Chaarat Gold Holdings (LON: CGH) struck a deal at the end of October to acquire the Kapan gold mine in Armenia from Polymetal International (LON: POLY) for US$55 million. The underground mine in southeastern Armenia’s Kapan province started production in 2003, and Polymetal has owned it since 2016. The acquisition in Armenia — formerly part of the Soviet Union, until its dissolution in 1991 — transforms Chaarat from a developer into a cash-flow-generating producer.
Last year Kapan produced 50,000 gold-equivalent ounces, with over US$20 million in earnings before interest, tax, depreciation and amortization. Based on current reserves, Kapan has a mine life extending until 2023, but Chaarat Gold says there is potential to extend production beyond that date through converting inferred resources to reserves and new exploration programs.
The acquisition accelerates Chaarat’s strategy of consolidating gold assets in parts of Central Asia and the former Soviet Union, and building a leading emerging markets gold company. It already owns the Tulkubash and Kyzyltash gold development projects in Kyrgyzstan. Earlier this year, Chaarat offered to buy the Kumtor mine in Kyrgyzstan from Centerra Gold (TSX: CG) for US$800 million in cash and shares. When that offer went nowhere, Chaarat says it offered to buy the entire company in an all-cash deal that was no less than a 35% premium to Centerra’s $5.48 share price at the time of the proposal. Centerra’s shares trade at $5.22 apiece. On Oct. 31, Chaarat said its board is no longer pursuing either transaction due to Centerra’s “unwillingness” to engage.
Artem Volynets, who joined Chaarat as a non-executive director in March, made a name for himself as the CEO of Russia’s En+ Group from December 2010 until June 2013, where he implemented strategies to make the group a global leader in mining, metallurgy and energy. Before that, he was senior vice-president of strategy at Siberian-Urals Aluminium Co. (Sual), and played a role in the US$20-billion, three-way merger of Sual, Rusal and Glencore’s (LON: GLEN) aluminum assets to create UC Rusal, where he worked as deputy CEO and director for corporate strategy. Volynets also helped orchestrate UC Rusal’s US$2-billion initial public offering on the Hong Kong Stock Exchange. He left the En+ Group five years ago and looked for opportunities in the fragmented gold sector, consolidating small, typically privately held companies in Russia and other countries in Central Asia. Volynets recently spoke with The Northern Miner about the company’s deal to acquire Kapan and Chaarat’s failure to advance talks with Centerra Gold.
The Northern Miner: Are you happy with the pace of Chaarat’s consolidation activity?
Artem Volynets: We are working to consolidate the gold industry in the former Soviet Union and have been moving like a fast horse (“chaarat” means “fast running horse” in the Kyrgyz language) through our development of existing assets and the acquisition of new ones. So we are very happy that we have signed an agreement to buy Kapan from Polymetal International. This is a stable cash-flow generator.
Polymetal invested US$35 million in capex over the two odd years they owned it, so there are significant improvements, which will see this mine generate on average US$25 million earnings before interest, taxes, depreciation and amortization (EBITDA) per year over the life-of-mine. The reserves are for five years, but we believe that, from the history of resource-reserve conversion, there will be another five or six years after that. So there’s great cash flow for the next five to 10 years, and this is the beginning of the platform. The new Chaarat becomes a producer with a presence in two countries, three assets, US$25 million in EBITDA, 1 million oz. in reserves and 9 million oz. resources of gold equivalent. We have significant near-term organic growth perspectives via the development of the Tulkubash project and several immediate merger and acquisition opportunities.
The acquisition of Kapan is a first, small, but very important step in building a solid industry roll-up story, as it demonstrates our strategic intent, and, very importantly, the investment case and the financial logic of our consolidation rollout in our target region.
In your part of the world there is a great gold company — Barrick Gold (TSX: ABX; NYSE: ABX) — buying Randgold for the same strategic reason: consolidation in the sector. The only difference between them and us is — not our relative sizes because obviously, they are slightly bigger — but Barrick is buying Randgold Resources at over eight times next year’s EBITDA. We are buying Kapan at just over two times average life-of-mine EBITDA. That is a good example of our ability to create value for our shareholders and this is before the synergies, reduction in overall cost of capital, etc., so a great solid, small asset with significant complementary to our existing assets being bought at a very, very, attractive price. And it will enable us, when our shares resume trading on AIM in the short future, to begin trading again as a different company — not as a developer but as a producer, with three assets and a growth story with attractive metrics.
It’s in this context that you look at Centerra. We have tried to engage the Centerra management in a constructive dialogue to acquire their Kumtor asset at a fair price that could have led to a value-creating transaction to our respective shareholders, both for Centerra and for us, but unfortunately, that didn’t happen. We tried twice. First, we proposed that we buy the asset itself, they did not engage, and then we said fine, why don’t we buy the whole company?
From the investment case perspective, this is a classic trapped value-breakup scenario that could be easily financed as a [leveraged buyout]. Centerra has been trading at a very, very, significant discount to peers primarily because it has exposure to Kyrgyzstan country risk, but 70% of its assets are in North America. Separating [Centerra’s] emerging market assets from its developed country assets will release the trapped value.
On top of that, by mid-September, Centerra’s share price went down 30% from the date that we made the first proposal to buy Kumtor.
So, while we were primarily still interested only in Kumtor, we thought that if we bought the whole company, even at a significant premium to current share price, it would still be attractive to keep Kumtor and auction off the North American assets — which were on the block a few years ago — so we thought it would not be a problem to sell them. It would have been a good transaction, which would have created a lot of value for Centerra shareholders.
By the way, its shares are up [20%] since our announcement, so it looks like investors agree with our thesis on trapped value. But the truth of the matter is that there are very few buyers who can acquire Centerra other than us, because it has a poison pill, and that is the geopolitical risk perceived to be associated with Kumtor. So I doubt that any large Western company would want to own this asset in a jurisdiction perceived as risky. We wanted it because we have been operating in the country for over 10 years, and we are very comfortable with the jurisdiction — it’s a great country.
There may be Chinese interested, but I doubt that would be acceptable, as, per reports from the local press, the Chinese already apparently own seven out of the 10 mining licences in the Kyrgyz Republic, and Kumtor is 10% of the local gross domestic product. The Kyrgyz Republic is a small, beautiful and independent country stuck between big neighbours: Russia, Kazakhstan and China.
So it has a poison pill and there are few potential counterparties in a position to remove it. We tried. Centerra didn’t engage, and we wish them good luck. We will move forward with our strategy, as we have plenty of other things in our pipeline.
TNM: How much debt does Kapan have?
AV: It’s intragroup debt. If there is any external debt it will be subtracted from the purchase price of US$55 million: US$50 million in cash and US$5 million in a convertible bond note. We are very happy with this statement of trust from Polymetal, a recognized leader in our sector in our region. They are taking our convertible bond note as part of its payment, and now they are our investors.
TNM: Were there other companies interested in buying Kapan?
AV: It’s a good asset. Polymetal made a significant investment to improve operational efficiency, for which we are grateful, but in this case, it’s speed that mattered. We signed the definitive documents in three months. We had to move quickly and diligently.
TNM: Why did Polymetal want to sell it after spending so much money on the asset and keeping it for just two years?
AV: As far as I can see from the outside, Polymetal is focused on large, complex projects, where they can create significant value and where they can deploy their excellent technical expertise. For Polymetal, Kapan is a very small percentage of its NAV, but was taking a disproportionate amount of time from management.
TNM: How much did Polymetal pay for Kapan (excluding the US$35 million they invested in it)?
AV: I think it’s in their press release — about $25 million — you will have to check.
[Polymetal says it acquired Kapan for US$38 million, including US$9 million fair value of the net smelter return royalty on future gold production. The transaction with Chaarat gives it an accounting profit of US$3 million, which it says it will use to reduce debt.]
TNM: Under the deal, Chaarat could also acquire Polymetal’s Lichkvaz deposit, which is close to Kapan.
AV: Yes, it’s not part of Kapan — we are not buying it. But we have right of first refusal to buy it or buy ore from it. It may or may not be an interesting deposit for us. We’re going to test the ore at Kapan and then decide whether to buy it or sign a supply agreement with them.
It’s possible to process ore from Lichkvaz at Kapan, but we need to understand what the process is, and how we can achieve a good mix from both deposits. There could be operational synergies but we can’t make that judgment yet, so we thought, we’ll buy Kapan and sign a right of first refusal, and now we have time to understand more about Lichkvaz before we make that decision.
TNM: How far is Lichkvaz from the Kapan mine?
AV: It’s not far, around 80 kilometres.
TNM: How many other assets, and in which locations, are you looking for more buying opportunities?
AV: I will be more than happy, once we find something, to discuss. But based on my previous experience, to get one deal done, you need to be working on three others. We are working on three other transactions and we have 12 others in the pipeline, and that doesn’t include Kumtor, so it looks like Centerra shareholders might have missed out on an opportunity to cash out at a good price.
TNM: Vitaly Nesis has been CEO of the Polymetal Group since 2003. How long have you known Nesis, and what’s he like?
AV: I have deep respect for Vitaly. In my opinion, Polymetal is the best-run company in our region. They trade in London at around six to seven times EBITDA, by comparison to two other Russian companies that trade around 4 to 4.5 times. The market is giving them a premium, and they deserve it. The business world is small in my part of the world. I knew Vitaly for some time.