This week's Financial Sense Newshour podcast featured an interview with Rob McEwan in the third segment, right after one with Jim Rogers about his latest book A Gift To My Children [.mp3 file.] McEwan, the chair and CEO of US Gold Corp., spent some time focusing on an issue that's important to gold mining investors but doesn't get a lot of mention: dilution. He said that some managers of exploration companies are tempted to overdilute along the way, to the point where their actions seem to contradict their words regarding the worth of their properties and their opinion on gold's prospects. He ascribed it to managers falling under the spell of the investment bankers, who tend to advise getting as much money as possible when the private-placement market is good. He also noted that some junior stocks fall because expectations got too high for amangement to meet.
His advice for junior investors comes down to waiting patiently and not being bothered by even large declines as long as the companies have good and improving fundamentals. Since many promising projects do not become mines, it's best to take a portfolio approach. In some cases, if the investor has the stomach for it, buying more shares of a good company whose price has been slaughtered is a good idea.
He doesn't mention it, but the dilution he speaks of is likely the result of cash-strappedness. Unless the private-placement market is good, it's hard for the typical junior to get money. Even though it's not good for the shareholders, getting a large private placement and lots of money in the treasury seems like a great idea when previous private placements fell short or were even cancelled. I think more than a few top managers fall into McEwan's dilution trap because they're too used to seeing even a great deposit being greeted with yawns. The investment-banking spell comes with the relief reflex kicking in: "My Gawd, they finally see it!" There's also the safety factor that come with having a large surplus of cash to draw on.
McEwan noted that top managers of senior producers don't take over juniors when the market is lousy and the juniors are undervalued because they're like ordinary investors: fear takes over. The relief reflex is a lot like ordinary investors who buy an undervalued stock and sell way too soon when it begins to recover. Top managers of junior explorers are like ordinary investors too, only ones that become frustrated with an undervalued stock that stays undervalued for a long time.
An example of a junior mining corporation that's fallen into the dilution trap is Premium Exploration. Recently praised by 321Gold's Bob Moriarty, Premium recently closed a $10 million private-placement deal resulting in the issue of 40 million additional shares and warrants. The warrants kick in at 35 cents. At the time the deal was announced, the stock price had shot up above the warrants' strike price. There are going to be twenty million of those warrants outstanding as a result of the deal.
There are currently 65.38 million shares outstanding. With the additional 40 million shares, there'll be 105.38 million. If all the warrants are exercised, there will be 125.38 million shares. Should Premium take off as a result of further good news, and should the warrants all be exercised, the company will have doubled its total shares outstanding. They'll still have the ten million, plus seven million from exercise of the warrants, but each share will only be entitled to half of what a pre-PP share was entitled to. The price of the shares-plus-warrants was recently lowered to 25 cents because Premium's stock was in a bear trend, which was reversed a little more than a week ago. [Chart here.]
Disclosure: It doesn't make me look very good, but I have a small position in Premium. Currently, I'm riding a loss on it.