Merging into the mainstream

Since we last reviewed Red Back mining much has changed on the corporate front. The group raised CAD$600m in a private placement from Kinross mining and is now set to merge with the larger gold miner. The merger puts Red Back’s high growth African projects together with Kinross gold’s more mature North and South American assets. With the combined group having the financial power to grow output we rate Red Back Mining a hold.

We first recommended Red Back Mining in April 2006 (FAT-USA-013) at CAD$3.85 while the stock currently trades at around CAD$28. It clearly shows the potential value a growing gold miner can deliver although clearly a rising gold price also helps.

When we recommended Red Back it had one mine in Ghana, Chirano, which had just started producing while the anticipated annual production for 2006 was 147,000 ounces. Output in 2009 came to 342,085 ounces showing that the group has made considerable progress. The first half of 2010 has seen output at 202,522 oz and so the company should be on course for 400,000 ounces for the full year.

Growth was partly achieved through the purchase in 2007 of the Tasiast project in Mauritania for $276m. Today Red Back mining has these two projects, Chirano and Tasiast, as its producing mines. The group is principally focused on West Africa and on Mauritania and Ghana.

In the second quarter of 2010 (three months to June) the Tasiast project saw production of 51,795 ounces (2009 36,973oz) while the Chirano projection saw production come in at 54,567 oz (2009: 43,264 oz). Thus output is at present fairly balanced between the two mines.

West Africa has been a strong growth area for gold miners as South Africa has seen output decline at its mature mines. Another notable success story in West Africa is Randgold Resources which has seen significant growth from its projects in or close to the borders of Mali.

The region hasn’t been known for good governance, with Ghana being the obvious exception, but miners have been able to find an accommodation with cash strapped Governments. Mauritania, for example, suffered a military coup in August 2008 although the General responsible did go onto win elections in mid-2009.

However, the Governance situation does appear to be improving with examples being Sierra Leone stabilizing and Charles Taylor of Liberia being held to account. The bottom line is that it is a region providing growth for gold miners and with relatively small countries, which means gold miners are welcomed for the economic benefits they provide.

Looking at the weekly chart of Red Back Mining we can see that this stock has driven higher in a near vertical uptrend. This trend paused for a few months and consolidated around the $25 level before gapping higher to retest the June 25thhigh of $28.94. The weekly MACD crossed lower during the consolidation however the shorter average is now pointing higher. We can also see the spike in volume that accompanied the gap higher which is bullish.

Looking at the daily chart of Red Back Mining we can see that the share price is once again testing the June high. Support lies at the $23 level. We can see the recent gap higher that took the share price back above the 50 day moving average. Should this stock break out to new highs we could see a large continuation move higher.



The key issue for Red Back Mining shareholders is what does it mean to be merged with Kinross Gold? On a production basis Kinross is clearly further ahead of Red Back with output of 2.24m ounces in 2009 in comparison to 342,085 ounces from Red Back.

Kinross is also concentrated in different geographic locations with the focus being on the Americas. The group has three producing mines in the United States, two in Chile, two in Brazil and one in Russia. Development projects are focused in Latina America with one in Ecuador and two in Chile.

Clearly then Kinross is a much more mature group than Red Back and also far more geographically diversified. The group produced US$304m of profits in 2009 and had revenue of US$2.4bn. Red Back had revenue of US$318m and net income of US$109m.

If the merger is accepted Red Back mining shareholders will hold approximately 37% of the combined group. When announced the merger terms valued Red Back mining shares at CAD$30.5 against a trading price of about CAD$26 before the announcement.

The deal is likely to go ahead as the boards of the two firms are in favour of it and since Kinross already holds a stake in Red Back which would make it difficult for other firms to make a bid. This stake stems from a CAD $600m private placement undertaken in the second quarter for a stake in Red Back. With a merger deal announced so quickly after this placement it does look somewhat circumspect to say the least.

In any event the merged entity will have a good chance of hitting the big league as the financial backing of Kinross Gold’s assets enables the full potential of Red Back’s exploration activities to be realized. As such the combined group’s gold production could reach 3.9m ounces by 2015 as Red Back’s two key projects in Ghana and Mauritania come on stream.

By comparison the world’s largest gold miner, Barrick Gold, has estimated production for the current year at between 7.6m and 8.1m ounces. The backing of Kinross clearly enables an acceleration of output growth in West Africa.

It would have been preferable to have an auction for Red Back mining but this deal nevertheless reduces the risks for the group’s stockholders. At the same time it does reduce the potential upside as the company’s high growth assets are being merged with more mature and production focused assets. However, the combined group does still have the potential for good output growth.

Accordingly, Red Back Mining will remain firmly held in the Fat Prophets Portfolio and we advise members to accept the tender offer.