The Biggest Risk In Mineral Exploration: Dilution
Equity issues invariably form an integral component of a corporation’s growth cycle. But they also result in dilution for existing shareholders, and too much dilution often turns a carefully crafted investment profile upside down. Take hundreds of junior mining companies as a classic example: exploration exercises, triggering repeated issuance of shares, have caused so much dilution that shareholders can only look forward to nominal returns (if any) even if a resource is eventually identified in accordance with industry standards. The dilution rate is an expression of the ratio of new shares issued for each existing share on a corporate transfer book at any given point in time. In theory, dilution should be accompanied by substantive enhancement in shareholder value along a pre-determined timeline. In practice, however, proceeds from shares sold are spent on useless experimentation and head office costs; particularly in the case of an exceptionally large number of juniors, also rather presumptuously called “growth corporations”.
As history proves, exploration can lead to windfall profits for shareholders. “The trick is to discover operations which can find the balance between new equity and sensible, fact-driven exploration schemes,” a European asset pool advisor highlighted in a recent client circular. “Our benchmark is to work with managements who are willing to walk away from an exploration target if the facts so warrant, and then to quickly move on to greener pastures.” It is indeed rare to find a mining junior acknowledging publicly that an exploration program has failed. On the contrary, geologists keep providing fodder for press releases which are conditioned by highly technical information and which, in most instances, essentially hide more than they disclose.
And, given the low market capitalization of the bulk of junior companies, fresh equity can only be placed at prices which significantly dilute shareholders on record. Therefore, to justify dilution in an exploration context, there are some fundamental thresholds which must influence the quest for value. For one, investors should remember that, in general, any well-structured exploration plan will suggest the presence of one mineral or another in a large underlying property; but will the potential resource ever lead to profitable mining? Another criterion is the use of a “drop dead” budgetary ceiling; at what stage, and under what conditions, will the money-tap be turned off? Juniors must also confront the challenge of diversifying risk on a continuous basis, without creating dilution scenarios. Should on-ground joint ventures be actively encouraged in the early stages of the exploration process? Finally, exploration need only be undertaken in regions with a proven past of generating sizable mineral reserves, with above-average concentration levels. There is little point in being a pioneer—at least not with other peoples’ money--in a situation where there are any numbers of “safer” bets, relatively speaking. Prior to investing in a mining junior, investors owe it to themselves to be aware of one critical piece of information: the dilution ratio. Without access to that information, you are better advised to keep your money in the bank./ Note: Dilution ratios are easily computed based on information obtained from corporate filings. You may also contact the author for a calculation format at the email address provided below.
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