unior development-stage companies in the precious metals sector face a daunting task in raising the capital needed to build new mines. Equity markets in the sector are subdued (to put it lightly) due to a lack of investor interest.
Generalist investors are more concerned about other sectors, while specialist fund managers struggle with redemptions. Meanwhile, in a twist of irony, mindlessly-managed passive ETFs, which are the largest pool of capital for precious metals mining investment, cannot allocate capital to build the projects in which they might have investments. Perhaps the lack of capital available to development stage companies is well-deserved given that investors have been burned in recent mine startups by juniors to whom capital was entrusted. TMAC, Detour, Asanko, Pretium, Rubicon, and many others have underperformed their published mine plans during startups, losing investor’s money in the process.
So, what is a development-stage company to do in its quest to maximize shareholder value? A company board and management must first make an honest assessment of the management’s ability to build a mine. In many circumstances, development-stage companies are managed by geologists, or opportunistic entrepreneurs or promoters. A different skillset is needed to build and operate a mine than is needed to find or promote one. If a company has realized that its cur- rent management is not well-suited to building a mine, it can either put itself up for sale or hire capable management who can either build a mine or adequately threaten to build a mine. If management or the board of a company has doubts about its ability to execute on a project build, it is almost guaranteed that these doubts are greatly amplified in the minds of prospective investors. Existing management must step aside if it’s the best course to creating shareholder value.
To the degree that a company chooses to go it alone, prospective investors will be focused on the jurisdiction of a project build, given that some projects in exotic locations (like the Canadian Arctic) have lead to exotic results for investors. Companies should keep this fact in mind when deciding whether they should or shouldn’t build a project themselves. A current conundrum that exists for development-stage companies that might not have the capacity to build projects themselves and would therefore look to sell, is the discrepancy between the market price of the company’s stock and the perceived valuation of the company. Many development-stage companies are trading at less than 50% of their net asset values, as described in technical feasibility studies, and company managements and boards are convinced that a valuation of 100% of net asset value can eventually be achieved in the market. Prospective acquirers, however, are unwilling to pay market premiums of greater than the typical 30%-50% of market price to acquire control of a company.
The best solution to this dynamic might be a partnership model whereby a producing company with technical expertise and access to capital acquires an equity stake in a development-stage company in exchange for a portion of the capital needed to build the mine. Continental Gold’s agreement with Newmont is a fine example of this type of arrangement. Newmont purchased newly issued equity in Continental equal to 19.9% of Continental’s pro forma shares outstanding for $109 million. Continental’s shares were trading at approximately C$3 per share prior to the transaction’s announcement, compared to Newmont’s purchase price of C$4 per share. The two companies agreed to form a joint technical, exploration, and sustainability committee, which can tap into Newmont’s expertise in these areas to help develop the mine. A producing company purchasing an eq- uity stake in a development company is preferable to producers taking project-level stakes in exchange for cash. When a minority equity position is taken, all parties are similarly aligned and incentivized to realize a higher stock price, while the option still remains for the development-stage company to sell 100% of the project to a third party acquirer.
Notwithstanding a, so far, favorable dynamic between Continental and Newmont, royalty and streaming companies in the precious metals sector have had an advantage in funding juniors, given their relatively low cost of capital. Can producing companies on solid financial footing with technical expertise to offer now compete with royalty companies in providing capital to juniors? Royalty companies’ advantage in providing capital stems from the fact that markets capitalize cash flow from royalties at a very low discount rate, such that royalty companies can afford to offer more cash upfront for less cash flow in the future. For example, I estimate that if Continental had decided to sell a royalty on production from Buritica, it could have received $109 million, the amount that Newmont paid for its 19.9% stake, in exchange for a royalty on roughly 3.5% of future production from the mine. I estimate that a royalty sale of 3.5% of future production would have been less dilutive to Continental shareholders than a sale of 19.9% of the company’s equity.
Producing companies can overcome this cost of capital disadvantage in three ways that are not mutually exclusive. The companies can demonstrate that their technical expertise is valuable, lend to the company itself at competitive rates using its own balance sheet, and offer to pay higher premiums for its equity stakes to stay competitive with offers being made by royalty companies. If producers follow this model and demonstrate that they are capable of helping companies achieve their stated net asset values, then a win-win-win scenario can be demonstrated whereby company managements, producing partners, and independent investors all benefit together.
Win-win-win financing outcomes are possible in the precious metals mining sector, and well-funded, disciplined producing companies can lead the way. In offering fair value for minority equity stakes in juniors and providing technical expertise and competitive financing, producers can demonstrate their ability to add value to a discounted project. As deals like these occur, producing companies’ valuation multiples will increase, allowing a virtuous cycle to exist in which more deals are done. There’s a silver lining to the cloud in the precious metals mining sector, and producing companies now have a golden opportunity to take advantage of it.