Kirkland Lake Gold’s (TSX: KL; NYSE: KL) proposed $4.9-billion all-share acquisition of Detour Gold (TSX: DGC) and its open-pit mine in northeastern Ontario will add 15.4 million oz. gold, or eight years, to Kirkland Lake’s mineral reserve base, and lift the company’s annual gold production to 1.5 million ounces.
Kirkland Lake Gold’s Macassa mine in northern Ontario and Fosterville mine in Australia — two of the highest-grade mines in the world — are on track to produce a total of between 950,000 and 1 million oz. gold in 2019, and the Detour Lake gold mine produces about 600,000 oz. gold a year. It has a 23-year mine life based on a revised life-of-mine plan in April 2018.
If the transaction is completed, Kirkland Lake will have net cash of US$630 million. The combined assets will generate free cash flow this year of almost US$700 million, based on analyst consensus, and Kirkland Lake says it expects to see pre-tax synergies of between US$75 million and $100 million per year.
Post-merger, Kirkland Lake and Detour Gold shareholders will own 73% and 27% of the larger company.
Under the deal, shareholders of Detour Gold will receive 0.4343 of a Kirkland Lake common share, representing a 24% premium to Detour Gold’s closing share price on Nov. 22, and a 29% premium to its 20-day volume-weighted average price.
Kirkland Lake Gold president and CEO Tony Makuch notes that the company will optimize Detour’s operations and start engineering work to evaluate expansion opportunities, which he says could lead to production growth, improved unit costs and higher levels of reserves and resources.
“We have already taken two mining operations, Macassa and Fosterville, and transformed them into high-quality assets that generate industry-leading earnings and free cash flow,” Makuch said in a statement. (During the first nine months of this year, Kirkland Lake has produced 695,000 oz. gold at average cash costs of US$296 per oz. and all-in sustaining costs of US$584 per ounce.)
“The addition of Detour Lake provides an opportunity to add a third cornerstone asset that is located in our backyard in northern Ontario,” Makuch said, noting that exploration at Detour will be a “key component” of its corporate exploration program.
The Detour mine in the Abitibi Greenstone Belt sits on a 1,040 sq. km land position, where Kirkland Lake expects to run extensive drilling at “highly prospective exploration targets.”
During a conference call, Makuch noted that $40 million had been spent on exploration at Detour over the last five years, and that Kirkland Lake “can see spending that amount of money every year.
“There’s potential to find new deposits in this region, and not far from the Detour mill.”
He also dismissed concerns that acquiring a higher-cost, open-pit mine would hurt Kirkland Lake’s premium multiple, which has been based on the strong margins it generates from the Fosterville and Macassa underground mines. “They all have a lot in common,” he said of the three assets. “They’re all good businesses that make money.”
Detour Gold’s CEO, Mick McMullen, told analysts and investors on the call that the business combination creates “a lot of benefits that just aren’t available to us on a stand-alone basis.”
Since he joined Detour, McMullen said, he had “been out and spoken to a lot of our shareholders and asked them what they want out of the business, and it has been an almost universal view that this asset shouldn’t be sitting in a single-asset structure over the medium-term, so what this transaction does is it eliminates the single asset risk that our shareholders have been quite vocal about.”
The board of directors of each company have approved the arrangement. Shareholder meetings are planned, and the transaction could close before the end of January 2020.
The deal comes with a US$148-million termination fee payable to Kirkland Lake if Detour walks away, and a US$202-million break fee payable to Detour Gold if Kirkland Lake does the same.
Makuch said the two companies started talks in August.
Analysts expressed a mixture of views.
“While the valuation of Kirkland Lake’s offer looked reasonable based on the pre-announced price of Kirkland Lake, it would appear that Kirkland Lake shareholders are less enthusiastic about the offer than either management or the board of directors, and the effective valuation of Detour Gold in the current market is well behind our target price,” Barry Allan of Laurentian Bank Securities writes in a research note to clients. “We believe the Kirkland Lake shareholder may be having a difficult time understanding the shift of being a high-grade underground producer of gold, to now adding a large, low-grade, open-pit mine to the operating mix. The worry would be that post-merger, Kirkland Lake loses its premium valuation for being a high-grade company.”
Kerry Smith of Haywood Securities says the deal is earlier than he would have liked, as Detour “was starting to deliver on the efficiency and cost synergies and probably needs another 12 to 18 months to get the operation running close to optimal,” but recommends Detour shareholders approve the deal, and argues that Kirkland Lake can extract more value from the mine.
“We expect the Detour mine can realize 15% reductions in unit costs and if Kirkland Lake, with its much stronger balance sheet, is able to accelerate a plant expansion, the mine could easily realize a +20% increase in throughput over time as well, leading to strong cash flow for +20 years.
“Kirkland Lake plans on evaluating possible expansion opportunities of the Detour mill that could bring value forward, something that Detour was not considering on its own as Detour was only focused on mill throughput gains from the existing plant, which minimized new capital expenditures,” Smith explains. “Kirkland Lake does not have these capital constraints and if warranted could easily fund any contemplated mill expansion quicker than Detour could on its own.”
The analyst also notes Detour generated US$246 million in cash flow during the first nine months of 2019, while Macassa contributed US$170 million and Fosterville US$530 million.
“Detour is a strong cash-flow-generating mine and while some multiple erosion is likely, we think the market is overly pessimistic on this deal.”
Smith also says there is “very low probability” of a competing offer.
“Any new suitor would also likely need to put a substantial cash component into any bid, which likely eliminates Agnico Eagle given their lack of cash today and aversion to taking on significant new debt.”
Cosmos Chiu of CIBC isn’t ruling out a competing offer.
“Now that Detour is in play, we believe there is possibility of other suitors for Detour, including some Australian companies with open-pit experience looking for a toehold in Canada. With that said, the $148-million termination fee could be a deterrent.”
Over the last three years, shares of Kirkland Lake have climbed more than 800%.
Kirkland Lake Gold’s shares finished the day down 17.3%, or $10.94 per share, at $52.38, with 4.9 million shares traded. Over the last year, its shares have moved within a range of $25.23 to $67.87.
The news sent shares of Detour Gold up 1.80%, or 40¢ per share, to finish the day at $22.61, on 7.6 million shares traded. Detour shares have traded in a range of $9.55 to $22.61 per share over the last 52 weeks.