Mining in a Dot-Com World

 

 

By:          Pierre Lassonde

          President & Co-CEO

          Franco-Nevada Mining Corporation

 

The mining industry has been very good to both our company, Franco-Nevada Mining, and to me personally.  But I have always remained cognizant that the greatest source of our success has come not from our own mining or exploration skills.  Rather, much of our success has come form the skills and talents of many of the people in this room who work for other companies.

Franco-Nevada has benefited from royalties on such great projects as Barrick's Betze-Post, Meikle and soon to be Rodeo mines.  From Homestake's Eskay Creek mine in British Columbia.  From Goldfield's Henty mine in Tasmania and Newmont's Maggie Creek mine in Nevada.  And from the great Stillwater platinum and palladium mine in Montana just to name a few.   Warren Buffet had it exactly right when he said that "the best investment is a royalty on a successful business."  I'm just thankful he never looked at mining because I wouldn't be here.  And honestly, with a personal worth of over $30 billion, he's rich enough.

It is no coincidence that our company name has Nevada in it.  Twenty years ago, Nevada was the best place to explore and develop mining projects.  It still holds true today.  Franco-Nevada has made the bulk of its money from gold mines in Nevada.  But our hearts have stayed Canadian. We have been reinvesting some of our Nevada profits into Canada's next generation of mining projects.  If there were any two projects that had the ingredients for success, I do not think there could be any competition in the world to Canada's Voisey's Bay nickel project in Labrador and the Diavik diamond project in the Northwest Territories. Between the two, Franco-Nevada has invested $150 million.

What has happened to both these projects is an embarrassment if not a disgrace to Canada.  I regularly get calls from shareholders and fund managers from outside Canada asking me why the Voisey's and Diavik projects are being delayed.  It is very difficult to explain!  Anywhere else in the world, the offer to construct billion dollar projects in remote high unemployment regions with hundreds of long term high paying jobs and the ability to generate billions in tax revenues is welcomed. 

In Canada, if the Voisey's Bay and Diavik experiences are taken as examples, investors are held to ransom.  Governments have retroactively changed taxation and permitting rules and then will again change them further in mid stream.  Politicians seek political gain by blocking development.  Special interest groups will go to the courts to block development as leverage for their larger ambitions.  And, of course, everyone wants a bigger piece of the pie.  A new discovery is like the popular new T.V. show "Who want's to be a millionaire/"

There's an expression in the brokerage business that there is no easier person to promote than a promoter. One of the greatest promoters this business has ever seen was Bob Friedland.  With the discovery of Voisey's Bay,  Friedland sold a dream that was larger than life and just about everyone including the industry and investors bought into it for awhile. After four years, the only one left quoting old Friedland promotional lines that Voisey's Bay is "the richest nickel, copper and cobalt deposit on the planet Earth" is the Premier of Newfoundland, Brian Tobin.   Tobin swallowed the Friedland bait along with the hook, line and sinker and, for political reasons, it still hasn't come out. His intransigence is costing Canada billions in tax revenue and is a black eye to Canada's reputation as a place to do business.  What Mr. Tobin will find out is that money talks…… and it will be saying goodbye!  

The same can be said about the Canadian federal government with respect to the permitting process for the Diavik diamond mine. The Department of Indian Affairs and Northern Development (DIAND) has created a permitting process designed primarily to win political points from environmentalists and aboriginal groups.   After years of consultation and permitting work, the result has been a mess that has generated lawsuits from the very groups it was designed to serve.  DIAND itself has contributed to the confusion and uncertainty by invoking arbitrary bureaucratic measures that delay a project where environmental approval has already been secured.

Mining is a temporary land use that has generated hundreds of billions of dollars in wealth for Canada.  We are blessed to have the resources, the people and the capital to continue this proud and vital tradition.  But this can only happen if all the many levels of government we are encumbered with, set fair and equitable rules that are not manipulated by politicians and special interest groups. Where environmental approval has been obtained as it has been for both the Voisey's Bay and Diavik projects, government has a duty to facilitate rather than obstruct economic development.  Industry also has a responsibility to speak up and be more proactive if we want to keep a place in this country.

My partner, Seymour Schulich, has been doing just that.  Last Friday, he laid out his arguments in an article carried by the national papers. It goes to the heart of being a miner in Canada.  If you haven't had a chance to see it, we have made copies available to you as you leave.

 

Now lets change gears and get on topic - mining in a dot.com world.  When the organizers of this convention asked me six months ago to pick a topic, I had no idea how appropriate the timing would be.

 

Lately, about the most tired joke among mining company executives is that if we added dot.com to our company names, our share prices would go up.  It's no longer a joke!  About a year ago, a trickle of resource companies began making the move from exploration to the internet.  Most of them were failed, shell companies with little cash or hope so there was no big surprise that they needed new business plans.  But in the last month, the attractiveness of making the move has taken on a whole new dimension when Vengold Inc. moved from being a part owner in a Papua New Guinea gold mine to an internet incubator.  The stock has gone from 6 cents to over $3.50 sporting a market capitalization of $600 million!  Once it sells its Lihir gold interest, Vengold will have about $60 million in cash.  In other words, Vengold is being valued at 10 times the cash that it plans to invest in the internet.  Now that is a successful promotion!   Just about every mining executive with an orphaned stock has to consider the idea of reincarnating his company as an internet play.  The trickle to dot-com is  becoming a tidal wave.

In the last 14 weeks, Canada's new venture exchange has more than doubled.  Unfortunately, speculators are no longer betting on mining exploration play.  Instead, they are trying to catch the next company that will reincarnate itself as an internet company.  The latest phrase between brokers on Bay Street is  "Gold today, dot-com tomorrow."

            In plain language, what is happening in today's dot-com world is the same kind of wonderful mania we experienced four to five years ago in mining stocks but about 100 times bigger.  Back then, any one could put together a company with the concept of finding wealth high in the Arctic or high in the Andes.  The concept was credible as Diamet, Arequipa and Diamond Fields were the proof it could be done. Today, the idea of striking it rich through something like being the portal for the convergence of broad band B2B applications is not much different.  Again the concept is seen as credible given the success of the AOL's and Amazon.coms.

            The mania died for the mining industry with the loss of credibility following Bre-X and with the realization that very few so called discoveries ever became real.  And a large percentage of the remaining real projects were subject to strong arm extortion by foreign governments or by de facto expropriation even by our local governments - Crown Butte, Crown Jewel, Windy Craggy, McDonald Gold and Cheviot are a few examples.

The beauty of the internet is that governments haven't yet figured out how to usurp the value of new discoveries in a virtual world that can move across any boundary.  Investors have caught on too.  The dot-com sector's performance is acting as a giant vacuum cleaner sucking money from all other sectors and none more so than our industry.

One measure that too vividly tells the tale is how far the weighting of the  mining and gold stocks has fallen in the Toronto Stock Exchange index.  In Canada, miners once took comfort that fund managers simply had to be invested in this industry.  That was true four years ago when the combined Metals & Minerals and Gold & Silver weighting on the TSE was over 22%.  Today, the combined mining and gold weighting is only 6.5%.  Not only do Canadian fund managers need fewer mining stocks for their portfolios, they can for the first time more easily ignore the sector all together.

                        As part of running a public company, I have for over 15 years done road shows to sell Franco-Nevada's prospects to institutional investors in Europe and the United States.  As well, there have been a lot of presentations to gold shows and mining conferences.  Looking back, I now realize our industry was privileged.  Despite a general downward trend in gold and metal prices, the mining industry had a core of dedicated investors.  These included old time Swiss or French money managers that for historical reasons always felt it important to have at least 10% of their portfolio in gold.  Or it was the many specialized resource or gold funds that were dedicated to investing in this sector.  And of course there was always a retail component of investors and newsletters that believed in gold over paper.  These captive investors allowed cyclical resource companies and especially gold companies to enjoy premium valuations.

            In the last three years I have noted a remarkable change in the investment universe.  In Europe, the restructuring of their financial markets with the common market has been accompanied by a restructuring of many of the investment firms.  The old time money managers are now gone.  The new money managers at many of these firms are close to my son's age.  The historic allegiance to Canadian mining stocks is gone.

            In the U.S., the story is similar.  The under performance of most resource and gold funds has been an embarrassment for the firms that have been active investors.  A combination of post Bre-X losses and investors redeeming their dollars out of those funds has decimated some of the high flying funds.  At the beginning of 1997, the high profile Robertson Stephen's Contrarian fund, which focused on resource stories had over $1.2 billion in assets.  At last report, it was down to $116 million, a reduction of over 90%!  These decimated funds will not be providing fresh capital to the mining industry.  It took our industry 20 years to build up a specialized institutional base.  In less than four years, we have dismantled two-thirds of it.   

            As for the gold shows, if you have been to one recently, it's like going to church.  The crowd is old, quiet and prays a lot.  The new generation of investors and the action is all at the technology and dot.com shows.

            The attitude of managements at many of the mining companies is to hang on. Once commodity prices move again or someone starts a new area play, they believe, like always, the funds and retail investors will be back and the old valuation measures will again apply. I believe what we are seeing now is more fundamental. 

The reality of how different this investment world has become really struck home to me last year.  Franco-Nevada, with a US$2.5 billion market value  ranking it as the fifth largest gold company in the world, was too small to be considered by some U.S. funds!  While we in the mining industry have remained focused on our businesses, we tend to lose sight at how fast the rest of the world is growing. A major future challenge for our industry is staying relevant in the new dot.com world.

            By relevant, I mean how will our industry reinvent itself sufficiently to continue to attract both investment capital and human capital?  Our industry needs not only money but the talents of the next generation of bright graduates.

            Let's look first at the investment side. With the loss of our traditional dedicated investors, the mining industry has to compete for a share in a generalist investor's portfolio. For a global business, access to the global markets is becoming more difficult.  In the U.S, the entire mining and metals sector including aluminum and steel companies make up less than of one percent of the S & P stock index. Adding together all the global gold, copper, aluminum, nickel, zinc and diamond producers represents a business with a total market capitalization of about US$200 billion dollars.  For perspective, there are individual companies in the U.S. such as Microsoft or Cisco Systems that are valued at over US$400 billion.  Even the biggest mining company in the world, Rio Tinto, with a market capitalization today of US$25 billion, looks very small. Taking the comparison even further, the Canadian companies look downright puny.  Alcan has a US$10 billion value and then it drops quickly to Inco and Noranda at US$5 billion.

            If a fund manager, be it Canadian or global, is going to invest in mining, he or she is going to buy only one or two mining stocks and will effectively limit their search to the larger investment grade companies that are the brand name leaders in their segment.

In the last year there has been a scramble among resource companies to become the leaders in their particular segment.  The proposed Alcan-Pechiney-Alusuisse merger.  The proposed Alcoa-Reynolds merger.  Phelps Dodge bought Cyprus-Amax and almost got Asarco as well.  Placer-Dome with Western Areas and Getchell.  Even my own Franco-Nevada with Euro-Nevada. 

All of these mergers had the usual business rationalizations about synergies and cost savings.  But why so many and so suddenly?  I believe if you got into the heart of the Chairmen and CEO's of all of those companies you would see that they had the same underlying fear. If their companies didn't become more significant, that in today's new dot-com investment universe, they would disappear from the radar screen of the key investors in the equity markets. We certainly are not attracting new capital with our investment returns. In the last three years, our combined sector has delivered annualized returns of negative 16% ranking it as the worse sector among TSE industries.

Investment capital has learned to put a premium on firms that can dominate and manage their respective niches. Whether it is a Microsoft in computer software, an AOL for the internet or simply a Nike in sporting equipment, the attraction for investment capital is the opportunity to invest in market leaders that have the potential to develop growing profitable markets. 

The only reason some our industry peers can keep their heads above water is that wood floats!  We see ourselves as price takers and, touch wood, let the commodity take care of itself.  A typical mining corporate strategy has been to strive to be the lowest quartile cost producer with the idea that our competition will go bankrupt before we do.   Another strategy has been when the metal price decreases to actually increase production or high grade ore bodies in order to lower unit costs.  Any rational industry would do the opposite.

The aluminum industry has figured it out and collectively cut production through a multi-government approved accord.  So has the pulp and paper and more recently the oil industries.   Oil producers have cut production by only 7% and oil prices have tripled.  Our industry can only wish.  We effectively subsidize consumers of our products by under pricing our product.  The cost is inadequate margins to take the extra measures for the environment, inadequate returns for our investors and lousy career paths for our employees who have to live through a boom and bust cycle.

The gold industry, rather than developing new markets for gold, actually sells its own product short.  In fact, I think it is very ironic that it took the leadership of the European central bankers to initiate the first limits on gold sales and lending.  The gold industry has been very slow to follow suit by reducing its own hedging and production.

Another issue facing the mining industry is a failure to do what is best for its shareholders.  Why did three separate mines get developed at Hemlo on what is essentially one ore body?  The oil and gas industry wouldn't have thought twice about unitizing it as one operation.  Why are two diamond processing plants being built virtually next door to each other in the Northwest Territories?   Inco and Falconbridge's nickel operations have operated side by side for over 60 years in the Sudbury Basin.  There is a lot of room for rationalization.  

Experience has demonstrated that commodity style corporate strategies have come at a cost of lousy returns to investors.  The other cost has been to the people in this industry.  Over the last 20 years the mining companies have done a good job of purging their organizations of layers of middle management.  But very little has been done to try to attract new talent.  What bright kid in his right mind would go into mining when dot-com companies are where it's at?  How is the industry retaining talent?  Unfortunately, so much effort is spent on short term cost control, the longer term investment for the future is lost.     

            Investors and the future talent aren't much interested in hearing about our political, environmental or commodity problems.  They have to make an investment either with their money or with the personal careers.  They have options of where they can put those resources.  The onus is on our own industry to think beyond our historical conditioning, to recognize the competition for investment dollars and for key talent that is coming from other new industries.

            There are signs that some sectors of the mining industry are moving beyond being just commodity companies.  Alcan is developing new uses for its product with its major auto customers.  Stillwater has done longer term supply arrangements in the platinum-palladium business.  Examples of companies that have become market leaders in their particular niches are Potash Corporation in fertilizers, Cameco in uranium and DeBeers in diamonds.  All of these companies reduce supply in periods of oversupply and are investing to increase the long term demand and value of their products.  They all deservedly have a global investment following.

            The gold and copper industries have a long way to go.  At the Denver gold show last October there were 48 gold companies presenting over 3 days involving 173 company spokesmen for an audience of only 62 real investors.  There were more sharks than fish!  Does the investment world really need that many gold companies? 

What if the gold industry did its own equivalent of the Alcan deal?  How would investors respond if Barrick Gold merged with Placer Dome, Newmont and Anglo Gold. The resultant company would have a $20 billion market cap, about the same league as a Rio Tinto or an Alcoa.  While this sounds very dramatic to those of us in the mining industry, it is relatively small potatoes to the big mergers already going on in the global oil, banking, telecom and pharmaceutical industries.  Either the industry moves to get bigger, smarter and more profitable or it risks being seen simply as a collection of low margin mom and pop commodity producers in small stagnant market niches.  For too long, we have dug deep for our metals and milled, smelted and refined them only to sell the final product too cheaply.

As you can see, I think there are a lot more dramatic changes to come.  If mining company executives aren't proactive, institutional shareholders will force the changes on them. I agree that mergers solely for the sake of getting bigger is not a solution.  But mergers that create proactive market leaders in their segments are something worth attaining. Imagine what a rationalized industry could do in a growing world economy with rapidly advancing technology that can use more of our products more effectively than ever.  Maybe such an industry could grow in a symbiotic way with its major customers providing higher value added products with better margins.

I believe our industry has the opportunity to create a great future and is just taking the first steps to get there.  A long life, low cost mine is a proprietary asset of great value that is very hard, if not impossible, to duplicate.  In the dot-com world, there is an infinite ease of entry.  Give me a long life mining asset, or better, a royalty on one, any day over a dotty dot-com crazy.

            This convention reaffirms without a shadow of a doubt the world class stature of Toronto as a mining and financial centre.  Here in Toronto we have the means to put it all together.  Canadians are at the forefront of this new wave mining age and billions of dollars of new wealth will be created.  When it comes, we need to support our universities.  Canada's mining, geological and metallurgical faculties need to concentrate their talents into fewer world class centres that will make a difference on a world scale.  Industry should support these centres to develop the research and talents that will allow this industry to take charge of the agenda rather than reacting to that of the special interest groups.  We need to put some back into the institutions that made it all possible for us to succeed so that we can prepare future generations. 

It's been said a thousand times but it is still true.  The most important natural resource of our industry and country is not nickel or gold or diamonds but its people.

 

Thank you