Junior Financings Glossary

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We’re posting the glossary we include in our custom reports here because we think you might find it useful. We do not provide the legal definitions of terms, but if you want to understand how we use terms, this is a good place to start.

Average Daily Volume (ADV): Average daily volume is the share trading volume of a stock over a period of time. We generally use 30-day and 90-day periods to monitor ADV.

Average Daily Volume (ADV) Dollars: To get ADV dollars, take the total shares traded over a month and multiply it by the weighted average share price, then divide by number of trading days.

Best Efforts: Depending on the bank, “best efforts” means different things. If the bank’s good name is on the line, a “best efforts” deal means the bank will do the work to place the shares, barring force majeure. For a weaker bank, “best efforts” means they make money if there is demand and they take no risk if the offering fails.

Bought Deal: The bank provides an insurance policy to the company, and shows that the bank is confident the shares can be sold. This means the bank must support the share price and has a vested interest in making sure the book is filled. For an investor, a bought deal is generally less risky than a best efforts deal.

Broker: A euphemism for banker, investment banker, or underwriter. The broker’s job is to convince the company of reasonable terms and then sell the institutions on the terms the company has agreed to.

The broker filters the good companies from the bad companies and helps clients to get realistic pricing from investors. A good broker is worth his or her weight in gold, but that tends to be what they get paid, good or bad.

Common Shares: This is what most investors buy. They give ownership of the company to the buyer without tax advantages or complex structure attached.

Discount Premium: When we look at a financing, we look at the discount of the offering share price compared to the previous day’s closing share price. This is important because it shows the discount required to sell new paper with a four-month hold on trading it.

Fees: Fees to brokers are a major part of the financing process. As an investor or company, you are concerned with total fees. However, not all fees are created equal:

·       Cash: The most desired form of fees for bankers and, in reasonable quantities, the least confusing and most reasonable way for companies to pay banks (it’s clean). Traditionally, cash fees range from 5% to 8% in Toronto. Often, companies doing non-brokered deals still pay cash fees to finders.

·       Finder’s Fees: Companies not large enough to attract a bank usually pay finder’s fees to third parties that find capital. These fees are more opaque than brokers’ cash fees because the third-party finder sometimes has conflicts.

·       Broker Warrants: A blessing and a curse. The blessing is that the broker is invested in maintaining the post-market share price. We like broker warrants in moderation, and we prefer them to cash. Anything that increases the contact time between the broker and promoting your stock post-offering is a good thing.

·       Other Costs: In every financing there is a five- to 10-inch binder of paperwork. There are legal fees, investor relations fees, analyst junket costs, and management time, not to mention the executive cars, wining and dining, and first-class travel that everyone on the deal requires.

Flow-Through Shares: A special type of share for Canadian citizens that gives a tax credit in exchange for buying. Our issue with flow-through shares is that they create a significant downward trend on share prices. A good flow-through investment does not go down during the year, while a good common share investment has to go up for investors to make money.

In the Money: Traditionally used to show that a financial instrument has cash value if exercised that day. For example, a warrant with a strike price of $0.35 (with a market price of $1.00) is in the money.

Institution: Traditionally manages other people’s money, makes profits from predicting the future, and values its privacy because it serves as a filter for quality versus crap. Most institutions are viewed from the outside as monoliths, but in reality there are tribes and sub-groups within. It is important for a public company to understand who manages the share position of the company within the institution.

Institutional investors operate within a set of rules, and it is important to structure your relationship with them so that you do not conflict with those rules.

Market Cap: To calculate market cap, take total shares plus options that are “in the money” and multiply by share price. Usually, non-investment grade companies have market caps under $50 million. Market caps of $50 million to $500 million attract growth and high-risk investors. We also use market cap to determine how much money a company can raise, as a company cannot easily raise over 25% of its market cap.

Oreninc Canadian Resource Financing Index: A numerical index that provides a sense of the overall financing market mood. It helps companies decide when to finance and helps brokerage houses determine what type of deals to conduct by giving a sense of market depth for new and secondary offerings. The index is updated weekly and released every Thursday on Oreninc’s blog Orenthink after market close.

Warrants: Warrants give the owner the right to buy a share at any time up to the expiry date at a predetermined price. Warrants can provide a secondary financing opportunity for a healthy company. When all goes well, warrants put cash in the treasury without additional fees.

We do not like financing warrants for two reasons:

·       Dilution: A half-warrant attached to a financing can increase the dilution by 50%. However, the dilution is asymmetric against existing shareholders; warrants give extra value to new shareholders at the expense of current shareholders. When the company under-delivers, the warrants do not get exercised and expire, no harm done. A significant amount of warrants creates a share overhang that rarely exercises and holds, but rather exercises and dumps paper onto the market.

·       Mispricing: Companies rarely get fair value for their warrants. Considering the significant transfer of wealth that they represent, one would think an offering with a warrant attached would attract a premium to market price.

Warrant Premium: Traditionally, warrants are issued at a premium to current share price. This is a good thing, but rarely is the discount rational. Most warrants are almost in the money when they are issued, so much of the value is attached to the warrant.

Warrant Valuation: We do not like the Black Scholes Option Pricing Model, but we agree that the core concepts of the equation are useful for warrant valuation. We look at warrant valuation from the view of existing shareholders. We recommend you understand the following concepts:

·       Underlying Price: The current share price of the company.

·       Volatility: The volatility of the underlying share price will increase or decrease the value of the warrant. Most junior mining companies are so volatile that this is a significant driver (or, rather, discounter) of value.

·       Risk-Free Money: The rate at which money will be lent with a 100% return guarantee of the principal. In the mining business, this is of small relevance. We set it at 4%, but it will not affect valuation much.

·       Strike Price: The price at which the warrant option can be exercised. We feel that this is rarely set high enough.

·       Maturity: The longer you have to pull the trigger, the more the warrant is worth.

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