Barrick Gold Corporation (USA) NYSE:ABX Could Go Bankrupt
A couple of weeks ago, Barrick Gold Corporation (USA) (NYSE:ABX) announced a “bought deal” private placement that saw the company issue 163.5 million common shares at a price of $18.35 per common share for net proceeds of approximately $2.9 billion. Significantly, the over allotment option was not exercised by the syndicate of investors led by RBC Capital Markets and including Barclays and GMP Securities L.P.
As of the December 2nd close, the stock was down to $15.54 a 15% drop from the offering price only two weeks after the financing was closed. I wrote an article suggesting that investing in Barrick was a bad idea, but institutional investors tend to be deaf and dumb (and I mean in the intellectual sense) when it comes to visionary foresight.
An examination of the trends inherent in the last five years financials should be enough to hoist all the red flags at one’s disposal as an analyst. Unfortunately, retail investors and investment banks and their analysts do not have their interests aligned in this day and age.
I’m presuming, judging by the pronouncement of Ned Goodman of Dundee Corp. (TSE:DC.A) where he called Barrick “the best buy on the board” on Canada’s BNN on October 16th, that there was a certain amount of favours being called in to get this deal done.
The Globe and Mail newspaper, of which Barrick is an advertising customer, not-so-coincidentally touted the company on the same day of the announcement of the $3 billion offering.
If one takes the long view in regard to an analysis of Barrick’s financial statements relative to the directional price of gold, the trend is definitely toward a catastrophic collapse in cash flow from operations that will likely cause the company to either sell itself, or else seek bankruptcy protection. The company has significant debt and debenture maturities spread out across the near and longer term horizons.
Scarier still is the fact that Barrick’s financial future is almost entirely out of its own hands. The company is at the mercy of the price of gold, and to a lesser extent, copper and silver. The prospectus the company issued to sell the most recent offering failed, in my opinion, to highlight that reality sufficiently. The only reference to the gold price came in the first paragraph under the section Risk Factors in a paragraph headlined “The Common Shares are Subject to Market Price Volatility”.
At no point did the prospectus distinctly and specifically itemize or otherwise describe either a) the acute dependence of Barrick’s financial performance on the price of gold, or b) the long list of factors that are contributing now to weak performance in the gold price and the likelihood that those factors will continue to depress the price of gold going forward.
There can be little argument that an investment in Barrick now is to some degree a wager on the price direction of gold, silver and copper.
The Eight Billion Dollar Debt
Concurrent with the above equity financing, and obviously in no small part the cause of it, Barrick is offering to buy back a total of $1.5 billion of its outstanding near and medium term debt from a series of debentures totalling $8 billion. Total debt of Barrick prior to this retirement program is $15 billion.
Here is an excerpted paragraph from the company’s 3rd quarter Management Discussion and Analysis:
“Our capital structure comprises a mix of debt and shareholders’ equity. As at September 30, 2013, our total debt was $15.4 billion (debt net of cash and equivalents was $13.1 billion) and our debt-to-equity ratio and debt-tototal capitalization ratios were 0.96:1 and 0.47:1, respectively. This compares to debt as at December 31, 2012 of $13.9 billion (debt net of cash and equivalents was $11.8 billion), and debt-to-equity and debt-to-total capitalization ratios of 0.57:1 and 0.46:1, respectively. The majority of our outstanding long-term debt matures at various dates beyond 2015. In May 2013, we issued $3.0 billion of debt (refer to note 18 for further details), using $2.0 billion of the net proceeds to repay existing indebtedness on our $4.0 billion revolving credit facility that expires in January 2018 (“2012 Credit Facility”). The key financial covenant in the 2012 Credit Facility (undrawn as at September 30, 2013) requires Barrick to maintain a consolidated tangible net worth (“CTNW”) of at least $3.0 billion (Barrick’s CTNW was $6.4 billion as at September 30, 2013).”
So this is revealed as a key covenant for the 2012 Credit Facility, but no mention is made of such a requirement among the covenant among numerous other credit facilities.
The disturbing pattern here for investors is the continuous issuance of longer-term debt to replace short term debt. This approach works if you are the United States of America, but for a gold production company whose Consolidated Tangible Net Worth is fast diminishing, its a short road to the abattoir.
Unfunded Reclamation Costs: The Elephant in the Room
One issue that emerges after a thorough historical peregrination through Barrick’s financial data is the company’s obligations in regard to returning closed mine sites to their former natural state as per their obligations in environmental permits.
While the company makes a great show of acknowledging their obligations in financial statements, the company’s dismal track record suggests that the company’s accounting for future liabilities related to mine closure and environmental rehabilitation may in fact be grossly understated.
According to the company’s 3rd quarter Management Discussion and Analysis:
“Provisions for the cost of each rehabilitation program are recognized at the time that an environmental disturbance occurs or a constructive obligation is determined. When the extent of disturbance increases over the life of an operation, the provision is increased accordingly. We record PER in our financial statements when it is incurred and capitalize this amount as an increase in the carrying amount of the related asset. At operating miners, the increase in PER is recorded as an adjustment to the corresponding asset carrying amount, and results in a prospective increase in depreciation expense. At closed mines, any adjustment to a PER is recognized as an expense in the consolidated statement of income.”
Thus while the costs of associated with future clean-up obligations are estimated and accounted for in current financial statements, no provision is made to reflect future disturbances that will result in increased overall reclamation costs if the mine expands. Additionally, there is no mechanism for ongoing adjustment of increasing costs of reclamation operations in accordance with rising prices of both labour and raw materials.
Again, Barrick’s track record exhibits the proclivity to minimize expenditure relative to reclamation through self-intereested interpretation of the terms of its reclamation obligations, and then fight a rear-guard action in courts and seek to diminish its financial exposure over time through a litigious war of attrition.
In the current environment, where governments and NGO’s are becoming more adept at tapping public outrage to ensure full compliance with reclamation conditions, this is a risky strategy that points to increased exposure for Barrick to reclamation costs that are not discussed in its financial statements.
Crisis of Leadership
Peter Munk has been the company’s Chairman since Christ was a young boy, and so to see him stepping down is akin to the company getting a double lung, liver, and hip replacement surgery in one go. But the problem with that kind of radical re-and-re is that the chances of an overall improvement in the whole machine as a result are very slim.
In Barrick’s case, the prognosis is not good.
First of all, Munk’s replacement- Goldman Sachs fixture John Thornton, 59 – is placing his bets on China. He figures that China Investment Corp. will be interested in partnering with Barrick to help the country extract its substantial gold reserves. China is not renowned for its fair treatment of foreign partners in the extractive industries, and the whole enterprise seems based on a faint hope.
Such “desperate thinking” is further evidence by Thornton’s retention of McKinsey and Co. to help Barrick with an evaluation of its business strategy. What McKinsey knows about the mining business that Munk doesn’t could fit in a thimble. And it was McKinsey who played no small part in the demise of Enron.
Desperate Times Call for Desperate Measures
A reduction in mean All In Sustaining Costs, though commendable, will do little to thwart disaster if gold continues its general decline. 2013 saw the company divest itself of higher cost mines and its energy business. The company’s All-In Sustaining Costs (AISCs) profile across its operating mines now looks like this:
“We continue to expect full year production to be in the range of 3.55 to 3.70 million ounces, adjusted operating costs to be in the range of $475 to $525 per ounce and all-in sustaining costs to be at the high end of the range of $750 to $800 per ounce for the region, primarily due to higher costs at Pueblo Viejo due to lower silver byproduct credits as a result of the slower than expected ramp up.”
Currently the gold price, since the September 2011 high of $1,924, is declining at an average pace of 20% per year. That means, from today’s price, Barrick Gold could be operationally unprofitable within 24 months.
The company’s decision to sell of higher All-in Sustaining Cost assets, and suspend development at Pascua Lama, means its inventory of ounces in reserve is in effect diminishing. At the same time, costs continue to rise for production generally, while revenue from more ounces produced is diminishing.
Barrick is ill-equipped to survive a prolonged bear market in gold. During the last bear market of 1998 to 2001, was kept alive by hedging low-cost production. That option is not available now, and this bear market looks as if it may worsen before it improves.
Barrick as an investment, in my opinion, is an excellent short candidate.