Special Situation Alert - Canagold Resources (CCM.TO)
Samuel Clemens is known to have said that a gold mine is a hole in the ground with a liar on top. In the world of mining stock promotion, he wasn’t much off his mark. Mining stock promoters have a well-deserved bad reputation – the lower the market cap of the stock they promote, the more well deserved the bad rep.
Far too often, the promoters feed off shareholder equity and keep the game going long enough to enrich themselves before their schemes unravel. Resource funds usually ‘play nice’ – in exchange, they profit off other shareholders through sweetheart deals, such as five-year or ten-year warrants, convertible debt carrying prohibitively high interest rates with a lien on the main asset, a NSR royalty, etc.
The warrants are usually priced just above market and handed out along with newly minted shares in private placements.
The convertible debt masks the hole in the balance sheet and kicks the can down the road – long enough for promoters and the management group to profit off the public company before it’s game over.
A NSR royalty is a ‘net smelter return’ royalty – or a royalty on the revenue earned by a producing mine net of smelter charges. It is not uncommon for small cap companies to forward sell 5% of revenues in exchange for enough cash to keep the lights on and pay salaries. Canadian Malartic, the largest gold mine in Canada, is encumbered by a 5% NSR royalty payable to Osisko Gold Royalties (OR, OR.TO) and a partial 1-1.5% NSR royalty payable to Royal Gold (RGLD).
The mining stock analysts and newsletter writers usually play nice too. Their incentive? Fully funded field visits, compensation for promotional articles, side deals for handling company PR, access to material news ahead of the public, etc. The more crooked the promoter, the more they lush up analysts.
Fully funded field trip → glowing analyst recommendation → private placement by institutions→ more money lining promoters’ pockets.
The 1996 Bre-X scandal was the most egregious case of this feedback loop, with promoters managing to pump up the value of a barren piece of land in Indonesia to C$6 billion in market cap. The analyst covering Bre-X for Nesbitt Burns (now part of BMO) had a Buy rating on the stock to the bitter end, never wavering in his conviction even after the stock collapsed, he got fired, and lost an estimated $15 million on his personal holdings. While not all promoters manage to obtain such a hold over the analysts/newsletter writers, it is possible, has happened, and can happen again.
Long story short, beware of any mining stock promotion!
Canagold Resources (CCM.TO, C$0.30, MCap: C$24.9 million) is “is a growth-oriented gold exploration company focused on generating superior shareholder returns by discovering, exploring and developing strategic gold deposits in North America”.
If “generating superior shareholder returns” is promoter-speak for 98% decline in share value since IPO, then that sounds about right.
The company does have an asset of merit. The New Polaris project in northern British Columbia is a past producing mine where gold was first discovered by prospectors in 1929. The mine produced 232,000 ounces of gold from 691,00 tonnes grading 11.9 g/t until 1957. Canagold acquired the project in 1992 and by 2019 had published a mineral resource estimate of 586,000 ounces grading 10.8 g/t in the Indicated category, plus an additional 485,000 ounces grading 10.2 g/t in the Inferred category.
When the gold price rose in 2020, the company updated the numbers on its 2019 Preliminary Economic Assessment. The updated study showed the project having an initial capex of US$111 million, after-tax NPV of US$333 million, after-tax IRR of 56%, and payback period of 1.9 years. These are the sort of numbers that would make any resource investors perk up their ears and tempt them into taking a stake.
Which is exactly what management was hoping for. The stock rose from 40 cents to a peak of 95 cents by December 2020. The company used the momentum to raise C$8.4 million in 2020 and followed up with a further raise of C$7.6 million in 2021.
What did the company do with all this cash?
In 2021, the company successfully completed a 47-hole, 24,000-meter drilling program at New Polaris at a cost of $4.25 million. For comparison, in 2019 and 2020, the cost of drilling was zero, i.e. no drilling was undertaken.
The company paid out $2.265 million to key management personnel (2020: $743,000; 2021: $1,522,000).
From 2019-21, the company spent $4.25 million on drilling New Polaris and $2.93 million on executive compensation. Interestingly, the company also spent $1.1 million on transportation costs at New Polaris and $1.1 million on shareholder relations over the same period.
Meanwhile, the stock languished, ending 2020 at 77 cents, 2021 at 39.5 cents, and dropping all the way to 25 cents by June this year. Maybe insiders got too cocky and thought shareholders wouldn’t notice, or maybe they decided they could get their way, but for whatever reason, management proposed a stock option plan which would allow them to dilute shareholders by 20% within a year. That’s C$5 million in free shares awarded to insiders assuming C$25 million market cap. After all, if you can get away with $1.5 million, why not go for $5 million?
In the case of company founder Bradford Cooke, greed led to insider trading, and he managed to profit off material news. Another director nominee, Martian Burian, also engaged in what could be construed ‘suspicious trading activity’.
Usually in such cases, insiders get away with it. They treat the public companies as vehicles to fund their lifestyle, run it down to zero, rinse and repeat.
This time, it wasn’t to be.
After probably losing a lot of money on their Canagold investment, shareholder Sun Valley Investments became activist.
Sun Valley, the beneficial owner of 17.61% of Canagold, decided to mount a proxy fight ahead of the July 19 Annual General Meeting. They even paid a 20% premium in order to obtain additional shares with voting rights.
Who is Sun Valley?
Sun Valley Investments is a private equity firm which strives to produce superior returns for all stakeholders. We focus on the precious metals industry with portfolio companies and branch offices in the UAE, United States, Colombia, Canada, Switzerland, Spain and India. Sun Valley has completed over US$2.5 billion in gold transactions, has over US$350 million in assets under management, and have raised over US$1 billion for projects in three continents.
According to their proxy, if the Sun Valley Board was elected, they intend to
Resume drilling in 2022/23 to increase the resource base with a view to move inferred mineral resources to indicated mineral resources.
Immediately tender the feasibility study and start it [sic] this year. We expect the feasibility study to take approximately 18 months to complete, but we expect it would provide sufficient data to define the design parameters needed for permitting to begin within six months.
Initiate the permitting process in Q2 2023.
Once elected, the company will add in C$7.6 million in equity capital at a 20% premium to market price.
Sun Valley won by an overwhelming vote of confidence in their favor.
The first 3 nominees were proposed by Sun Valley. Scott Eldridge, the current CEO, was voted in by 22.98% of shareholders, a far cry from the 43%+ the Sun Valley team secured. The Sun Valley case was so solid that independent proxy advisor Institutional Shareholder Services (ISS) advised shareholders to vote for them. The support by ISS, Sun Valley uncovering undisclosed trading activity by Bradford Cooke, and shining a light on the egregiously dilutive stock option plan clinched the vote in their favor.
Results were announced yesterday (7/20) and the Sun Valley team is in charge of Canagold.
I acquired shares yesterday, hitting the offer price (30 cents) to acquire my stake. There appears to be a sell wall in place at that level, and there’s enough volume in the stock that acquiring a meaningful stake is doable. That’s not always the case for a TSX small cap.
My expectation is that Sun Valley will follow through on their promise and infuse cash into Canagold at a 20% premium to market. That’s at least 35 cents, assuming the premium is based on the 29 cents closing price yesterday. Their original proposal called for a C$7.6 million financing at 32 cents. Whichever path they take, as long as cash comes into the company and goes into proving up New Polaris (as opposed to enriching insiders yet again), I think buying Canagold at these levels offers a decent risk:reward.
If you want to follow me on this and my other trades, I run a free Telegram group that you can join.
Disclaimer: I have no affiliation with Sun Valley Investments or any insider at Canagold. I am not a Registered Investment Advisor (RIA) and nothing in this article should be construed as “investment advice”.