Funding: Industry Partners, Royalties & Market Cap v NPV And Conclusions

So starting with industry partners. Industry partners in situations where junior companies take investments from bigger companies is what I'm going to be talking about now. And it's an interesting topic because it can be a really valuable source of capital for a junior company. But I'll just make a few observations on what

the major companies doing here? What's their philosophy? Industry typically has very different goals to private equity or indeed equity investment funds, long-only institutions. Industry isn't really looking to make money from the investment per se. What they're trying to do is to buy access to information and potentially an entry into an area. A mining company...

doesn't really care what the share price of the junior is doing, within reason of course. But if you're a $100 million market cap company and you invest a few million dollars into an exploration company and that exploration company suddenly becomes a ten bagger, then yes it is relevant to your position. And I've seen that often where...

Companies have got a kind of a minority position in an exploration play that suddenly becomes a source of capital for them so they can sell it and trade it. But essentially, a producing company, which is mid-tier or higher, has little interest in the share price of the junior company in which they're investing. Producing companies are looking for the next generation of assets to support their steady state or their growth plans. They're looking to replace resources or add resources.

Larger companies can also fund management teams and new junior companies so they can gain better access or a better understanding of a region or an asset. And this is a strategic approach and the monetary stake is much less important, much less interest, and therefore they don't typically offer any selling pressure over time.

For this reason, larger mining companies can often take a position, whether it's Sentera, or Teck, or Kinross, or BHP, or Newcrest. They can take a 10% or a 15% or a 20% position, or they can reach into, in the habit of doing this over the last 15 years, or doing an exploration agreement with a junior company. And then these bigger companies can sit back. Once they've made the initial effort in terms of time and commitment,

getting to the point where the lawyers have been happy to sign off on it. At that point, they're quite often happy just to see their initial investment passively dilute through subsequent placings. Now that those communication lines, those links with the exploration company have been established. Liquidity is pretty much irrelevant for them. Their goal is to better understand the region. They want to know if this junior company in question is going to develop an asset capable of being a part of their future portfolio.

Producing companies also have a completely different way of assessing risk to your average investor. They're not too fussed about the capital structure or about the shares or the warrants or the options and everything else that a retail investor or normal investor has to

consider so carefully. Producing companies are much more focused on the metallurgy, the geology, the continuity of the mineralization and the ground conditions for mining. They're focused on the technical side of things and whether this asset is going to be

something that ever comes out of the ground and would suit their growth plans or their production plans. Whether it's going to be capable of sustaining production for their investment horizon at a level that's going to suit them.

When an industry partner comes into a stock, obviously it can be a good sign because they think, oh, this is a good asset, let's just ensure that we don't miss out on learning as much as we can about this area. I would say that the amount of capital that's invested, the size of their investment is perhaps of less interest to the retail investor. And that by having the companies on your board or on your shell to register, it's not in itself necessarily a sign that everything's fine. You know,

you can see a company which has got a passive investment by a big mining company that's been there for years. And they might have just written it off because they've seen that the exploration potential or the management team haven't shaped up. So rather than selling it, they just sit there. I mean, it doesn't matter to them. It's just photocopying money. There are many more up-to-date factors that one should look out for in your investment.

due diligence for a company rather than just, oh look, tech or whoever is a shareholder. For example, look at the funding history. Is this next share issuance that your company that you're thinking about buying into happening at a higher or a lower price than the previous one? Look at the news flow. Don't be distracted by the fact that, oh, company, big company A is on the shareholder register. It's, it's, it's not for you. It's for them. Now

For junior companies to get funded, the availability of capital through the cycle is of course a critical factor. Many companies get financed in the bull market, but only very good assets get funded in the bear markets. And moving away perhaps from the majors, during the last downturn in the bear market, alternative financing methods proliferated. I've spoken in a previous episode about the role of private equity

played and the way that stepped up to be pretty much the one of the funding sources of last resort. But royalties were also being issued. And of course, there were offtake rights, pre-production financing, underlying sales and the asset, and that's a classic one. But when you've got a major capital investment ahead of you, when you're a junior company trading at a discount to the value of the assets,

the sale and underlying sale in the asset is a really key thing to consider. The first time I saw this was in the mid 1990s when Randgold was really struggling with Sayama. Randgold was hemorrhaging cash because of the roasting process and refractory ore at Sayama, but they had a really good exploration development asset in Mali called Marilla. They just didn't have the capital to build it. And because the state of their balance sheet,

They couldn't finance it and they knew that they needed the cash flow from Marilla to turn the fortunes of the company around. They didn't want to sell the asset, so in the end what they did was they sold half of it to Angler Gold, who paid for their 50% by covering the capex with the entire mine. And it's not going too far to say that Marilla saved Randgold resources. And not only that, but the 50% share of production from Marilla saved Mark...

Bristow's bacon and the rest is history. Merilla made so much money that it covered all the losses at Sciamma and enabled Rand Gold to start growing. And of course, since then, Mark Bristow has done fantastically well and is now the CEO of one of the largest gold miners in the world, Barrick. So a strategic decision to sell 50% of an asset to get it financed into production was the right thing to do.

Going back to royalties, often junior companies in a stress situation will sell a royalty. Now remember that some majors, major companies, producing companies and many institutional investors don't like junior companies having sold royalties unless that royalty has been capped. Uncapped royalties can be a poison pearl. And some companies, I mean I know that

from smaller companies or assets that have got onerous royalties on them. So if you're an investor in a junior company and you're looking for the company or your investment to be bought out, you've got a better chance if the company has only sold royalties that are capped rather than uncapped. Remember that one of the most attractive aspects of the resources sector is optionality, leverage to rises in commodity prices or leverage to any new discovery.

and royalties pretty much remove all of that optionality. Ever wondered why the royalty companies as a group do better than the producers as a group? Well, apart from not having to operate all that dirty machinery and deal with geologists, the royalty companies are experts at capturing the optionality upside at the expense of the operating companies.

One more thing to consider really is the market capitalization of your company that you're looking at versus the NPV of the project in question. This is one of my bug bears in the sector and I call this the market cap trap where a junior company has an asset with a very large NPV but the market capitalization is way below that. In these kinds of situations it's almost impossible to get the project financed and it's a vicious circle.

You have to be extremely cautious not to be lulled into thinking that this is an opportunity because this discount will be removed. The only way that those companies can get their equity portion financed is by going through massive dilution. And therefore the time to invest in those companies is when they've got their financing sorted. There are some ways out of the market cap trap, but you really have to know what you're doing. Generally there are things to avoid. And I'll actually just bring it back and say that

probably one of the best ways is to sell 50% of the asset in order or in exchange for the 100% of the capex to be carried. So in conclusion, when you're looking at trying to understand how a company is financed and how it will continue to be financed, it's good to have a good mix of professionals and owners on that shareholder register.

the original people who picked up the idea and have equity positions, as well as some more recent additions to the management team in the form of professionals who know what they're doing and getting reasonably paid, but not overly paid. I always urge investors to check the GNA of a company. You want to make sure that the GNA is reasonable. And what is reasonable? I would say two to $3 million, that's fine. Make sure the company has got rewards to the upside.

for good performance and they're not getting paid too much. It may be tedious, but you do need to check the small print. You need to download or open the financial statements, go into the annual accounts and actually look at the remuneration table. It really does matter. Check the small print. Has this CEO or whoever been paid handsomely for many years and the project not progressed over a number of years? Anything more than about five years and you realize that this is actually a lifestyle company rather than a development.

Another critical factor is to try and understand the health of the company, how it's been funded and how it will be funded. Check the record of share issuance. Has it been done at continually lower, bad, or continually higher prices? Good. Has the same management team presided over a period of good value for money or bad value for money? Be wary of companies where the number of shares has grown in excess of the number of the percentage gain in the share price.

What levels were the previous issuances done at? I come back to that. Has their investment dollar been spent well or has it led to an 80 cents on the dollar return or a $2 return investment on the dollar? Remember that institutions are subject to very different pressures to you or I. They get different access to company information. They can meet the CEO on a much more regular basis than you can. They face greater hurdles to getting into a stock but once funds are in they can be very loyal and liquidity is always a plus in any company. Liquidity is an asset which is worth following.

Another key point is you've really got to ask yourself is the company funded to reach its goals? Has it got enough money to pay for the G&A and to fund the next phase of work that's going to be, that's going to genuinely be a value catalyst that will de-risk or rerate the company? Watch out for poison pills in the forms of offtake agreements, which actually transfers value to other companies or onerous royalties, which may prevent your exploration company from being taken up by a major. Or royalties that give away the upside in terms of exploration success or leverage to a commodity.

I come back as a final thing that is so important. You need to have clarity from the management team as to how they will drive value on this funding cycle. You need to be comfortable that your management team, the CEO, knows how it's going to take $1 and turn it into $2, maybe $5 or $10. Thank you very much.

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