largest portfolio of reserves and resources makes it a good bet for investors seeking exposure to gold. If gold enters a bull market, the value of its annual gold production and the value of its undeveloped reserve properties will rise driving the stock price up as well. However, Newmont Goldcorp is still not a sure thing for investors.

It's worth noting that development is a risky undertaking, no matter the company. Success can never be guaranteed. However, large miners such as Newmont Goldcorp are much more likely to survive setbacks in development than smaller mining companies. Investors seeking to own a profitable business and gain exposure to gold will do well to look at large gold producers like Newmont Goldcorp. 

Evan D'Silva has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.