Uranium, Marijuana and The Walking Dead
One of the recurring commentaries from market participants is that there are too many small public companies chasing the same investment dollars, whether from financings or in the secondary markets. Some of those companies are on financial life support, wasting limited resources better used by other members of the community.
InvestorIntel’s Global Analyst Christopher Ecclestone cites a Tony Simon study in a commentary titled Toronto Venture Exchange nears an ‘Event Horizon’ where it’s calculated that the total working capital of just the mining industry’s “zombies” is negative $2-billion, even though they claim to have $5-billion of capitalized assets.
It seems that close to 600 natural resources issuers are failing to meet the TSXV’s continuous listing requirements, and although this list looked at natural resource issuers, this situation exists across sectors. Biotech, hi-tech, low-tech and no-tech – every industry has its brain-dead-but-body-still-moving members.
The TMX Group, owner of the Toronto Stock Exchange and the Venture Exchange, is part of the problem because it is itself a listed for-profit company. 24% of its revenue comes from “Issuer Services”, with another 6% being directly contributed by its subsidiary CDS. See page 13 of the TMX’s latest investor presentation here.
If there are fewer companies listed, the TMX Group will have less revenue and likely a worse return for its shareholders. From that viewpoint the TMX is motivated to keep herding the zombies along forever.
But at the same time, the TMX has duties as a quasi-regulator to maintain standards, protecting Canada’s reputation abroad and helping to create a respectable fair investment platform. TMX also has to explain to GoodCompanyA why it should pay its annual listing fees, when MediocreCompanyB has not paid its fees but still maintains its listing. This means the TMX must continually prune its tree to keep the fruit alive, creating a conflict with its own revenue generation model.
The 2000 demutualization of the Toronto Stock Exchange, while highly profitable for the seat-holders at the time, is still having an impact and in our opinion ranks as one of the most damaging financial events in Canadian history. The current system, despite the good people in it, has predictably led the TMX into a compromised conflict, and the zombies are partial proof of that. Lou Eccleston, the Chief Executive Officer at TMX Group, must hate this topic. There is no good easy resolution to it.
We also lay some blame at the feet of the International Accounting Standards Board who continues to make public company audits more expensive without delivering any proportionate increase in value to the stakeholders. Being financially literate is no longer a guarantee of actually understanding a public company’s audit.
Remember when the notes used to just add commentary to the numbers? Now the notes run on for 20plus pages in the smallest of reporting issuers, spurred by ISAB’s latest pronouncements and the fear of class action litigation or backward-looking regulatory action. The extra cost without value adds to the drag on a company’s resources, but it provides some auditors with an incentive to keep the zombies shuffling along from one expensive annual audit to the next.
Whatever your choice of causes, it’s a fact that those zombies really exist, barely getting by.
Humans in Robert Kirkman’s graphic novel series The Walking Dead know how to deal with zombies – ignore them until they become a problem, and then slaughter them. Your survival over theirs.
The listed zombies are becoming a problem for the rest of the public company industry, which means it’s time for the cull. If you’re a listed company meeting the continuing listing requirements, what do you do to not just survive but thrive? Here are two possible strategies.
First, find like-minded survivors. Then add their strength to yours to form only one cohesive community rather than mutiple communities battling for hard-to-find resources. Build one set of walls, fill one armory, sow one set of seeds, have one leadership group, live by one set of rules to protect your family and friends.
Two companies who did this were Tweed Marijuana Inc. and Bedrocan Cannabis Corp., in the medical marijuana space. In June of this year, these were two of the largest companies in this new industry. Each one of them had different obvious vulnerabilities and each faced a looming financial crisis. Technically a takeover of Bedrocan by Tweed, this merger of resources will upon shareholder approval create one strong issuer, ready to defend itself against outside attacks and to grow. This was an excellent long-term decision for the shareholders.
The other licenced producers will need to create their own competitive advantages to survive, lest they become arrogant zombies themselves.
In the uranium industry, in July/15 we saw Alpha Exploration Inc. and Lakeland Resources Inc. agree to “merge to form a consolidated, well-financed uranium exploration company” (from the joint press release). The logic is solid. It will be more efficient to raise funds for and then explore the uranium property portfolio in Canada under one leadership team with one treasury. Risk is decreased and the potential return is increased under this model. They each avoided becoming zombies.
This isn’t only a North American phenomenon. Talga Resources Ltd. this morning announced a transaction with Beatons Creek Gold Pty Ltd. for Talga’s Western Australia gold properties. Talga gets cash to focus on its European graphite assets and a Net Smelter Royalty if one of the gold assets gets into production; Beatons gets three prospective properties at fair pricing.
The second strategy for survival is to take matters in your own hands. Don’t wait for the regulator. Go kill yourself a zombie.
We are hearing serious recurring rumours about strong juniors making survival-level offers to the weaker juniors. For example, in the mining space, almost every company has more than one explorable asset. The strong junior will offer the weaker one just enough joint venture money to allow the weaker one to minimally explore one of its assets, but at the cost of parting with another of its strong assets for almost nothing in return.
The zombies wobble in a very precarious position. Try to keep both good assets and they risk not raising financing, losing both assets, and being de-listed by the stock exchange. Sell one asset at theft pricing but keep the other asset in good standing, leaving the company smaller but alive to fight another day, but they run the risk of missing out if that other asset proves up and yields a big find.
Be a survivor or be a zombie? Which end of the axe do you prefer?
Those stronger juniors deserve investor attention. This weak market provides heartless patient investors with the opportunity of a lifetime to invest in the stronger juniors, and not to merely survive but to reduce risk, to build, to prosper.
Mr. Clausi is an experienced investment banker, executive, director and shareholder activist. A graduate of Osgoode Hall Law School called to Ontario's bar in 1990, ... <Read more about Peter Clausi>