Rick Rule: 'Free is a Very Good Price'
Issue 38, April 2013
“My goal is to end up with a purse full of lottery tickets,” resources investor Rick Rule tells Global Mining Observer, “paid for in large part with other people’s money.” Rule, who is credited with coining the ‘prospect generator’ phrase, says he in fact lifted it from the US oil and gas business. In the mining sector he has financed more than fifty such companies and is the money behind their rise.
Founded in 1997 and focused on Canada’s northeast tip, Altius Minerals was the first clear example of an exploration strategy that aggressively stakes ground and repeatedly options out projects, retaining a carried interest rather than incur drill costs.
Rule says that he agreed to finance Altius on condition it adopt the model. The company’s chief executive, Brian Dalton, was then in his mid-20s. “He was I think probably in some danger of pursuing the traditional exploration model in the Labrador Trough, which clearly would have bankrupted Altius, because it was very high risk, very costly exploration.”
Dalton’s age was to his advantage. “Being a very young man, he didn’t set any barriers for himself. He was young enough not to know that BHP wouldn’t do business with him, or Agnico-Eagle, and as a consequence of that they did. He was so determined, he wore out every obstacle, including me.”
Altius has since grown from being a frontier exploration stock into a royalty house, or merchant bank, with exploration upside. Beneath its C$335m ($330m) market cap the company has 11 exploration joint-ventures, including Rio Tinto, Agnico and Cliffs, a growing portfolio of royalties over iron, nickel, uranium and gold, $158m in cash and an equity portfolio of “spin-outs” including Alderon Iron Ore and Mamba Minerals (up 60 per cent this year).
Rule has poured several juniors into the same mold. Through a series of partnerships held within Sprott US Holdings he is a cornerstone investor in 15, including Virginia Mines, Lara Exploration and Reservoir Minerals. “We’ve covered the waterfront.”
Rule primarily looks for those that have “turned the most projects.” Into this bucket he drops Eurasian Minerals and London-listed Stratex International, both with projects in Turkey. “You can’t fall in love with the property,” he stresses, “you have to fall in love with the process, or you obviate any advantage.” Given that their strength lies less in any one asset than in the model itself, the discipline with which it is followed and the calibre of each company’s partners, prospect generators are difficult to value.
Rule approaches valuation by extrapolating a joint-venture partner’s spending commitments, even if they are contingent, onto the prospect generator’s share, creating what he terms ‘synthetic revenue.’ From this he deducts the prospect generator’s exploration and administrative costs, leaving ‘synthetic profit.’
“I use these phrases sincerely,” he says. “What I’m trying to determine is a team that generates substantially more third party benefit, or third party expenditure on my behalf, than they spent generating that expenditure.”
Since 1997, $150m has been spent exploring 56 projects co-owned by Altius Minerals, of which the company has funded only 10 per cent. Virginia Mines is likewise funding less than half of its $15m drilling budget for 2013.
The model also leverages a company’s expertise. “A junior might be able to afford 3 or 4 good geoscientists,” says Rule, whereas prospect generators partner with teams from the world’s largest mining conglomerates. He describes it as a “huge unspoken benefit.”
Rule’s metrics indicate that investors systematically overlook the model. Virginia Mines’ Eleonore royalty for example he believes to be worth the company’s C$321m ($316m) market cap, such that its exploration business is free. “People are bored by process. What works on the sales side, time and again, is to get somebody excited about a property.” Everyone considers their properties above average, he adds.
Mr. Rule points out that investment banks have an entrenched interest in promoting the sole-ownership model, whereby a junior attempts to advance a prospect to production from its earliest stages, repeatedly forcing issuers “back to the well.”
He does not believe prospect generators will ever come to represent the dominant financing mechanism in the exploration industry, because investors are “driven by the incredible reward to occasional success that the industry exhibits. Investors have made the mistake of being reward driven in a high risk business,” he says. For risk averse investors however, “reward will take care of itself.”
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