Mining sector feels cold splash of reality – by Fabrice Taylor (Globe and Mail – April 25, 2012)

The Globe and Mail is Canada’s national newspaper with the second largest broadsheet circulation in the country. It has enormous influence on Canada’s political and business elite.

Fabrice Taylor, CFA, publishes the President’s Club investment letter. His letter and The Globe and Mail have a distribution agreement.

The biggest risk in mine investing isn’t geology or third-world dictators or metallurgy. The biggest danger is purely financial. It’s called dilution.

Most of us underestimate how devastating this process can be until it’s too late. Simply put, dilution is when your economic interest is watered down. If a company you’ve invested in sells new stock and the share count goes up more than the value of the company, your investment is diluted. The more it can sell its new shares for, the less you’ll be diluted.
 
Waves of dilution usually herald the beginning of the end of the investing cycle in mining. I think we’re close.
 
By way of example consider the travails of Baja Mining Corp. It’s a junior miner with a promising copper-cobalt-zinc project in Mexico. The company has spent hundreds of millions bringing the project to the cusp of production. In late March it told shareholders that construction of the site infrastructure was on schedule for production next year. It also said that the cost to build the mine was creeping up and that it would try to find ways to cut costs to bring the project in on budget.
 
On Monday, Baja treated its owners to some unpleasant news: the cost to build the project would come in at $246-million more than originally expected, a 22 per cent increase over the original costs that were estimated only two years ago.
 
The stock, not surprisingly, collapsed from about $1 to as low as 30 cents, with the market cap plunging to $130-million. That’s bad, but it’s just one part of the company’s problems. It now needs to come up with a lot of money fast to bring its mine into production. It will most likely have to sell new shares to do so. Let’s assume it needs to raise $100-million through the sale of fresh shares. At $1 that would have increased the share count by a hefty 30 per cent. At 40 cents the dilution will be a brutal 73 per cent.
 
Existing shareholders who don’t partake in this financing, should it materialize, will lose more than half their current interest in the company. Dilution is painful and permanent. It never goes away.
 
One hopes the company can find alternatives to equity so that the dilution can be kept to a minimum, but some pain for shareholders is guaranteed as the market reaction proves. 

For the rest of this article, please go to the Globe and Mail website: http://www.theglobeandmail.com/globe-investor/mining-sector-feels-cold-splash-of-reality/article2413101/