Evolution Dreams The Impossible Dream

This story features EVOLUTION MINING LIMITED. For more info SHARE ANALYSIS: EVN

-Exploration upside at Frog's Leg
-Quality, diversity improved
-More acquisition firepower
 

By Eva Brocklehurst

Gold producer Evolution Mining ((EVN)) has struck a deal with La Mancha, issuing new shares and taking on some debt in return for La Mancha's Western Australian assets. These assets include Frog's Leg, which produces around 100,000 ounces per annum, White Foil, which produces around 40,000, and the Mungari plant. The additions will lift Evolution Mining's production to around 600,000 ounces per annum.

Deutsche Bank estimates the value at $356m, below the $413m implied price of the deal, but accepts exploration success or cost reductions could bridge the gap. The broker's FY16-18 estimates are raised by 8.0% on average and 1-2 years of mine life is modelled beyond reserves.The key advantage of the deal is that Evolution Mining is now better positioned, with a cornerstone investor, to explore other merger & acquisition opportunities. Moreover, Deutsche Bank considers the company now has critical mass and access to capital which will make it easier to deliver on its growth strategy.

From La Mancha's perspective the transfer of Mungari operations and the cornerstone stake in Evolution Mining means it can leverage off a company that can run the assets better and build a presence in Australia off a larger platform. La Mancha will hold a 31% stake in Evolution Mining, with a 24-month equity lock-up, and assume two seats on the board, contingent on its shareholding remaining above 20%.

Evolution Mining will issue 322m shares to La Mancha and assume $114m in net debt to acquire the Mungari operation and surrounding tenements. Deutsche Bank anticipates the company could source a further $139m in debt before its gearing hits 20%, which along with free cash flow and La Mancha's support, would allow it to bid for larger, longer-life assets.

Macquarie incorporates the transaction into estimates, but notes the deal is still conditional on Foreign Investment Review Board and Evolution Mining shareholder approval. While expecting the acquisitions to be earnings accretive and a strong strategic fit, the broker downgrades valuation after incorporating the La Mancha hedge book and assumed debt. Evolution Mining has indicated it expects to roll the La Mancha debt into its existing corporate facility.

For Morgans, the deal holds up on the rationale of low production costs and significant exploration upside at Frog's Leg. Evolution Mining's assets are mature and this should inject new life into the portfolio. More importantly, the broker expects the deal should build the balance sheet and enable bigger acquisitions. This shifts the company to an aggressive acquisition stance and Morgans suspects another could be in the pipeline. The broker makes no changes to valuation yet, awaiting shareholder ratification and any competitive bids for the La Mancha assets that may be flushed out.

The acquisition improves asset quality, diversity and mine life, in Credit Suisse's opinion. Evolution Mining has been seeking such a deal for three years and the broker observes these assets meet the criteria. Key to the benefit is the acquisition of a major shareholder that appears committed to growing the gold exposure and willing to contribute $100m towards funding this aspiration. On the other side, La Mancha has been seeking partner to accelerate growth of its gold exposure. Strategic synergies and confidence in the management of Evolution Mining, seem to have been uppermost in La Mancha's decision and more important than more obvious partners, Credit Suisse observes.

While the broker does not yet make adjustments for the La Mancha assets the deal appears neutral to valuation on the current numbers. The company's projects are considered all positive for cash flow with cost performances continuing to benefit from a focus on operating efficiencies, negotiation of supply contracts and some oil benefits. In Credit Suisse's view the acquisition means that meaningful growth is still possible without resorting to high risk, high capex ventures.

Morgan Stanley considers the deal reasonable, but high relative to nearby transactions. La Mancha bought Alacer Gold's ((AQG)) share of Frog's Leg in 2013 for $141m plus toll treatment. In Morgan Stanley's calculations this implies $288m for 100% and, adding $110m for the new mill, equates to a value of $400m, roughly comparable with the current deal. Based on spot gold and FX Morgan Stanley estimates a 5.5 year pay-back.

FNArena's database contains four Buy ratings and one Sell (Morgan Stanley) for Evolution Mining. The consensus target is $1.02, suggesting 7.7% upside to the last share price. Targets range from 70c (Morgan Stanley) to $1.15 (Macquarie).
 

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