Last week it was announced that Sinopec, a large Chinese oil and gas company, is purchasing Canadian energy company Daylight Energy for $2.1 billion (B) in cash. The deal was struck at a whopping 120% premium to Daylight's share price prior to the announcement and a 43.6% premium over the 60-day weighted average price, according to Reuters.
Back in July, the first large-cap company to go discount shopping was BHP Billiton when it purchased Petrohawk Energy for just over $15B. The deal, which gives BHP access to the highly coveted shale gas reserves, was struck at $38.75 per share, a 49% premium from where Petrohawk shares were trading prior to the announcement.
Not to be outdone, the gold mining sector got into the action when B2Gold Corp. (BTO:TSX; BGLPF:OTCQX) announced it was purchasing Auryx Gold in a $160 million cash, all-stock deal. The deal represented a 74% premium on Auryx Gold's shares from the previous week's close.
It was also announced that Agnico-Eagle had gained access to promising gold prospects in Mexico via Canada by agreeing to purchase Canadian gold miner Grayd Resource Corp in a $463.5 million deal. At $2.80 per share (Canadian), the buyout represents a nearly 66% premium over the trading price prior to Agnico's announcement.
The strategy behind each deal is specific to the purchasing companies but all four deals crystallize the inherent value in the equity market. Junior exploration and development companies in both the energy and gold mining sectors have suffered steep declines during the market selloff that began in April.
Large-cap companies in both energy and gold mining must continually replace diminishing reserves. For example, decline rates for oil-producing wells in the Gulf of Mexico can range between 15-30% a year and significant investments must be made to keep the well producing, according to BP. Establishing new wells is also expensive. An offshore exploration well, for example, can cost $100-$200M dollars and that doesn't guarantee it will become a producing well.
In fact, currently the cheapest barrels of oil and ounces of gold aren't in the ground, they're listed on the stock exchange. This is why the smart money, such as the world's largest mining company, is swooping in to pick up reserves at discounted prices. This could just be the tip-of-the-iceberg for BHP. BMO estimates the company will spend between $68-79B by 2020 to add unconventional shale assets to the company's mammoth portfolio.
This isn't a new phenomenon in the gold sector. As I explained in The Goldwatcher: Demystifying Gold Investing, the big miners have chosen the express route to increasing reserves by purchasing the known assets of their rivals rather than the heartache and headache of drilling core samples and filling out permit applications.
In addition, higher gold prices have filled the coffers of large-cap companies with plenty of cash. BMO forecasts that the gold mining universe will accumulate $120B in cash by 2015 if prices remain elevated.
We think this "takeout potential" creates one of the best opportunities in today's market.
Editor's Note: The timing of this piece appears extremely appropriate. This piece was originally published on Friday, October 14 but two additional big mergers have been announced on Monday morning. Kinder Morgan is gobbling up its competition in a $21B acquisition of El Paso Corp. At a 37% premium to the 20-day share price, the deal is the second-largest M&A of 2011 behind AT&T's purchase of T-Mobile, according to Reuters.
Also, it was announced this morning that Brigham Exploration is being acquired by Norway's Statoil ASA for $4.4B. The deal was struck at a 40% premium to current Brigham share prices.
These two acquisitions represent the sixth and seventh takeouts of the year in the energy space, underscoring how the market has tremendously discounted the value of smaller energy companies.
U.S. Global Investors, Inc. is an investment management firm specializing in gold, natural resources, emerging markets and global infrastructure opportunities around the world. The company, headquartered in San Antonio, Texas, manages 13 no-load mutual funds in the U.S. Global Investors fund family, as well as funds for international clients.
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The following securities mentioned in the article were held by one or more of U.S. Global Investors Fund as of 9/30/2011: Agnico Eagle, BHP Billiton, AT&T, El Paso Corp, Grayd Resources.
