December 2018

The difference between big and small companies: much more than just size

  • By Hedley Widdup MAusIMM Manager, Lion Selection Group

While small companies can be nimble, they face unique challenges that, if improperly managed, can affect the rest of the industry

There are some obvious differences between large companies and small ones. Remarks such as, ‘you have to wash your own cup’ or ‘there’s no HR team around here’ imply a difference based on availability of resources and size of bureaucracy. These differences are easy to spot, and from a strategic point of view, are superficial. In our industry, the largest companies in the world are all miners, and the smallest ‘mining’ companies are all at exploration stage. Therefore, there is a rough correlation between company capitalisation and the number and stage of its projects (which consume and perhaps generate cash).

Miners and explorers of all sizes have a continuous need for capital to identify and develop new sources of production. The not-so-obvious challenges for small companies have to do with the continual need to raise capital from investors.

It ain’t easy being small

Successful small companies in the mining space need to do the following:

  1. find a project
  2. progress it to the point that it can be built into a mine
  3. fund development
  4. build and operate the mine.

Evolution from explorer to miner is a lot less like ‘kissing frogs in order to find a prince’ and more like ‘falling in love with a frog’. While the largest round of funding is usually needed to build a project, all stages require fundraising for ongoing project assessment and company overheads. In other words: to be successful, a small company needs to be able to raise money. This influences the nature, amount and timing of technical work, and creates the need to cultivate a public image specifically for the purpose of attracting investors.

This sounds like hard work – and it is. But small companies have become an important part of the resources industry – over the last couple of decades, they have assumed a growing role as explorers and now account for a material proportion of exploration activity and discoveries. So the challenges they face are far from menial and are of concern to the entire sector.

Hoping for success

In a large company, budgets are allocated to exploration with a long(ish)-term view, with the luxury of a robust balance sheet and/or cash flow to fund work through multiple campaigns. Exploration is an iterative process; multiple layers of data and drill holes are required to achieve a discovery. Gatekeepers to this funding are typically seasoned mining executives and, generally speaking, exploration teams in large mining companies are funded with an element of understanding of the likely long-term nature of the endeavour.

In smaller companies, exploration funding comes almost exclusively from the investment market. Funding is raised in chunks, the size of which has more to do with what is obtainable at the time, rather than how much is actually required. Like a large company, a case needs to be made for what the funding will potentially find, but unlike the large company with a board who approve the budget, there is often no central gatekeeper for a small company. The audience is the stock market, which lacks technical sophistication and patience for unsuccessful drilling campaigns. For small companies to obtain future funding, there is an imperative to demonstrate success as assessment work is carried out – what is achieved with investors’ money has a direct linkage to the availability of future funding.

Valuation, estimation or total speculation?

There is a difference between what something is worth and what investors will pay to own it, and this can vary immensely. There is a limit to what can be valued. Large mining companies can be valued on operating cash flow, and the biggest sensitivity is fluctuating commodity prices. At the opposite end of the size spectrum, small companies (explorers) are a far more challenging ‘valuation’ proposition. Assets typically include one or more focus projects and some cash. The market price for such companies varies, from a discount to the cash in the company up to dazzling numbers that impute a substantial ‘value’ for the focus project. 

The majority of companies that rely on the investment market for funding are unsuitable to be valued because there is insufficient data (to put it mildly) to estimate cash flows. Even so, investors do put a price on small companies, which implies there is a value. The challenge for a small company is creating a sense of value well before value can be estimated or even approximated, so the trick for funding exploration in a small company is getting investors to recognise ‘blue sky’ – which in practice is where the greatest pricing volatility exists. Aptly named, ‘blue sky’ potential is theoretically unbounded, which is what makes it appealing to speculators. When ambiguity exists, perception becomes reality – if enough people are prepared to pay a price, it becomes ‘the value’.

The theory and practice of differentiation from a crowd

The 1995-96 Register of Australian Mining listed less than 600 companies focused on Resource extraction or exploration (including hydrocarbons and minerals). By 2013-14 this number had doubled to almost 1200. Through the 1990s, the annual rate of new mining or exploration companies listing on the ASX was less than ten per year. The 2000s saw a huge increase in the rate of new listings, peaking at 143 in 2007. The vast majority of companies that list via an IPO are small – in fact usually absolute microcaps.

The population explosion of mining enterprises exacerbated an existing challenge for small companies – competing for the attention of investors in the most populous segment of the market. Efficient market theory suggests that an individual company will be valued by the market according to its assets, but in a large population where valuation is already a challenge, the reality is that many stocks are completely overlooked while only a small number become shooting stars. In reality, small companies need to work hard to make themselves known to investors, which consumes a great deal of management time and represents a material cost to the business.

The proliferation of the internet has provided some assistance to public relations – company home pages are an incredibly cheap and easy facility that can act as a beacon to investors. The flip side of the internet, which is a major challenge, is managing a company’s message and reputation through the myriad unregulated forums for posting stock discussions and opinions. Company presentations must carry a legal disclaimer, but posts on Twitter carry no such warning – and genuine personal opinions can be barely distinguishable from posts designed to generate stock price movement.

Small explorers are essential participants in the mining industry, contributing a large proportion of cutting-edge exploration for future sources of mining production. These companies consume a substantial amount of funding – almost all of which is sourced from the investment market. There are immense challenges to overcome for an individual company to be successful, above and beyond the technical challenges of exploring. Well before these companies can be valued for cash generated from operations, obtaining technical success is important but conveying a positive message to investors is vital.  Small companies promote their company virtues into a market where a huge (and expanding) number of peers all compete for the same pool of capital, which derives mostly from a speculative investor base. Publicity is a tightrope walk between maintaining a clear story that is compelling, complies with regulation and penetrates the growing number of places investors search for information.

The views expressed in this article are the views of the author. This article provides general information, does not constitute advice and should not be relied on as such. Professional advice should be sought prior to any action being taken in reliance on any of the information.

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