'Golden' opportunities don't come cheap

FABRICE TAYLOR

Globe and Mail Update

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February 11, 2009 at 6:00 AM EST

Is Osisko Mining's management lucky or unlucky? The company needed a few hundred million bucks to build a mine on its Northern Quebec property. On Feb. 3 it announced a deal to raise $250-million. Such was the clamour for a piece of the action that the offering was jacked up to as high as $400-million the next day.

While investors who wanted in were happy, the company's newest shareholders weren't wallowing in mirth. On Jan. 28, the stock changed hands at $4.45. Four trading days later, when the bought deal was announced, the stock was $5.45 – apparently driven higher by promising drilling results.

That was a short-lived quote, brought down by the financing, which was pegged at $4.55 with warrants that will be worth something if the stock moves above $5.45 – a nod, perhaps, to that fleeting high price. The upshot is that management and the Street may have doubted the market's valuation of the company. If so, there might be good reason for that.

Osisko is a hot ticket. Its property is the Canadian Malartic project, which was mined and shuttered in a bygone era of much lower gold prices. At today's price, the resource looks good, and the company now has the money to build a mine, so odds are excellent that it will be a producer, and a good-sized one at that.

Over its 10-year life, according to the prospectus, the mine will crank out on average 591,000 ounces of gold a year off a proven and probable reserve base of 6.3 million ounces. The operating cost is pegged at $319 (U.S.) an ounce. Capital expenditures are estimated at $146 an ounce (and some of that has been spent. The company needs $119 an ounce to finish.) With gold at $914 an ounce, the economics look great. But if you needed any more convincing, the internal rate of return for the project, we are informed by the prospectus, is a juicy 29 per cent.

Ready to invest? Maybe a little more due diligence is in order first. Let's start with the sobering fact that the prospectus cites a feasibility study that pegs the net present value of the project at $1-billion, but that's before tax. After tax it has to be less. The company's market capitalization, assuming the overallotment on the deal kicks in and the warrants are exercised later this year, would be $1.6-billion (Canadian).

That valuation is based on gold prices of $775 (U.S.) an ounce, which seems conservative if you think gold has legs. But the operating costs are based on rates prevailing in the third quarter of 2008. Gold does well in inflation but financial models for gold companies do better without any (many companies, to be fair, fix expenses).

Most importantly, the valuation uses a discount rate of 5 per cent to give future profits a value in today's dollars. That is not unusual, but it's absurdly low. Gold mining is risky, so 15 per cent seems like a minimum, but even at say 12 per cent, the difference can be huge. For instance, a profit of $600 per ounce four years from now is worth $490 today using 5 per cent but only $380 using 12 per cent.

The market isn't stupid: Clearly Osisko has the hallmarks of a good project since it appears to be breezing through its financing so easily. Boosters will say the company has other potential projects that are worth something. We'll see.

But the fact is that sexy gold concerns always sell for a big premium. That doesn't mean they won't make you money, by any means. But you have to be mindful of this before you buy them because sometimes premiums disappear at inopportune times.