In my opinion, the best method for a CEO to make shareholders richer is to be good at wheeling and dealing. CEOs like Brian Dalton and Kevin Mcarthur (Tahoe and ex-Goldcorp CEO) are very good at valuing assets and structuring deals. These CEOs are good at shuffling paper around and making deals in a way that more wealth accrues to their shareholders. They look for undervalued assets and sell shares/assets when they are overpriced.
Paper shuffling versus value creation
Creating actual value in mining would involve:
- Finding efficiencies on the exploration side. This is the most difficult and open-ended problem in mining.
- Finding efficiencies on the operations side. Generally speaking, all mine engineers generally do good work and none of them generate substantially more efficiencies than their peers.
Conversely, the opposite should be avoided. Unfortunately, too much shareholder capital is wasted on stock promotion, “travel and entertainment”, old mines that should be mothballed, building mines that are clearly uneconomic, etc. etc.
In general, the mining industry creates very poor shareholder returns. Those who sustain high shareholder returns over long periods of time tend to have some combination of (A) luck and (B) skill in paper shuffling / deal making.
Greenfield exploration
In theory, high-risk greenfield exploration can create a lot of value. Some explorationists are a lot better than their peers at finding economic deposits. In practice however, this is a tough game. Because the odds of a mineral discovery is so low, there are problems associated with Gambler’s Ruin. Often, it is not sensible for a mining CEO to allocate more than a small fraction of the firm’s capital to greenfield exploration. The position sizes need to be kept small to avoid Gambler’s Ruin. It is difficult to fund a large number of projects because only a small handful of explorationists are good at what they do and there are only a small number of sensible projects. If only a small portion of the firm’s capital is invested, high returns on a small investment can only generate small returns relative to all of the firm’s capital.
The prospect generation model (practiced by Brian Dalton at Altius) mitigates some of these problems. However, Altius’ prospect generation business has not discovered a single deposit that has turned into a profitable mine. Not one. In that sense, Altius has not proven itself as a value creator. In practice, Altius’ prospect generation business has delivered incredible returns because of Dalton’s wheeling and dealing. Altius bought/created exploration potential (land claims) at very low prices and sold exploration potential at very high prices during the commodities bull market that ended in 2007.
Brownfield exploration
The best places to look for minerals are generally:
- Near existing mines that are highly profitable.
- Near deposits that will likely turn into a highly profitable mine.
This strategy is well understood and obvious. Land rights and asset prices often reflect obvious exploration potential. However, the market is cyclical and sometimes some parties sell assets at depressed prices for silly reasons (e.g. Sherritt’s deal with Altius). This creates opportunities for buying exploration potential at a discount. Kevin Mcarthur likes to buy deposits that may be the “tip of an iceberg”.
Skill in valuing assets
I think that Brian Dalton (Altius) and Kevin Mcarthur are highly skilled in valuing mining assets and the value of their own company. They are rather sophisticated because they understand the exploration potential in the assets that they buy.
However, not every CEO in the mining world is like this. Some CEOs like Nolan Watson do not have formal (or informal) training in mine exploration or mine engineering. Despite the lack of mining expertise, they do not hire mining professionals onto their staff. These are the people who make really dumb investments. So far, every single Nolan Watson investment in Sandstorm Metals and Energy has turned out to be a disaster. Likewise, institutional investors generally have no idea what they’re doing when it comes to valuing mining assets. They are also the fish at the poker table. Usually these people are easy to spot because it is easy to get biographical information on the people involved (e.g. what did these people study in university, did they ever work as an explorationist or mine engineer, etc.).
Formal training with perverse incentives
Investment banks sometimes hire analysts with mining backgrounds. However, every single investment bank missed the Bre-X fraud (whereas the senior miner Freeport McMoran didn’t). Investment banking analysts typically have conflicts of interests with their clients that cause the analysts to overlook how crappy the bank’s secondary offerings and IPOs are. I would not take any of the investment banking analysts seriously.
In general, almost all senior miners have the right technical expertise to value assets because they have mining professionals on staff. However, for political reasons, they sometimes make really dumb investment decisions and chase projects that they know are uneconomic. The CEO may surround himself with “yes men” who bend the numbers to make a project seem economic.
- One way to identify these CEOs is to check whether or not the CEO promises to increase mineral production beyond what existing assets will produce. To actually fulfill this promise, they would have to buy more mining assets at any price. That is obviously a dumb strategy. They should only expand production if the rates of return are reasonable.
- Figure out the cash flow of producing mines. Mines with negative cash flow should likely be mothballed. Some CEOs will piss away money on uneconomic mines to keep a stock promotion going.
- For mines in construction, look at the grade and quality of the ore versus producing mines with similar characteristics. Unfortunately you have to know a little bit about various mining methods (open pit, cut and fill, stoping, etc.) and various processing techniques (heap leaching, acid leach, roasting, etc.). Work out an estimate of what the proposed mine’s margins might be. In practice, some management teams will build uneconomic mines to keep a stock promotion going.
Ponzi economics
In a Ponzi scheme, no value is actually being created. Ponzi schemes involve wealth transfers from the incoming participants to the participants who got into the scheme early. In the mining business, there are many roll-ups that use their high share price to buy up mining assets. Some of these roll-ups will actually make money for shareholders who get in early. However, this is ultimately a dangerous game to play because shareholders in aggregate will lose money.
Currently, both Altius and Tahoe are issuing shares to acquire mining assets. Mcarthur’s old company Goldcorp has a long history of increasing share count.
Really awful CEOs
The worst CEOs are the ones who waste shareholder money on projects with negative expected return. Underwater mining likely has a strongly negative expected return. However, this may not be obvious because there is a lot of uncertainty involved. We won’t know the exact economics until we start a commercial-scale mining operation.
Old mines that are cash flow negative are the easiest shorts to figure out. Because the mine already has a history, we know a lot about the economics of the mine. Yet many promotional CEOs will continue to waste money on a money-losing mine despite overwhelming evidence that the mine will continue to lose money.
Don’t forget about integrity
I think that integrity is extremely important in the mining industry. Skill without integrity can potentially be a very dangerous combination for shareholders. Charlatans usually end up stealing from shareholders or cheating them in some way. Without integrity, you cannot trust the technical reports. Without reliable technical reports, you cannot value the assets with precision.
Unfortunately, very very few people in the mining industry have integrity. While I think Kevin Mcarthur is extremely skilled at what he does, I don’t really trust him. Shill stock promotion websites have listed his companies (Tahoe, Goldcorp) as sponsors/clients. Tahoe’s reserve estimation struck me as having a questionable methodology in being aggressive with the wireframe modelling. There is a BNN interview with Kevin Mcarthur where he suggests that Tahoe will not issue more shares (at the 2:20 mark). That scenario strikes me as unlikely because both Goldcorp and Tahoe have issued shares.
*Disclosure: No position in Altius or Tahoe.
Links
My original writeup on Altius – I explain why I think Altius’ royalty strategy is a form of smart dealmaking.