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Feb 2002 - Anglogold Newmont

What does “fair and reasonable” actually mean ?

The latest corporate battle between Anglogold and Newmont each making “fair and reasonable” yet increasingly higher offers for Normandy has called into question the whole comment called a “fair and reasonable offer being made to shareholders and consequently that is why they should accept now! “. Only one year ago (17 Jan 2000), no one was interested in Normandy at 93c, it was even still languishing at 106c in September 2001, and yet it has been in a corporate bidding battle that has resulted in NDY attaining a share price of 199c (16 Jan 2002).

Somehow, Anglogold justified paying A$0.30 more than their original 2.15 AGG –per- 100 NDY “fair and reasonable offer”, while Newmont managed to justify paying an additional A$0.50 more than their original 3.85 NEM –per- 100 NDY “fair and reasonable” share offer. Consequently “fair and reasonable” seems to have become “fair and reasonable, depending on what other offers are already on the table”.

The justification for what is offered comes down to what is included in the valuation of the target company and what is left out, with clearly some very woolly parameters involved. In Normandy’s case whole mines can either be omitted or included such as Boddington’s Wandoo expansion.

Starting with the Gold Fields move on WMC’s gold assets and following up with NDY and more recently Harmony’s planned takeover of Hill 50 (HFY), suddenly the Australian gold companies have become a bargain hunter’s paradise.

The initial impression in the market was that Gold Fields were overpaying for the WMC assets until the market realized that perhaps they were not, and why they were not overpaying suddenly sparked a gold company asset scramble. At the heart of the issue as to why Australian gold shares are so undervalued is what is included in their valuations.

The normal practice when valuing a gold company is to base the mine’s life on its gold reserves. The definitions of gold reserves have undergone some dramatic changes world-wide in the past decade, such that most countries conform to the Australian definitions (in that a competent person must sign off on them), however, the drill-hole spacing requirements can be dramatically different.

About 10 years ago, most South African gold companies only had an ore reserve life of 2 years, because the underground mines had to expose an ore block on 4 sides in order to include it in its reserves. That situation was regarded as a farce leading to distorted company valuations (which were based really on estimated resources) compared to their reserves, especially when most mine’s had 5, 10 and in some cases 20-year or so life of mine plans. So the South African definitions changed.

It has been commented that the South African orebodies are so uniform and consequently it can be justified to have 0.5km or 1km drillhole spacings and use those to determine ore reserves. However, we know of quite a few instances in which shafts were sunk down the often singular drillhole only to close that area of the mine soon after, because it was not what was expected, usually due to faulting.

In Australia, the drill-hole spacing governed what was included in reserves, which was acceptable since the majority of the gold mining was by open-cuts. That 40m x 40m drill-hole spacing for reserves continued underground where it has really become completely impractical from an ore reserve valuation viewpoint, and has resulted in ore reserves being greatly understated.

Hill 50 for example has drilled deep holes showing the probable downward continuity of its orebodies, but cannot put them into reserves, so there becomes little point in undertaking deep drilling in Australia, which has resulted in huge upside potential from an overseas perspective. NFM’s deeper mineralisation at Callie is spectacular but cannot be fully included as ore reserves in a valuation, nor can that at Anglogold’s Sunrise, nor the expected jump in grade at the Hill 50 mine at Mt Magnet when it starts stoping below 15 Level in about one years’ time.

Australian gold company reserves consequently often only include ore to a short depth below or around their current workings, and yet the overseas gold companies have shown that gold can be mined at depths far greater than 1km. From a South African perspective, a typical 2mtpa mine could cost at least A$0.5bn and take 6 to 12 years to bring into production, compared to Australia’s often 1 - 2 years (or in some cases even less).

A change to the drillhole spacing for underground ore reserves does appear unlikely, which should keep the Australian golds undervalued, and understate the “fair and reasonable” offers that can be made.

Being attractively undervalued with material upside potential, it is perhaps a surprise that it has taken so long for the international gold companies to realize it of the Australian gold companies. Further consolidation and takeover activity does appear likely to occur.

This article has been written by Keith Goode, the Managing Director of Eagle Research Advisory Pty Ltd, who has a Proper Authority with State One Stockbroking. This e-mail address is being protected from spambots. You need JavaScript enabled to view it The opinions expressed in this article should not be taken as investment advice, but are based on observations by the author. The author does not warrant the accuracy or completeness of any information and is not liable for any loss or damage suffered through any reliance on its contents

  • Written by: Keith Goode
  • Friday, 01 February 2002