It looks like we were just a step away from witnessing a birth of a gargantuan gold miner. The Wall Street Journal reported earlier this week that Barrick Gold (NYSE:GOLD) and Newmont Mining (NYSE:NEM) were recently discussing a merger. Reports show that the merger plan was almost complete, but Barrick and Newmont could not agree which mines to spin off from the new entity. This means that the merger is still probable, but will it bring value to shareholders?
Cost savings are the only viable reason for merger
The possible merger would create a company of a huge size with a total capitalization of almost $33 billion, 1.7 times more than the capitalization of the closest peer, Goldcorp (NYSE:GG). Cumulative debt would also be huge, as Barrick had almost $13 billion of debt at the beginning of this year, while Newmont had more than $6 billion of debt.
The rumor of a merger came at a time when most gold miners actively manage their portfolios in an attempt to become leaner and more profitable. In fact, Barrick itself was active on this front, divesting Kanowna in Australia, part of African Barrick Gold and a minority interest in Marigold mine, which was operated by Goldcorp.
The only viable reason for the merger is possible cost savings. Both Barrick and Newmont are very active in Nevada, so the merger could potentially bring improvements on the cost front there. Yet, it's too early to judge the scale of such improvements. Newmont will be holding its first quarter earnings call on April 25, and analysts will try to pull out some information about the merger from the company's management.
Barrick shareholders could be skeptical of the deal
Apart from possible cost savings, the combined power of the two companies is under question. Together, Barrick and Newmont would share a portfolio of the most spectacular delays in the industry: Newmont's Conga and Barrick's Pascua-Lama projects. Newmont and Barrick are building water management systems on these projects, while all other activities are postponed. The fate of both projects is unclear. What's more, a combined company would probably have to choose between them, as it would be hard to find the necessary financing for both projects.
Barrick projected that its all-in sustaining costs will be $920-$980 per ounce of gold in 2014. Newmont's expected all-in sustaining costs are higher in the $1,075-$1,175 range. From the cost point of view, the merger is more favorable for Newmont, as the company joins a lower-cost miner. The cost story mostly explains why Barrick's shares were down 4% on the day the merger rumor was announced, while Newmont's shares rose more than 6%. The difference in cost profiles means that savings from joint operations must be substantial enough to satisfy Barrick's shareholders.
The merger of Barrick and Newmont is still plausible. This is good news for Newmont shareholders, as their company could merge with a more cost-efficient producer. For the same reason, the attractiveness of the deal for Barrick shareholders is under question. The merger talk doesn't mix well with the freshly proclaimed goal of making Barrick a leaner company.
All in all, the perception of the possible deal will depend on the amount of cost savings and the organizational structure of the new company. Newmont's and Barrick's earnings calls will be held this month, and, hopefully, will bring more information about the merger.