Tight money forcing major shift in junior sector

The after-shock of last year’s market crash is still being felt by the mining industry, especially the junior sector. Although the popular flow-through financing mechanism will remain in place until year-end, to be followed by an alternative grant program, the dearth of traditional equity financings is placing severe constraints on junior explorers.

Probably the most visible manifestation of these financial constraints has been the massive restructuring of the entire industry currently taking place.

With traditional sources of capital drying up, share prices trading near 52-week lows and investors reluctant to get back into the marketplace, the junior exploration sector is being forced back to the “good old days”. Days when cash- rich senior companies acquired interests in projects by funding capital costs, or directly invested in the juniors themselves, only to swallow them whole several years later.

Those days, which were good for the majors — and frightening for the juniors — are back. Since the crash, one of the major recourses to financing has been via deals with cash-rich majors. “The juniors have gone back to old-style deals” Manford Mallory, a mining analyst with Capital Group Securities explains. Just two years ago, the opposite was the case. Junior companies were funding cash-strapped majors by issuing flow-through shares. “Now we’re back to the old days where juniors get funding from seniors,” Mallory says.

In Canada, at least 12 emerging and producing gold mining companies have been forced to give up equity to senior companies inorder to get cash. One of the largest deals completed this year was between Muscocho Explorations (TSE) and two of its affiliates, with Echo Bay Mines (TSE) for $50 million. Muscocho needed the cash to build two mines, and Echo Bay, with large amounts of cash, deemed the move a prudent investment in eastern Canada where the company has little exposure.

Such arrangements are also defensive. In the Muscocho case, Echo Bay, which holds a 21% interest, is bound by a standstill agreement barring the company from increasing its stake beyond 33% for a 6-year period. Such a deal effectively insulates Muscocho from hostile predators eyeing a takeover. Takeovers attractive

Along with private placements, the cash-rich majors have been mounting takeovers of undervalued companies and buyouts. The largest has been a $500-million spending spree by Western Mining Corp., an Australian mining company. Western has taken three listed companies off exchanges following the purchase of 100% of their issued stock. These include Seabright Resources, Grandview Resources and Western Goldfields.

On the takeover front, everyone is looking but few are actually making offers — most majors preferring the non-hostile route. Two deals which began as hostile takeovers were Homestake Mining’s bid for North American Metals (VSE) and Total Resources’ $136 million offer for Getty Resources (TSE). Both were initially rejected by their respective boards, only to be accepted after higher bids came in.

This spate of wheeling and dealing is a direct result of the market crash and the negative impact it has had on equity financings. Issuing shares from treasury for cash is a much more difficult task today. “This market is pitiful,” Paul Esquivel, a mining analyst with Davidson Partners says. “But at the moment, if it (a mining project) is reasonable, it can be done.” Deals are still being done, but at a vastly reduced level.

For the 4-month period ended February, small business financings totalled $118 million — down more than 50% from the preceding 4-month study period, the Investment Dealers Association of Canada (IDA) has determined. Of these deals, which are usually less than $20 million, more than half were completed by resource companies, Ian C. W. Russell, vice-president capital markets at the IDA, commented.

Although much of the funding went to resource companies, many were Quebec-based. Quebec issuers took advantage of the Quebec Stock Savings Plan which offers tax reductions to investors in that province. As a result, a lot of the year-end issues were tax driven, Russell adds. Small deals still possible

A minor consolation following the crash is that very small deals — usually $500,000-$2 million — priced at less than a dollar per share, stand a reasonable chance of getting completed. “Deals under a dollar are still there,” Robert Sibthorpe, director of the natural resource group at Yorkton Securites, told The Northern Miner. “Investors still perceive that its easier to move to $1 than from $1 to $2.”

Another consequence of the depressed state of equity markets are low share prices and the lack of desire on the part of mid-to senior sized companies to issue shares which would be excessively dilutive. As a result, most emerging gold producers have found recourse in debt instruments. The most popular has been the convertible debenture which provides the holder with both a coupon and speculative appeal as the debenture can be converted into common shares at a fixed price sometime in the future.

In a bull market, such instruments were very attractive. Canadian companies raised more than $200 million last year via convertible debentures. Adding other forms of debt, such as gold-indexed bonds and bonds with gold purchase warrants, total European financings exceeded $443 million (US), according to Metals Economics Group.

However, even this vehicle appears to have suffered from the crash and the general market malaise which followed. Not only have several of the deals soured, due to low share prices which make the original conversion prices untenable, but several projects have experienced technical setbacks which actually threaten repayment of the principal.

“The general sense is that European institutions are open to financings but want the big established names,” Mallory says. “according to our London office, the funds are retrenching,” Sibthorpe adds. “A few institutions are scooping up bargains, but the environment in Europe remains similar to that in Canada.” Flow-through maintained

Throughout all this bad news, the junior sector was given a ray of hope this spring, with the announcement by the Conservative government that flow-through financings — the mainstay of the exploration sector for the past three years — will be extended to year- end. The announcement was a major reversal of the government’s original plan to have the tax vehicle phased out. Beginning in 1989, a grant program will become effective, essentially providing investors with similar benefits to those offered by the current flow-through structure.

A major boost to juniors, it will keep many in business especially the majority which are still in the early exploration stage. Just how successful the new grant scheme will be, remains to be seen. However, most observers feel that companies will have to offer more than just tax benefits to entice investors. Flow-through deals will also have to offer quality projects and good technical management teams which will increase the investors’ chances for capital gains. Window of opportunity

Despite the negative impact the stock market crash of 1987 has had on the mining sector, the very changes being experienced by the industry provide a window of opportunity not witnessed in years — opportunity for acquisition of companies and reserves at greatly reduced costs.

Strong commodity prices are generating healthy profits for major resource companies, improving balance sheets and arming many with cash-rich war chests. This dichotomy between the cash-rich and cash-poor has set the stage for a year of more takeovers, mergers and private placements. As many in the junior sector are bemoaning, “welcome back to the good old days.”