Kirkland Lake Gold Detour Gold Deal is a Gamble

Kirkland Lake Gold Ltd. (TSX:KL) announced an all-stock agreement to acquire Detour Gold (TSX:DGC) in a transaction valued at about $4.9 billion

SmallCapPower | November 29, 2019: Kirkland Lake Gold Ltd. (TSX:KL) (NYSE:KL) Monday announced an agreement to acquire Detour Gold Corporation (TSX:DGC), a 600,000 oz gold producer located in northeastern Ontario, in an all-stock deal valued at about $4.9 billion. The takeout price of $27.50/share implies a 24% premium over Detour’s closing share price on November 22, 2019. Closing is expected by the end of January 2020. For reference, the termination fee is US$148M to KL and US$202M to DGC.

Takeover leads to 1.5M+ oz/Au gold producer. The acquisition combines the large scale open-pit, long-life Detour Lake mine with two of the highest-grade underground mines in the world, Macassa and Fosterville. Kirkland Lake Gold’s 2019E production guidance is currently 960,000 oz with an ASIC of ~$610/oz and Detour Gold’s 2019E production guidance is 600,000 oz with an AISC of ~US$1,140/oz. As such, we estimate that the acquisition should increase Kirkland Lake’s ASIC by 33% to $814/oz. The combined entity would have a pro-forma 2019 target of 1.5M+ oz and consensus free cash flow of ~US$700M.

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Hostile takeover attempt from other bidders unlikely. This is because the Detour Mine has long been viewed as a disappointment by the Street, however it seems to be turning around (a 588M/oz producer in a jurisdiction with little political risk is uncommon). Barrick Gold (TSX:ABX) is currently divesting assets and it is improbable that they would make a bid. In addition, Newmont (NYSE:NEM) is still absorbing Goldcorp and has shown little interest in further developing its North American assets.

Market is less than thrilled about the deal. Since the acquisition was announced, the share price of Kirkland Lake Gold has fallen 16.3% to $52.97/share (Nov 27/19), which using the same exchange ratio (0.4343), implies a takeout price of $23.00/share. This is 1% lower than DGC’s closing price of $23.23 (Nov 27/19), which implies a 1% discount compared with the 24% premium over the original announcement price. Detour Gold trades at 8.0x 2020E P/CF, a premium compared to its Tier II gold producer peers, which trade at an average of 5.2x.

Kirkland Lake Gold is buying a large bulk tonnage, low-grade gold operation – basically purchasing a lot of gold still in the ground. For this deal to work for KL long term, the gold price would have to continue to move higher from current levels.

Kirkland Lake Gold shares closed Wednesday’s trading session up 1.9% to C$52.97, while Detour Gold added nearly 3% at $23.23. Kirkland Lake Gold stock trades at a market cap of C$10.9 billion.

Disclosure: Neither the author nor his family own shares in any of the companies mentioned above.

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