Unhedged Newcrest, Lihir fuel takeover talk as gold price soars

By Alex Wilson
The Wall Street Journal
Monday, October 15, 2007

In Newcrest Mining and Lihir Gold, there is no hedging on their prospects -- and potential acquirers view that as a good thing.

The two biggest Australian-listed gold miners are seen as potential takeover targets after they closed out gold-hedging books that had been denting their earnings. By hedging, the companies had agreed to deliver gold at prices that -- with gold recently trading at multidecade highs -- were below market value. Nymex December gold ended Friday at $753.80.

The move to close the hedging books thus has given the companies greater exposure to the soaring price of gold. It also makes them more attractive to North American gold majors, which are actively hunting for fresh reserves and have a strong preference for unhedged gold plays. Both of those factors likely will serve to underpin the Australian miners' stock prices.

Takeover speculation has been stoked by industry players and industry observers alike. Newmont Mining, the world's second-biggest gold producer by output after Barrick Gold, recently told the industry's Denver Gold Forum gathering that Newcrest's and Lihir's low-cost production is making them look increasingly attractive.

And Credit Suisse, which has a "neutral" rating on both stocks, said there is strong potential for consolidation in the gold industry. "In our view, both Lihir and Newcrest appear attractive takeover targets," Credit Suisse said in a client note Sept. 8.

In April, Lihir was the first of the two to close out its hedge book, funding the move with a A$972 million (US$878.2 million) stock issue. The increased exposure to rising gold prices brought about by eliminating its hedging contracts helped Lihir quickly overcome the dilutive effect of the stock issue, and its shares have climbed about 30% since. On Friday, Lihir shares rose 1% to $A4.14.

Newcrest followed suit in September, announcing a A$2 billion stock issue to close its hedge book. While such a flood of new stock ordinarily would weigh on shares, the strength of gold prices and Newcrest's newly bought exposure to the metal's fortunes have driven up the miner's stock price by 13% as of Friday's close. The stock ended at A$28.09 Friday, up nine cents.

ABN Amro analyst Warren Edney, who has a "hold" rating on both stocks, said the closeout of the companies' hedge books has made them more attractive targets for majors like Newmont and Barrick Gold, which are on the lookout for acquisitions.

"What we are seeing is that it is easier for big companies to acquire assets rather than try to replenish their reserves and resources every year through exploration," he said. Newcrest and Lihir are midtier gold players on the global stage and are therefore seen as more likely to be prey than predator in any further industry consolidation.

While both Newcrest and Lihir are on track to boost production, many analysts see Newcrest as the more preferable takeover candidate for its diversity of operations and growth profile.

Lihir produces only gold and relies on one asset, its rich mine on Lihir Island in Papua New Guinea that produced 650,000 ounces in 2006. By comparison, Newcrest has five operating mines -- four in Australia and one in Indonesia -- that together produced 1.5 million ounces of gold and 88,940 metric tons of copper in the year ended June 30.

Lihir Chief Executive Arthur Hood said he recognized the stock was discounted because of the company's reliance on Lihir Island. "You get discounted once for the single-mine operation, and you get discounted for the perception of PNG's sovereign risk," he told reporters after addressing the Melbourne Mining Club earlier this month, in reference to the firm's reliance on its Papua New Guinea mine.

"So the only way to deal with that is to give yourself geographic and revenue diversity."

To help Lihir grow, Mr. Hood has outlined plans to double output to about 1.2 million ounces a year over the next four to five years. In its fist step in this direction, Port Moresby-based Lihir last year launched and has since completed a A$350 million friendly takeover of Ballarat Goldfields and its development project on the historic goldfields of the Australian state of Victoria.

Despite plans to launch gold production at Ballarat next year, with Lihir forecasting initial output of 100,000 ounces before ramping up to 200,000 ounces by 2009, some analysts remain skeptical about the project.

Morgan Stanley analyst Craig Campbell earlier this month said the Ballarat acquisition hasn't impressed the market. Even though it looks better now given higher gold prices, it was still likely to be only a small contributor to earnings, and Lihir needs to keep looking for acquisitions. "I would prefer to see a more diversified earnings base," he said.

Meanwhile, Newcrest continues to draw analyst favor for its greater production capacity and growth projects including the Cadia East and Ridgeway Deeps developments in the Australian state of New South Wales. Analysts say there is growing confidence in Chief Executive Ian Smith, who took the top job at the miner in August 2006.

However, a key stumbling block for the Melbourne-based miner has been the repeated underperformance of its giant Telfer mine in Western Australia -- once slated as a million-ounce-a-year gold mine. Mr. Smith has cut reserves at Telfer and built what he says is a conservative base from which Newcrest plans to deliver 750,000 to 800,000 ounces a year.

ABN's Mr. Edney said he prefers Newcrest to Lihir for its more-diverse operations. "I think they are turning the corner in terms of operational performance," he said. "They have been a bit of a perennial disappointer in the past but I think that is changing."

For his part, Morgan Stanley's Mr. Campbell has an "overweight" rating on Newcrest and an "equal weight" rating on Lihir.

One caveat: Mr. Campbell said the surging gold price could be due for a pullback in the short term. But he does see a silver lining for the gold miners, saying that any weakness in share prices could be a prime chance to build a position in Newcrest and Lihir.

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