Weekly Commentaries

This is Sunday Chronicle's weekly commentaries on various issues of interest affecting the country. All individual commentators are done by elite Papua New Guineans from diverse educational backgrounds.

Monday, March 01, 2010

Lihir a takeover target?


SIR Julius Chan, the former Finance Minister who was once dubbed the finance whiz-kid of Waigani, seems to have a problem with two gold mines in his province. He wants junior gold miner Allied Gold out of Simberi and is bitter against Lihir Gold Ltd using revenue from his province to invest in failed ventures overseas, especially the Ballarat mine in Victoria.

Knowing the business acumen that characterizes his personality, he is obviously angered by the fact that his Namatanai township has fallen into disrepair and became dysfunctional despite the presence of the two gold mines in the Namatanai electorate.

When Lihir was preparing for construction, he wanted the Namatanai to become the supply base for the mine. Had that been done, many of his family businesses including a shipping company would have blossomed.

If Sir Julius Chan had the money, he'd be buying big into Lihir, at least to have some control over it and make it become a development tool for New Ireland, especially Namatanai, something he wanted happen for many years. He is threatening a revolt against the government for holding back K400 million from the mine that should rightfully be returned to his province.

Australian market analysts are now saying Lihir is a takeover target after the departure of its veteran CEO Arthur Wood.

It has not paid any dividends to investors in the last 6 years until last year. They tipping Lihir Gold as a worthwhile investment has made fools of stockbrokers - and journalists - for 15 years.

But this time should be different: Weak management, led by chairman of 13 years Ross Garnaut, and a poor use of shareholder's funds are the reasons why Lihir is effectively for sale, and there is little doubt that institutional investors would rush a bid priced at $3.50-4 a share, with the higher price being about 30% above Lihir's most recent sales, which have slipped beneath the $3 support level to around $2.94.

Tim Tredgold, an investment analyst says patience with Lihir, and its never-ending list of excuses for failing to perform as promised, means that it's time for wholesale change, with the first whiff of that coming on January 18 with Hood's abrupt departure. The move suggests further management ructions at the group with no obvious CEO replacement plan - former chief financial officer Phil Baker has been temporarily installed in the position.

Significantly, and somewhat embarrassingly, Lihir's share price rose slightly after Hood walked out. The immediate message from the market was that change - any change - has to be for the good.

As Hood headed for the door his boss, and Lihir's chairman since the company floated in October 1995, Ross Garnaut, provided a second clue into Lihir's fate as a business for sale.

Garnaut used two magic words in his widely reported briefing of selected commentators. The next chief executive, he said, would focus on "maximising value" from its assets rather than just running the operations.

There are two ways to maximise shareholder value in a company: run the business better, which is a bit hard to accept in Lihir's case after 15 years of false starts; or sell it and bring in an expert team from a bigger mining company.

Whether a bid comes from one of the gold majors, such as Canada's Barrick, South Africa's AngloGold, Newmont of the US, or local gold sector leader Newcrest is hardly relevant: The point is that Lihir's share register is loaded with investors who are willing sellers having watched their company lurch from crisis to crisis despite being the owner of one of the world's great gold deposits on Lihir Island.

Perhaps the greatest damage to Lihir's relationship with institutions can be traced back to a $US325 million fund raising in March last year, which saw new shares issued at $3 each.

Funds raised were earmarked for expanding operations on Lihir Island and in West Africa, where Lihir had expanded via the takeover of Equigold. Little mention was made at the time of the company's third business unit, Ballarat Goldfields.

However, a month after the capital raising, Lihir reported that the Ballarat mine was being "streamlined" after failing to perform as planned. By June, Lihir management announced plans to effectively write off the Ballarat investment for between $US250 million and $US350 million, roughly what was raised from shareholders three months earlier.

The 2007 Ballarat investment was an attempt by Lihir to invest in Australia, a move that would "derisk" the company with its heavy focus on PNG and Africa. It failed and the jury is out on whether the 2008 Equigold investment will be any better.

For investors, the question with Lihir is whether its current status as a business, which appears to looking for a new owner as well as a new chief executive, makes it - in terms of gold holdings - the best gold stock on the market.

Among Lihir's key rivals are:
  • Newcrest Mining, which also offers exposure to copper as well as gold, with the potential for tungsten production in the future. Like Lihir, Newcrest has had its management moments but is now settling into a highly profitable pattern, which should see earnings rise from $248 million last year to as much as $900 million in 2012. Over the past 12 months, Newcrest's share price has risen from a low of $27.64 to recent trades around $33.30.
  • Kingsgate Consolidated, a company dogged for more than a year by slow government approvals for a major mine expansion in Thailand, but now free to grow there and perhaps elsewhere as well. Production at its flagship mine will double over the next two years, and perhaps more thanks to ongoing exploration success. Management has also started talking about expansion outside Thailand, with Australia and South America the prime targets. Over the past 12 months, Kingsgate's share price has risen from a low of $3.42 to recent trades around $9.49.

Other gold stocks with solid production profiles and growth prospects included Avoca Resources, Dominion Mining and Silver Lake Resources. Each offers direct exposure to the gold price, strong management and the potential for exploration success.

Set against these rivals, Lihir is a company sitting on a staggeringly good gold deposit at Lihir Island with official reserves of 28 million ounces, enough for 28 years of production at the current target rate of one million ounces a year and total resources measured at 43 million ounces.

Production costs are running at $US454 an ounce, yielding a gross margin of more than $US500 an ounce, with profit in the current financial year tipped to come in at around $300 million.

The problem is that management has struggled from the day mining started to maximise value from its namesake mine, partly because of the difficulty working in the hot ground of an open pit mine in a dormant volcano and partly because the ore needed expensive processing.

As if difficulties in the pit, and in the processing plant, were not enough to keep management fully occupied, Lihir's board decided to expand via acquisition, including the loss-making takeover of Ballarat Goldfields and the far-from-convincing merger with West African specialist, Equigold.

The move on Ballarat was supposed to lower the risk profile of Lihir. The move on Equigold was supposed to diversify gold production. Neither initiative has yet succeeded although that is not to say any, or all, of these difficulties could not be overcome by a new owner.

Curiously, despite the layers of bad news currently washing over the stock, Lihir is persevering with its attempts to impress mining analysts by organising a tour of mining facilities in the coming days, a move certain to increase attention on the assets of the company.

A sum of the parts calculation, with the treasure trove on Lihir Island and the potential of Equigold's Bonikro mine and exploration tenements, could easily produce a valuation greater than Lihir's current market value of $7.2 billion, less than half the value of Newcrest's $16 billion.

If ever there was mining company looking for someone to show it how to perform as a business it is Lihir - which is perhaps why Garnaut said the future was all about "maximising value" for shareholders.

For comments, information and interaction email: yehiura@gmail.com

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