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Sunday, November 13, 2016 Derek Macpherson

KLG Turns Down Offer, Continues with Planned Merger


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On Friday, Kirkland Lake Gold (TSX:KLG), in response to rumors, announced that it had turned down a C$1.44 billion dollar combined offer from Silver Standard Resources Inc. (TSX:SSO, NASDAQ:SSRI) and Goldfields Ltd. (JSE:GFI, NYSE:GFI). This offer represents more than a 50% premium to Thursday’s close. Our understanding is that this proposed offer would stop the planned merger with Newmarket Gold (TSX:NMI). While this offer is a substantial premium to Kirkland Lake’s current share price, Kirkland Lake’s board and financial advisors, see superior value in the merger with Newmarket being completed. In our view there are three possible outcomes. First and most likely, considering board, management and shareholder support, is that the merger between Kirkland Lake and Newmarket is completed as announced (~70% likelihood). The second is that because of a board conflict which supports the planned merger, Silver Standard and Goldfields make a hostile offer for Kirkland Lake and are successful (~25% likelihood). The last and probably least likely is that shareholders (of one or both companies) do not vote in favour of the merger (~5%). With these odds and that Newmarket is trading at a ~13.6% discount to Kirkland Lake based on the exchange ratio, likely represents the most attractive value. However, should Silver Standard and Goldfields continue to pursue Kirkland Lake it could provide higher near-term return, but with higher risk.


Market did not appear to view the merger favourably. Since the merger was announced on September 29, 2016 (through November 10th) both Newmarket and Kirkland Lake have underperformed peers, down 29.6% and 29.4%, respectively, while the GDX (Gold Miners ETF) was only down 15.5%. This underperformance implies that the market disliked the merger. As we wrote previously, we believed the combined company would attract a higher multiple because of its increased size, and adjusting our estimate for the recent pullback in gold stocks estimate, the combined company would trade between C$5.00-6.00 per pre-consolidation Newmarket share (C$10.53-12.63/share post-consolidation), based on the valuation uplift alone. This implies a +49% premium to Newmarket’s close and a +31% premium to Kirkland Lake’s close.

New offer was turned down on a basis that it was not a “superior offer”. The most recent combined offer from Silver Standard and Goldfields would notionally value Kirkland Lake at C$1.44 billion (~C$12.27 per share), more than a 50% premium to Thursday’s close (C$7.85) and just below the 52-week high of C$12.39 per share (July 2016). In the joint management circular, Kirkland Lake noted that two previous offers were made, ahead of this third one, all of which were rejected by the board on the basis that it was not a “superior offer”. No additional details were provided (i.e. how much cash, number of shares, ownership structure of the combined company, etc) and the term “superior offer” is also subjective such that while the notional value could be higher; however, the company’s advisors and board may view this alternate combination as having lower value or potential than the planned Kirkland Lake-Newmarket merger. We note that Kirkland Lake’s Chairman, Eric Sprott, is a significant shareholder of both Kirkland Lake (6.7%) and Newmarket (13.5%) and is conflicted. Mr. Sprott had previously recused himself from the planned merger vote and it is our expectation that the same occurred for the offer from Silver Standard and Goldfields.

What happens next? In our view, there are three possible outcomes:
1.  Most likely, considering board, management and shareholder support, is that the merger between Kirkland Lake and Newmarket is completed as announced. We estimate there is ~70% of this occurring.
2.  Because of the noted conflicts, we believe the potential exists for Silver Standard and Goldfields to make a hostile offer for Kirkland Lake and win. And while the mechanism is slightly different, Silver Standard and Goldfields could also successfully make a sweetened offer for Kirkland Lake that is accepted. By either method, we estimate there is ~25% of Silver Standard and Goldfields successfully acquiring Kirkland Lake.
3.  Considering both company’s share price underperformance since the merger was announced, there is a small chance the merger is voted down as proposed, despite management, board and shareholder support from both companies. We view this as relatively unlikely, though more likely than when the deal was first announced, and estimate there is a ~5% chance that this occurs.
We note that this is our view based on current information; however, as more information becomes known, it is likely that our estimates for the likelihood of possible outcomes may change.
 
Planned merger ratio favours Newmarket; tough to ignore the potential for a hostile/higher offer for Kirkland Lake. Recall, that in this merger, each Kirkland Lake shareholder is to receive 2.1053 Newmarket shares (before the stock is consolidated, and company renamed Kirkland Lake). Based on Friday’s close, Newmarket is trading at a ~13.6% discount to Kirkland Lake based on the exchange ratio. This along with our estimate on the likelihood of possible outcomes, it appears as Newmarket represents the most attractive value. While higher risk, Kirkland Lake has the potential to provide higher near-term return, particularly if Silver Standard and Goldfields continue to pursue Kirkland Lake.

Second suitor highlights the scarcity of quality assets. As suggested in our 3 Themes and 10 Companies for a New Bull Market in Gold post from June of this year, quality assets in good jurisdictions are becoming scarce. In our view, both the merger of these two companies and the fact there is a second suitor for some of them highlights that theme.

Derek Macpherson | VP Mining Analysis
Sunneva Bernhardsdottir | Associate, Mining Analysis
Victoria Ellis Hayes | Associate
 
Red Cloud Klondike Strike Inc.
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Toronto ON., M5K 1H1

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Company Specific Disclosure Details
Newmarket Gold Inc. - TSX:NMI - None 
Kirkland Lake Gold Inc. - TSX:KLG - None
Silver Standard Resources Inc. - TSX:SSO, NASDAQ:SSRI - None
Goldfields Ltd. - JSE:GFI, NYSE:GFI - None

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