Prospect Generators with John Kaiser
John Kaiser (JK), whose Bottom Fish website has become one of the go-to sites for investors seeking opportunities in undervalued mining stocks. In the interview below, they discuss prospect generation in these difficult markets.
AT: In a recent interview with the Gold Report, you outlined some strategies for success in these tough markets. I want to talk to you today about the prospect generator model, which many people will be familiar with. To begin, can you explain how the prospect generator model generally works?
JK: Well, to start off, exploration is a very difficult business. Economic deposits are few and far between. In junior exploration companies, their talent is to bring a lot of geological creativity to bear, to think of areas that could host a significant deposit, and then spend the money gathering basic information, early stage stuff, like do physical surveys, do chemical surveys and so on, to generate a target that just might turn out to be an economic discovery.
But the proving of that costs expensive drilling. And, because of the poor statistics, what these juniors do is they seek a farm-out partner, which can be a major mining company or a junior exploration company, which perhaps does not have the internal exploration management resources to generate their own targets.
By doing this, the junior generates prospect after prospect and shifts the expensive drilling risk onto another party, which may have more promotional skills to raise the money to finance the exploration. And, as a result, they get the majority interest in the project if they have a win, but they also end up with nothing if it is a dud and will end up with lots of shares outstanding and a cheap stock price.
Whereas the prospect generator, they’re already onto the next prospect — dressing it up and farming it out to another — and they’re able to maintain their existing share structure at a fairly constant level and just stay in the game for a long time until finally one of the partners makes a major discovery that results in a buyout of the prospect generator company at a substantial premium to its share price prior to the discovery.
AT: You’re really sort of playing the odds that one of those projects will turn out to be a winner, right?
JK: Yes, and it can take a long time.
AT: Prospect generation seems to work well in a good market, when juniors farm out exploration costs to other larger companies. But right now everybody is hurting for cash, as you know. So, is this model still relevant in a bear market?
JK: Well, in a bear market like this, you really want to farm out a project, because it is very difficult to raise money from speculators just based on an encouraging result that makes your target better but doesn’t quite turn it into a discovery. And the type of partner you want in this market is a major, because a major has patience, they understand the geology, and they have deep pockets. And, unlike a junior, which cannot finance on the basis of encouraging work, the major can continue to put money into it as they see it come into focus.
This is a bad market to farm out to other juniors, because the type of party that’s willing to farm into another junior’s prospect, they’re generally weak on the exploration side. And, because they don’t quite have the credibility, they cannot, in a bear market, promote the story and raise the money.
So, that group of companies, which are strong on promotions in bull markets, are completely useless in a bear market such as this one. So, the juniors are pretty much stuck trying to find a major to farm into their project, and for that to happen the project has to have a very special conceptual angle that intrigues the major and that does offer the possibility of a very, very large, rich discovery.
AT: Okay. What about from an investment point of view? What are some of the advantages of this model versus the disadvantages?
JK: Well, the pros are that you overcome the negative statistics of the exploration game, in that there are far more marginal zones of mineralization than there are economic deposits. And by constantly farming out the prospect and recovering your initial acquisition and dressing up costs through a combination of stock and/or cash, you can maintain your existing shares at a fairly even keel.
And then, you just play the waiting game for the one prospect that finally delivers a no-brainer discovery hole, where the other side, if it’s a junior, has no problem funding further exploration or the major, of course, becomes very excited and starts fast tracking exploration.
The con side is that it can take a long time for this discovery to happen, and the aggressiveness with which the partner pursues exploration sometimes be wanting as far as the farm out junior is concerned. In the case of a major as a partner, if initial work does not produce a discovery that meets the minimum size threshold of the major, the major may end up vesting, but it’s not interested in developing the project, so it ends up with majority ownership. The junior might be able to do something and perhaps sell it to an intermediate producer company or even develop it itself as a standalone project, but it is now stuck in the minority position and it cannot advance the project.
And, also, typically, when you farm out a property, you shift the operatorship to the other party, and you may have good ideas as to what should be done to properly explore this property, but the other party may have different ideas. And it can do something that leads to nothing and can be very frustrating, because you, as the original prospect generator, feel that this is how you should have approached the exploration of this target.
AT: And as an investor, you could be waiting a long time for your money to grow at all, right?
JK: Yeah. One big con with the prospect generator model is that if you’re chewing through 30, 40 projects, it would be nice if it were one of the first five that delivered the discovery, but it might be the fortieth one. And, therefore, from a shareholder’s point of view, prospect generators, which cannot really control the flow of information or the pace of exploration, are like watching paint dry. That’s the downside of it, and very often shareholders capitulate just before that discovery finally materializes.
AT: Right, so patience is the key.
JK: Yes.
AT: Let’s talk about some companies that have successfully employed this model. Avrupa Minerals (AVU-V) has a number of exploration licenses in Portugal and Kosovo and, I believe, Germany as well. They have a joint venture with Antofagasta Minerals and another with Blackheath Resources (BHR-V). Their strategy is to look for targets in old mining districts and then hive off the exploration expenditures when they get to the drill stage. Is that a good strategy for a prospect generator?
JK: Well, prospect generators can use two approaches. One is to go into a complete virgin territory where no exploration has ever been done, and they put together some conceptual theory as to why there should be significant deposits here to be found.
Another approach is to look at old districts and come up with a new way of interpreting the geology. And, in the case of Avrupa and its south Portugal projects, which cover the northern end of the Iberian Pyrite Belt, Avrupa has attracted Antofagasta because it has a new theory about the succession of the stratigraphy that hosts these world class volcanogenic massive sulfide copper zinc deposits.
And Antofagasta is now looking at geophysical targets and testing them and monitoring the stratigraphy and instead of stopping when they hit a marker horizon, they actually become excited and go beyond the marker horizon. So, in effect, they are testing targets that would have been ignored by previous exploration groups.
AT: Let’s move onto Nevada Exploration (NGE-V), which is another company you’ve discussed in your newsletter. They’ve come up with a method for sampling gold in groundwater. What can you tell us about the viability of this method?
JK: There’s a deposit called Twin Creeks in Northern Nevada which has over 20 million ounces, and it was discovered by drilling a gravel covered portion of the basin. And a study was subsequently done by a government geologist, which demonstrated that, indeed, there is a gold and Carlin pathfinder element groundwater anomaly closely associated with this giant system.
So it clearly works, but it has not been done on a regional scale because the means of assaying very low gold levels in groundwater have only existed in the last 10 years, and Nevada Exploration has put innovative work in play to come up with a protocol for taking these measurements.
It’s an approach that is in its infancy as far as gold exploration in these gravel-covered terrains of Northern Nevada are concerned. It’s an exciting story, because there’s reason to believe there are 200 to 300 million additional ounces to be found under the gravels in Northern Nevada outside of the main trends, Carlin and Cortez, where the ground is all tied up by Newmont (NMC-T) and Barrick Gold (ABX-T).
AT: Nevada Exploration shows elements of the prospect generator model in that its Grass Valley project is 70-percent owned by McEwen Mining (MUX-T), which is paying for the exploration costs and a three-hole drilling program costing $600,000.
But, you probably are aware, recently McEwen said it will cut back on its gold production, so do you believe that will affect its ability to fund Grass Valley?
JK: Grass Valley is one of the prospects Nevada Exploration has generated during the past three or four years while doing hydro geochemistry sampling. This is an example of where a company is doing filtering, actual exploration work, on areas where nobody in the past has ever had reason to look.
In this case, it’s because these areas are basins covered by gravels, and you cannot see the bedrock. There is no reason to spend expensive exploration dollars trying to find a focus under the gravels. Grass Valley is one of these golden ground water anomalies that they generated, and farmed out to McEwen Mining. It’s in a good area, but it’s offset from the main trend. McEwen Mining’s problem today is that it’s got several gold and silver mines in production, and it wants to expand them. And now it’s being hurt by declining gold and silver prices, and it’s looking at cutting its costs.
So, it’s coming up to a decision point where either they become very aggressive about Grass Valley and try to demonstrate that, indeed, we’re talking about a five, 10-million-plus ounce gold system here that’s worth far more than the existing operations or they back off and say, “We cannot at this time afford to explore this deposit.”
This is an example of a risk where farming out to a major whose priorities change, and then you’re stuck in a deal where the major doesn’t want to advance it at the pace that the junior would like to see happen.
AT: How about another example of a prospect generator?
JK: Virginia Mines (VGQ-V) is the successor to Virginia Gold Mines, which found the Eleonore deposit in 2004 that got bought out for $750 million by Goldcorp (G-T). It’s now being constructed as a gold mine. Virginia Gold Mines traded sideways, $1 to $2, for seven years and eventually got bought at $15. Virginia Mines was spun out. The shareholders of Virginia Gold each received a half share of Virginia Mines. And Virginia Mines owned the rest of the portfolio, plus $40 million in working capital.
And they have continued the tradition of generating prospects in central Quebec, which is a region of Canada that has very interesting geological potential but has not seen the intensity of exploration that other areas, such as the Abitibi Greenstone Belt, have received farther to the south.
So, it may take another seven years for Virginia Mines to come up with a major discovery, but it has the track record behind it of having already done it, and it has the machine in place to keep playing the statistical game. It may be like watching paint dry, but it is the kind of stock that’s not going to go away and disappear because they run out of money or end up having a billion shares outstanding because they have to keep financing at ever-lower prices.
AT: Looking at their current portfolio of projects, is there anything on Virginia’s horizon right now that could be another Eleonore?
JK: One of the paradoxes of a prospect generator is that you cannot tell. You ask them, “Which is your favourite project? Which is your flagship?” And they often say, “We don’t have one yet. We’ve got them farmed out. There’s a couple that we have that have ounces and/or pounds in the ground. They’re not at the critical mass to be developed. We may need better metal prices. If we get better metal prices, we will farm it out to a major or something like that. But, at the moment, we just don’t know.”
And tomorrow, there could be another Eleonore, some obscure thing they haven’t even put on their website, which they are out in the field generating prospects. This is the one exciting thing about the prospect generator is you never know when, out of the blue, they can suddenly tell you, “We think we have the goods, and we’re going to keep it and not farm it out.”
AT: Almaden Minerals (AMM-T) is highlighting its Ixtaca gold-silver project in Mexico. Can you talk about Almaden as a prospect generator?
JK: Almaden is another good example of a company which has been around for decades, generating prospects in various parts of North America, initially in the United States. Then they shifted to Mexico in the ’90s and in the last decade. They constantly farm their prospects out to others. Sometimes they were disappointed at the speed with which the other parties did exploration, but one of the projects, Ixtaca, also known as Tuligtic, they decided several years ago that this target was so interesting that they were going to drill it themselves, in complete violation of the prospect generator farm-out rule.
The result is a discovery that’s not yet obviously a no-brainer mine, but the initial resource estimate has them at 1.7 million ounces of gold and nearly 100 million ounces of silver in a setting that is potentially open pittable and a project which would certainly benefit from gold and silver prices rebounding from current levels.
So, now this company has evolved from being a prospect generator to actually having a flagship project that is entering the resource feasibility demonstration stage and a company still well-financed with $14 million working capital. So, it is not stuck, being brought to its knees and having to finance at rock bottom prices, and if they are going to do a farm-out it’s going to be on terms which will see them carry to production within a reasonable timeline.
AT: Right. So, this is an example of a prospect generator that ended up going alone on this project?
JK: Yes. One of the problems with the farm out model, if you have a major as your partner, is that the major typically gets to go to, at the very least, 51 percent, but typically, 70, 75, sometimes even 85 percent, by funding all costs, even for construction costs, to bring it into production.
Now, when a significant discovery like that is made, the major controls the asset and the junior really has no exit strategy, except waiting for that major to make a buyout. In contrast, if you have a junior partner, who ends up with something like 70 percent, 75 percent max, at some point it makes sense for the other junior, the prospect generator, to do this butterfly transaction, where they merge the minority stake into the majority owner company for typically a proportionate share of the market cap. The stake then gets distributed to the shareholders of the prospect generator, who also, like in this example of Virginia Gold Mines, get shares in a survivor company that continues to hold the rest of the portfolio.
A very good example of this in the past few years was Fronteer Gold and OX Ventures. OX Ventures generated the Long Canyon prospect, which became a discovery into which Fronteer Gold farmed-in to earn a 51 percent interest. In late 2010, OX merged into Fronteer Gold on a basis of about $600 million valuation for the project. Six months later, Fronteer, who had 100 percent and was suddenly appetizing to a major, doubled in price and disappeared in a Newmont buyout for 2.3 billion dollars.
AT: Right, I remember, that was a huge takeover.
JK: So, that’s an example of how, if a junior has a hundred percent stake in a project, it can be auctioned. If it is a significant enough discovery, its ownership will be auctioned amongst big players. And that’s how the prospect generator farm out model requires the expectation that the other party will absorb the minority interest, because the majors do not like it if they have to deal with two juniors, one with, say 65 percent and the other with 35 percent. They want to negotiate with just one junior that owns 100 percent.
AT: The downside in keeping 100-percent ownership is, of course, you don’t have anyone to share the exploration expenditures with.
JK: Yes, but once you have a significant discovery, the project becomes almost self-funding. Because people can see what a good discovery looks like and capital is naturally discovered to what appears to be an emerging winner.
AT: Right. It once again comes down to what’s in the ground.
JK: Yeah. And can you take that target and turn it into that discovery hole that blows everybody away. And we’re in that type of market right now, where whoever is still left watching it wants to see a monster discovery hole materialize where they can say, “Wow, we are dealing with tremendous upside potential.” And such plays, such exploration discovery plays, become life rafts in a bear market like this, where metal price trends are not fueling any sort of investor enthusiasm for the resource sector.
AT: Okay. Let’s leave it at that, John. Thanks for speaking with us today about the prospect generator model and how it is relevant in today’s markets.
JK: Thank you for the invitation. |
