OTPP's Innovative Deal With New Gold

Aoyon Ashraf and Paula Sambo of Bloomberg News report Ontario Teachers' signs US$300M investment deal with New Gold:

New Gold Inc. surged after forming an unusual partnership with Ontario Teachers’ Pension Plan that gives the miner US$300 million in exchange for selling a portion of the free cash flow from its flagship operation.

Miners often sell rights to future production called streams, as well as royalties, to help finance development of big projects.

But in the agreement announced Tuesday with the Canadian pension fund, New Gold will sell a 46 per cent free cash flow interest from its New Afton mine over four years. After the term ends, Teachers’ has the option to convert it into a 46 per cent joint venture interest in the British Columbia mine, while New gold retains an “overriding” right to buy back the stake under certain conditions.

Investors showed their approval by pushing shares of the Vancouver-based miner up as much as 16 per cent in Toronto, the most since July, on a morning when gold was down. Before Tuesday, New Gold gained 2.6 per cent in the past 12 months, underperforming both bullion futures and its peers.

The deal is positive because it allows New Gold to help reduce its debt, while it makes the company a potential takeover target, according to Canaccord Genuity Capital Markets analyst Dalton Baretto.

“This transaction makes New Gold a more attractive takeover target to deep-pocketed, mid-cap gold producers who are looking to acquire production in safe jurisdictions,” Baretto said. However, the deal, with high costs to New Gold, has lowered the company’s net asset value, he added.

Rising gold prices have given miners of the precious metal a steady lift in the past year as investors flock to safe-haven assets amid turbulent global macroeconomic environment such as the coronavirus outbreak. However, New Gold has struggled to benefit from this surge amid missteps at its Rainy River mine in Ontario.

The New Afton deal may allow the gold miner to regain its footing, said Laurentian Bank Securities analyst Ryan Hanley, who upgraded the stock to a buy rating last week. “While we note the cost of funds may seem a bit high, the increase in financial flexibility and the potential impact of being able to use the funds to offset additional debt is a benefit,” he said in a note.

For its part, Ontario Teachers’ move appears to be part of a larger strategy to diversify its portfolio. Lower-for-longer interest rates have pushed pension funds to cast their nets far and wide in search for returns amid a slew of geopolitical risks and trade tensions. Investors looking to diversify are seeking shelter in low-volatility assets that tend to be illiquid.

The fund is diversifying so it doesn’t “regret being overexposed to one asset class in particular,” Ziad Hindo, the chief investment officer of the $201.4-billion fund, said in August.

Ontario Teachers’ said it wasn’t available to comment on the New Gold deal Tuesday.

OTPP put out a press release on this deal:

New Gold Inc. (“New Gold” or the “Company”) (TSX and NYSE American: NGD) is pleased to announce that it has entered into a strategic partnership with Ontario Teachers’ Pension Plan (“Ontario Teachers’”). Under the terms of the strategic partnership, Ontario Teachers’ has agreed to acquire a 46.0% free cash flow interest in the New Afton mine (“New Afton”) with an option to convert the interest into a 46.0% joint venture interest in four years, or have their interest remain as a free cash flow interest at a reduced rate of 42.5%, for upfront cash proceeds of $300 million payable upon closing of the transaction (the “Transaction”). The proceeds from the Transaction will be used to improve New Gold’s financial flexibility and to reduce net indebtedness.

Key Transaction Highlights

• Provides New Gold with immediate cash proceeds of $300 million at an attractive cost of capital, materially reducing New Gold’s net indebtedness and increasing financial flexibility.
• New Gold retains full operating control over New Afton during development of the C-Zone as the mine transitions to expand its operating mine life.
• Ontario Teachers’ is a world-class financial sponsor whose support of New Afton serves to increase New Gold’s visibility and its vision of creating value for all stakeholders.
• Overriding buyback option provides New Gold with the flexibility to potentially re-acquire 100% of New Afton in the future.
• New Gold will retain 100% of the exploration claims outside of the New Afton mining permit area and has granted Ontario Teachers’ an option to acquire its proportionate share of these claims upon conversion into the joint venture interest.

Summary Transaction Terms

• Ontario Teachers’ will initially acquire a 46.0% free cash flow interest in the New Afton mining claim area with a four-year term (“Interim Interest”) for $300 million in upfront proceeds and New Gold will retain 100% ownership of New Afton.
• After four years, Ontario Teachers’ has an option (“JV Interest Option”) to convert the Interim Interest into a 46.0% partnership interest in New Afton (“JV Interest”) with New Gold holding the remaining 54.0% partnership interest in a limited partnership New Gold and Ontario Teachers’ will form at the time of conversion.
• If Ontario Teachers’ does not exercise the JV Interest Option, Ontario Teachers’ will continue to hold a free cash flow interest in New Afton, but at a reduced rate of 42.5% (“Reduced Interest”).
• New Gold will hold (i) an overriding buyback option to re-purchase and cancel the Interim Interest (the “Buyback Option”) during the JV Interest Option exercise period and (ii) a right of first offer for the life of the agreements.

“We are pleased to be partnering with Ontario Teachers’, one of the world’s preeminent and most well-respected investors, in this transformational transaction that provides us with up front cash allowing us to restructure our balance sheet and lower our level of net indebtedness via a true shared risk and upside partnership focused on free cash flow. This transaction provides New Gold with an attractive cost of capital, further strengthens our financial position, allows us to benefit from the full exploration potential elsewhere on the New Afton land package and provides the opportunity to re-acquire 100% of New Afton,” said Renaud Adams, President and Chief Executive Officer of New Gold. “Ontario Teachers’ is known to conduct in-depth due diligence and partner with high quality management teams that share its values of integrity and operational excellence. We look forward to our partnership with Ontario Teachers’ as we continue our mission to turn New Gold into Canada’s leading intermediate diversified gold producer.”

“We are delighted to partner with New Gold, a leading Canadian mining company, in this distinctive transaction. We gain access to a free cash flow interest from a top quality asset in a stable and well-established mining area, with the ability to convert to a JV interest in four years. Ontario Teachers' Natural Resources group has a global mandate to pursue investments that provide attractive returns and inflation protection through exposure to a basket of key commodities,” said Dale Burgess, Senior Managing Director, Infrastructure & Natural Resources of Ontario Teachers’.

Additional Transaction Details

Under the terms of the agreement, Ontario Teachers’ will acquire the Interim Interest, effective from the closing date of the Transaction with a term of 4 years for upfront cash proceeds of $300 million payable upon closing. After four years, Ontario Teachers’ will have the option to convert the Interim Interest into a 46.0% JV Interest in New Afton, such option to be exercisable during a 60-day period immediately after the fourth anniversary of the effective date of the Transaction. Should Ontario Teachers’ elect to exercise such JV Interest Option, Ontario Teachers and New Gold will form a limited partnership and Ontario Teachers’ will contribute the free cash flow interest in exchange for a 46% JV Interest in New Afton. If the JV Interest Option is not exercised by Ontario Teachers’ during the exercise period, Ontario Teachers’ will hold the Reduced Interest, which provides Ontario Teachers’ with a 42.5% free cash flow interest in New Afton. For purposes of calculating the Interim Interest and the Reduced Interest, free cash flow is defined as: the greater of, (i) gross revenue less treatment and refining costs, operating costs, exploration costs, interest costs, British Columbia mining taxes, lease payments, and capital costs, inclusive of changes in working capital, and (ii) one dollar. For any new, jointly approved, capital project which is outside of the current mine plan, which results in free cash flow declining below zero, New Gold is permitted to recover Ontario Teachers’ share of that capital expenditure from future free cash flow payments to Ontario Teachers’. Under the terms of the agreement, New Gold has also agreed to provide Ontario Teachers’ with a minimum guarantee of approximately half of expected free cash flow over the interim period, subject to certain adjustments for realized commodity prices and foreign exchange rates.

The agreement provides New Gold with an overriding Buyback Option to re-purchase and cancel the Interim Interest during the same exercise period described above at the greater of (i) an agreed upon internal rate of return to Ontario Teachers’ and (ii) the fair market value of the free cash flow interest at that time. The Buyback Option in favour of New Gold would be exercisable in priority to the JV Interest Option granted to Ontario Teachers’ and regardless of Ontario Teachers’ exercise or intention to exercise of the JV Interest Option. The Buyback Option provides New Gold the opportunity to re-acquire 100% exposure to New Afton’s cash flows, at its sole discretion, in four years, allowing New Gold sufficient time to build the necessary balance sheet strength. Both New Gold and Ontario Teachers’ will have a mutual right of first offer for the life of the agreements.

The Transaction agreements set out certain governance rights and protections for Ontario Teachers’ in relation to the operation of New Afton, including establishment of an advisory committee to assist with operation and budgetary decisions.

The Transaction is subject to approval under New Gold’s credit facility and is expected to close on or about March 31, 2020.

Scotiabank is acting as financial advisor to New Gold. Cassels Brock & Blackwell LLP and Lawson Lundell LLP are acting as legal counsel to New Gold. BMO Capital Markets is acting as financial advisor to Ontario Teachers’. Stikeman Elliott LLP is acting as legal counsel to Ontario Teachers’.

New Gold looks forward to working with Ontario Teachers’ to realize the full potential of New Afton, where both New Gold and Ontario Teachers’ see significant value creation opportunities. Both New Gold and Ontario Teachers’ are committed to working with local communities and other partners to ensure New Afton generates value for all of its stakeholders for many years to come.

About New Gold Inc.

New Gold is a Canadian-focused intermediate gold mining company. The Company has a portfolio of two core producing assets in top-rated jurisdictions, the Rainy River and New Afton Mines in Canada. The Company also operates the Cerro San Pedro Mine in Mexico (which transitioned to residual leaching in 2016). In addition, New Gold owns 100 per cent of the Blackwater project located in Canada. New Gold’s objective is to be a leading intermediate gold producer, focused on the environment and social responsibility. For further information on the Company, please visit www.newgold.com.

This is definitely an interesting deal which caught my attention yesterday. The key is what Dale Burgess, Senior Managing Director, Infrastructure & Natural Resources of Ontario Teachers’ states:

"We are delighted to partner with New Gold, a leading Canadian mining company, in this distinctive transaction. We gain access to a free cash flow interest from a top quality asset in a stable and well-established mining area, with the ability to convert to a JV interest in four years. Ontario Teachers' Natural Resources group has a global mandate to pursue investments that provide attractive returns and inflation protection through exposure to a basket of key commodities."

Now, it remains to be seen if after four years Ontario Teachers' converts its cash flow interest into a partnership interest, with New Gold retaining 54% ownership of the copper-gold mine, or if New Gold exercises its Buyback Option to re-acquire 100% exposure to New Afton’s cash flows.

Why is OTPP striking this deal? As Ziad Hindo, CIO of OTPP states in the article at the top, the fund is diversifying so it doesn’t “regret being overexposed to one asset class in particular.”

But it's more than this. From a risk-reward perspective, given rates are at record lows, Teachers' sees this deal as a way not only to diversify away from public markets but to also hedge against future inflation risk.

After all, the team bringing this deal forth is the Infrastructure & Natural Resources team, assets that are seen as inflation hedges.

And $300 million is no small chunk of change for Teachers'. It could have put that money into stocks, bonds, hedge funds, private equity funds but chose this innovative deal for a reason. It conducted a thorough due diligence and partnered with a high quality management team looking to develop the New Afton mine to its full potential.

For New Gold, the cash infusion allows it to reduce its debt load and focus on operational excellence. If all goes well, it will re-acquire 100% of New Afton in four years. Even if it doesn't, having a partner like OTPP isn't a bad thing.

Lastly, before I forget, I'd like to publicly congratulate Katie Lokash, Senior Principal at Teacher's Private Capital, for being highlighted as one of The Deal's top women in private equity:



Good for her, quite an honor and endorsement from her boss, Jane Rowe, who states: “Katie is a fantastic example to anyone looking to succeed in private equity. Our industry needs more people who can bring great communication skills, agility and intuition to match their deep industry knowledge. In short, we need more Katies.”

Below, Jaime Carrasco of Canaccord gives his outlook for shares of New Gold. He recommended to "stay away" but that was before the company signed this deal with Ontario Teachers'.

Also, when I look at the five-year weekly chart of the VanEck Vectors Junior Gold Miners ETF (GDXJ), it looks pretty good to me:

Lastly, in a webcast Thursday (Feb. 13), New Gold President and CEO Renaud Adams updated the public and shareholders about plans for New Afton, as well as the Rainy River mine in northwest Ontario.

Adams says over the next five years, the company plans to put $460 million into developing the New Afton C-zone, deeper and to the east of the current caves. The development will be self-funded by the company. You can watch that clip here.