Barrick CEO Aaron RegentSTRINGER/CANADA
Barrick Gold Corp. 's shares fell 6.45 per cent Wednesday, as soon-to-be diluted investors considered the implications of an even larger share offering than announced just a day earlier.
In a major bet that gold's rally has a long way to go, Barrick unveiled plans Tuesday to largely eliminate its troublesome gold hedge book with a massive equity issue worth as much as $4.04-billion (U.S.). Originally the deal was set at $3.45-billion, but investor interest allowed the company to up the offering.
The Toronto-based company said it is selling shares at $36.95 each. It will use the proceeds to eradicate more than half of its hedge contracts which have locked the company into receiving a fixed price for some of its gold production.
Blackmont Capital analyst Richard Gray said the negative effects of the dilution - more shares means fewer profits to be shared among existing investors - are balanced by the gains made by eliminating the hedging program.
"While increasing the share count by 10.6 per cent was a steep cost, the elimination of the hedge improves the valuation of two of the company's major growth projects and more importantly, the marketability and optics of the world's largest gold producer," he wrote in a morning note, as he shaved a dollar off his price target, to $48.50.
The world's largest gold miner, Barrick produces about 8 million ounces a year. But its hedge book totals 9.5 million ounces, fixed at prices hundreds of dollars less than the current $1,000-plus range.
"For Barrick, it is the elimination of a significant future liability that was becoming more difficult to defend with the increasing gold price," said the Blackmont analyst. "Just as important is the monumental signal by the world's largest gold company that it believes gold prices are poised to increase further."
The enormous stock sale marks the first major strategic move for Aaron Regent, Barrick's chief executive officer, who took over the top job in January. He has been under pressure to get rid of the costly hedges, which have lowered profits and scared away shareholders seeking full exposure to the rising price of gold.
"The gold hedge book has been a particular concern among shareholders and the broader market which we believe has obscured the many positive developments within the company," Mr. Regent said in a statement.
The move to get rid of hedges shows that Mr. Regent and Barrick are banking on an increasingly positive outlook for the price of gold. The company said because of the financial crisis, it expects global monetary and fiscal reflation will be necessary for years to come.
Reflation raises the risk of inflation and would hurt global currencies. A falling U.S. dollar and inflation are generally positive for the price of gold.
"They see what the world is moving to," said Jamie Horvat, a senior portfolio manager at Sprott Asset Management Inc. in Toronto.
"A substantial move in the gold price above $1,000 and these guys start to lose a lot of money. It's becoming an increasing concern with their investors so they are going to focus on eliminating it, which is a positive thing.
"They obviously believe the gold price is going higher," he added.
Barrick is a gold company that has forged its reputation on clever financial engineering more than a belief in metal prices.
In the past, it has hedged its copper production by selling forward its future production and locking in the price it will receive.
When the price of gold was falling in the late 1990s, Barrick's gold hedging strategy help shield the company from the yellow metal's declines.
Gold, however, has been on a winning streak since 2001, rising from less than $300 an ounce to over $1,000.
Sources said that in meetings with investors, Mr. Regent quickly came to realize that the hedge book was an enormous issue facing the company and should be eliminated.
"Every institution Aaron met said, 'Get rid of the hedge book,'" said one banker close to Barrick.
Of the 9.5 million ounces contained in its hedge contracts, 3 million ounces are fixed-price arrangements that do not allow the company to participate in movements in the price of gold. The remaining 6.5 million ounces are under floating price contracts.
Barrick said it will use $1.9-billion of the net proceeds to eliminate all of its fixed price contracts within the next year and $1-billion to eliminate a part of its floating price contracts.
The proceeds from the stock sale won't be enough to rid Barrick completely of its contracts, which have a market value of approximately $5.6-billion.
The company said it will take a $5.6-billion charge during the third quarter, due to a change in accounting treatment for the contracts.
A recent report issued by National Bank Financial analyst Tanya Jakusconek estimated it is costing Barrick $110-million a year, or about 4 per cent of the company's cash flow, to hold the floating spot price hedge contracts.
With files from reporters Andrew Willis and Steve Ladurantaye