The 300 Club

Fabrice Taylor

From Thursday's Globe and Mail

19:03 EDT Wednesday, August 11, 2010

The Kinross offer for Red Back has an air of desperation to it.

If things were going well at Kinross , would it essentially bet the company on West Africa?

Red Back’s assets are supposedly quite good but, judging from the market’s reaction, they don’t justify the price – and consequent dilution – Kinross chief executive Tye Burt is willing to pay. “Just trust me,” he says. “No thanks” screech investors trampling each other as they run for the exits. Can you blame them? The story doesn’t add up.

Kinross has done a lot of work on Red Back’s properties and says it found wonderful prospects. But Mr. Burt says he can’t go into details for regulatory reasons.

So I called the company to ask exactly what regulation prevents them from telling the owners of the company why they should buy Red Back for a huge premium. Company spokesman Steve Mitchell said that although Kinross has done a lot of drilling on the properties, it’s not enough to produce an NI-43101, which is a regulated document that describes the characteristics of an ore body.

Investors tend to prefer companies that have such a document to share because they can use it to verify management’s claims. Kinross chose not to wait until it had enough data to produce one before it made the offer to Red Back.

What’s even more strange, in my opinion, is that Kinross’s drilling consisted of twinning holes, said Mr. Mitchell -- that is, drilling next to holes Red Back had already drilled. That might confirm what Red Back has said about the properties but it doesn’t add much, if any, new information. The market is saying that based on existing knowledge of Red Back, the deal is bad for Kinross. So when the company says “trust us,” the reaction of investors is understandable.

The company says it has a lot more drilling to do but is confident the results will justify the deal. How do they know that? Based on what data? And for that matter, why not just wait until the drilling is done before making a bid?

“Because we saw an opportunity,” Mr. Mitchell told me. Well what opportunity is that, exactly? Kinross already owns about 10 per cent of Red Back; that won’t stop someone else from bidding but it’s a deterrent.

Mr. Mitchell said that if it had waited for more drilling results, Red Back would have gotten more expensive. But the stock was close to its 52-week high when Kinross made the offer.

And, while we’re at it, if there’s a lot more gold in the ground than has been disclosed, why wouldn’t Red Back management just wait for more drilling results before agreeing to a friendly deal? What do they know that the rest of us don’t?

Kinross says Red Back management thought it would be better to be part of a bigger company. But if Red Back’s future is as bright as Kinross says (and Red Back management is, unlike the rest of us, privy to Kinross’s drilling results), why not go it alone? (I called a Red Back executive to ask, but my call wasn’t returned.)

It’s quite possible that Red Back saw a rich offer and took it. It’s also quite possible, if not probable, that the opportunity Kinross saw was not in Red Back’s share price but in its own.

Kinross stock is wilting. Why? Because it doesn’t make any money, like most big gold miners. Kinross has burned cash and lost money cumulatively over the past three years, in a bull market for bullion. Gold mining is a brutally tough business. And like every other producer, Kinross is under intense pressure from the deep thinkers who manage our savings to add reserves, and more reserves, and yet more reserves. So they do. And sometimes they pay too much. (For evidence, look no further than the goodwill charge the company racked up in 2008.)

And that means it’s better to do a paper deal now than wait for more drilling results from Red Back, by which time Kinross's stock might be a lot lower.

If I’m right about all this and the deal nevertheless gets done, there also could be a lot of selling pressure in store for Kinross shares as Red Back investors will look to convert their stock into cash.

I wouldn’t want to be a holder when that cascade of sell orders hits the trading desks.

Kinross' share price has done well over the past decade, but its recent financials show how tough the gold mining business can be

Source: Company reports