China National Gold Group Corp. has ended talks with
Barrick Gold Corporation
(
ABX
) to buy a 74% stake in its African unit. This caused the shares of
African Barrick Gold, which trades in London, to fall by as much as
20%. The breakdown in talks comes as a setback to Barrick Gold,
which is looking to get rid of its African unit on account of
falling profits and rising costs. The talks seem to have broken
down over the issue of valuation. Barrick Gold said that while it
is keen to shed some assets, it will do so only if the value
generated is acceptable.
Now that no sale seems to be on the horizon for some time,
Barrick Gold will try to focus on improving business operations at
the African mines. This is clear from the full operational review
ordered for the African mines to improve returns. Without achieving
this, we think that it will be difficult for the company to unlock
the full value of its African business. Any potential buyers would
ask for a discount due to the unfavorable economics of the business
and a hostile operating environment.
See Full Analysis for Barrick Gold Here
Why Does Barrick Gold Want To Sell The African
Business?
The primary reasons for wanting to sell are poor performance of
the African business as well as problems Barrick faces in other
regions of the world, which has caused capital to become
scarce.
Barrick's African mines have faced problems due to security
issues and power blackouts, leading to production shortfalls.
Security issues at the North Mara mine, which is the company's main
driver of production growth, have been a persistent headache and
constitute a major risk to operations. North Mara is located
in the north of Tanzania in its most problematic region, where
historically the government has been apathetic towards looking
after security and hasn't invested much in the development of the
region. This combined with poverty and unemployment is causing the
people in this region to give vent to deep-seated resentments. They
view mining companies as rapacious corporations out to steal their
wealth while giving nothing in return. There has been violence in
the past, leading to a few deaths. In short, the hostile operating
environment is a big business risk and measures undertaken to
mitigate it add to the cost of doing business.
There is also the problem of illegal mining in the region at
Barrick Gold's mines which is an added headache for the company as
it caused disruption of normal operations in various ways.
Due to operational setbacks, Barrick Gold cut its annual
production forecasts for African Barrick Gold in October. This was
the third consecutive year when it was forced to do so. Total cash
costs for 2012 here are expected to be about $900 to $950 per ounce
of gold produced, compared to the previous guidance range of $790
to $860 per ounce. These figures are much higher than Barrick
Gold's overall total cash cost of $592 per ounce incurred thus far
in 2012.
Due to the high cost of production, it turns out that African
Barrick Gold doesn't meet Barrick Gold's criteria as far as rates
of return are concerned. The company has adopted a policy of
giving priority to projects which provide decent rates of
return, rather than those which result in the largest production by
volume. This is due to scare availability of capital and burgeoning
capital expenditure at other projects like Pascua Lama in South
America. You can read about it
here
.
What Now?
Barrick cannot hope to unlock the full value of its African
assets until it improves operations and the operating environment.
We are aware that the company has already been attempting to do the
latter. It has been trying to reach out to people in partnership
with Search For Common Ground (SFCG), an international NGO.
We think that resolving problems with the local citizens is
necessary to turn around operations and bring down costs incurred
on security. However, we doubt that Barrick has much leverage with
the Tanzanian government whose cooperation is important to resolve
power supply issues. Intermittent supply of power reduces
productivity and hampers operations. The company hasn't provided
any details on how it intends to achieve operational efficiency. In
our opinion, the potential to reduce costs is limited in such a
scenario and will not be enough to persuade potential buyers to pay
a fair value for the high-quality assets of African Barrick
Gold.
We have a Trefis price estimate of $51 for Barrick
Gold. We will update our estimates after results for the
fourth quarter are declared.
Understand How
A Company's Products Impact Its Stock at Trefis