Mining Investor Guide: The Alamos-AuRico Merger, Part 1

Precious Metals

Cipher Research breaks down the proposed merger between Alamos Gold and AuRico Gold. The firm believes both companies are pursuing a sound growth strategy, but believes Alamos may be selling itself short with the proposed 50/50 structure.

Keeping a finger on the industry pulse, looking for growth opportunities, Cipher Research applies its GEONOMICS analyses on the potential merger between Alamos Gold Inc. and AuRico Gold Inc. announced on April 13. The two Canadian mid-sized gold companies will be merging in a $1.5-billion (U.S.) friendly deal. Shareholders of Alamos Gold Inc. and AuRico Gold Inc. would each own half of the new company.

The following is a brief overview of Cipher’s analysis in a three part series.

  • Part 1: Alamos Gold Company Analysis
  • Part 2: AuRico Gold Company Analysis
  • Part 3: Merged Entity Analysis


Alamos Gold Overview

  • Project
    • Quality of Operations – MODERATE-HIGH
      • Operations have been very robust over the last 3 years but recently average grades have fallen and margins have shrunk. Expectations are for margins to return to sufficiently high levels to offer investors high returns
      • Quality of Reserves – MODERATE-HIGH
    • Quality of Resources – LOW
      • The company has total R&R of over 12 million oz Au but other that the 4.8 producing R&R in Mexico the remaining have little or no value at current gold prices
  • Capital
    • Quality of Financials – EXCELLENT
      • The company has $350 million in cash on $96 million in total debts and has averages 13% annual ROI over the last 3 years (albeit near 0% for the most recent year as margins were squeezed)
    • Quality of Liquidity & Valuation – HIGH
      • The liquidity ranks very high with an annual 1.0 turnover ratio
      • The market Cap and EV have been reasonable throughout the company’s history
    • Quality of Structure – MODERATE
      • The Company has raised $509 million through conventional equity offerings and exercise of stock options. It had one failed acquisition that resulted in the issuance of $110 million in equity but this was recovered when the target was sold to a different suitor
  • People
    • Quality of Management – MODERATE-HIGH
      • Well qualified management team committed to a sound growth strategy

In our opinion both companies are pursuing a sound growth strategy however Alamos Gold seems to be selling itself short with the proposed 50%-50% structure. Unless there is more to the story, we do not consider the companies to be equals

Alamos Gold Detailed Analysis

In our opinion Alamos is a quality company and on the right track of development however AuRico may not be the best suitor for them.

Following a brief company introduction our analysis is divided as follows, applying a 5-point grading scale:

  • Project
    • Quality of Operations
    • Quality of Reserves
    • Quality of Resources
  • Capital
    • Quality of Financials
    • Liquidity & Valuation
    • Structure
  • People
    • Quality of Management
  • Cipher Value

Alamos Gold Inc. is a mid-tier gold producer operating the Mulatos gold mine in Sonora State, Mexico.

In addition Alamos has several development stage projects: Esperanza Gold Project, Morelos State Mexico, Kirazli, Agi Dagi & Camyurt Project, Canakkale Province Turkey, Quatz Mountain Gold Project, Oregon, USA.


Quality of Operations

Cipher’s unique analysis of key operating parameters over the last three years is summarized in the following table:

Production Levels and Revenues

Of some concern are the declining production levels, which is mostly attributable to the decrease in average grade. Management reports that production is expected to reach 150,000 – 170,000 ounces in 2015; however costs are also expected to rise as strip ratios increase in the short term. By 2016 the company predicts grades and strip ratios to “normalize” which should result in significantly higher production (170,000 -190,000 oz/yr) and lower costs than those in 2014 and the estimates for 2015.

Average Grade and Operating Costs

Operating Costs have been rising with falling production, which coincides with the declining average grade. Even at the current level of 51% of revenues, Operating Cost is manageable particularly if production increases as management expects.

Investments in Mining Properties

IMP has shown significant increases over the last 3 years as the company looks to sustain operation and develop additional areas at its Mexican operations. According to management’s projections this number should fall slightly in 2015. At 31% of revenues Investment in Mining Properties is manageable.

Adjusted Free Cash Flow (AFCF)

AFCF is cash flows from operations (CFO) adjusted for changes in non-cash working capital less Investment in Mining Property (IMP). Cipher uses this number as its measure of the real profitability of the operations. As shown this number has fallen from 140 million in 2012 to 1 million in 2014.

Total Operating Costs and Break Even Price of Gold

Total Operating Cost is calculated as Revenues less Adjusted Free Cash Flow (AFCF) and represents the total costs incurred running the mining operations. Calculated this way we are sure to capture all of the costs associated with the operations. When divided by the total ounces produced we derive the break-even price. This is the price of gold which would sustain operations but not allow for growth or other return on investment.

Adequacy Ratios

Cipher calculates 2 Adequacy Ratios, the first one Cash Adequacy Ratio (CAR) is based on actual inflows and outflows for the company and is calculated as Revenues/Total Operating Costs + Dividends paid + Debt Repayments.

The second is Cipher’s Cash Adequacy Ratio (CCAR) where we measure the ability of the company to offer reasonable returns on investment. In this measure we use total debt plus share capital as the measure of the company’s total investment. We deem 10% on debt and 5% on equity as reasonable returns for those investments and use them in the denominator in place of actual dividends and debt repayments. This is our most comprehensive measure of corporate health. As we see in 2012 and 2013 Alamos had a very healthy CCAR but in 2014 it fell below 1.0. Since the company has abundant cash from previous years of very healthy operations, if this decline is temporary the concern is not as big as it would be if the number was below 1.0 for several consecutive years.

Since it is below 1.0, we must analyze further to see if the company is at risk.

Based on current production levels, we determine the company require an average gold price of $1467/oz in order for the CCAR to return to healthy levels of greater than 1.0. Conversely, based on current gold prices and operating costs the company would need to produce 172,000 ounces per year in order for the CCAR to return to greater than 1.0.

Both of these scenarios can be reasonable expected to occur in the next couple of years considering management’s expectations for production and the overall gold market. As a result we feel the company is well positioned to provide adequate returns to investors via growth in equity and/or dividends payments.

Based on the most recent years of operations we rate the Quality of Operations as MODERATE-HIGH (4.0). If production levels increase above 170,000 oz/yr as management predicts or if gold prices rise, our rating will rise.

Quality of Reserves and Mineable Resources

Mulatos Mine, Mexico (In Production)

The updated Reserve Report on the Mulatos mine in Mexico shows:

Since the mining operations have been healthy:

  • Gold price assumed is $1250/oz is reasonable
  • Cut-off grade of 0.3 g/t is adequate
  • Average grade of 1.16 g/t is good.

Based on the quality of operations we give the Reserves a grading of MODERATE-HIGH (4.0)

Aği Daği & Çamyurt project, Turkey (Feasibility Stage)

The 2 projects in Turkey have a combined Pre-Feasibility Study completed in June 2012, which resulted in the following mineable resource:

Cipher has conducted a detailed review of the report and notes the following:

  • Gold price assumed is $1250/oz is reasonable
  • Cut-off grade of 0.2 g/t is too low; raising the cut off grade will reduce the overall resource size
  • Average grade of 0.66 g/t is a red flag (at current prices it will be extremely challenging to make this project profitable)
  • OPEX estimates appear too low, tax rates assumptions appear too low, and the discount rates (5%) used are too low.

Adjusting the price forecast down to today’s values and even small adjustments to the OPEX, CAPEX and tax rates quickly erode any margins, never mind using a more appropriate risk adjusted discount rate of 10%. We give the Mineable Resources a grading of VERY LOW (1.0)

Quality of Resources

The following table summarizes the companies Resources by region and category:


  • The gold price assumption of $1400/oz is too high and reducing it will slightly impact overall size


  • Cut-off grade of 0.5 g/t for open pit and 2.5 g/t for underground are reasonable since the mine has been operated profitably using these assumptions
  • Average grade of 1.06 g/t is very reasonable and is in line with historic production at the mine and should allow for highly profitable operations


  • Cut-off grade of 0.2 g/t is too low; raising the cut off grade will reduce the overall resource size
  • Average grade of 0.64 g/t is a red flag (at current prices it will be extremely challenging to make this project profitable)


  • Cut-off grade of 0.21 g/t for oxide and 0.58 g/t for sulphide in Oregon is too low; raising the cut off grade will reduce the overall resource size
  • Average grade of 0.80 g/t is a red flag (at current prices it will be extremely challenging to make this project profitable) not to mention potential permitting issues in Oregon

Overall the Resources would be graded as LOW (2.2), with the Producing Mexican Resources MODERATE-HIGH (4.0) and the Turkey and USA Resources grading VERY LOW (1.0)


Quality of Financials

Cipher’s unique analysis of key financial information over the last three years is summarized in the following table:

The Company has a solid cash position and to date has returned 74% of its total Invested Capital

The Quality of Financials is EXCELENT and gets a grade of 5.0.

Quality of Structure

The company has share capital totaling $509 million and 127.4 million shares issued for an average cost of $4.00 per share; the highest equity offering was done in 2009 at a price of approximately $6.00 per share. The total amount raised through conventional financings was $200 million at the pricing was very reasonable for investors.

Management exercised and sold nearly 10 million shares between 2009 and 2013 with proceeds to the company of approximately $113 million. The average share price from Jan 2009 through Dec 2013 was nearly $15.00. If we use average annual share price as the sales price, management made $32.65 million, but if the year high was used it is close to $72 million. Either way the options helped finance the company albeit in a less conventional manner.

The company’s practice of granting stock options to directors management and other key persons has helped ensure that management has incentive to perform well and have that reflected in share price.

The Quality of Structure is MODERATE and grades 3.5

Quality of Liquidity & Valuation

Since inception the company has maintained reasonable liquidity; since 2006 has averaged $1.5 billion per year with levels reaching $2 billion in 2011 and 2012. This represents an average annual share turnover of just over 1.

The annual average market capitalization for the company peaked in 2011 at over $2.1 billion and averaged nearly $2 billion for he 3 years from 2010 – 2013. The average Adjusted Free Cash Flow (AFCF) for these years was $85 million meaning the company was trading at 24 times AFCF.

The Quality of Liquidity and Valuation is HIGH and grades 4.5


Quality of Management

Directors, Officers and Management all have excellent credentials, have executed well in building a highly competitive mid-tier gold mining company.

Since 2003 stock options have been exercised at prices well below the average trading price giving management the opportunity to profit from the increase in share prices along with shareholders.

Based on insiders report on Sedi, management owns a low percentage of equity, which could indicate misalignment with shareholders interest. However the salaries and benefits to related parties and the overall administrative costs are reasonable and management uses stock options to ensure key people can be rewarded with rising share prices and has done this very well in the past.

Management appears intent on building a larger mining company, which will be in the best interest of all investors.

The Quality of Management is MODERATE to HIGH and grades 4.0


The market value of a mining stock roughly follows the market value of its reserves and resources which based on Cipher’s research is currently ranging between $150-$ 350 per oz of gold in the ground. Companies with quality operations (particular with long history of it) are valued higher on the range; if the quality of operations is not as good the company is discounted accordingly.

In the case of Alomos, due to the lower quality of production in 2014, we value the producing reserves and resource (4.77 Mi oz) on the lower end of the range – at $150. We will adjust that value as the production levels are shown to grow to the 170,000 oz per year level.

At $150/oz for the producing reserves and resources of 4.77 we derive a Value of $715 million.

Our valuation would be adjusted down if grades continue to fall and/or costs rise and up if margins improve. Cipher will monitor the company closely.

The remaining 7.4 million ounces in reserves and resources were rated very low and Cipher assigns little value to them.

We currently value Alamos as follows:

  • $715 million Value of reserves and resource plus
  • $90 million paid for the projects in Turkey plus
  • $350 million in cash

Resulting in total Value of $1.15 billion or $9.00 per share.

With a current market capitalization of $940 million ($7.41 per share), Cipher considers Alamos a strong buy.


Note: Since this report the share price has risen from $7.41 on the day of the announced merger to $8.60 as of the close on 28 Apr 2015.

Columnist Rod Husband is a partner at Cipher Research. Cipher Research is an independent research and analysis company that covers the mining and metals sector of the commodity markets. For more information on this topic or on Cipher Research please visit: or contact

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