Brian Gaynor: A golden offer with a tarnished history

COMMENT

Oceana Gold's initial public offering should be of considerable interest to New Zealand investors yet it has received little media attention.

This may be because of the bad memories associated with the company, which was previously known as Macraes Mining.

The country's largest gold miner was floated by Perth-based GRD in 1989, bought back by the Australian company in 1998 and is now being partially sold again. Its value has increased from $109 million to $404 million since the 1998 acquisition.

How has GRD managed to raise the value of Macraes Mining nearly four-fold over the past five years?

Gold played an extremely important role in the European settlement of New Zealand. Between the 1860s and the mid-1970s more than 26 million oz of gold were produced, but by the mid 1980s production was only 30-40,000oz a year.

In the 1980s a discovery was made at Macraes Flat, 100km north of Dunedin.

In the mid and late 1980s the project had a number of shareholders including California-based Homestake, Wellington based Jarden Corporation and BHP Gold.

BHP Gold sold to Perth Based Union Gold Mining (now called GRD), which floated the company in 1989.

Macraes Mining was listed on the New Zealand Stock Exchange on January 17, 1990, following the issue of 42.5 million shares to the public at $1.00 each. Prior to the issue GRD was issued 45 million shares, or 51.4 per cent of the company, credited as fully paid.

The sharemarket capitalisation of the gold operator at the $1.00 a share issue price was $87.5 million.

Operations commenced in October 1990 and over 1.7 million oz of gold have since been produced.

The mid-1990s was the golden period for Macraes as a listed company. By the December 1996 year gold production had increased to 138,500oz, pre-tax earnings reached $23.7 million and the shares had peaked at $3.80, giving the company a sharemarket value of almost $600 million.

But the situation began to go badly wrong in 1997, mainly because of a rise in operating costs.

Macraes annual report for the year ended December 1997, its last as a New Zealand-owned company, painted a bleak picture. Earnings were adversely affected by a $111 million asset write down and an increase in cash operating costs from A$357oz to $437oz. The write down included the Reefton project, which had run up expenditure of $32.3 million up to that time.

The poor performance continued into the 1998 year and the company reported a small loss for the six months ended June 30.

GRD's shareholding had fallen to 35 per cent but it still dominated the board with four of the six directors. The small Perth based company was in financial difficulty and its only significant assets were the Macraes shareholding and 32 per cent of Minproc, a project design company with total losses of A$45 million in the previous three years.

On September 7, 1998 - the day Macraes share price closed at an all time low of 48c - GRD proposed a merger with the New Zealand company. This was a takeover dressed up as a merger.

Macraes shareholders would receive one GRD convertible redeemable preference share, paying a dividend of 8.4Ac a year, for every two of their own shares. The preference shares could convert into ordinary shares on the basis of 1.25 shares for every preference share or be redeemed for A$1.20 cash on March 31, 2006.

Macraes, which had shifted its primary stock exchange listing to Australia but was still a New Zealand registered company, had to meet the following requirements: * Approval of 75 per cent of shareholders, including GRD, under New Zealand's Companies Act 1993;

* Approval of 50 per cent of shareholders, excluding GRD, under ASX rules.

In an acrimonious meeting in Dunedin, from which the media were barred, shareholders approved the merger by 76.6 million shares to 24.1 million. The motion would have been defeated if GRD had not voted.

GRD knew it was in trouble if the Australian meeting went ahead because under ASX rules only minority shareholders could vote. The ASX insisted that this meeting be held but GRD took its case to the Western Australian Supreme Court, which decided that ASX rules did not apply to a company that was registered and based in New Zealand.

GRD spotted a loophole in the regulations and exploited this situation at the expense of New Zealand shareholders.

Macraes turned out to be a disastrous investment for New Zealand shareholders. The takeover valued Macraes Mining at just $111 million, or 71c a share, yet shareholders had contributed nearly $200 million in equity (30 million Macraes shares were issued at $2.96 each).

Macraes paid total dividends of only 17c a share in the nine years it was listed.

The company has made a remarkable turnaround since it was acquired by GRD. In the five full years under GRD ownership the North Otago mine has reported pre-tax earnings in excess of $150 million compared with $52 million in the last five years as a listed company. As a result GRD's share price has risen from just 17Ac in September 1998 to a recent high of A$2.08.

The main reason for the improved performance has been the sharp reduction in the mine's cash operating cost per oz (this cost can vary depending on whether an accessible/rich ore bearing area or inaccessible/poor ore bearing area is being mined).

Macraes cash operating costs rose dramatically from A$357oz in 1996 to A$476oz in 1998, the year GRD made its bid for the New Zealand company.

After GRD acquired 100 per cent ownership the cash operating cost per ounce dropped dramatically to A$342 in 1999, A$289 in 2000 and A$296 the following year. The takeover/merger documents predicted a reduction in operating costs but these have been far greater than anticipated. For example the cash operating cost was just A$296oz in 2001 compared with A$441oz forecast at the time of the takeover.

The lower than anticipated cost structure had a huge impact on Macraes profitability, and valuation, as 170,000 oz of gold was produced in the 2001 year.

Oceana has been dressed up and packaged for the current IPO. The company's mining assets, which were written down from $179 million to $103 million between December 1996 and September 1998 are now valued at $409 million (A$365 million).

Oceana has an extremely strong balance sheet but investors are reminded that its assets were dramatically written down just before the 1998 takeover offer and have been written up just before the current float.

Oceana is predicting that output will increase from 175,000ozs to at least 350,000ozs over the next four years, primarily because of 140,000ozs of new production at its Reefton project. Directors are forecasting net earnings of A$17.1 million, or 4.8Ac a share, for the December 2004 year and a dividend of 1Ac.

As part of the offer GRD shareholders can exchange one GRD ordinary share for 2.4 Oceana shares, an offer they should take up. The public offer, which closes next Friday, is for 50 million shares at A$1 each.

After the issue Oceana will have 360 million shares on issue with GRD owning 55.6 per cent.

There is little doubt that Macraes Mining is a top class operation with good growth prospects.

But the one big problem is that GRD always seems do far better than the gold producer's minority shareholders.

* Disclosure of interest: Brian Gaynor is a GRD shareholder.

* Email Brian Gaynor