“The world clings to its old mental picture of the stock market because it’s comforting; because it’s so hard to draw a picture of what has replaced it; and because the few people able to draw it for you have no interest in doing so.”
― Michael Lewis; Flash Boys
Have you read Flash Boys? If not, you should.
It’s a book by Michael Lewis (of The Big Short fame) in which he details the rise of high-frequency trading and its impact on the market and financial industry at large.
Lewis sets up a dramatic storyline with good and bad guys, deceit and scandal, and all of the other elements required to give a story about computer nerds widespread appeal; but the key takeaways from the book is that evolving technology can cause a massive phase shift within a market that most people, even those already participating in it, are largely unaware of.
Lewis also shows that those equipped with a barometer sensitive enough to detect these changes (and bold enough to act quickly) are able to benefit disproportionately.
There is a similar shift happening now in the mining industry. The flow and source of capital has altered irrevocably over the past several years and few investors, CEOs, or financiers truly appreciate these movements.
One person who has done an excellent job of identifying and articulating this shift is Sandstorm Gold (TSX: SSL & NYSE: SAND) President & CEO, Nolan Watson.
The Three Great Shifts
At the recent Mines and Money conference in London Watson discusses the changes in the availability of capital to miners and the evolution of equity financings. I highly recommend you check it out.
Watson covers three points:
1. Capital Has Moved From Active to Passive Investing
A significant portion of almost any financing comes from institutional equity investors (funds, banks, etc.). Sandstorm stock is held by ~50% institutions, but over the past several years the makeup, and mandate, of these institutions have shifted from active to passive.
Instead of funds that participate in a financing round (active), the money is flowing in from ETFs or Index Funds, pools of capital that by design are unable to participate in equity financings (passive). They can, and do, enter a company on the market, but are unable to place the lead order to get things started.
This means that there exists an increasingly widening capital chasm previously covered by brokers and financiers (active). You may have heard of equity financings, often referred to as PIPE’s (private equity investments in public equities) or “private placements”. This is a sector of the market extremely critical to resource companies in particular… and it’s been dying a quiet death.
How does a passive ETF participate in a private placement? The answer is it can’t.
To highlight this point. Sandstorm’s institutional ownership has gone from 0% passive investment to 30% in just 4 years.
If this is reflective of the industry at large, and Watson believes it is, that means it’s getting harder and harder for a CEO of a junior or mid-tier company to get a banker to sit down and write a check when it’s time to acquire a new project, start construction, launch a drill program, or any of the other crucial value add events in the early life of a mining company.
2. Brokers and Bankers are Disappearing at a Rapid Pace
Only a few years ago an equity financing would work like this: a mining CEO would call up a banker that he knows and tell him that he wanted to do a financing to achieve “X”. If that banker trusts the CEO, believes in his ability to execute on the goal and thinks it will add value (or maybe he just owes him a favor) he’ll agree to raise the funds; generally this is accomplished through what is called a bought deal.
This means that the bank will guarantee the financing. They’ll take the risk, raise the funds and in exchange they’ll cut a fee (~6%). To complete the financing the banks institutional sales guys will reach out to the funds and institutional investors they have relationships with and convince them to participate (usually at a slight discount to the current share price). In some cases they’ll also have their brokers call up their retail clients and bring them in.
Ever had your broker call you up with the next big opportunity you can’t afford to miss? Now you know why.
Then along came the internet. Now you can make a trade from your living room for a few dollars instead of paying your broker a cut. Additionally, the brokerage industry has undergone an evolution from the service business to the information business.
When everyone has access to the same information you don’t have to rely on brokers for tips and access to data; the ones that have survived are those with particularly strong corporate and client relationships and a value add understanding of the companies they sell (read: not many).
As less institutions participate in active investments, and retail investors are relying less and less on brokers to enter the market, the banks source of capital is depleting. Thus, the days of the bought deal are coming to an end.
Sandstorm’s own research indicates that the number of brokers focused on mining equity, at one major Canadian bank, is down 78% in the last four years!
The equity capital that the mining industry has traditionally relied on is drying up, or as Watson puts it:
“I think a lot of us have the belief, this false narrative, that one of the reasons it’s so hard toraise equity capital right now is because of things like a rising interest rate environment, people not being that bullish on gold… or because a lot of investors got burnt during the downfall of the last mining crash and it’s hard to get them to come back into it.
The reality is, the mechanism we use to get attention to a story and to an equity financing is broken, those people are no longer employed doing that job. That equity is still out there, it’s just a person sitting behind their laptop trading for $6.99 a trade.”
3. Capital Has Moved to Other Parts of the Capital Structure
A massive amount of capital has moved from direct investment in miners to investment in allocators of capital. Instead of investing directly into a mining equity deal, a growing number of institution (large funds, endowment funds, pension plan, sovereign wealth, etc.) are putting their money behind the expertise of streaming & royalty companies and private equity funds.
Watson notes that in 2004 the global value of all streaming & royalty companies was $2 billion, at the height of the bull market in 2011 this grew to $24 billion and today, despite half a decade of low metal prices, their combined global value sits at $35 billion.
Times have changed.
Fund Sourcing For The Industry
What Does it Mean?
In short it means that the game has changed for both the guys who need money (CEOs) and the ones providing it (investors).
“Building a mine is hard, it takes longer than you think it’s going to take, and it costs more than you think it’s going to cost, and in your first year of operation you lose more than you think your going to lose.”
– Nolan Watson; CEO Sandstorm Gold
Building a mine is hard and expensive, there are often more unknowns than knowns, and cost overruns and delays are the norm. Today a CEO can no longer rely on his relationships with a few bankers for a quick injection of capital or an emergency financing. Instead it often comes down to three options:
- Debt, which can and often does cripple an exploration or development stage company;
- Strategic investment from major mining companies (Teck, Goldcorp, Barrick, etc.) and royalty/streaming groups (Franco-Nevada, Silver Wheaton, Sandstorm, etc.);
- Direct investment from retail investors, also known as the Non-Brokered Private Placement.
The Non-Brokered Private Placement
A non-brokered private placement is similar to a bought deal in that its purpose is to bring in a large chunk of equity; the main difference is it cuts out the bank.
What typically occurs is that a company decides to raise capital, but instead of calling their banker they go straight to the market to complete the financing. A private placement can range from a few hundred thousand to hundreds-of-millions of dollars depending on the company, the goal and a host of other factors.
The benefit of a non-brokered placement is that a bank isn’t taking a fee off the top, the risk is that the financing is no longer guaranteed and the company may not be able to fill the order. To sweeten the deal and draw in investors the company will often issue full or partial warrants as part of the financing.
Today the companies that have access to capital are the ones that are able to engage directly with investors and rally them behind an opportunity.
A recent example of this is Novo Resources (NVO.v) who on the back of some drilling, trenching and a few very savvy YouTube videos (in which they locate gold nuggets with the help of a metal detector and jack hammer). I saw this happen:
In May Novo (of whom I am a shareholder) completed at a private placement for CAD$15 million at CAD $0.66 a unit, which included a share, and a full warrant executable at CAN$0.90.
One can wager that investors who participated in that financing are pretty happy with themselves these days. A few months later Novo completed a CAD$56 million strategic equity financing at CAD$4.00 a share with Kirkland Lake Gold; demonstrating that companies able to directly engage investors still have access to the capital needed to progress projects.
This also represents a tremendous opportunity for the informed investor…
The Autonomous Investor?
This shift in capital and the rise of online trading means that individual investors have both more autonomy and more influence than ever before.
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It also means that because companies are more reliant on individuals they have access to opportunities previously reserved for banks and brokers. This has resulted in greater access to management and an increase in opportunities to participate directly in equity financings.
In December of last year Aston Bay Resources (BAY.v), an arctic copper and zinc explorer run by Thomas Ullrich and renowned ex-Ivanhoe copper geologist David Broughton, announced that they would be raising C$4 million at C$0.16, with a half warrant executable at C$0.20. On April 2nd the financing closed at nearly C$4.5M; at that time the stock was trading on the market at over C$0.25 a share.
Two days ago (April 11th, 2018) Aston Bay announced a second financing for an additional CAN$2,000,000 at CAN$0.16 for investors they were unable to accommodate in the previous round.
Five years ago these opportunities were rare for retail investors.
Today companies are begging for their attention (and their dollars). Investors can now participate directly in equity financings, but with added autonomy comes greater responsibility. A consequence of the freedom of online trading is that investors no longer have a broker they can trust to vet opportunities for them. It’s now up to them to find the deal, evaluate the project, and appraise the management.
What The Future Holds
The evolving equity financing landscape has created a host of pitfalls and opportunities for companies and investors alike. For both parties the path to success is simple: good projects and trusted relationships.
Companies need committed investors that understand their story and back them through the ups and downs of getting the job done. Investors need to find companies they can trust, that engage them actively and openly, and continually to demonstrate they have their best interest at heart.
If you’re anything like us here at Capitalist Exploits you’re probably interested in getting exposure to these types of opportunities. This is an area that our team is heavily focused on. We’ll be sourcing and investing in deals of this nature, if you’d like to join us sign up here for our pre-launch list and learn more about the upcoming opportunity.
“I can tell you that I will not be investing either sandstorms money, or my personal money, in a mining company if the CEO does not get the concepts of how this equity market has changed.” – Nolan Watson, CEO Sandstorm Gold