Tahoe Resources (NYSE: TAHO) is a midsize precious-metals mining company that operates a diverse portfolio of mines and projects in Canada, Guatemala, and Peru. However, it also offers investors a unique opportunity to buy into what will soon be the world's largest publicly traded silver miner at a discounted price. While there's lots of upside potential here, everything must go right for this investment to pay off.
Digging into Tahoe Resources
Last year was a challenge for Tahoe Resources, as shares of the mining company tumbled 24% after the Government of Guatemala suspended its license to operate the Escobal mine. The stock fell as much as 54% at one point but rocketed from its bottom after rival silver miner Pan American Silver (PAAS +0.34%) agreed to acquire the company in a cash-and-stock deal. The transaction structure is worth noting because it means that investors who buy Tahoe Resources today will soon receive some cash as well as shares of Pan American when that deal closes, which should happen next month.
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Under the structure of the deal, Pan American Silver will pay current shareholders of Tahoe Resources $3.40 per share in cash or 0.2403 Pan American shares for each Tahoe share the own, worth about $3.50 per share at Pan America's current price. However, the deal is subject to proration, which means investors might not get all of their chosen option, since the company will only issue a maximum of $275 million in cash and 56 million new shares, for a total consideration of $1.067 billion. As such, most investors are likely to receive $0.88 per share in cash and 0.1778 shares of Pan American stock, worth about $3.46 per share right now.
On top of that, they'll get a contingent value right (CVR) entitling them to another 0.0497 Pan American shares for each Tahoe share they currently own following the restart of operations at Escobal. That works out to a total value of $4.18 per share, given Pan American's current stock price. With Tahoe Resources' stock recently selling for $3.70 per share, it's trading at a 13% discount to the merger price. However, there is a catch, which is that the contingent payment of additional Pan American shares doesn't kick in until the company restarts operations at Escobal. No one knows when that might happen, but the company is working with the Guatemalan government to resolve the dispute, which could get the mine operating again.
Creating a new silver mining giant
In addition to the potential of an additional share payment through the CVRs if Escobal resumes operations, investors in Tahoe Resources also have upside from the Pan American Silver stock they'd receive upon completion of the merger, assuming they don't opt for and receive all cash. That means they'll own a stake in what would become the world's largest publicly traded silver mining company. Not only that, but it would also have the highest margin operations in the sector, which should enable it to generate strong cash flow that it can use to pay dividends as well as invest in expansion projects. Meanwhile, it would have a strong financial position, with nearly as much cash as it has debt on the balance sheet, which it intends on enhancing by selling non-core assets. These factors position Pan American Silver to create more value for investors in the coming years, suggesting that the shares Tahoe Resources' investors receive in the deal could be worth much more in the future.
However, two things must occur for this to happen. First, the price of silver needs to remain at least steady, if not gain value. If its price plummets, it'll probably take Pan American's stock with it. Meanwhile, Pan American needs to execute on its integration plan, which includes getting Escobal up and running. That's a concern, considering that mining companies have historically had trouble integrating acquisitions, which increases the risk that Pan American could falter, especially since so much of Tahoe Resources' value lies at Escobal.
Intriguing upside, but loads of risk
Investors could be richly rewarded by buying Tahoe Resources right now, since they'll soon receive not only shares of what will become the largest silver miner -- which has upside potential -- but also an additional slice of that company if Tahoe's Escobal mine restarts. However, doing so would be a high-risk gamble, since there's no guarantee that Pan American will be able to reopen the mine or integrate Tahoe into the fold. On top of that integration risk, there's always the possibility that the price of silver will tumble again in the future, putting additional downward pressure on the stock. Because of that, the upside potential doesn't seem to be worth the risk, in my opinion.
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