Keith Phillips, a managing director and head of Cowen & Company's Mining Investment Banking Group, says strong companies with solid balance sheets are on the hunt for precious metals development projects or small producers trading at steep discounts. In this interview with The Gold Report, Phillips explains that these juniors represent unprecedented value for acquirers with longer-term goals, and he tracks some potential M&A prey.

The Gold Report: Canada's Financial Post reports that as of July 30, 2014, there have been 41 mining deals worth a combined CA$7.1 billion (CA$7.1B) in 2014. The total value of the deals reached CA$9.3B in 2013. Do you believe that total will be eclipsed before 2015? 

Keith Phillips: I expect so. Aggregate deal volumes are really driven by one or two large deals in a given year. This year, Yamana Gold Inc. (YRI:TSX; AUY:NYSE; YAU:LSE) and Agnico-Eagle Mines Ltd. (AEM:TSX; AEM:NYSE) bought Osisko Mining Corp. (OSK:TSX) for about $4B, which has obviously had an impact on the aggregate numbers. I wouldn't be surprised to see one or two more billion-dollar deals, and that would drive us above 2013 levels. Obviously, there is a lot of merger and acquisition (M&A) dialogue going on. I'm optimistic that activity will continue to be strong and, with any luck, be stronger than last year.

TGR: You said there is dialogue going on. What have you heard?

"NOVAGOLD's Donlin is one of the premier undeveloped gold assets in the world."

KP: We are in regular dialogue with our clients about their strategic objectives. For a period in the downturn in 2012 and 2013, companies were purely internally focused, driving operating and general and administrative costs to more sustainable levels. In the past several months—and we've seen this on the deal calendar—companies that have dealt with their internal issues are now trying to capitalize on lower target valuations to achieve longer-term goals. I suspect there will be some positive activity.

TGR: Are you suggesting that M&A activity in the mining space will be a value play?

KP: Yes. Value is always a core component of merger dialogue, but in today's market, buyers are increasingly focused on doing value-accretive deals. Institutional investors will punish buyers seen chasing growth for growth's sake. Explorers and developers are currently trading at steep discounts to the larger producers, so the value arbitrage for buyers is very attractive.

TGR: Will M&A be aided by rising metals prices, or will the impact be minimal?

KP: I don't see metals prices testing the highs from two or three years ago in the near-term, but I remain positive about the longer-run outlook. The thesis in M&A is not necessarily dependent on commodity prices improving. With commodity prices where they are, many situations are undervalued, and it's a compelling buying opportunity for those that are properly positioned.

TGR: As you mentioned, the biggest takeover deal so far this year was Yamana Gold and Agnico-Eagle Mines joining to buy Osisko. What are some things investors learned from that deal?

KP: A handful of things. The deal started with an aggressive approach by Goldcorp Inc. (G:TSX; GG:NYSE), which was a wakeup call for some people. Unsolicited takeover activity is considered more acceptable by aggressive boards than it used to be. That won't be the last time that a board will be aggressive if it sees an undervalued situation.

"Pretium Resources Inc.'sBrucejack is a spectacular asset."

Two strong gold producers, Yamana and Agnico, with strong balance sheets, were ready to react when a compelling situation was presented. They may have paid full value, but I see the deal as a win-win, and I think both buyers are stronger.

We don't often see joint bids in mining: Joint-venture activity is far more prevalent in the oil and gas business. I wouldn't expect a flurry of joint venture activity, but it was fascinating to see two competitors get together.

Assets of the quality of Osisko and the Canadian Malartic mine are scarce. It's a big asset in a politically friendly place that was derisked with a 15-year mine life. It was a unique opportunity for two companies to change their strategic profiles.

TGR: Do you expect more M&A between similar-size companies with complementary assets, be it cash or projects?

KP: There have been a series of "mergers of equals" (MOE) in recent years, where two management teams and boards come together to create a vehicle that's more substantial industrially, and also that's more compelling in the capital markets. All things being equal, institutional investors prefer bigger, more liquid companies, and those ultimately collect valuation premiums in the public markets. MOE activity will continue, but traditional "acquisitions" will always be more plentiful.

"Tahoe Resources Inc.'sEscobal silver mine in Guatemala is truly world class."

TGR: In June, HudBay Minerals Inc. (HBM:TSX; HBM:NYSE) bought Augusta Resource Corp. (AZC:TSX; AZC:NYSE.MKT) for about $550 million ($550M) in shares and warrants. Augusta Chairman Richard Warke was also chairman of Ventana Gold Corp. (VEN:TSX) when it was sold for roughly $1B in 2011. Can you suggest three or four other current mining chairmen or CEOs who have positioned previous companies for successful takeover bids?

KP: That's a great point. A number of executives have been successful creators of value either through monetizing a business or driving a company to market cap strength and then turning over management. One obvious example is Ross Beaty, chairman of Pan American Silver Corp. (PAA:TSX; PAAS:NASDAQ). Beyond the great success of Pan American over two decades, Ross has had a series of successes involving the Lumina Group, including sales of Regalito Copper Corp., Northern Peru Copper Corp., and most recently Lumina Copper Corp. (LCC:TSX), which was just sold to First Quantum Minerals Ltd. (FM:TSX; FQM:LSE).

Rob McEwen is the chairman and CEO of McEwen Mining Inc. (MUX:TSX; MUX:NYSE ). He was the founding CEO of Goldcorp, which he merged with Wheaton River Minerals in 2005. That was a spectacular valuation creation success, and Rob is very focused on creating similar value for shareholders of McEwen Mining.

Interestingly, on the other side of the Goldcorp transaction was Ian Telfer of Wheaton River. Telfer is now Goldcorp's chairman. He's had a series of successes, from the gold business to the uranium sector and beyond. In a market such as today's, where institutional investors approach the mining business with great skepticism, there is definitely a bias to invest dollars behind a proven winner.

TGR: What are some precious metals companies with strong balance sheets that could be looking to M&A to meet long-term objectives?

KP: Goldcorp is a strong company in every way. It has abundant capacity to continue to acquire assets.Alamos Gold Inc. (AGI:TSX) is well positioned, with about $400M in cash, but it will be very disciplined as it considers growth opportunities.

I'd also note that Yamana and Agnico-Eagle are not necessarily done. While they parted with some cash in the Osisko deal, they each have far stronger operating cash flow to finance future business. I see both of them being open minded about other transactions.

"True Gold Mining Inc. is doing a nice job in Burkina Faso."

In silver, Pan American Silver has a strong balance sheet, and is well positioned to be a consolidator.

TGR: Goldcorp owns a significant block of Tahoe Resources Inc. (THO:TSX; TAHO:NYSE). Do you believe it would monetize that to go after other assets?

KP: Hard to say. Tahoe CEO Kevin McArthur has done an outstanding job, and the Escobal silver mine in Guatemala is truly world class. I'm sure Goldcorp is happy with Tahoe's stewardship of that asset, and certainly its Tahoe stake offers some financial flexibility if it wanted to do a large deal in gold.

TGR: What are some companies with experienced management teams that are managing quality assets in safe jurisdictions that could garner closer looks from potential acquirers in an undervalued market?

KP: A recent research report by Adam Graf focused principally on preproduction development-stage assets, which have been beaten down the most. From a valuation arbitrage perspective, the gap between a big producer and a small preproducer has never been greater. NOVAGOLD (NG:TSX; NG:NYSE.MKT), Pretium Resources Inc. (PVG:TSX; PVG:NYSE) and Seabridge Gold Inc. (SEA:TSX; SA:NYSE.MKT) are good examples. Others, like Paramount Gold and Silver Corp. (PZG:NYSE.MKT; PZG:TSX), Gold Standard Ventures Corp. (GSV:TSX.V; GSV:NYSE) and Gold Canyon Resources Inc., (GCU:TSX.V) are also attractive.

TGR: NOVAGOLD bills itself as an "unrivaled opportunity for investors seeking leverage to gold." Its 50%-owned Donlin gold project in Alaska has 39 million ounces (39 Moz) in Measured and Indicated reserves. But the sheer size of that project also means things like permitting and environmental impact would take longer to complete. Is that something investors understand?

KP: Investors definitely understand it, but it's true—Donlin is one of the premier undeveloped gold assets in the world, full stop. There's also a strong partner in Barrick Gold Corp. (ABX:TSX; ABX:NYSE). Donlin is a large, high-grade opportunity in a good jurisdiction, and once it becomes a mine, it will be producing for decades. It's one in a handful of truly strategic assets in the world.

TGR: Cowen and Company, JP Morgan and RBC Capital Markets all cover NOVAGOLD. Does that help NOVAGOLD get the money it needs to develop Donlin?

KP: That institutional support is certainly helpful, but a project of that scale is challenging to finance in today's market. In the market we had four years ago, it would be viable, and we will certainly see such markets again in the future. NOVAGOLD and Barrick are advancing the project and there will ultimately be a construction decision, but even if Donlin were permitted and ready to go, and all they had to do was spend the money, I expect they would both choose to pause and wait for better capital markets and better valuations.

TGR: You mentioned Pretium, which is on a number of lists of potential takeover candidates in the junior mining space. I'm not aware of any offers made for Pretium.

KP: Well, for an offer to be made public, it would have to be either hostile or accepted by the board. It's fair to presume that the board doesn't think valuations are compelling right now, so it would have to be hostile. It's very unusual to do a hostile on a preproduction asset that has not been derisked.

Brucejack is a spectacular asset. Pretium CEO Bob Quartermain has done a great job, but this is a technically complex asset that would require proper due diligence. My sense is the Pretium management and board have their interests properly aligned with shareholders, so I suspect it's a matter of time before a larger company makes a compelling proposal.

TGR: Seabridge recently received environmental approval for its massive Kerr-Sulphurets-Mitchell (KSM) gold-copper project in northern British Columbia. Is that a game changer?

KP: It's definitely important. It's a large asset. The Seabridge team has done an outstanding job advancing KSM from all perspectives, from exploration to engineering, and very importantly on the social and permitting sides. Seabridge has been diligent and patient, and I was not surprised to see it get this permit. Now I expect it to get federal approval.

TGR: Will Imperial Metals Corp.'s (III:TSX) tailings dam failure at its Mount Polley mine in British Columbia affect Seabridge?

KP: It's a great question. What happened at Imperial is unfortunate, and the entire industry will learn from that occurrence to make the mining world safer going forward. Having said that, Mount Polley and KSM have little in common, other than being located in the same jurisdiction! What mine developers need to do is ensure they are advancing their projects to the highest technical standard, and I'm confident that Seabridge has approached KSM from that perspective from the beginning.

TGR: What are some other companies that investors should be aware of?

KP: Guyana Goldfields Inc. (GUY:TSX) is worth mentioning. This is a Toronto-based company with a sizable high-grade, open-pit gold project in Guyana. It's fully permitted, fully financed and in construction. Production should start later this year. There will be a startup curve, but over the course of the next 12–18 months it will ramp up to full production. If the ramp up goes smoothly, Guyana stock should react quite favorably.

It's an asset that, over time, could have strategic appeal for a lot of people. It's in the Americas. It's high grade. It has a long mine life. It's low cost. That's one people should have their eyes on.

TGR: When does management expect to generate free cash flow?

KP: Probably sometime in 2015.

TGR: Are there others worth noting?

KP: Paramount is interesting. Its core project is the San Miguel gold-silver project in Chihuahua, Mexico. It's at the preliminary economic assessment phase. It has good grade and could be a fit for a lot of people. That's another one to keep your eyes on.

TGR: You also listed Gold Standard Ventures among your potential takeover targets. Is that because it has projects in the Carlin Trend?

KP: It's more than that. It has the Railroad project, an outstanding exploration target that is potentially very large and high grade. Those kinds of assets are hard to come by. It's early, and drilling there is expensive. It's a junior in a difficult capital market, so it's not in the best position to raise capital. Six or seven years ago, this kind of company would have raised a lot of money and been drilling hard, but it's been moving relatively cautiously.

TGR: What types of companies would be interested in that kind of asset?

KP: Gold Standard has two assets, Railroad and Pinion. Railroad is really a big company asset. It's a Newmont Mining Corp. (NEM:NYSE), Barrick or Agnico kind of asset. Someone that's big can do the right drilling. Pinion is likely something that could fit in portfolios of more modest-size companies. Over time, it's quite possible we will see different owners of those two assets.

TGR: With the exception of Guyana Goldfields, the one thing that all these companies have in common is that they are in North America. Is that a coincidence?

KP: Our business tends to focus more on the Americas and less on some other parts of the world. We don't spend a lot of time in Australia, and we don't spend a lot of time in Africa, but there are some pretty compelling opportunities in West Africa. Companies like True Gold Mining Inc. (TGM:TSX.V) and Roxgold Inc. (ROG:TSX.V) are doing a nice job in Burkina Faso. We don't cover them as actively, but we have a lot of respect for both of those groups.

TGR: Could you give our readers a couple of final thoughts on mining M&A?

KP: You should expect private equity investors to continue to look hard at the space. Leucadia National Corp. (LUK:NYSE) recently made an investment in Golden Queen Mining Co. Ltd. (GQM:TSX). There are lots of private equity people with cash in what continues to be a difficult capital market, and they review opportunities regularly. There was private equity interest in Marigold, which Silver Standard Resources Inc. (SSO:TSX; SSRI:NASDAQ) ended up buying. Private equity investors will continue to look at some of these companies and compete with the traditional public buyers, if need be.

TGR: Heading into 2013 and then into 2014, many mining pundits believed that private equity was going to be quite active in the mining space as valuations sunk lower and lower. Why hasn't private equity been more active?

KP: There have been numerous private equity investments in the space but we haven't seen the blockbuster deals. Most traditional private equity firms prefer private, "control" situations, and the mining business tends to be a "public company business," particularly in the precious metals space. Also, the traditional leverage buyout model doesn't work well in mining because commodity cash flow swings are too volatile. It's tough for private equity to fund preproduction assets. It happens, but it's challenging.

The mining-focused private equity firms have actively been pursuing minority investments, and that will continue—these are deals where people buy, say, a 19% position in a company and take a board seat. Some recent examples of private equity investments include True Gold bringing in Liberty Mutual Insurance Co., Appian Natural Resources Fund L.P. taking a stake in Roxgold and Leucadia buying into Golden Queen. But you're right, the traditional large U.S. private equity firms, the Apollo Global Managements (APO:NYSE), etc., haven't deployed their capital yet. The time will come when they will.

TGR: Please compare the current deal flow at Cowen & Company versus this time last year.

KP: It's much stronger now. A year ago, clients were really internally focused and trying to understand where the bottom might be in the gold market. People tend to believe we've since hit the bottom. The breakout has not happened, but people feel there's more opportunity on the upside than risk to the downside.

TGR: Parting thoughts?

KP: The most important thing we haven't talked about is the institutions. Long-only institutional investors largely abandoned the gold space a couple of years ago, based on declining gold prices, rising capital and operating costs, and disappointing performance by many companies. With gold prices having stabilized and bounced off the bottom, and companies successfully improving their cost positions, we are beginning to see institutions looking at the sector again, particularly at these low valuations. The strong M&A activity is also attracting investors, as shareholders in the Osiskos and Augustas of the world have been rewarded with strong premiums in 2014.

TGR: Thank you for your insight, Keith.

Keith Phillips is a managing director and head of Cowen and Company's Metals & Mining Investment Banking Group. Phillips joined Cowen upon Cowen's acquisition of Dahlman Rose, where he had similar responsibilities. Previously, he was with J.P. Morgan, where he headed the investment bank's metals & mining practice. He previously ran the metals & mining investment banking groups at Bear Stearns & Co. and Merrill Lynch. Phillips has worked with over 100 metals & mining companies during his 28-year Wall Street career, including established global leaders such as Rio Tinto, Vale, Barrick Gold and Peabody Energy, successful growth companies such as Goldcorp, Yamana Gold and Pan American Silver, as well as exploration and development stage-companies such as Silver Standard Ventures, NOVAGOLD, Seabridge Gold, Guyana Goldfields and Gold Canyon Resources. Phillips received his master's degree in business administration from the University of Chicago and a bachelor's degree in commerce from Laurentian University in Canada.