SVH Tracker - August 22, 2017: Setting up abnormally successful fund managers for a shakeout
Novo Resources Corp has plunged to $4.00 from a high of $5.93 during the past two days following a Bloomberg article (A Cosmic Theory and 2-Inch Lump of Gold Spur 500% Novo Surge) which was generally favorable about Novo's Wits 2.0 theory but did quote Brent Cook as describing the valuation as "just absurd". A couple weeks ago after returning from a Karratha site visit he wrote that he was buying a small amount with the expectation that he would be buying more at a cheaper price if results justify doing so. It will be quite some time before results justify buying Novo above the $0.66 price of the $18 million private placement completed in early May 2017 and which comes free trading on September 5. This is a problem for Brent Cook and his audience which includes risk adverse investors such as Rick Rule who said good-bye to Novo last year in stark contrast to Sprott Global's Eric Sprott who doubled up his position through the recent financing. What is now underway is a shakeout of the placees who are sitting on very unexpectedly big paper profits. Spec Value Hunters should brace themselves for a roller coaster ride while staying focused on the Wits 2.0 outcome which represents a future price target in the $50-$100 range.
Novo initially announced an $8 million financing on March 30 to be led by Chad Williams' Red Cloud Klondike Strike, an exempt market dealer which specializes in resource sector financings. Red Cloud operates an online platform to which accredited individuals and institution sign up so as to be able to participate in any financings that get listed. Red Cloud does its homework in deciding which financings to list but does not really market them to its "members". Red Cloud is a precursor for how the financial system will interface between companies and retail investors once Canada's securities commissions and that bank-serving IIROC pseudo-regulator end their war on venture capital companies and streamline private placement participation for all investors. But for now the BCSC and others are engaged in Fake Reform where retail investors can supposedly participate in a private placement provided they have a full service broker willing to declare buying a stock like Novo at $0.66 is "suitable". Any intelligent broker would have declared the Novo private placement as unsuitable because all the funds were earmarked for a PFS on the Beatons Creek project. A week later the offering was boosted to $12 million, and by May 4 the offering closed at $18 million which included a $3 million greenshoe option. On April 11 Novo announced the Comet Well option and mentioned that it had applied for additional nearby ground. But that news release was not overly inspiring and apparently played no role in the oversubscription of the financing. Beatons Creek was a lame development story with a gold optionality component (for heaven's sake, Sumitomo is interested in it!), suitable for institutions but not so much for retail investors.
It turns out that the 27,727,350 units were placed 80% by Red Cloud and 20% by Haywood, a traditional brokerage firm that still offers transaction fee based services to its clients. Of the 47 placees only one "pro", meaning somebody who works for a brokerage firm, participated and only in the amount of 26,000 units. Eric Sprott in his capacity as a private investor separate from the brokerage firm Sprott Global took down 5,107,900 units. Given that Red Cloud has styled itself as an online platform I assumed that it was largely individual investors who participated. It turns out that most of the financing was taken down by institutions and the rest spread among members of the "president's list". These were institutions experienced with the mining sector, the usual suspects to which Bay Street caters. Their strong appetite was whetted by Novo's plan to demonstrate that the 300,000 plus ounces at Beatons Creek could be turned into a cash flow generating operation with a modest capital cost. The upside for Beatons Creek was at best a $2 price target over the next couple years unless gold soared to the moon without dragging costs along with it. It is also the reason the private placement was shunned by individual investors who would rather bet on outsized gains arising from discovery exploration.
What nobody quite understood until July 12, 2017 was the scale of Novo's acquisition spree at the opposite end of the Pilbara Craton 350 km from Beatons Creek. It took me about a week to figure out that Quinton Hennigh was onto something spectacularly different, better and bigger than his original focus on the conglomerate bed hosted gold mineralization in the Beatons Creek area that the Australians had never managed to turn into something special. On July 24, 2017 I issued a Good Relative Spec Value Buy recommendation at $2.12 for Novo and made the Wits 2.0 story my main focus at the Sprott Conference in Vancouver where both Novo and Eric Sprott were conspicuously absent. (Rick explained to me there is a difference between Sprott owned and being owned by Sprott Global's asset management complex.)
Eric Sprott's response to the soaring stock price was to get Greg Gibson, President and CEO of Eric's private Sprott Mining Inc, appointed to the board. That turned out to be of strategic value for Novo because on August 10 Gibson had an important conversation with David Lenigas, chairman of Artemis Resources Ltd, about getting the Artemis Farm-in JV closed by the August 23 deadline which led to Novo sweetening the deal with the issue of 4 million shares. When the deal was announced on August 15 Artemis jumped from $0.16 to $0.215 on heavy volume, prompting the ASX to send a letter asking if Artemis perhaps broke some disclosure rules. The Artemis August 21 response reveals the behind-the-scenes scramble underway during my Karratha site visit. The irony of the ASX query is its suspicion that closing the 50% farmout was a materially better development than keeping 100% by reneging on the deal with Novo. Those 4 million shares, restricted for a year, had a CAD $20 million value at $5, which is a staggering amount to pay for 50% of an unproven property. However, on the Friday before the weekend Novo agreed to issue 3 million shares for 100% of the Pipeline claims with a deemed value of $15 million. 7 million shares is a small percentage of the 167 million fully diluted Novo now has out, but the $35 million of value a year from now is impressive; if Novo is at $50 a year from now the $350 million value will be more than 10 times impressive. It will be off the scale and still deemed "absurd" though justified by strategic reasoning just as was the case when Friedland played Inco and Falconbridge against each other on the way to a $4 billion buyout.
I point out these numbers to illustrate the problem facing the institutions who invested in the $0.66 financing. Unlike Eric Sprott and the handful of private individuals who participated in the private placement and are personally responsible for how this windfall plays out for them, the institutions are run by fund managers, individuals with no skin in the game other than the heads I win tails you lose 2 and 20 formula and their continued engagement as salaried custodians of other people's money. At a $5 stock price these fund managers are sitting on a 1,300% gain when the $0.90 full warrant is included, achieved over a 4 month period. Quite likely the Novo position represents a disproportionate value in those portfolios that will have to be trimmed once it is free trading. Never mind that Novo could keep going up in price towards $50 if the Wits 2.0 story gets validated; respected analysts are publicly declaring the valuation "absurd" and what fund manager wants to explain to the trustees why he or she let such a windfall gain evaporate? Besides, it is other people's money they are managing and it is not their job to take on big risk to earn outsized gains. Only about 1.6 million shares were declared short as of August 15 according to the TSXV (the 26 million share figure posted by shortdata.ca and quoted by various letter writers is implausible). Quinton Hennigh has changed the story and the institutions need out. This was the problem Paul Stephens encountered in 1995 when Robert Friedland changed the diamond story into the Voisey's Bay nickel-copper discovery and Diamond Fields became a major value component of the Roberston Stephens funds. Major discoveries are always "absurdly" over-valued. They are a nightmare for fund managers when they blossom before they can be sold.
Novo has retreated from an unsustainable hyperbolic uptrend but there is also a great effort underway to talk the stock down, not to protect innocent shareholders, but to enable those who missed the boat to get a position without suffering the humiliation of chasing the stock. The institutions who dominated the Red Cloud mediated financing are perfect marks because they do not have any "trusted" experts on the brokerage side to blame for the outcome. Spec Value Hunters should brace themselves for a roller-coaster ride in Novo until the 27,727,350 units have been free trading for a couple weeks and no longer represent a structural time bomb. Those who are wondering if Artemis might be a cheaper interim alternative should be aware that it has 490 million shares fully diluted, which means that at AUD $0.245 and a 50% net interest in the relevant ground it is carrying an implied value of AUD $240 million. Of all the Artemis ground only the Purdy's Reward property is currently ready. We need to learn a lot more about the other properties to judge whether Artemis has a piece of Wits 2.0 or just half of a local freak show.