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 June 10, 2015 - 11:16 AM EDT
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There Are Way Too Many Gold Companies In The World

There Are Way Too Many Gold Companies In The World

The "Rule Of Three" in business was first hypothesized by Bruce Henderson of the Boston Consulting Group in 1976. Later it was tested and modified by other individuals. The idea is that a stable, competitive industry will never have more than three significant competitors.

These "Big 3" are called generalists, and they typically have 40 percent, 20 percent, and 10 percent of the entire market respectively. The financial performance of generalists gradually improves with increases in market share. The rests are known as specialists, they must find a niche in that respective industry just to remain a viable business. As smaller players try to grow market share, their margins shrink. Which is why the companies "in the middle" (also known as the "ditch"), almost always are the worst financial performers. They generally have a 5-10% market share and a weak competitive position. Companies close to the ditch are likely to fall in so they want to be as far away from the middle as possible.

(click to enlarge)

(Source: "The Rule Of Three" book)

There are an umpteen number of examples of the Rule of Three, across a wide range of industries. If we look at the cell phone carrier space, it's Verizon (NYSE:VZ) and AT&T (NYSE:T) at the top with about 68% combined market share, and Sprint (NYSE:S) was in third place until T-Mobile (NYSE:TMUS) started to make a run at gaining subscribers. Now those two are battling it out, and trying to merge (unsuccessfully) because either one could fall into the ditch. Below are many other examples just in the tech space.

(click to enlarge)

(Source: Forbes)

However, there isn't a "Rule of Three" for the gold industry. About 3,000 tons of gold were produced worldwide during 2014. That's 96 million ounces, or $115 billion in revenue using a gold price of $1,200. Barrick (NYSE:ABX), Newmont (NYSE:NEM), and AngloGold (NYSE:AU) were the largest gold producers in the world during 2014 (not including state owned mining companies), but they mined just 15.5 million ounces of those 96 million ounces that were produced worldwide. That's just 16% market share for the "Big 3". The rest of the top 10 gold producers (shown below) mined just as many ounces combined.


There are literally hundreds of publicly traded gold producers that help generate that $115 billion in revenue and 96 million ounces of production. And there are over 1,000 gold explorers and developers looking for more gold or trying to build new mines. Just check out this list here.

The reason the "Rule of Three" doesn't apply to the gold industry is gold companies aren't really "competing" against each other in the normal sense of the word. They might battle it out in the race for a certain deposit, or acquisition targets, or investors' dollars. But in the end, each individual gold company can go about their business, and not feel threatened by larger players in the sector. After all, every producer sells their product for the same price, which is the spot price of gold. Almost all commodity sectors are like this, but gold also has the advantage of being "precious", so it's not easy to just increase supply, which could decrease the price and drive marginal players out of business.

So really these gold companies are just competing against themselves. Can they run a profitable business, can they grow it, can they produce shareholder value?

This might seem like a luxury for gold stock investors. I mean hey, not having to worry about competition and being taken down by a larger player makes it easier to sleep at night. But this also results in a very troublesome outcome, which is too many companies in one sector. If you don't have competition that can drive you out of business, you can stay in business for a long-time. Sucking up investors' resources and continually producing undesirable returns.

This is where we are at in gold at the moment. This is a very divided industry, with everybody off in their own corner doing their own thing. Which is probably why these companies have consistently underperformed.

Consolidation Is Desperately Needed

During 2006-2010, we saw many mergers and acquisitions take place in the gold industry. Meridian Gold was purchased by Yamana (NYSE:AUY) for $3.5 billion, Kinross (NYSE:KGC) bought Red Back for $7.1 billion, you had Metallica Resources, Peak Gold, and New Gold (NYSEMKT:NGD) combine in a three way merger, Barrick bought Placer Dome for $10.5 billion, Goldcorp (NYSE:GG) bought Glamis Gold for $8.6 billion in a $21.3 billion business combination, etc.

There were some real blockbuster deals occurring, and the gold industry was experiencing a lot of consolidation. Stock prices were doing extremely well at that time too. In 2010 though, things started to slowdown, and the last few years there have hardly been any big M&A deals amongst gold companies. It feels like everything has just ground to a halt.

The industry simply needs to shrink in size, there is no need to have all of these gold producers in existence. There is a massive amount of competition for investors' dollars simply because of the amount of publicly traded gold securities. 75% of these companies shouldn't even be in business, at least in their current form.

The companies in this industry are holding themselves back by keeping this trend going. Many have good operations mixed in with some bad ones, which creates a marginal investment opportunity. They need to merge/acquire and create gold conglomerates that can perform better in both an up and down precious metal environment.

Instead we are seeing companies just rotating assets, with many unloading their non-core or higher costs mines to other gold producers.

The miners need to take a page out of the banking industry's playbook. The 2008-2009 financial crisis really brought back the "Bad Bank" strategy, where a bank divides its assets into a good pile and a bad pile. The good pile has the core assets that represent the ongoing business, the bad pile is the junk like risky mortgages, non-performing loans, etc.

The gold industry should do the same, but also take things a step further by completely offloading these "bad" assets instead of just separating them. We do have this occurring to a degree, for example Yamana Gold is unloading its junk into a spin-off called Brio Gold. But I'm suggesting taking this to a much higher level and across the entire industry.

Bullet-proof Gold Companies

The reason why the gold stock sector has produced such poor returns over the last decade, even though the gold price is still up over 100% during that time, is because there are no companies in this industry that are close to being bullet-proof. Actually there is one exception and that would be Franco-Nevada (NYSE:FNV), but it's a royalty company, not really a producer as it gets its gold from other miners.

The point is, there is no "Big 3" in the gold industry, and there never will be since it would be impossible for three gold companies to produce 70% or more of the annual worldwide gold production.

That's unfortunate, as the big dog usually has great margins and a great stock price to go along with it. It is possible for the gold industry to get around this, however, a massive change in thinking and structure is needed.

It's time to separate the good from the bad, give investors a place to park their hard-earned money for the long-haul. Create several bullet proof companies that can consistently generate strong returns over the long-term.

Does IAMGOLD (NYSE:IAG) really need to exist on its own? It's got some good assets and some bad assets. Does this company just keep on going in its current form? In the last 10 years it's down 65%, while Gold is up 174%. Need I say more?

IAG Chart

IAG data by YCharts

Isn't it time we put Gold Fields (NYSE:GFI), Harmony (NYSE:HMY), and AngloGold out of their misery? Wouldn't it be better to combine the strongest assets of these into one company, and dump the junk into another?

GFI Chart

GFI data by YCharts

Kinross has got some strong operations that produce good cash flow, but does this company create shareholder value? Or does it just exist?

KGC Chart

KGC data by YCharts

I look around the gold sector and I see very exciting possibilities/combinations. Why isn't Goldcorp buying Rubicon (NYSEMKT:RBY) and their Phoenix Project, which is high grade project that is right next door to Goldcorp's Red Lake mines. Or how about buying New Gold? You have all of those high quality Canadian mines and projects (New Afton, Rainy River, and Blackwater), plus they are partnered with Goldcorp on the massive El Morro project in Chile. Or how about Yamana? Goldcorp wanted Canadian Malartic.

Why isn't Eldorado (NYSE:EGO) buying Alacer (OTCPK:ALIAF)? Why isn't Detour Gold (OTCPK:DRGDF) trying to diversify? They have a big market cap, they should use it. Why are all of these companies like Pretium (NYSE:PVG), NovaGold (NYSEMKT:NG), Almaden (NYSEMKT:AAU), Torex (OTCPK:TORXF), etc., all with good projects, still trying to go about it alone? What if all of those projects were combined into one company, imagine the premium that type of developer would command in the market.

I hate it when I hear companies like AuRico (NYSE:AUQ) and Alamos (NYSE:AGI) say they have been discussing a possible merger for years, but never did go through with it until recently. Why the wait? Why did it take Coeur (NYSE:CDE) so long to finally buy out Paramount Gold and Silver. It made 100% sense for these two to combine, but it took years for it to finally happen.

There are so many interesting combinations available, it's a shame that gold companies keep letting time go by when they can create much stronger investment vehicles for gold stock investors.

Not About A Paycheck

Some might say that M&A activity isn't happening because all these CEOs care about is their paychecks. They want to keep milking the company for as long as they can, the argument goes. It's not that simple though, and I find that argument coming from disgruntled shareholders more than anything.

The CEOs that are running these companies want to do well, they aren't just there for a paycheck. It's naïve to think that these leaders believe they can just sit at the top while their stocks underperform, and they will continue to get paid.

Look at the turnover this industry has experienced during the last few years:

  • Aaron Regent - Former CEO of Barrick Gold was fired in 2012.
  • Tye Burt - Former CEO of Kinross was also fired in 2012.
  • Gerald Panneton - Former CEO of Detour Gold, the company announced back in late 2013 that he was resigning "effective immediately".
  • Richard O'Brien - Former CEO of Newmont, stepped down in 2013.

Those are just the bigger names, many smaller gold miners have seen major turnover in the CEO ranks as well.

Most CEOs know they can't exploit a company for a paycheck. Besides, these leaders want to grow their companies, they want to do well. They get paid more if they do.

Time For Change

Change happens not just from within but shareholders and activist can get the ball rolling as well. Shareholders in this industry should demand better. Replacing CEOs is not the answer, at least most of the time. This is about creating better investment vehicles. This industry needs some major rejuvenation and re-imagination.

I do believe that a new gold bull market will soon occur, and almost all of these companies mentioned will see their stock prices dramatically increase in value. However, this doesn't fix the fundamental underlying problem of this industry. There are simply too many gold companies in existence, and there are no real bullet proof stocks (or market leaders) for investors to put their money. There could be though.

I would like to see some of these CEOs of the larger gold outfits get more aggressive. Nobody says that a takeover has to be passive, it can be hostile if need be. It time for consolidation in a major way, from the small juniors all the way up to the senior producers. There is a tremendous amount of value in many of these companies, but it can't be unlocked if you have the bad mixed in with the good. It's time to create bigger, better, stronger gold companies, get rid of the…

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Source: SeekingAlpha (June 10, 2015 - 11:16 AM EDT)