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Why Did China Gold Walk Away From The African Barrick Gold Deal?
1/11/2013 9:00:00 AM
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.
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 .
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.