Agnico Eagle Mining case: The presenting team should show the value of Agnico Eagle. The team should take us through some case facts, apply DCF if/where appropriate, and go into the treatment of tax...

Microsoft Word - 9b07N011.doc S w 907N11 AGNICO-EAGLE MINES LTD.1 George Athanassakos and Dan Buffery wrote this case solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality. Ivey Management Services prohibits any form of reproduction, storage or transmittal without its written permission. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Management Services, c/o Richard Ivey School of Business, The University of Western Ontario, London, Ontario, Canada, N6A 3K7; phone (519) 661-3208; fax (519) 661-3882; e-mail [email protected]. Copyright © 2007, Ivey Management Services Version: (A) 2007-09-10 INTRODUCTION On April 30, 2002, shares of Agnico-Eagle Mines Ltd. (AEM) of Toronto, Ontario, a Canadian gold producer with more than 30 years of precious metals mining experience, had just closed at US$13.89 on the New York Stock Exchange, a decline of nearly a dollar from the previous day. Dan Acker, a senior portfolio manager at National Securities Inc. (National) of Toronto, Ontario, reclined in his office chair, stared at his computer monitor and contemplated the red numbers beside AEM’s ticker symbol. He was in his fourth year of managing one of the largest Canadian equity portfolios for National. Acker, whose portfolio had a substantial number of AEM shares, had considerable interest in the future of the company. AEM had been one of his portfolio’s strongest performers over the past four months and Acker had become accustomed to seeing daily gains from the company. With such a large one day sell-off, he and his investment team at National wondered whether the price decline was a harbinger of further declines. Acker couldn’t afford to give back the gains he had made year-to-date. He wondered to himself, should National be selling? Acker and his team of MBA graduates, Michel Nickols and Bill Chelonis, had recently spent time at AEM’s LaRonde mine and believed in the operational potential of the company. National’s research department had prepared free cash flow forecasts for AEM, which, following their visit with the company, Acker had reviewed and modified to the team’s satisfaction. Acker knew that despite his team’s belief in the future prospects of AEM, the stock may have become overvalued from a fundamental viewpoint. Acker asked his team to perform a fundamental valuation of the equity of AEM. Typically, the team would use the discounted cash flow (DCF) methodology, with financial assumptions that had been carefully examined; however, Acker knew that a DCF valuation would likely undervalue resource companies, such as AEM, because the DCF valuation tended to overlook the flexibility provided at a mining company’s decision nodes when it was extracting commodities from the ground. As a result, 1 This case has been written on the basis of published sources only. Consequently, the interpretation and perspectives presented in this case are not necessarily those of Agnico-Eagle Mines Ltd. or any of its employees. This document is authorized for use only in Professor Ma. Theresa P. Mañalac's WSGSB - MBA 2022B-Advanced Valuation at Asian Institute of Management from Oct 2022 to Mar 2023. Page 2 9N07N011 Acker reminded Nickols and Chelonis that the DCF method, when applied to a mining company, had to be expanded to explicitly include the value of the unmined metals. The underground un-mined gold would need to be valued as a real option, using an adjusted Black-Scholes model. To help Nickols and Chelonis with their DCF valuation of AEM and its equity, Acker gave them his notes on AEM and the related information he had gathered, including a gold sector report and additional reports on the economy, industry and company. Acker also passed along a report on AEM’s weighted average cost of capital (WACC) estimation produced by a financial consulting company, A-G Financial Consulting, of Toronto, Ontario, headed by one of his former professors. Having received and verified AEM’s free cash flow forecasts and the WACC estimation, the key task ahead for Nickols and Chelonis was to value the un- mined gold using a real options methodology. THE HISTORY OF GOLD Since primitive time, gold has been accepted as a universal means of exchange. Gold evolved from being part of an individual ruler’s treasury, to being part of the reserves of a nation, typically held by its central bank. The gold standard, which became the dominant monetary arrangement in the world, beginning in 1880, collapsed in 1914.2 It was reinstated as a gold exchange standard between 1925 and 1931. After the Second World War, the 1944 Bretton Woods agreement set a legitimate standard for all major western countries. Under this agreement, countries undertook to maintain a fixed value for their currencies against the U.S. dollar, while the dollar itself was pegged to gold at US$35 per ounce. This peg came under pressure in the late 1960s and was ultimately abandoned in 1971.3 The price of gold rose rapidly during the 1970s after the link was finally abandoned, reaching a price of more than US$850 per ounce in 1980. Following that all-time high price, the average price of gold decreased to US$277.90 per ounce by the end of 2001 (see Exhibit 1). THE GOLD MINING INDUSTRY Global Mining Industry As of 1999, South Africa, the United States and Australia were the world’s largest gold producers. In 1999, Canada ranked fifth in gold production, producing 5.1 million troy ounces out of a total of 81.0 million ounces.4 In 2000, India was by far the world’s largest consumer of gold, buying more than 27.5 million ounces. Companies in the mining industry were generally divided into three categories based on the size of their yearly production. There were senior gold producers, such as North American Barrick Gold, Newmont Mining and Placer Dome; and South African seniors, such as Anglogold and Gold Field Limited. Each of these companies produced more than one million ounces of gold per year. Senior producers actively acquired junior gold companies to ensure continued production. Junior gold companies concentrated on locating, investigating and developing early stage exploration projects. These companies produced less than a hundred thousand ounces of gold each per year. 2 Peter Newman et al. (eds.), The New Palgrave Dictionary of Money & Finance, Macmillan, London, 1992. 3 Ibid. 4 The troy ounce is the most common unit of weight used to measure quantities of precious metals. One troy ounce equals 1.09714 avoirdupois ounces or 31.103 grams (of a fineness of 999.9 parts per 1,000 parts). This document is authorized for use only in Professor Ma. Theresa P. Mañalac's WSGSB - MBA 2022B-Advanced Valuation at Asian Institute of Management from Oct 2022 to Mar 2023. Page 3 9N07N011 AEM fell in between the senior and junior gold producers, known as an intermediate or mid-tier producer. Companies in this category produced between 100,000 and 1 million ounces of gold per year. These companies concentrated both on ramping up production and exploring new properties. Within this space, AEM had five major competitors: Echo Bay Ltd., GoldCorp, Cambior Inc., Meridian Gold Inc. and Kinross Gold Corporation. Financial statistics of AEM’s competitors had been assembled by National’s research department (see Exhibit 2). Canadian Mining Industry Canada was one of the world’s most attractive mining countries. The Fraser Institute ranked Canadian provinces and countries around the world based on their gold mining investment attractiveness. In 2001/02, Quebec and Ontario tied for first position, while Australia, Chile and Brazil rounded out the top five. Gold companies in general and Canadian companies in particular had endured a tough period since the fall of gold prices started in the early 1980s. Few gold companies had generated positive net income in the years from 1998 to 2001 (see Exhibit 2). Return on equity (ROE) in the intermediate mining sector had largely been negative. A total of eight Canadian gold mines had closed or suspended operations in the past two years in response to either the depressed gold prices or ore exhaustion. However, industry prospects had started to look brighter (see 2001 figures in Exhibit 2) manifested in a 19.5 per cent increase in equity prices over the last three months, with AEM up 40.7 per cent year-to-date (see Exhibit 3). The By-Products Industry Mining gold yielded a number of by-products, such as zinc, copper and silver. Generally speaking, the depth of the production shaft determined the type and purity of the extracted minerals — as mining depth increased, the grade of gold extracted increased. The sale of the by-products was subtracted from the cost of production, thereby reducing the cost of goods sold. Over the past 20 years, the price of zinc had appreciated, whereas copper and silver had seen significant declines (see Exhibit 1). Mining Taxation, Accounting and Valuation Taxation A resource allowance was offered by the Canadian federal government as a deduction against the marginal tax rate to arrive