A golden takeover target?

Gold M&A activity should increase with the price of the yellow metal.

by James Kwantes

The first company that I featured on this blog wasSandstorm Gold, a money-maker with strong and growing cash flow that recently co-listed on the New York Stock Exchange.

Many Venture firms fall into quite a different category: exploration properties of varying worth, their payrolls a mix of geologists and promoters, their stories a blend of hype and hope. The bottom line for investors who don’t do their homework: there will be pain.

The subject of this blog is in a different category again. Yes, it’s listed on the TSX Venture Exchange. No, it has not yet produced an NI 43-101-compliant mineral resource, let alone have the term “gold” in its name.

Yet this company owns an attractive gold deposit in a growing gold belt near a producing mine, in a country with an attractive risk/reward profile. And with the U.S. Federal Reserve’s “QEternity” putting a floor on the price of gold, I believe this company is well-positioned to become a takeover target at a premium to the current share price.

The company is Newstrike Capital (NES).

Newstrike’s 100%-owned Ana Paula property is located in Mexico’s prolific Guerrero Gold Belt, which hosts 16 million ounces of gold in all categories. Down the road is Goldcorp’s Los Filos, which at 345,000 ounces annually is Mexico’s largest gold mine (until Penasquito comes fully on line). Torex Gold’s nearby Morelos deposit hosts an NI 43-101 resource estimate of about 5 million ounces in the measured and indicated categories. Key members of Newstrike’s team helped discover both deposits.

Newstrike’s latest Ana Paula drill results were in the “sit-up-and-take-notice” category. Among the highlights was drill hole AP-12-111, which intersected – from surface – 174 metres of 5 grams per tonne gold and almost 12 grams per tonne silver. That hit included a 76-metre interval of more than 10 g/t gold and 15 g/t silver.

The two most important words in that last paragraph were “from surface.” More on that later.

AP-12-111 was not an outlier – Newstrike has been drilling impressive intercepts since purchasing the property from Goldcorp in June 2010. AP-19 hit 214 metres of 3 g/t gold, AP-37 intersected 317 metres at 5.8 g/t and AP-101 hit 103 metres at 5 g/t gold. AP-97 included an intersect of 12 metres of 32 g/t gold.

Before the end of the year, Newstrike is projected to release a maiden NI 43-101 resource estimate of more than 3 million ounces of gold, with plenty of upside. The gold is contained in two different zones: a high-grade breccia and a lower-grade bulk tonnage gold corridor. The holes mentioned above were drilled from the breccia.

I recently interviewed Newstrike CEO Richard Whittall and he said the Newstrike team is developing Ana Paula as a “turn-key” project that a major could step into and quickly ramp up. Power, water, paved roads, good relations with the locals – each of those important ingredients is present.

The high-grade breccia would likely be mined first for quicker payback, Whittall said, followed by the lower-grade material for the life of mine.

Newstrike holds a vast land package – 88,000 hectares in Guerrero and 26,000 hectares in Oaxaca – but drilling is focused on Ana Paula, with four drill rigs operational and a 45,000-metre drill program for this year. Future spinoffs are possible with such a large land package, and with silver selling for $35 an ounce, Newstrike’s substantial silver credits are a nice bonus for project economics.

Establishing the value of a gold exploration company is tricky – each project has unique gold grades and geology, each company has its own share structure and management. Overlaid on these factors are country and geopolitical risks.

But investors researching Newstrike have the measuring stick of Torex’s Morelos project next door. Morelos is bigger at almost 5 million ounces and Torex (TXG) is at a more advanced stage, with a bankable feasibility study completed in August. But the feasibility study pegged capex at $675 million and payback would take three years. Combined with Torex’s $800-million-plus market cap*, Morelos would be a big meal for any of the big gold producers to digest. The Morelos deposits are located on the side of a mountain, so we’re not talking about a stripped-down strip ratio either.

Newstrike’s deposit is closer to surface – a critical feature that translates into lower capex, a lower strip ratio and quicker payback. That’s no small advantage – just ask Aaron Regent of Barrick or Tye Burt of Kinross, both of whom lost their jobs in no small part to project cost inflation that cut into profitability.

Here’s the Newstrike vs. Torex comparison:

NEWSTRIKE MC: $271M minus $34M cash = $237 million for 3+ million ounces
TOREX MC: $896M minus $69M cash = $827 million for 4.8 million ounces

For the sake of argument, let’s say NES comes out with just 3 million ounces of gold in the measured and indicated categories, and we’ll say TXG has 5 million ounces in those categories. In that scenario, NES has 3/5 the gold that TXG does but a market cap of less than 3/10 that of TXG. Put another way, if Newstrike’s ounces were assigned the same value as Torex’s, Newstrike’s stock would be at $4.50 a share – and that’s not including any takeover premium.

Those with a high risk tolerance and looking for more torque in the Guerrero Gold Belt should check out Oroco Resources (OCO), an earlier-stage company that is described in more detail by my friend calichebahada.com. Oroco is developing a project very near Goldcorp’s Los Filos gold mine.

Newstrike managed to pull through the grim climate for junior exploration financing unscathed – a testament to the quality of management. NES is cashed up after raising $25 million in a March bought-deal private placement at $3.10 a share just before the junior market tanked. Newstrike is sitting on about $35 million in cash, giving it more than enough firepower to achieve project goals. NES has 115 million shares outstanding, a number that is unlikely to rise.

Plenty of exploration companies on the Venture have established gold resource estimates, but if their gold is buried deep underneath the Earth’s surface, they’re punted to the back of the takeover line. Newstrike’s near-surface glow puts it near the front.

Lukas Lundin: “Let’s make a deal”

There’s one more feature that makes Newstrike Capital an interesting investment idea – its major shareholder is Lukas Lundin, the billionaire mining tycoon with a long and impressive track record of creating shareholder wealth. Lukas Lundin owns or controls (through two family trusts) about 20% of NES stock. Lundin’s most recent score was the $7.1-billion sale of Red Back Mining to Kinross Gold – a takeover that turned out much better for Red Back shareholders than Kinross shareholders, and Lundin-backed Africa Oil is up more than 500% year-to-date.

Family trusts Lorito Holdings and Zebra Holdings and Investments own a combined 12.6% of outstanding NES shares, according to INK Research data. Lukas Lundin owned more than 10% of outstanding shares until June of last year, when he trimmed his position in NES and fell below the 10% threshold.

Lorito Holdings participated in Newstrike’s March financing, however, purchasing 800,000 shares – a $2.5-million investment at $3.10 a share. So investors initiating a position at these levels are buying stock at a 24% discount to levels deemed attractive by Lundin. Newstrike executives have also been adding to their positions at current levels, as shown by Canadian Insider.

* All share price information as of Wednesday’s close.

Disclosure: I own shares of Newstrike Capital and Sandstorm Gold.