New Gold (NGD.TO, NYSE:NGD) announced today they entered into a letter of agreement with Rainy River Resources (TSE:RR) to acquire all of Rainy River’s outstanding shares.

New Gold will offer at the election of each holder of Rainy River common shares, 0.5 of a common share of New Gold or $3.83 in cash, representing a 42% premium over the closing price of Rainy River on the day before the offer.

From the perspective of New Gold, this is an excellent deal. As Rainy River had approximately $90M in cash at the end of Q1, New Gold acquires 4 million ounces of gold in reserves and an additional 4.4Moz in resources for a net acquisition cost of approximately $310M, or at a price of $36/oz in the ground, which is relatively cheap even given the market circumstances.

As Rainy River has a 52wk high of C$6.17, we can imagine several shareholders think this offer is insufficient, given the fact the company has $90M in cash and thus has several options to move the project forward. The Rainy River project has a NPV5% of $721M based on the reserves and a $1250/oz gold price, equaling C$8/share.

Based on the fact New Gold is offering to pay approximately $36/oz in the ground and approximately 45% of the NPV (before deducting Rainy River’s cash position), we think New Gold’s offer is fair and reasonable. On top of that, by choosing payment in the form of New Gold shares, Rainy River shareholders will still have upside potential, but now as part of a producing, cash flow positive mid-tier gold company.

We would recommend to accept the offer, and tender the shares to New Gold. The more sophisticated investors who accept payment in New Gold shares can write call options on New Gold for an additional return (warning: until the takeover is complete, those written calls will be naked, and thus highly speculative).