I Like prospect generators. They’re almost the only bet I’m willing to make on pre-discovery exploration. You know… “10-bagger” (1,000% gains) hunting ground.
What’s a prospect generator? It’s a company that acquires a portfolio of prospective properties and then options them to joint-venture partners who pay for the super-high-risk exploration work. In exchange, the optionee gets most of whatever is discovered. Typically, the partner gets 60–80%, depending on how much of their money they put into the deal. This puts Other People’s Money (OPM) to work on the riskiest stage of exploration, from the perspective of the prospect generator’s shareholders.
Why give away the lion’s share of prospective properties?
I hear that from CEOs of exploration plays spending their own company’s (i.e., shareholders’) money. They say things like: “We have great projects and we own them 100%!”
The quick answer is that the prospect generator may end up with only 30% of a mine, but none of the risk.
Going from having nothing to having 30% of a world-class mine—paid for with OPM—is huge value added for shareholders.
Remember that building a mine big enough to matter requires hundreds of millions of dollars—if not billions. Unless you’re a major mining company with that kind of cash on the balance sheet, you’re going to need OPM to get the job done.
If you are one of those major miners, you may not need OPM—but even a rich new discovery will have only a marginal impact on your share price.
The hunting ground for 10-baggers is among the junior explorers.
But…
There’s no way for a $30 million company with $3 million in the bank to pay for the exploration—let alone the construction—of a mine big enough to matter.
Actually, that’s not enough money to build the smallest mine a publicly traded company might consider. (I’ve seen tiny projects with budgets of around $10 million, but those generally have poor track records.)
Those CEOs who talk about how great it is that their company is keeping 100% ownership of its properties tend to forget to mention that shareholders don’t get to keep 100% of their stake in the company. Not unless they step up to the plate with more cash every time the company raises funds to advance its projects. If you get in early on an exploration company that ends up issuing 10x more shares in order to build its mine and don’t keep putting money in, you end up with 10% of the stake in the upside you started with.
Key point: the dilution dilemma is inherent in all exploration. (Please read my article on this if you haven’t yet.)
But suppose I take 70% dilution as a shareholder in a company that owns a project 100% on which it discovers a great deposit and builds a mine. How is that different from owning a prospect generator that gives away a 70% interest in a project in exchange for being fully carried through to production?
Night and day.
No one—absolutely no mere mortal—knows which projects will yield valuable discoveries. Not even the great Rick Rule, the mighty Doug Casey, nor even I, your due diligence wolf, knows.
Mineral exploration is an extremely difficult business. Even people who have discovered multiple deposits that became profitable mines don’t always succeed at finding another. Industry veterans say that only one in 300 discoveries becomes a mine. And there’s no way to count all the thousands of targets geologists evaluate and discard before they pick one to explore in hopes of making a discovery. Exploration itself is worthless; only discovery adds value, and that is both expensive and never certain.
The baseline expectation for all exploration efforts is failure.
That’s why I generally avoid pre-discovery exploration, despite its explosive potential when a discovery is made.
Prospect generators mitigate this risk with OPM and can still deliver 10x, 20x, or higher returns if they end up owning 30% of a world-class mine.
In other words, prospect generators with properly structured joint venture deals mitigate both the high risk of exploration and the dilution needed to advance discoveries to production.
I’m a big fan.
Please keep in mind, however, that even when it leads to success, the prospect generator (or “joint venture”) business model doesn’t do so on any sort of schedule.
It’s typical for successful prospect generators to burn a lot of OPM drilling holes in many projects before making a potentially economic discovery. Often, projects that eventually deliver fail to do so for several joint-venture optionees before the discovery is made.
Of course, lack of news, or even disappointing news from one of a prospect generator’s many projects doesn’t change the basis for speculation.
What does change things is when prospect generators fall off the bandwagon. Sometimes they are tempted by a really exciting target—or driven by a long bear market in which joint venture partners are hard to come by—to spend their own shareholder’s money on high-risk drilling. That’s not like the relatively cheap work on surface that identifies targets. Not only does drilling cost more, the usual result is disappointment.
Beware of fallen prospect generators.
Constant due diligence is still required.
So is patience. But if you do the math on dilution and risk mitigation through OPM, speculating on prospect generators is hands-down the best way to bet on pre-discovery exploration.
That’s my take,
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