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Junior Mining's Private Equity Appeal

Panel debate from Toronto's Fall Mining Showcase...

SOME $2 trillion is being invested worldwide by private equity funds every year, with a chunk of that destined for junior mining companies.

Demand is as strong as or stronger than ever as investors see a shopping opportunity. Who is deciding where it goes and based on what criteria?

At the annual Fall Mining Showcase event in Toronto this year, Red Cloud Mining Capital enlisted the help of three private equity panelists to answer those burning questions – Cheryl Brandon, a partner at Waterton Global Resource Management; Dan Wilton, a partner at Pacific Road Capital Management; and David Thomas, managing director of Resource Capital Funds, brought their insight.

This spirited debate – here edited and first published by The Gold Report – was moderated by Anthony Vaccaro, publisher of The Northern Miner,

Anthony Vaccaro: A few years ago, there was a perception that private equity was going to come in and wash away the junior sector's worries about insufficient capital. Was that perception misplaced?

Dan Wilton: The perception was somewhat misplaced. I think people saw big numbers being raised, $2, $3, $4 billion by people like Mick Davis, but that's very different from what we do. You need to understand our investors to understand how we invest. It's a different investor base than you would find in a traditional mining resource fund. Our investors tend to be big US pension funds or university endowments – not retail investors. They commit money to us for 10 years, and they're patient. Unless the fund has a specific mandate to go out and fund exploration – and few of the private equity funds do – there tends to be a bias toward later-stage asset development.

Funds like ours are not investing in a portfolio, they're looking to buy an asset and grow a company. The pool of traditional mining-focused private equity is smaller than people know. It tends to be focused more on later-stage opportunities because that's where you can deploy larger amounts of capital. It's difficult for us to put money out in $1, $2, and $3 million increments when you have a $475m fund to invest. When you're looking to put it into six or seven assets, those numbers get fairly large. And if you're a $6 or $7m market-cap company and someone offers you $20m, you'd be amazed at the resistance. People don't want to take the dilution at these levels, but at some point you have to have a supportive partner. It's a viable strategy, but most companies don't want to sacrifice the option value.

Anthony Vaccaro: There is also a perception that private equity firms can sometimes be ruthless. Is that fair?

David Thomas: It's important to make the distinction between what Cheryl's, Dan's and our funds do versus the big private equity generalists. We're a sector fund, with a "niche-y" investor base, which happens to be the same as Dan and Cheryl's investor base. Sector funds would be more akin to a venture capital fund. The bad guys, if you will, would be the bigger, leveraged buyout funds. Because of the inherently risky nature of the mining sector, you really don't want to multiply those risks by layering in financial risk, so Resource Capital Funds (RCF) does not use any leverage when it's making investments.

Anthony Vaccaro: What are some of the advantages that mining companies would garner from working with a private equity firm?

Cheryl Brandon: The mining sector in general has been very retail investor-based or institutional resource-focused investment funds, not private equity. As a result, most of the projects are long-dated, meaning long-term capital. That's one thing that our groups bring to the table – long-term capital. Our fund lives are 10 years. All the funds here have large technical groups internally, so we really understand the risks associated with the underlying projects, and we underwrite as such. When we are putting an investment into a company we say, "Okay, if the company needs X and they want to do Y, let's come up with a fully financed plan to create value, so that when the market turns, not only will the company have a strong, supportive partner, it will also have a project that's much more advanced." That's the way we look at it.

Back to Dan's point about dilution, a lot of the companies we speak with don't want to take the dilution at these levels. However, when the commodity cycle turns, having a strong partner and a project that's further along the development curve will benefit shareholders.

We all do different types of structures and financings – joint ventures, asset purchases, equity investments and structured financing. The advantages are different for each structure.

Anthony Vaccaro: Dan, what kind of risk profiles are you looking at? How do you distinguish between later-stage projects?

Dan Wilton: There's no shortage of risk in this business, so a big part of our due diligence process is about understanding those geological, metallurgical, operating, jurisdictional and financial risks. It's a risk/return business. When we see a risk that we can mitigate, that becomes part of the funding plan. But our return expectations are higher for something that has risks we can't control. For example, we have an investment in Kenya, which is a challenging place to do business, so our return expectations are higher than they would be for a gold project outside of Val-d'Or, Quebec, where you don't have the same inherent risks.

Private equity groups have a pretty high tolerance for risk. We're in a risk-seeking business. We have to take risks to earn upside returns, but I think we have a better understanding of a lot of the risks that mining companies face. We have a portfolio of 12 or 15 investments right now and we would tell you that a lot of people running companies don't have the full appreciation of (the risks) because they don't necessarily have the benefit of the experience of a diversified view on a whole range of projects.

Cheryl Brandon: With a structured-lending investment, we typically don't take board seats. Essentially, we get an operating report from the company every quarter that says how the company is advancing the project.

Most of the joint ventures we've done haven't been as the operator, so we allow the company to operate the asset and have a management committee, of which we make up a portion and the public company makes up a portion. The annual budget determined at the beginning of the year says: "This is what we're going to accomplish and this is what we're going to spend." We fund a pro rata portion of that budget.

As an equity investor, we recently made a 19.99% equity investment in a public junior with a project in Nevada. We have one board seat on a six-seat board and another on the three-member technical committee. As it relates to corporate decisions, it's ultimately what's best for shareholders. All the private equity funds here invest using different structures, which I think is an advantage because we can help shape the investment for what the company needs.

Anthony Vaccaro: Tell us about accountability and how that works.

Dan Wilton: In situations where we're a 25%, 35%, 40% shareholder, a lot of management teams find it quite different managing a company where you have one shareholder who really cares. We like to think that we can bring something to the table, whether it's best practice, free advice or getting some good technical people in our network to help. One of the single biggest differences between having a diversified shareholder registry and one large shareholder that is really vested in your success, is that with that large shareholder comes a significant degree of accountability.

The reality is management teams should always be accountable to the smallest shareholder, that's their fiduciary duty. But it takes on a different meaning when that shareholder or a couple of shareholders are 80% of your shareholders. The people who really prosper with private equity see it as positive. It removes a lot of the uncertainty because we generally don't care about week-to-week. We care about getting good technical work done, de-risking a project and unlocking the fundamental value of those resources. If that means shutting down an operating mine for a period of time if that is the right thing to do, it doesn't bother us. We like to think it's a real positive, but there is only a limited subset of people running public companies who see it that way.

Anthony Vaccaro: How does your group deal with tension when it happens?

Dan Wilton: It depends on the situation. We have a number of investments where we're 20% shareholders with a board seat. Frankly, we have found that to be pretty ineffective because you don't have sufficient influence to execute change. It comes down to boardroom dynamics.

When you're a majority shareholder, you can speak with a more direct voice. We had one investment where the management team told us they were interested in having a supportive, long-term investor, but the reality was that they weren't. The choice was to sell the stock or change the management team. It can go in either direction. Generally, if we're not happy, most of the other shareholders aren't happy either.

Anthony Vaccaro: Thank you all for your insights.
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