The soap opera that is the Harmony(HMY.NY) battle for Gold Fields (GFI, NY) drags on with apparent stalemate, but is drawing towards a close.

Harmony made its all-share bid for Gold Fields in mid October, with the backing of the latter’s 20% shareholder Russia’s Norilsk Nickel. The audacious bid for a company nearly twice its size was based on several claims, including Harmony’s ability to cut costs, but also focused on Gold Field’s alleged move away from South Africa: the claim that its South African mines were in “harvest mode”, and that the company was attempting to transfer profits abroad.

Be careful who you go after

Gold Fields’ vigorous counter-attack-to call it a “defense” would be mis-characterizing its vehemence-denies Harmony’s claims and attacks Harmony:

  • questioning Harmony’s ability to meet maturing debt obligations, given its balance sheet and six consecutive quarterly losses
  • criticizing Harmony’s accounting, its reserve calculations, and its ability to cut costs
  • calling the massive issuance of new shares need to complete the acquisition highly dilutive
  • challenging Harmony’s lack of management depth
  • hinting at back-door deals with Norilsk.

The bitter battle has featured numerous legal and regulatory challenges along with the bitter exchange of words. Although Harmony has beaten most of Gold Fields’ legal challenges and succeeded, in early December, in defeating its plan to merge its international assets with Iamgold, it has been losing shareholder support, given the enormous decline in the price of both companies’ shares since the bid was announced; Harmony’s stock is down well over 40% in dollar terms.

Whatever else, the saga is yet another illustration of the dangers of making a hostile bid; it shines a spotlight on one’s own company and invites negative comments from the prey (vide Coeur d’Alene last year).

It’s stalemate

Right now, the situation is stalemate. Harmony can’t increase its offer because its largest shareholders have stated they would not support that; it is very unlikely that Harmony will increase significantly the number of shares already tendered; Gold Fields can’t get on with its reorganization since Harmony controls over 30% of the company (including Norilsk’s 20%); and Norilsk is locked in to supporting Harmony. Meanwhile, there has been no progress towards a friendly solution since talks in Moscow over a month ago.

Last week, Harmony makes its offer unconditional, meaning it will accept any new shares tendered, even if they are not sufficient for control. It is unlikely to gain many more shares and almost certainly not control, with its current offer. Some analysts suggest Harmony now realizes it cannot win, but wants to gain as may shares as it can to strengthen its balance sheet. CEO Bernard Swanepoel’s comment on last week’s results call for analysts that he expected the offer to end “nearer to three weeks than three months” can be read as further indication of this.

Harmony could cash in

With 11.5% of Gold fields shares (worth US$636 million even at today’s greatly reduced stock price), Harmony’s best bet might be to arrange a sale of the shares and pocket the cash. Their gains would be reduced by their enormous investment banking fees, already standing at $46 million.

At that point, Norilsk would be released from its commitment to support Harmony. Already, the company is under political pressure from the Kremlin, and recently fired the instigators of the Harmony deal. This suggests that the company may be prepared to deal, either to sell its stake or swap it for some Gold Fields’ assets (Arctic Platinum, perhaps).

Gold Fields still wants to internationalize

Once Harmony and Norilsk are out of the way, Gold Fields would be free to return to its plan to internationalize the company. It is possible that it could renew its transaction with Iamgold, although clearly would not do that without clear knowledge it would gain the support of its shareholders this time around. Iamgold, whose shareholders had overwhelmingly supported the deal, would be supportive of such a renewed offer.

At the same time, Newmont Mining is rumoured to be circling and could become the international partner that Gold Fields lost with the defeat of its Iamgold transaction. Though Newmont has no appetite for extensive South African operations, it has a merchant bank division-the former Franco Nevada-that is expert at dealing assets. It is also possible that Newmont might follow up by acquiring Iamgold, since its assets fit neatly with some of Gold Fields’.

Gold Fields is stronger company

Of the two companies, Gold Fields is much the stronger. The fourth largest producer in the world, and South Africa’s second, it owns what are broadly acknowledged as the best mines in the country, large and relatively low cost. That, and its strong balance sheet, enables CEO Ian Cokerill to state that “we will survive (the high rand) and we will be the last man standing”. Like other South Africans, Gold Fields has pursued an active strategy of diversification, and now has about 40% of its revenues and reserves outside South Africa, with several development projects in the pipeline, including the Arctic platinum project in Norway.

Indeed, Gold Fields International (the proposed merger of Gold Field’s international assets with Iamgold), would have created the world’s 4th or 5th largest gold mining company, depending on whether looking at production or reserves.

Harmony, of the other hand, is highly leveraged, having grown by acquiring mostly high-cost mines, and has focused on domestic production; it is the leading producer of South African gold. As such, it has been particularly hard hit by the strength in the South African rand, forcing it to close several shafts over the past year.

This contrast is reflected in the quarterly results issued by both companies last week. Gold Fields reported a jump in profit, based on increasing production and cutting costs. In contrast, Harmony bled more cash, even though it did succeed in cutting rand costs again. It did sell two assets–a 20% holding in African Rainbow, a black empowerment group, for 1.1 billion and, as well as its uranium dumps-which will help it shore up it balance sheet.

What to buy or sell

Given the strength in the rand, which has appreciated steadily over the past three years from over 12 to the dollar, to just over 6, the South Africans are struggling, but do offer substantial upside on any turn in the currency. We favor Gold Fields (GFI, NY, 11.26) as the more defensive, though aggressive investors can also look at Harmony (HMY.NY, 8.09); calls on the stock, which provide the leverage should the stock turn, are inexpensive.

A January ’06 10 (YTB+AB) is only 90 cents. Given that Harmony was over $14 just three months ago, that seems like a reasonable bet. For more “conservative” speculators, the January ’07 7 ½ (OHT+AU) is only $2.35. One could sell Harmony common-protecting against further loss should the rand continue to strengthen-and put some of the money into calls, maintaining most of the upside.

One could also buy Iamgold (IAG, Amex, 6.59), a quality company in its own right, on speculation of a renewed bid.

The next several weeks should see this saga come to a conclusion, most likely with Harmony deciding to call it a day and cash in its chips, but without winning the prize.

Adrian Day is editor of Adrian Day’s Global Analyst, a premium e-mail service (P.O. Box 6644, Annapolis, MD 21401; $490/year) and president of Adrian Day Asset Management, a discretionary money manager in global and resource stocks for individuals and small institutions. Visit for information.