Why Goldcorp Might Walk Away From the Osisko Deal

In January this year, Goldcorp (NYSE: GG  ) offered to acquire Osisko Mining for C$2.6 billion ($2.4 billion). The unsolicited offer was, however, rejected by Osisko. With Goldcorp continuing its pursuit, Osisko recently found a "White Knight" in Yamana Gold (NYSE: AUY  ) to thwart the hostile takeover offer. The big question now is whether Goldcorp will raise its offer.

Yamana comes to the rescue
Goldcorp had offered to acquire Osisko in a cash and share deal valued at C$2.6 billion back in January. However, the offer was immediately rejected by Osisko. According to Osisko, the hostile takeover offer undervalued the company. For Goldcorp, the main attraction is Osisko's Canadian Malartic mine, one of the biggest gold mines in North America. In an update last month, Osisko said the mine would have average gold production of 610,000 ounces per year over the next five years.

The mine also fits in with Goldcorp's strategy of disciplined portfolio enhancement and investment in low political risk jurisdiction. In addition, it has low all-in sustaining costs. According to Osisko, the all-in-sustaining costs for the mine are expected to be $691 an ounce. As I have noted in previous articles, the key for gold miners such as Goldcorp and Barrick Gold (NYSE: ABX  ) going forward will be to lower their production costs.

Given the value of Canadian Malartic mine to Goldcorp, it's not surprising that Osisko expected a higher premium.

Osisko, meanwhile, has struck a complex deal with Yamana Gold recently in order to thwart Goldcorp's hostile takeover offer. Under the deal, Yamana will acquire a 50% stake in Osisko's mining and exploration assets, including the Canadian Malartic mine. The deal, which requires approval of Osisko shareholders, will help Yamana Gold to diversify its operations. Yamana's offer of C$7.60 per share is well above Goldcorp's offer, which is currently worth around C$6.30 per share. Goldcorp is continuing its due diligence and has extended the date to acquire all of the outstanding shares of Osisko to April 15, 2014. The key question is whether the company will raise its offer.

Goldcorp might walk away from the deal
Gold prices have found a strong floor since the start of this year, as I have noted in previous articles. This is mainly because of strong physical demand for gold from Asia. At the same time, though, gold prices are not expected to see significant upside as the Federal Reserve factor is now out of the equation. As a result, gold prices will likely trade between $1,200 an ounce and $1,300 an ounce. For miners, the key will be to reduce their costs and improve margins. This is something they've already been doing.

With reduced costs and steadier gold prices, gold miners would be steady cash flow-generating companies and not the high-growth companies of the era of high gold prices. Growth will come from acquisition of low-cost mines such as Canadian Malartic mine. Not only will the mine help Goldcorp increase its production, but it will also help the miner bring down its all-in sustaining costs. Indeed, given this, scenario one would expect Goldcorp to raise its offer for Osisko.

If indeed Goldcorp raises its offer, there is likely to be a counterbid from Yamana, which has a right to match any new offer for Osisko shares. I don't expect Goldcorp to get into a bidding war in the present environment for gold prices. The company has also said it would rather walk away from the deal than overpay. Also, any deal is likely to face political hurdles. Political leaders in Quebec, where Osisko is based, are in favor of enabling local companies to fend off hostile takeovers like the one from Goldcorp. In fact, the Yamana deal, which also includes the participation of two pension funds, has already been welcomed by the Montreal board of trade.

While a deal with Osisko makes strategic sense for Goldcorp, I doubt the company will be willing to get into a bidding war, especially given the political hurdles. 

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