We Need To Kill Our Zombies
"When you start digging, so many juniors are way messier and less valuable than they first appear."
So said a friend – let's call him John – who I encountered on transit the other morning. John is a mining analyst. He worked for one of the bigger investment banks for a good many years, before moving to an advisory firm.
His group helps junior companies figure out their options. Is raising money possible? If so, how and on what terms? Are there mergers or acquisitions that make sense? How should assets be valued in such scenarios? Who might be interested?
To answer these questions, John and his team delve into a company's details. More often than not, they encounter one of two problems.
The first: promoting an overly rosy financial picture. There are many ways to spit-polish finances, some more sinister than others. On the dark end of the spectrum are companies that distort blatantly by overblowing property valuations to keep the corporate balance sheet in the black.
Less sinister are the companies that produce reasonable financial statements, but then talk a much prettier picture knowing many investors and brokers do not look closely.
"We have $1 million in the bank," one CEO told John. Great, he thought: a company with some money.
Then he went through the financials and saw all the monies owed. A quarter million-dollar property payment looming, $200,000 in accounts payable, and a $75,000 tax bill.
"They actually have less than half a million, which is a big difference," John said. "But they're telling everyone they have a million. It's not a lie but it's not the truth either, and the difference is a huge impediment to any kind of deal."
John sees CEOs gloss over all kind of financial messes in their quest for a path forward. "It's amazing how ugly so many of these companies really are," he said. "From monies owed to grossly overstated valuations to unmentioned payments looming – most of the companies I assess are a mess."
The second common problem – and one that often adds to the first – is golden parachutes.
Major miners overhauled their management teams during the bear market, replacing at least the CEO if not several top positions. Juniors didn't go through that exercise. Instead, many explorers are still being steered by managers who negotiated their compensation packages back in the heydays of 2006 and 2007.
The better among these professionals have accepted or even offered to take salary reductions. But many a contract still requires a significant payout if employment is terminated.
That is what happens if a company is taken over.
So we have junior exploration CEOs marching around town supposedly seeking someone to buy their company. After four bear years the company in question might carry a market cap of $8 million. The system could still work: a larger fish might be interested in a takeover…if change-of-control clauses didn't also demand $4 million in payouts.
That's a normal kind of number. Golden parachutes add significantly to the cost of a deal and generally are not payable in shares. They are a real impediment to M&A activity in the junior sector.
Worst of all, the temptation of a million-dollar payout distracts many a CEO from what should be the prime focus: doing what is best for shareholders. John says he regularly hears, "Just find a buyer, at any price" from company presidents who want out.
That is truly the worst. Investors have to trust that the people running a public company will pursue the highest return on capital for everyone invested. If that focus is lost, if management pursues personal gain over shareholder benefit, the system is broken.
I get it. It's been a long bear market. People are tired. Wishing your company's finances were better is understandable. Wanting out is reasonable. But actions that undermine the system are unacceptable, because they will come back to haunt.
Junior exploration investors already deserted the sector in droves after the bear market piled into a sector sick with overpromotion and unrealistic expectations to rob most portfolios blind. To win investors back everyone has to step up their game: underpromise and overdeliver, operate on conservative assumptions, and employ shareholder capital very carefully.
CEOs selling out their shareholders to secure golden parachutes is exactly the opposite: a reminder of the worst our business has to offer and a good way to ensure investors and their money stay away.
Rick Rule says the bottom is not truly in until juniors capitulate: accept money on whatever terms to drill one more hole, to buy that neighbouring property, to acquire that ridiculously undervalued competitor, to survive. That makes sense for companies that are still actually alive.
What is also necessary is for all the zombie juniors out there to stop pretending – to themselves and to others – that they are viable, that there is any chance they could be taken out, that the people at their helms are even in this business for the right reasons any more.
Don't get me wrong. There are great companies, projects, and management teams out there doing excellent work, persevering until the markets turn. These companies are why I have a portfolio of explorers and producers that I believe will generate killer returns in time.
However, the horde of zombie juniors that continue to sell false facts to raise just enough capital to cover paycheques until a suitor sweeps in (not gonna happen) or a bull market saves them (undeservedly, if at all) are not helping.
This long bear market exposed weak links in the chain that is metals exploration, development, and production. Some of those links have been strengthened. Majors are now focused on profit, not growth. Explorers no longer view equity as an endless pool and are much more careful in how they spend money. Developers have raised the bar for new projects many notches, requiring far more robust economics.
Shareholders, burned by the sector's failure to capitalize on gold's ascent and then hammered by the bear market, are thinking about coming back. To encourage their return and, importantly, to increase their odds of success this time around, the sector needs to stop these zombies from continuing to damage our reputation.
Because when your business relies on other peoples' money, reputation matters. So call out bulls**t when you see it. It's a start.
28 year investor. This is by far the best description I have ever seen of what's happening and what's going to happen in the uranium space. You are amazing.
The change is terrific for two reasons: it's current and concise. I suspect it really isn't that much harder for you to do since you always have opinions on the companies anyway. For me it provides current assessment without having to wait for an occasional update.... Another comment on your service is that you cover way more companies than I want to invest in but that provides me with a selection. I've always considered advisors as desperately needed filteres in the dog eat dog investment world. Keep up the good work