The bankruptcy of yet another precious metals mining company – this time, the Canadian listed junior miner Colossus Minerals Inc. (TSX: CSI) – supports what the naysayers have been telling us all along, “Stay clear of precious metals companies. They just can’t survive with such low metals prices.”
The $7 million nano-cap exploration and mining development company filed for bankruptcy and restructuring protection on January 14th after failing to make its December 31st loan interest payments.
But when looking a little more closely at the nature of Colossus’ business we find that its failure is actually quite the common occurrence for small exploration companies – they ran out of cash before they could complete their mine.
Rather than use Colossus’ failure as a reason to avoid the mining space all together, we can instead use it as a telling example of two very important lessons that can help us immensely as investors… the importance of proven reserves and cash flow, and the advantage to creditors.
The Importance of Proven Reserves and Cash Flow
Colossus Minerals is in a high risk field of business to begin with – searching for mineral deposits and building new mines which they can either keep for themselves, sell to larger producers for a substantial profit, or simply take the highest buyout offer forthcoming.
If they succeed, the payout can be many times the cost of exploration and mine development. But they don’t always succeed right away. It is always a run against the clock to get that first mine developed before the money runs out. And many never make it.
Even so, if the company can convince its creditors that the land it has leased is worth another search, it can usually get enough money to go back keep looking. It appears that Colossus has managed precisely that.
“Its board has approved a proposal from certain noteholders and [financer] Sandstorm Gold Ltd. (TSX: SSL) that provides for interim debtor-in-possession financing while the company pursues a six-week sale and investment solicitation process,” the Times Colonist reports. “The credit facility will be for up to US $4 million, subject to increase by up to an additional US $6 million with the consent of the lenders.”
This gives Colossus access to an additional $10 million, giving it time to look for a buyer, solicit additional investments, or complete the development of its mine at its Serra Pelada cite in Brazil. Colossus may be down, but it’s not out just yet. After all, it is sitting on one of the richest mining sites in South America.
“Discovered in 1979, Serra Pelada hosted the largest ever gold rush in Latin America,” the company explains at its website. “During the 1980s, up to 80,000 garimpeiros (artisanal miners) produced an estimated 2 million ounces of gold plus platinum and palladium, from a 400m x 300m x 100m hand dug open pit. Garimpeiro production declined due to pit wall collapse and flooding causing the cessation of bedrock mining since the late 1980s.”
So the company is at least looking in the right place, a real bonus to securing ongoing operating capital. When Colossus purchased 75 percent of the property in a joint partnership with the Brazilian miner COOMIGASP, more than 200 holes had already been drilled, providing Colossus with plenty of guidance on where to look.
The only problem is that “the company does not currently have any mineral properties that are in production or that contain a reserve or resource as defined in National Instrument 43-101 – Standards of Disclosure for Mineral Projects (“NI 43-101″),” Colossus revealed in its Q3 2013 report.
According to Yahoo! Finance, the company has burned through over $21 million in the last 12 months, so access to another $10 million could last another six months. Whether that buys them enough time to produce some revenue remains to be seen.
Investors should understand that development stage mining companies are lottery tickets that at pennies per share can make you rather rich in quick order. But like lottery tickets, the odds of winning are slight.
If you don’t like to gamble with your investments but still want to be in the mining sector, then there are two things you should look for in a miner… proven reserves and ample cash flow. We just recently saw that very thing with large-cap producer Newmont Mining (NYSE: NEM), which is already generating some $450 million per quarter in cash flow and has some $1.5 billion in cash. Miners remain good investments where there are proven reserves and plenty of cash.
So Colossus’ bankruptcy shouldn’t necessarily turn us away from miners altogether. Investors just need to be more selective of their choices.
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The Advantage to Creditors
Another valuable lesson investors can learn from Colossus’ bankruptcy is the advantageous position that mining financers hold in the industry. Have a look at the deal that one of Colossus’ major creditors – Sandstorm Gold Ltd. (NYSE: SAND) – struck with the small exploration company as noted in Colossus’ Q3 report:
“In September 2012, Colossus Brazil entered into a precious metals purchase agreement with Sandstorm to sell refined platinum, palladium and gold produced from the [Colossus’] 75 percent owned Serra Pelada property. In return for delivering life of mine payable metal equal to 35 percent of both platinum and palladium and 1.5 percent of gold, [Colossus] received an upfront deposit of $75.0 million [from Sandstorm].”
“Sandstorm will also pay [Colossus] a purchase price equal to the lesser of $400 per ounce of gold, $200 per ounce of platinum, and $100 per ounce of palladium and the prevailing market price.”
Did you catch that? In exchange for a $75 million deposit into Colossus, Sandstorm has the right to purchase gold at $400 per ounce, platinum at $200 per ounce, and palladium at $100 per ounce or their prevailing market prices, which ever are less. The current prices for the metals are around $1,230 for gold, $1,420 for platinum, and $730 for palladium. Sandstorm gets to buy the metals for just 33 percent, 14 percent and 27 percent of their current prices.
If only Colossus were producing.
But Colossus isn’t Sandstorm’s only client. “Sandstorm Gold Ltd., a gold streaming company… offers upfront financing for gold mining companies that are looking for capital and in return it receives a gold streaming agreement, which gives the right to purchase a percentage of the life of mine gold produced, at a fixed price. As of February 18, 2013, it had 10 gold streams, including 6 producing gold streams; and 4 net smelter return royalty agreements.” (Yahoo! Finance)
So if one client fails to produce, the financing streamer can still purchase precious metals at a deep discount from its other partnerships. A small-cap at $435 million, Sandstorm generated $56 million in revenues over the past 12 months, with an EBITDA of $27 million and a return on assets of 0.72 percent.
Yet there are other metals streamers that provide even better value, including:
• Royal Gold, Inc. (NASDAQ: RGLD) – a $3.34 billion mid-cap with a profit margin of 22 percent, operating margin of 56 percent, and return on assets of 3.52 percent,
• Silver Wheaton Corp. (NYSE: SLW) – a $7.6 billion mid-cap with a profit margin of 55 percent, operating margin of 60 percent, and return on assets of 8.28 percent.
These compare to a typical all-purpose capital provider such as General Electric (NYSE: GE) – a $272 billion mega-cap with a profit margin of 9.6 percent, an operating margin of 11.9 percent, and return on assets of 1.6 percent.
So if the word “Bankruptcy” gets you all excited, simply take a deep breath and look at the whole picture. Everyone in the mining space is well aware that junior exploration and development stage mining companies are shots in the dark. They’re looking for needles in hay stacks, and they miss more often than they hit. They quickly run out of money, and the parade before creditors is neverending.
Depending on your tolerance for risk, there are plenty of solid companies to choose from among the more established producers like Newmont, or the financing streamers like Sandstorm, Royal Gold and Silver Wheaton.
And remember the lessons that Colossus and Newmont have taught us… proven reserves and plenty of cash flow will keep your mining investments steady even amidst falling metals prices.