Is Cash the Mining Industry's Most Valuable Resource?

Is cash the mining industry's most important resource?

The old adage that cash is king is perhaps most true in the resource sector, especially among early stage exploration and development companies. Far from being able to rely on earnings from production, these firms need to raise capital to do more than keep the lights on. Funding is needed for the core elements of the business: geology, discovery, analysis and building. Without adequate funding, a company’s progress can be halted, sometimes for months or years.

Smirnova, who is senior portfolio manager and chief investment officer at Sprott Asset Management, identified three key elements she evaluates when examining companies in the resource sector.

“The first is the people. What’s the team? Have they done this before? What is the knowledge they have? Number two is the asset — the geology and location — and number three is the financial situation of the company,” she said.

Smirnova emphasized that while a company's personnel and financial position can be altered, geology remains unchangeable. This has prompted her to adopt a more holistic approach when analyzing opportunities in the mining sector. She wants to see key elements utilized efficiently, including the strategic management of cashflow.

“Cash is important because you have to do things as a company. You want to discover the resource, and you want to move it towards production, but people definitely optimize that process,” Smirnova said.

Woodyer Sherron, who is president and CEO of Empress Royalty (TSXV:EMPR,OTCQX:EMPYF), echoed this point.

“You need cash. Without cash, a company is constrained. It’s difficult to move forward, so absolutely I think cash is the most important resource,” she told the audience at VRIC.

When asked if there is a minimum level of capital that would define a productive raise versus a non-productive raise, Woodyer Sherron suggested this is dependent on the stage of the company.

“There are so many different aspects to money, whether it’s exploration, development, production," she said.

"From Empress’ point of view, we invest $5 million to $10 million into companies, but we focus on ones that are producing. They’re going to bring immediate cash," added Woodyer Sherron.

Kiernan, who is founder and principal at Bellevue Strategic Advisory, and Rule, the proprietor of Rule Investment Media, said money is important for mining companies, but not as important as leadership.

Rule has frequently said that people are the most important part of a company, but has also acknowledged that cash may be the most underrated asset. Drawing from his extensive experience in the resource sector, he noted that retail investors get excited about stories, not cash, and companies worry about the cost of capital inside the industry.

“They say the cost of capital is extraordinary. Have you ever considered the cost of not having capital? This is a capital-intensive business. If you don’t have capital, you have no business. So I think cash, it’s not exciting, but if you don’t have cash, you eliminate your ability to cause things to occur,” he said.

4 ways mining companies raise money

Mining companies raise capital through four primary methods, each with its own advantages and challenges.

Equity raises are a common approach in the industry, especially among early stage exploration and development companies. These agreements involve companies raising capital through the selling of shares.

This approach can be easy for those with compelling projects, good locations or favorable early exploration results. However, it can also dilute overall value for existing shareholders.

Equity raises can also be sensitive to overall market conditions. With that in mind, Smirnova spoke to the benefits of “raising when the ducks are quacking" — in other words, raising cash when conditions are favorable. This approach can ensure that funds are available when needed, even if the market enters into a downturn.

Debt financing is a less common fundraising method in mining. Rule has extensive experience in this area.

He told the VRIC audience that during his time in the industry he's overseen many deals. He explained that debt structures have their uses, but aren’t widely used due to their capital-intensive nature.

Debt structures often involve secured loans that are leveraged against company assets. They can be attractive because companies can raise capital rapidly, but they risk becoming overextended and losing valuable assets.

For Rule, debt financing is always a win for the issuer, but not always for the company.

“I can take a lower internal rate of return than I would ask for as an equity holder, because, by the nature of the transaction, it’s a secured loan. At the end of the exercise, whether I want it or not, the assets are mine, not theirs, and my coupon, assuming that I get paid, reduces my risk and allows me to recycle the cash,” he said.

Royalty and streaming agreements, like those offered by Woodyer Sherron’s company Empress Royalty, are an alternative to traditional equity and debt. In these types of agreements, companies receive upfront cash in exchange for a percentage of future revenue or production, often at a discount.

“We’re not buying third-party existing units, and we’re able to provide directly to them the financing they need … it's less diluted than equity, it’s less restrictive than debt,” Woodyer Sherron said.

“We really want that revenue to come in so that we can reinvest it,” she added, emphasizing that Empress is interested in later-stage assets that are producing cash or close to doing so in order to ensure a steady revenue stream.

One final method of funding projects in the mining industry is joint ventures.

Similar to a merger, a joint venture involves two or more companies coming together. The advantage is that larger companies can provide reliable financing and expertise to move a project forward. However, joint ventures can also be highly complex, with differing views on ownership stakes and responsibilities.

“They’re very expensive and complex to negotiate, and they’re very expensive and complex to administer; if a joint venture goes bad, you’re in a problem where you have to unwind. You’ve got all kinds of conflicts, maybe with a much larger counterparty,” said Kiernan, who is an independent director for various mining companies, including Empress.

She also indicated that there are several reasons for joint ventures. Smaller companies get more experienced partners, while larger companies use them to gain access to jurisdictions by partnering with locals.

“There are going to be very big wins when they’re done for the right reasons and the proper diligence,” Kiernan added.

What should investors look for when it comes to cash?

In closing, the panelists offered final advice on evaluating companies based on their cash handling.

“Look at the ownership that the management team has in their own stock,” Smirnova advised.

“That will help you assess whether they’re in it just for a paycheck or for long-term value … that’s something we look for more and more. Question management teams to make sure that they actually have skin in the game."

Rule offered advice that went beyond how companies use cash, suggesting that investors put their cash to work. He noted that with positive interest rates and deteriorating purchasing power, “cash is costing you money.”

"Cash gives you the ability to take advantage of the illiquidity of others rather than being taken advantage of yourself," he said. Rule also noted that investors should get to know companies before they part with cash.

“I believe that 85 percent of the juniors that are listed on a global basis are valueless. I believe they’re worth nothing, and so I believe the junior sector is perpetually overvalued … if you learn to separate the 10 percent from the 90 percent, this is actually a hell of a sector. If you don’t, good luck to you,” Rule said.