Market crash hurting junior resource equity finance opportunities

The stock market crash last October has affected junior mining companies in more ways than just knocking down share prices by an average of 40%. Black Monday, which witnessed the largest one-day collapse in equity market history, appears to have put to rest the speculative euphoria which was driving most junior exploration listings on Canada’s stock exchanges.

More importantly, the market collapse has had a stifling impact on equity financings — the life blood of non-cash flow generating junior exploration companies.

“Investor confidence in small cap (capitalization) companies has been severely damaged,” Ian C. W. Russell, director of capital markets for the Investment Dealers Association of Canada, told The Northern Miner. “A preliminary look in October shows that no issues were done at all,” Russell says. The grim conclusion is obvious. The plethora of junior concerns, which came to market riding a flow-through share driven gold exploration boom, could find themselves in serious financial trouble during the next 12 months.

A majority of these new issues, listed during the past three years, have large portfolios of grass roots exploration plays. Many in the underground exploration stage will need considerable funding to go to the development stage in the future. Without ready access to equity funding, many of these projects could become stalled. Only flow-through available

Russell expects that the current dearth of small financings, defined as less than $1 million, will continue for at least three to four months. “The only financings being done today are flow-through,” William F. White, senior vice-president of corporate and government finance at Merrill Lynch Canada, explained to The Northern Miner. Although equity deals have dried up, “there could be a finance window in the New Year,” he added. “Companies should be prepared for this.”

White explains that if the October crash is really a major downward correction, similar to that experienced in 1962, “then we could be back in business by March.” However, if the correction is in fact the first leg of a long-term bear market “then all bets are off,” he cautions. In 1962, the financing window closed for a period of five months before opening up again. Flight to quality

“Business has come off a lot,” Michael Pickens, a mining analyst with the natural resource group at Yorkton Securities explained. Yorkton, which has been a leader in small private placements of junior resource issues in Canada, is still planning to do more corporate finance work. Pickens notes that his group is working on two $1-$2-million deals which have been placed. However, he stresses that investor emphasis today is on quality. White agrees, saying “there has been a flight to quality.”

Quality in gold issues means that companies have proven-probable reserves, good potential for production, low cost mining parameters and strong technical management, preferably with a track record. Unfortunately, that definition of quality excludes the majority of Canadian juniors. As one broker quipped, in the past “the promoter has the vision and the public the money. In the end, the promotor ends up with the money and the public with the vision.” Selling vision in a nervous, fragile market, is a difficult venture today. Tax reform another problem

Compounding the potential problems faced by the junior mining industry is tax reform. Proposed changes to flow-through share financings — the mainstay of every junior and the catalyst behind the Canadian exploration boom — “will have a devastating effect on the industry,” Russell believes.

Merrill Lynch’s White, who has had extensive experience with resource flow-through funding notes that “the national funds will all close in December. But the absolute amounts raised will be closer to the minimums.” In 1987, for example, almost $1 billion was raised via flow-through. “Of that, the national funds started with $500 million at the beginning of the year,” White says. “This year, we expect to see closer to $110 million.” If the early performance of the national funds, such as cmp, nim and First Exploration are precursors of things to come, then flow-through funding in 1988 could be down by more than 70%.

Also, proposed changes to the treatment of future capital gains will further exasperate the junior industry. Few juniors pay dividends, stock or cash, and even fewer are evaluated on an earnings-per-share basis. What they sell is the possibilty of becoming cash flow generators through mineral discovery and production. As a result, investors purchase such shares for their potential to generate a capital gain. Negative treatment of capital gains “further decreases the appeal of buying junior shares,” Russell concludes.

The combination of market nervousness, shift to quality, and proposed negative changes to flow- through share financings and capital gains, could result in a major shake-out in the booming junior mining industry next year.