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Alamos Gold Inc. AGI-T is buying Canadian competitor Argonaut Gold Inc. AR-T in a bet that it can turn around the troubled Magino mine in northern Ontario.

Toronto-based Alamos on Wednesday said it had reached a friendly arrangement to acquire Argonaut in an all-stock deal worth roughly US$325-million, or 40 cents a share.

Argonaut investors are set to receive 0.0185 of an Alamos common share, and one share of a spin-out company that will hold Argonaut’s U.S. and Mexican operations. Alamos is paying a 34-per-cent premium based on Argonaut’s closing share price Tuesday on the Toronto Stock Exchange.

Alamos’s main motivation for buying its competitor is to combine its own Island Gold operation in northern Ontario with Argonaut’s Magino mine. The two deposits are located right next to each other. By combining them, Alamos says it hopes to realize US$515-million in cost savings over time by sharing mill and dam operations. Magino is located 40 kilometres northeast of Wawa, Ont.

Argonaut has experienced multiple operational setbacks since starting production late last year at Magino, which sent its shares into a tailspin. The open-pit mine has encountered grade shortfalls and reliability problems with its mill. As a result, Argonaut’s costs soared, and investors fretted about the viability of the operation, and the company’s ability to service its debt.

As part of the deal announced on Wednesday, Alamos is buying a 14-per-cent equity stake in Argonaut in a private placement financing worth $50-million that will allow Argonaut to address a shortfall in its liquidity. The shares are being issued at an 8-per-cent discount.

In a conference call with shareholders on Wednesday, Argonaut chief executive officer Richard Young expressed confidence that it is managing its challenges well at Magino.

Earlier this year, Toronto-based Argonaut ratcheted up its all-in sustaining costs for extracting gold at Magino to roughly US$1,725 an ounce and said its average grade will be 5 to 10 per cent lower than previously predicted.

“The issues are well understood. We are implementing changes to address these issues, and we are seeing steady improvements,” said Mr. Young.

Among the steps under way to get Magino on track are replacing problem parts at the mill and adjusting its blasting practices at the mine in an attempt to address the grade shortfalls.

Kerry Smith, analyst with Haywood Securities said in an interview that while there are still concerns about how Alamos will be able to solve the grade shortfall at Magino, the mill problems appear to be fixable. He cited other low-grade open-pit mines in Ontario that previously had mill problems and were subsequently able to overcome them, including the Detour Lake mine owned by Agnico Eagle Mines Ltd.

By buying Argonaut, Alamos won’t have to build a new mill and tailings pond to replace its existing infrastructure at Island Gold, which should save it US$140-million in capital expenditure. Alamos plans to eventually use the new mill and tailings facility that Argonaut built.

“It’s going to be a decent mine once they amalgamate those two projects into one,” said Mr. Smith.

While the deal will see Alamos’s production grow, and skew its production increasingly toward Canada, its costs to extract gold will climb, owing to Argonaut’s higher cost structure. The company’s liabilities will also go up, because it will assume US$240-million in debt that Argonaut was carrying.

In addition, about 350,000 ounces of production coming out of Magino over the next few years will be sold at prices that are around US$350 an ounce lower than the current price of gold because Argonaut agreed to hedge part of its output to raise bank debt.

Argonaut shareholders are expected to vote on the deal in June. At least two-thirds of votes cast must be to be in favour for the transaction to succeed. Already two investors who hold 40 per cent of Argonaut’s shares said they will vote for the deal.

The transaction between the two Canadian gold miners comes as bullion trades at an all-time high of roughly US$2,210 an ounce.

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