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Re: Tommy post# 291

Sunday, 10/20/2013 1:20:14 PM

Sunday, October 20, 2013 1:20:14 PM

Post# of 714
$NGD - New Gold: The Hidden Genius Behind The Rainy River Acquisition

http://seekingalpha.com/article/1755842-new-gold-the-hidden-genius-behind-the-rainy-river-acquisition?source=email_rt_article_readmore

On Tuesday October 15th New Gold's (NGD) acquisition of Rainy River Resources (RRFFF.OB) was finalized. On the surface it appears that New Gold bit off more than it could chew: after the acquisition New Gold has two very large development projects--Blackwater and Rainy River-- that it cannot fund internally given:

Its current financial position
Its anticipated cash-flow from its producing projects at the current gold price

What, then, is the logic behind the acquisition?


From my figures it follows that not only will New Gold not be able to fund Rainy River and Blackwater, but it would have difficulty funding Blackwater's development alone even in a high gold price environment. Blackwater's development has a price tag of $1.8 billion, and in order to go through with the project New Gold would have to issue stock or more debt. Neither of these are favorable options, but postponing the project while accumulating cash is not exactly favorable either, especially for a company that is looking to grow its production.

In this context the Rainy River acquisition begins to make sense. Rainy River will not generate the production that Blackwater would have (300,000 ounces annually for Rainy River vs. 500,000 ounces annually for Blackwater), but it has a development price tag of just $713 million, which New Gold can afford. Thus not only does the Rainy River acquisition give New Gold a relatively simple path towards significant production expansion from 400,000 ounces annually presently to 700,000 ounces annually in 2-3 years, but this growth can be funded internally. Finally, the company still has the Blackwater project. This gives New Gold further growth along the road if it targets production for 2019 - 2020 as opposed to 2017.

Herein lies the genius of the Rainy River acquisition. Before it New Gold had a growth plan that entailed spending more capital than it had access to without a significant spike in the gold price. It therefore would have been forced to issue stock and/or debt, and given the company's current financial position (which I discuss below), stock issuance was the more likely outcome. Now the company has a smaller development project that it can easily fund internally, and yet it still has an ambitious, yet achievable growth path: the company can conceivably grow production from 400,000 ounces presently to 700,000 ounces once Rainy River goes into production, to 1.2 million ounces once Blackwater goes into production in 6-7 years. Furthermore, this timeline could be shortened by a year or more assuming a higher average gold price.

All of these ounces have low production costs relative to the rest of the industry, and they do not have a lot of exposure to high-risk jurisdictions. These qualities make New Gold a relatively low risk investment with significant potential upside and leverage to the gold price. The only potential concern is the company's debt, and this shouldn't bother investors who believe that the gold price will rise, as the company can already easily cover its interest expenses even in a depressed gold price environment.

New Gold's Capital Situation

New Gold had approximately $690 million in working capital as of the end of June. While it has $855 million in debt it does not have to pay this back until 2020 at the earliest. The company's debt will eat into the company's realized cash flow from its producing assets, but otherwise there is no reason to subtract it from its capital in calculating its capital needs.

The company exchanged some cash for Rainy River shares ($220 million) and acquired the company's $75 million working capital position giving it an approximate $545 million in working capital.

New Gold has four producing projects--Cerro San Pedro, Mesquite, New Afton, and Peak Mines--which combine to produce about 400,000 ounces of gold annually. Only New Afton is expected to see meaningful increases. For the sake of being conservative I will say that the company will have 400,000 ounces of production for the next couple of years.

New Gold had "all-in sustaining costs" of $1,010 per ounce in the first six months of 2013, but this figure rises if we are calculating what the company will actually see on its bottom line given taxes and interest payments. The company sold 193,000 ounces of gold in the first six months of 2013 and it realized $1,383/ounce (I use six months because that will necessarily include one interest payment). Since it saw its net income at $51.3 million it made $266 per ounce of gold sold, and it therefore had costs of $1,117/ounce. Costs should come down slightly at New Afton, but for the sake of being conservative I will ignore this and use a production cost of $1,125/ounce.

The following chart calculates the company's cash position given these assumptions at the end of 2013, 2014, 2015, and 2016 at various average gold prices. For higher gold prices I am leaving 2013 blank as an average gold price of $1,500 or higher for the second half of 2013 is highly unlikely.
New Gold's Available Capital in Millions of USDAverage Gold Price 2013 2014 2015 2016
$1,250 $570 $620 $670 $720
$1,500 $770 $920 $1,070
$1,750 $920 $1,170 $1,420
$2,000 $1,070 $1,420 $1,770

Looking at this chart we see how the Rainy River acquisition makes sense for New Gold, which wants to grow, but which is in a position where it cannot fund Blackwater's development internally. Rainy River is a different story the company can fund the entire project at the current gold price with production beginning in late 2016 or 2017. Even if the average gold price is around $1,250 the company, assuming it begins development of Rainy River in 2014 (to begin commercial production in 2016, with the first full year of commercial production being 2017), will only have to borrow a small amount of capital.

Funding Blackwater After Rainy River

With Rainy River in production New Gold should be able to borrow the funds needed to develop Blackwater. By the time Rainy River is in production New Gold will be producing 700,000 ounces a year. If we assume production costs are roughly the same at $1,125/ounce (Rainy River should bring overall costs down, but I am being cautious), then the following table estimates the company's annual cash flow at various gold prices.
Gold Price New Gold's 2016/17 Cash Flow
$1,250 $87.5 million
$1,500 $262.5 million
$1,750 $437.5 million
$2,000 $612.5 million

With this amount of cash-flow the company will be in a position where it can feasibly borrow $1.8 billion at 7% (the company has two debt issues outstanding yielding 6.25% and 7% respectively, with the former being the larger issue) with annual payments of $126 million. This is a high-end borrowing expectation for Blackwater. The company's figure of $1.8 billion includes a 24% contingency, which means that the company's capital needs for Blackwater might be $1.45 billion, dropping the annual interest payment down to $102 million. I should also note that the company has roughly 28 million warrants outstanding with a $15/share strike price that expire June 28, 2017. If these are exercised the company will raise $420 million (while this is dilutive keep in mind that the current share price is <$6, making $15 a very nice price target for current shareholders). In this scenario the company's capital needs for Blackwater drop to about $1 billion, making the annual interest payment $70 million. Finally I should note that New Gold may not have to borrow this much, as these estimates are not taking into consideration free cash-flow from the company's (then to be 5) operations. If gold is trading higher than the current price then New Gold's capital needs may be far less than $1 billion.

Ultimately from the above chart it is evident that New Gold can easily cover its interest expenses if we assume that gold is trading at at least $1,500/ounce in a few years, and we can even assume a lower price (but then there would be little justification in buying a gold miner in the first place). If 2017 is the first full year of production at Rainy River then construction of the mine at Blackwater can begin the same year, and commercial production can begin as early as 2019.

These are not outlandish assumptions, and yet the end result is a company tripling its production from 400,000 to 1.2 million in a matter of 6-7 years.

Conclusion

The Rainy River acquisition places New Gold in a class of its own among gold miners insofar as it has arguably every attribute that investors are generally looking for in the sector.

Rapid yet reasonably attainable growth
Profitability even in a depressed gold price environment
Downside protection in the event of a mine closure (as a result of the company's four operating mines)
Limited geo-political risk

Many companies have some of these attributes, but only New Gold has them all, and the first is a direct result of the Rainy River acquisition. New Gold is currently positioned to grow its production 3-fold over the next 6-7 years without any share dilution, debt issuance beyond its reasonable capabilities, or acquisitions. This growth can be even greater if El Morro--New Gold's JV with Goldcorp (GG) in Chile--gets the approval it needs and begins production. Furthermore, this growth is not the growth for growth's sake that we saw with a lot of gold mining companies before the 2011-2013 market correction: all of New Gold's projects are or will be comfortably profitable even at the current gold price.

Shares of New Gold may languish or underperform the rest of the sector as a result of increased share supply from the Rainy River acquisition. I think investors who are looking for a solid investment in a gold mining company should take advantage. More aggressive investors may consider purchasing the warrants that expire June 28, 2017 with a strike price of $15/share (NGDAF.PK).

Today is a Good Day to Trade - Good Fortune and Happy Trails -
Tommy

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