Warrants can be an investors’ sweet dream, and an issuing company’s worst nightmare.
Warrants are basically like stock options given to investors on a financing–and in the high risk junior mining, game they are used a lot. I would argue that sometimes they are used too much.
Yesterday, I spoke at a conference hosted by my colleague and friend Gwen Preston, who writes exclusively on junior mining as The Resource Maven. Like me, she is not a trained geologist but she is a trained trader and market watcher with great insight, and a gift to that community.
She asked me to speak on the topic of warrants, because she knew my thoughts–they are overused by promoters, management teams and brokers. I would not be popular!
I spent the first 18 years of my career in the market in junior mining, and got to work with some amazing management teams–and some not so amazing. I was there when there was no institutions and liquidity was tight and 8 million shares was a rollback and if a stock hit a good hole it could go to $10–because the share counts were so few due to lack of liquidity/funding. (Sonny, get me my cane over there in the corner!)
My overall message was that warrants DO have a place in this high risk business, and certainly other industries (think biotechs with convertible preferreds etc) use worse instruments that impeded an efficient market and transparency. But by judiciously using warrants, and having clean share structures, mining might be able to attract more investors just as this market starts to ramp up.
The original intent of warrants was to incentivize investors to take a shot at either a high-risk play, or one that could take a long time to develop.
Why do I think warrants can be bad? Warrants are a drag on a stock. Warrants create inefficiencies in markets. And they steal value from future investors.
If there are 20 million warrants at $1/share strike price and they don’t expire for another two years, as soon as the stock starts trading….I don’t know, let’s say…50% higher…those warrants start to get exercised and sold into the market.
They become a really annoying supply that management does not control. It makes it more difficult for me to buy any stock as an investor knowing that a large supply of new stock could swamp the stock at any time. I want to buy stock right after warrants expire.
We have now, as an industry, got into the habit of longer dated warrants—3 and five years now, and that can create a barrier to funding at higher levels. We all know that although value gets created in the ground, having control of the supply demand on your stock is an important tool in creating the best price to finance your stock.
And management’s goal is to get their deposit developed to a buyout or into production with fewest shares out as possible. Aside from ESG concerns, that is their #1 goal (and my wife says I’m not PC). The fewest shares means the highest price. Warrants rarely help those goals.
Unless management can force the exercise of the warrants under a certain scenario, they have no control over when these get exercised. And while getting the money in from warrants is a positive, it may be at a bad time when they want to raise a larger amount of money and find they have to do it at a lower price than they want.
Again, I think warrants do have a place in junior mining, but are now overused—a lot. Especially now that we are in a bull market for gold. Warrants are to be used as an incentive to raise money in hard times—not to reward greed in good times. But for the most part, that’s what it has become.
And while it may enrich a few, I would say it makes us all a bit poorer because the next round out of investors—generalist institutions, retail investors who only come our way in a bull market when gold is in the news—they realize that they have to fight the insiders as much as the gold price.
I can’t tell you how much the rest of the investing world looks down their noses at our sector because of warrants. Not only do generalists have to deal with high risk situations—geology—and management execution same as other sectors–but they also have to deal with structure in a way they don’t with most other sectors.
By the way, I would point that on the NASDAQ, in biotechs in particular, warrants and preferred shares and convertible offerings are actually much worse than the way we use warrants. Please don’t think that I’m saying we’re the worst of the lot—not by a long shot. But we can do better, and raise the image of our sector in the eyes of more investors.
Let’s look back at 30 years ago.
That market was very different than the one we have today. That was the last cycle that really didn’t have much institutional following. There were a very few specialty gold funds that dipped their toes in exploration plays, but the liquidity was MUCH lower than it is today in the exploration sector.
Example: 8 million shares or more generally meant a roll-back of somewhere between 3 and 8 to 1. And the company would go dormant while insiders slowly accumulated, letting everybody else get bored and sell their board lot and a half back to them at pennies on the dollar.
It was a long time ago, but my recollection is that rollbacks happened a lot more often then than now. Mgmt would issue themselves a new financing with a full warrant after quite a bit of time, and that’s one of the ways they kept control of the public vehicle. Insiders generally had enough cash they could exercise & cross out those warrants to keep the treasury alive.
I would also add that in those days, people who bought financings had their stock tied up for one whole year; 12 months. Now, IMHO, anybody who did that was entitled to a full warrant. We can look back on that and say…that was crazy.
ANYWAY…then some very high profile successes—
- Arequipa being bought out quickly for $27 in 1996, or
- Diamondfields discovering the Voisey Bay nickel deposit in Newfoundland in 1994—that stock by the way went to a pre-split high of $160 from 39 or 49 cents was the original Rutherford Resources financing—
- and even the Bre-X mania brought institutions into this field and transformed it into a much more mainstream sector.
Huge gains like the ones I just described will do that—meaning they will bring Big Money to our market. Huge liquidity.
I would argue that warrants have not evolved with our market. Back in the day when liquidity was very low and money was truly hard to find, warrants were a good incentive to help finance.
But now, the quality of both financial and technical management is much higher in our sector, and transparency is a lot better. Information comes out quicker. That has brought a lot more liquidity to our market.
Liquidity and transparency are good for investors, and thus reduce the need for warrants. Anything that helps investors trade these stocks reduces risk, which is what warrants are supposed to compensate for.
What do I mean when I say that—reduces the need for warrants. Again, warrants are to be used as an incentive to get investors to finance a risky situation.
But look, this is still one of the highest risk industries in the world, and warrants can handicap that to a certain degree for investors, at certain times of the exploration cycle and the business cycle.
If we look at the market we have today, this very day, we are nine months into what could be a major bull market in gold.
Now, IMHO, you don’t need to use warrants near as much in a bull market. This is all just my opinion, but right now financings 10 cents and under are going to make money. So they don’t need a warrant.
No management team is going to find it hard to get a roster of value-add shareholders on a 5, 10 or 15 cent financing right now—so they don’t need a warrant.
When you see a warrant on those financings, again this is just My Humble Opinion, you’re seeing management use it consolidate control on the stock or…I’ll tell you what goes through my mind…it’s a weaker team, and it makes me question if they can raise money at 50 cents or higher without a big discovery hole.
Will a team who offers warrants on these cheap financings have the ability to develop an audience for their story, their stock, to finance at higher prices without that very rare home run drill hole?
Now obviously, in a bear market, I do believe you can throw a warrant on those cheap financings. In a tough market you don’t know where your next dollar is coming from. The equity window is closed a lot more often in a bear market, and even cheap financings can be risky.
To me, the best time for a warrant in a bull market is before the discovery hole, or maybe even the first financing after a discovery hole. There is real risk there, all the time.
Do they always have to be full warrants and half warrants? Can they be third or quarter warrants?
Let me tell you a quick story on a genius move by a management team with warrants. I was lucky enough to work on Wheaton River Minerals in 2001, that grew up and merged with Rob McEwen’s Goldcorp. The legendary Ian Telfer ran that deal and did a hell of a job.
In those early financings, the gold bull market was barely underway, and still uncertain. Telfer put warrants on I think THREE of his first financings, maybe it was two. But he put the same strike price and expiry date on all those financings.
And as the stock moved up and all those warrants were in the money, Ian wanted them exercised…so he offered an additional quarter warrant at a higher price to those who would take their profits now—they had to be exercised before a certain date, and not wait until final expiry.
In one stroke he made his shareholders happy and cleaned up his capital structure so he could finance at the best price possible moving forward. There would be almost no drag on the stock after this.
Let’s move forward in the exploration cycle. What is the need for a warrant once the market knows a resource calculation is coming? It’s less. Lots of expansion and delineation drilling is coming—hopefully all good news.
Over the next couple years, assets usually get 2 or 3 annual updated resource calculations where they hopefully get bigger and better. During that time, there is a lower need for warrants.
After the final resource calculation, and all the work starts to map out the mine plan and the capex etc…there is no news. And these stocks drop. You see, only two things make gold stocks go up—finding more gold, or generating more cash flow from that gold (ie. Higher gold price, mine expansion etc. ) But there is an asset underlying the stock now. The Market has a rough calculation from history what a rough buyout price would be.
Should warrants be issued then? I don’t know the answer to that.
There are other ways to be creative with warrants. A simple one is to list them or not to list them. You see, I have this theory—listed warrants don’t get exercised near as much, and unlisted warrants do. Certainly the longer a listed warrant trades, and the more liquidity it has, the less chance it has of getting exercised. It just becomes a more levered proxy for the stock itself. Though it still counts on a buyout if that comes before they expire.
I would be curious to hear from management teams that have used listed warrants—how much get exercised. I would be surprised if it was more than 50%.
The longer the warrants, to me it makes sense the less they should impact the stock. You want to put a five year warrant on the stock? Make it a quarter or a fifth warrant.
The other thing management teams do is—create a forced conversion clause. If the stock trades at some level—lets say double the financing price—for a certain # of days, management can call the warrants to be exercised or they expire.
This allows investors to make some extra coin on their financing, and allows the company to get rid of this ongoing drag on the stock. Everybody wins. I like those clauses.
This has been a long winded talk on a first world problem. Folks it’s only money. But in our industry’s quest for more credibility and more liquidity, managing warrants a bit more judiciously could make us all a lot richer.
EDITORS NOTE—coming MONDAY–a management team that has put TEN mines into production. Their next one is simple, cheap, in a good jurisdiction and will payback capital in less than a year! That’s incredible!