Should You Be Betting With Paulson On AngloGold's Split?

Marshall is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Billionaire John Paulson, in his 2012 investor letter, stated that he believes that a split up of AngloGold (NYSE: AU)'s operations would unlock more value for shareholders, and I believe that's true. Paulson said this about the potential upside:

Based on our analysis, AngloGold’s shares could increase in value by up to 68 percent if the company was to split its business into South African and non-South African businesses. 

I agree, but since the end of 2012 the stock is down 8.5%. Although gold miners have predominately underperformed gold prices, the next few years should prove fruitful for gold miner investors as the mines shift from 'growth' mode to 'returning capital' mode. One of those possible steps for AngloGold includes splitting into two companies, one a high-growth international business and the other a mature dividend paying South African focused company. 

Paulson is a gold "bug," to say the least. Per his latest 13F filing with the SEC (Sept. 2012), his Paulson & Co. hedge fund had major gold investments such as NovaGold, Gold Fields (NYSE: GFI) IAMGold, and Barrick Gold (NYSE: ABX)Paulson also had the ETF, SPDR Gold Trust, as his largest 13F holding, making up 29.5% of his funds' 13F assets (check out all of Paulson's stocks). 

Back in November 2012, AngloGold stated that the company is open to spinning off South African operations into a new company. Since then they have only made plans to reduce South African gold output to 30% of its total gold production, from the previous 37%, with expectations to lower this contribution even further to 20% by 2016. 

The renewed talks of South African operations spin offs comes as a wave of unrest has hit the country, including strikes. Labor unrest is expected to lower economic growth in the country, where it will take a year to recover from job losses following the strikes, according to South African Finance Minister Pravin Gordhan. South African assets are expected to continue to be a drag for AngloGold, where the company cut its dividend, almost in half, in November amidst after a number of South African mine shutdowns because of work stoppages.

By spinning off the South African assets, the gold miner has positioned itself as one of the most attractive gold mining investments. The stock already trades on the "cheap" side of the industry with a 6.4 times P/E ratio:

<table> <tbody> <tr> <td> <p> </p> </td> <td> <p><strong>Price to Earnings</strong></p> </td> </tr> <tr> <td> <p>AngloGold</p> </td> <td> <p>6.4</p> </td> </tr> <tr> <td> <p>Gold Fields</p> </td> <td> <p>6.5</p> </td> </tr> <tr> <td> <p>NovaGold</p> </td> <td> <p>--</p> </td> </tr> <tr> <td> <p>Barrick Gold</p> </td> <td> <p>6.8</p> </td> </tr> <tr> <td> <p>IAMGold</p> </td> <td> <p>8.4</p> </td> </tr> </tbody> </table>

Follow the leader? 

Gold Fileds, another one of Paulson's gold investments, announced in November that it was spinning-off its South African operations. Gold Fields' decision came after the country saw gold output fall 46% year over year in October 2012. The South African share of Gold Fields’ total output will fall to 13%, from 47%, following the split. 

Unlocking value

The recent deals by gold miners suggest that investors also see the latest industry trend of unlocking shareholder value as a positive. Barrick was up almost 10% after announcing it was in talks to sell part of its African mining business. In December, Barrick also came out and announced that it would be looking to sell other assets and had already been approached by potential buyers. This method, asset sales, could also be a way for AngloGold to further explore unlocking shareholder value, either by selling lower return or higher cost assets. As the industry undergoes various restructuring and refocusing, whether through asset sales or spin offs, there should be a shift from growth to returns. It appears that AngloGold is well positioned for this transition toward value creation, having the highest return on assets amongst its peers:

<table> <tbody> <tr> <td> <p> </p> </td> <td> <p><strong>Return on Assets</strong></p> </td> </tr> <tr> <td> <p>AngloGold</p> </td> <td> <p>12.1%</p> </td> </tr> <tr> <td> <p>Gold Fields</p> </td> <td> <p>9.0%</p> </td> </tr> <tr> <td> <p>NovaGold</p> </td> <td> <p>7.1%</p> </td> </tr> <tr> <td> <p>Barrick Gold</p> </td> <td> <p>6.6%</p> </td> </tr> <tr> <td> <p>IAMGold</p> </td> <td> <p>8.3%</p> </td> </tr> </tbody> </table>

I think the movement to unlock shareholder value and return capital to shareholders is very advantageous for investors, especially considering that gold miners have constantly underperformed the commodity for the last five years. It is about time that gold miners started looking for ways to reward shareholders, who, if they simply would have bought the the SPDR Gold Trust, would have outperformed all five of the major gold miners: 

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Gold outlook

Paulson and others, myself included, believe that gold stocks are are undervalued. The price of gold is expected to climb in the interim, which in turn will help boost gold miner earnings. Gold is currently trading around $1,670 per ounce, but a survey in November by Bloomberg shows that analysts believe gold could reach $1,925 per ounce during the fourth quarter of 2013. A number of factors should help contribute, including quantitative easing and inflation concerns, the Fed's intention of keeping short-term interest rates near zero through mid-2015, demand from China and India, and political and economic volatility in Europe (read more about what's wrong with gold stocks). 

Don't be fooled

Many of the mining companies that are operating in South Africa have been disappointed by declining productivity and increasing costs. As a result, many of the companies have been under pressure and trade at depressed multiples; notice that both Gold Field and AngloGold trade well below IAMGold on a P/E basis, which has no South African operations. Not only do I believe that AngloGold is one of the top companies in the industry, but I also believe it could get even better, namely with a South African operations spin off. 

mhargra has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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