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Given Multiple Compression, Is More Mining M&A on the Horizon ? Thoughts on UEX & KGC

Following this past week’s market rebound (reversing three consecutive weekly declines) we note that the market has seemingly (and finally) acknowledged the new reality of lasting inflation, higher rates and a general slowdown in the global economy. As central banks continue to raise rates (most recently Norges Bank with a surprise +50bp hike hike), an increasing number of Fed officials are openly advocating for another +75bp rate hike for the upcoming July meeting. As markets seem to be finally recognizing the oversold conditions, markets ended the week on a very positive note given the University of Michigan sentiment survey which suggests that the Federal Reserve may have overreacted after the inflation expectations numbers fell back to 3.1% on the 1-year measure, and to 5.3% on the 5–10-year measure. YTD, as yields have shot up (yields on the 10-year treasury have nearly doubled before retreating somewhat as of late), equities have been routed as the S&P declined by -17.9% while commodities such as gold, silver and copper have fallen by -0.2%, -9.5% and -16.2% YTD respectively. Though earnings estimates still will likely to be trimmed further, 2H/2022 can't surely be as treacherous as the first half.

Physical Gold Futures: GC=F

Physical Silver Futures: SIL=F

Physical Copper Futures: QC=F

Yields on the 10-Year Treasury: TNX

Dollar Index: DXY

S&P 500: GSPC

Given the volatility, no better time to re-examine the mining sector since our last update on February 1, 2022. As one can expect, the predominant theme since then has been valuation and multiple compression with base metals faring worse than their precious metal counterparts. On a YTD basis, Kinross Gold (KGC), IAMGold (IAG) and Capstone Mining (CS.TO) have fallen the hardest with share price declines in the 30%+ range.

Note that two of the aforementioned largest decliners have been involved with recent transformational M&A activity as Kinross Gold announced a divestment of its Russian assets (initially for $680M then being squeezed in typically Russian form, Kinross agreed to half that amount) and Capstone Mining purchasing privately held Mantos Copper, as announced late last year. That said, the previous 12 months have been busy on the M&A front with several large-scale deals beginning with the Agnico Eagle (AEM)Kirkland Lake (KLG) merger of equals to the more recent Goldfields (GFI) takeover bid for Yamana Gold (AUY). In terms of recent corporate activity, the more significant transactions in the mining space are as follows:

Given the volatility and multiple compression we have seen over the past few months, we ask ourselves if the environment remains ripe for additional (or even increased?) M&A. Two thoughts from the above table are worth highlighting:

1) Uranium Energy Corporation/UEX Corporation. On June 13, Uranium Energy Corporation (UEC) announced an all-stock definitive agreement to acquire all the issued and outstanding common shares of UEX Corporation (UEX.CN) by way of plan of arrangement. At time of announcement, the share exchange ratio implied a UEX share price of $0.43 which was a 50% premium to the previous day’s closing price, and a total transaction value of C$234M or $181M. What UEC acquired was essentially a vast uranium development/exploration portfolio located in the strategic eastern portion of the prolific Athabasca Basin. Specifically, UEC acquired a 49.1% ownership in the flagship portfolio asset of Shea Creek (one of the largest undeveloped deposits in the Basin) which currently hosts a global resource (100%) of 96M lbs U3O8. Additionally, 100% of the Horseshoe-Raven open pit project was acquired (37.4M lbs U3O8 indicated resource), which is located just 4km from Cameco’s Rabbit Lake mill. Additional assets acquired include an 82.8% stake in Christie Lake, a 16.9% stake in Kiggavik, a 15% stake in Millennium, a Feasibility stage project between the McArthur River Mine and Key Lake mill and a 5% ownership stake in Wheeler River, Denison Mines’ (DNN) flagship development project. Our initial thoughts haven’t changed as we don’t see any strategic benefit of combining UEC’s U.S. focused ISR asset base and technical know how, to the predominantly conventional uranium mining projects located in the Athabasca Basin. On the development front, UEC has been largely inactive with minimal asset development and zero ISR production from the Hobson Texas facility as activity has been purposely shut-in for the last seven years. That said, we view the bid as not only opportunistic, but also on the very low side given the high grade nature of the deposits, located in the exclusive Athabasca Basin. We say this because if valued on the primary asset in exclusivity (Shea Creek), UEC’s bid would be roughly equivalent to C$4.88/lb. This is well below post-Fukushima Athabasca Basin transaction multiples such as Denison’s acquisition of Waterbury Lake (7.8M lbs U3O8) in 2013 for the equivalent of C$8.97/lb and Rio Tinto’s acquisition of Hathor’s Roughrider Project (57.9M lbs U3O8) in 2012 for the equivalent of C$9.95/lb. Note that Rio’s entry into the Basin via bid for Roughrider sparked a bidding war involving Cameco (CCJ) which led to 3 subsequent bids, with Rio’s sweetened winning bid representing a 75% gain from the day prior to the initial first bid. We would argue that given the current geopolitical trends, themes such as lowering our reliance on hydrocarbons, energy security/independence along with securing reliable supply chains have led to the recent renaissance in interest for nuclear power, and with it, the need to secure uranium from safe/reliable jurisdictions. As previously written, we think that uranium is a hotter commodity now, versus anytime in the previous 10 years - more information here and here. All that said, (and without getting into the bare details…we do have many), entry into the Athabasca Basin is akin to entry into an exclusive club- it is only for the privileged few. Any ownership in the Athabasca Basin can be seen as an old boys club, dominated by the likes of Cameco, Orano (previously known as Areva, the giant French nuclear company) and Denison Mines. Now that UEC has working relationships with all the above mentioned players via the JV’s it bought into, we question if management teams from Cameco, Orano and Denison would be open to working with or having UEC as a partner on certain projects (there’s more to say here, but we’ll just leave it as is). We feel that UEC’s concurrent $5.0M private placement into UEX (at $0.43/share) is a sort of insurance policy. Knowing that their bid is low, the private placement is a way to benefit from any upside should a competing bid emerge. Low-ball bid, plus upside insurance from a potential competing bid sounds pretty win-win for UEC. We’ve established that the bid is low, we’ve also established that Cameco and Denison, wanting to protect their turf and JVs would likely want to keep an outsider like UEC away and consolidate what they have. Though it all makes sense, this thesis is challenged by three key facts which are hard to reconcile in our view:

A) Denison Mines had its own M&A transaction with UEX just last year on June 15, 2021 as a $20.5M agreement to acquire 50% of a portfolio (owned by a third party - Overseas Uranium Resources Development, OURD) in the Athabasca Basin was agreed upon. The highlight outcome of the deal was Denison’s increased ownership in the flagship Wheeler River property, going from 90% to 95%. We have no doubt that Denison would love to finally consolidate 100% of Wheeler River, but clearly a deal for the missing 5% couldn’t be made last year on Denison’s part. Would Denison like seeing UEC President Amir Adnani (the shrewd businessman that he is) now own the missing 5% ? ...unlikely, but its beyond us why a deal couldn’t be reached last year.

B) Cameco used to be a substantial owner in UEX (23.3% ownership), however since 2010, current CEO Tim Gitzel has been slowly but surely divesting its equity stake. Cameco has been concentrating on its tier one Athabasca assets and we question whether stepping back into junior exploration/development companies in the Basin for the sole purpose of limiting foreign entry into the Basin is or will be a motivating factor to reverse the selling trend seen since 2010.

C) If Denison can’t get a deal done and Cameco is no longer interested in juniors, can any other bidder emerge, in light of the understandably low current bid ? This remains to be seen however from a strategic standpoint, we would be surprised to see any other player emerge and bid for a package of JV properties.

2) Kinross Gold. Though the company started the year with its Russian assets representing approximately 10% of NAV, years of development and acquisitions in the Americas and Africa have done little to shed the moniker of Kinross being a Russia focused miner. The decision to divest its Russian assets following the invasion of Ukraine was the right one, but being a seller of an asset deemed as untouchable (Russian gold) will always imply selling at a large discount. The initially announced $680M purchase price for the Kupol mine to Russian-based Highland Gold Group was initially seen as low, but fair given the overhangs of the current geopolitical climate. When the Russian Sub-commission on the Control of Foreign Investments approved the sale, weeks later it stipulated that the price may not exceed $340M (half the originally agreed upon amount). Without fuss, Kinross promptly agreed to the lower price, with both parties knowing that a competing bid would not materialize. With Kinross desperately wanting to turn the page (finally) on all things Russian, closing the deal (any deal) took precedence over finding the right price and dealing with continued bad press. Whether Kinross got fleeced or not, they can now in the least focus on being an Americas and Africa focused company. With all that said, we maintain our view that Kinross Gold will be dead money for the foreseeable future given that the asset pipeline in the Americas and Africa has been both problematic (Tasiast) and uninteresting (Lobo-Marte and pretty much everything else). We previously outlined our thoughts earlier, link here. Kinross has bet a lot of its future on Great Bear Resources, a $1.4B acquisition for an asset without even a maiden resource. For this reason, the asset update scheduled for June 28 will be key. If Great Bear won’t be the company maker for the new-Kinross, then we believe that much like the sale of the Russian assets, Kinross itself will be in play, and will itself receive a bargain basement bid.

* Update on June 28: Kinross provided an update for the North American portfolio, with most time spent on updating the developments on the recently closed Great Bear acquisition. On site at Red Lake, a 200,000m drilling program is currently underway with 11 rigs currently active on site. Note that the LP Zone has a strike length of 10.8km, of which 4.6km is well defined. At present, a high grade open pit is envisioned, with an eventual transition to underground. In terms of metallurgy, a standard gravity/leaching circuit is expected. In terms of additional work needed, upgrades to power and distribution will be needed as will further land and water studies. Advanced exploration at the site is expected to begin sometime in 2024, with a resource expected by 2025/2026. Management has stated that permitting will be challenging, if all goes well the receipt of the final permits will be expected for sometime in 2027. With production coming in at best by 2030, a lot of patience will be needed with this one.


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