As spring turns into glorious summer in Canada, it is easy to forget that only a short time ago, the metals bull market we now enjoy was recently a desolate Canadian winter! Between 2012 and 2019, cheap, grizzly bear market valuations in the mining sector were the norm and a painful reminder to investors of the sector’s cyclical nature.
Today, at Dundee Goodman Merchant Partners (DGMP), a division of Dundee Corporation, we believe we are in the early innings of what is likely to be a multi-year bull cycle for the mining sector. With the onset of the global pandemic in 2019, upward price appreciation in precious metals accelerated as governments responded aggressively to the crisis. States worldwide continue to pump trillions of dollars of liquidity into the global economy on an unprecedented scale while keeping borrowing costs near zero. This dynamic has led to a meaningful uptick in global inflation. At the same time, increased demand for metals serving the “green energy economy”, as well as “hyper-connectivity of everything”, has resulted in robust inflows of capital into the mining space. This phenomenon has come at a time of limited new supply due to many factors, including a lack of investment, supply chain disruptions, ESG considerations, jurisdictional (political) risks etc., which have slowed the market response.
The early years of any bull market are where the most significant gains are made as fresh capital floods in to resurrect a once dormant sector. Appreciating that change in sentiment is critical for speculative investors who rush in seeking relatively easy early returns on stocks. At this stage, typically, these players need not get too granular concerning valuations or due diligence as a rising tide floats all boats! With some hindsight, early 2020 constituted that aforementioned “purple patch” for the junior mining sector! Not surprisingly, picking winners today is much more difficult, and investors need to be very discerning when deciding which bets to make.
Rigorous due diligence
To help fireproof yourself from getting burned as we transition into the next phase of the bull cycle, a rigorous due diligence process, coupled with proper alignment of interests – “skin in the game” – between management and investors is crucial to protecting your investments and rebuilding trust in the junior mining sector.
Thus, at DGMP, before we consider making any significant investment, we first conduct a thorough process of due diligence. Only after our team has come to a positive conclusion on an investment opportunity would we ask outside parties to invest alongside us. Today, we see a persistent flow of new issues (privates, IPOs, RTOs, secondaries, capital raises) for all stages of mining companies. Much of the time, these companies’ pitches sound like the greatest investment you have ever heard and, as Robert Friedland would say, “the hand to wallet reflex” is stimulated. However, it is at this point in the cycle where the real work for us begins, and that work goes well beyond comparative analysis charts and “arm wave” predictions of future production and cash flow!
As a capital provider, we are often able to offer a price and help structure a deal as a lead order in a financing. Understanding a company’s project, geology, jurisdiction, infrastructure, ESG considerations, their pathway to a resource or project development plan, initial metallurgy, management reputation etc., are only some of the key factors to consider. However, the reality for most investors is that they do not have the capacity or experience to conduct this process themselves. Within our team at DGMP, we have the relevant technical, financial skills and expertise to filter the massive volume of mining investment opportunities that we see every day.
“Don’t tell me what you ‘think’, just tell me what is in your portfolio” – Nassim Taleb
Critical questions and challenging discussions
Before making an investment, investors need to ask some pointed questions to really understand what they are being asked to pay for a company. For example, at what price was the last round of financing done and what valuation was ascribed to the company at that time? How much value did the last financing add to the company? How much do they want you to pay for that? Who else is at the table looking to invest in the proposed round and are they short term or long term in orientation? How did the management come up with their proposed valuation? How much of the company does the management currently own? Did management pay for the stock with their own cash? Or did they get their stock granted to them at fractions of a cent? Is management participating in the financing themselves? And if so, is it meaningful? What percentage of the capital raised was used to advance the project rather than paying salaries and doing promotional work? Mining and exploration is an inherently risky proposition – we strive to narrow our risk down to geological risk, and filter out management risk.
These are some of the critical due diligence questions we ask when trying to establish fair value. At times, they can be challenging discussions, but discussions we need to have as investors while maintaining our objectivity. To be sure, we are not opposed to paying some premium value to insiders for their “promote”, but like many things in life, it is all about the degree.
Cases in point
While we invest globally, two recent Canadian-focussed investments we have made include Moneta Porcupine (TSX: ME) (10%) and Maritime Resources (TSX: MAE) (19.9%), which help illustrate our approach.
Concerning Moneta, we recently made a significant investment with a view that further drilling would increase their current 8MM oz resource base at the Golden Highway Project in Timmins. Earlier this year, O3 Mining (TSXV: OIII) vended in their strategic Garrison Project into Moneta in exchange for a 30% ownership. Concurrently, we at DGMP became a cornerstone investor and a co-lead manager in a C$22.6M capital raise involving some other Canadian investors. In this case, the rationale for the transaction was clear, the deal was attractively priced, the use of proceeds was straightforward, the strategic investment by O3 made sense, and there was significant alignment with existing shareholders. In addition, the project had moved from being a proposed selectively mined project, to a bulk mining project. Moreover, decreasing the cut-off grade combined with new drilling could significantly increase the size of the deposit. In our opinion, Moneta is undervalued versus its global peers – especially given the size of the resource potential and its proximity to the mining hub of Timmins, Ontario.
Similarly, Dundee, as a 19.9% owner of Maritime Resources, worked with management and the brokerage community to craft a C$10M private placement in a recent capital raise. While not relying exclusively on our due diligence, several other large global funds joined the Maritime registry on that financing. Knowing a high calibre technical team had executed thorough due diligence (as part of our investment process) provided a degree of comfort to non-specialist investors, the knowledge that we have significant skin in the game likely carries even more weight! The alignment of interests is critical.
Playing the long game
The valuation process is as much art as science, but it is where investors need the most help in making those judgements. For investors looking to potentially invest alongside DGMP, they can make that assessment based on their confidence in our investing ability, and subsequent track record. However, sharing the risk and the opportunity together goes some way towards putting us on an equal footing with our co-investors. We believe this approach is a step in the right direction towards rebuilding trust between mining companies and all investors. During the previous cycle, that trust was broken, confidence was lost and the scarring effect of that still lingers to this day.
From our perspective, “skin in the game” is a critical value we hold dear at DGMP. Naturally, you pay a lot more attention to the price you pay and care a lot more when your own money is at risk. As such, we do not ask other investors to co-invest in our deals unless we are also putting our own money to work. While our approach to deal-making does not guarantee success, it does align the interests of investors with each other and management. While Dundee does not “run” the companies we are investing in, we do, as a “value added” shareholder, have influence and often make several informed suggestions to management with respect to use of proceeds and strategy. When you know what you own and why you own it, you are usually better able to play the long game and consequently are well ahead of most of the market.
Thus, a rigorous due diligence process helps you understand who has skin in the game and where their interests lie so that you can get “aligned”. Working through this process is a critical aspect of risk mitigation but also often where the real gems of opportunity lay. As a result, we at DGMP would like to think that we are beginning to win back trust for investors in the junior mining space one investment at a time
