The support for Geodrill as an investment comes with an array of risks, some of which are outlined below. GEO has a 50% margin of safety priced in, which acts as a buffer against losses if some of these risks either continue longer than expected or become more severe.
Global demand and supply for metals
Gold mining continues to be a large contributor to GEO’s revenue stream. The macroeconomic environment has put recent pressures on prices for metals, in particular gold, and additional pressure is expected. Decreased prices lead to decreased mining, which leads to decreased demand for mining services. We advocate the bull case for metals long term but acknowledge that the current outlook remains weak and further weakness could cause damage to GEO’s business and fundamentals.
Ghana is often viewed as a paragon of political and economic reform in Africa. The country is supported by world-class mineral belts, a pro-mining, stable government, and a burgeoning middle class. The country continues to be well supported on the world corruption index and among African countries. Ghana is expected to remain stable. It has been noted that social pressures are increasing due to a decline of the country’s agricultural sector and difficulty of providing jobs to a growing workforce.
Surrounding countries including Burkina Faso and Cote d’Ivoire are known for instability. These areas suffer from political unrest and low incomes, and rank low on the scale of ability for corporations to conduct business. Geodrill previously removed and then returned operations Cote d’Ivoire due to instabilities. Obviously, requirements to leave a country will have repercussions on revenue, but GEO seems capable of maneuvering through the stress and diversifies its risk by having much of revenue coming from Ghana.
CEO David Harper is the single most influential figure behind Geodrill. Material changes in health, motivation, and similar factors would have a negative outcome on GEO’s future. This is a difficult risk to quantify. We look at it based on the fact that Harper owns 40% of GEO, and has suffered losses with other equity holders. His incentive to build GEO is high, and his actions seem congruent with this thought.
High-margin profitable operations most often attract competition. GEO competes with both small shops and large global organizations. Smaller firms ebb and flow based on profitability, but GEO seems to have done well keeping clients and growing its fleet so we do not view small shops as overly problematic given their fickle nature. Obviously, larger firms have additional resources and ability to scale via acquisitions and market share. Whether or not this will affect GEO in the future is unclear, but investors can certainly see that size is not always a benefit. Boart is in terrible condition and other large firms could easily follow suit.
When thinking about competition, it is important to consider that locations such as Ghana and Burkina Faso have been competitive for years. Harper successfully competed with two drills in 1998, continues to do so with his 30+ fleet, and should be able to continue this trend with additional drills. Additionally, continued presence strengthens relationships and Harper will very likely be able maintain his stance as other drillers with significantly worse balance sheets struggle and close down.
Small company, talent, and directors
Small company risk is a concern, and there are a few issues worthy of investor attention. First, small companies have a harder time attracting skilled talent, and often become more of an insider playing field. In our opinion, GEO has faced difficulty finding and retaining talent for a few positions, including those of the CFO and board of directors.
CFO Greg Borsk does seem to have started his career within the accounting profession and he is a chartered account, but one can notice his weakness comprehending issues such as tax and free cash flows by listening to previous conference calls. Borsk is also getting paid a very nice employment package for such a small operation. Nonetheless, he does seem to be better understanding operations, since his initiation and his participation on more recent calls exemplifies this.
Directors John Bingham and Victoria Prentice require investor skepticism. According to his bio, John Bingham has been in the financial services industry for quite some time. He also serves as director for a number of companies. In our opinion, it seems that John’s skill-set is fitted to setting up off-shore trusts and accounts, not necessarily as Chairman of Geodrill, which prompts the question of whether Bingham is just filling the seat so Harper can get capital and grow. Obviously, Harper controls the show via ownership percentage and operational prowess, so what value Bingham adds as Chairman remains in question.
Victoria Prentice is, in our opinion, GEO’s most mysterious director. Her ties to Bingham are also quite mysterious. It’s troublesome to have found very little on Prentice. Victoria has in the past served director positions, but certainly not for companies in which we would place capital. A quick Google search of “Victoria Prentice” + “Isle of Man” (also “Victoria Kay Prentice”) brings an array of little companies on which Prentice has served.
Obviously, not all companies get the luxury of having characters such as Warren Buffett or David Einhorn on the board, and small companies especially have trouble picking among well-known talent. That said, it would be humbling to see GEO unveil the mysterious qualities of these directors and provide more explanation of how or why Harper picked these candidates. To be fair, GEO does have additional directors who seem to quite qualified, including Colin Jones of Dundee Resources, Ron Sellwood who previously was CFO of Boart, and Daniel Im who is CFO of Adriana Resources.
Customer concentration should not be taken lightly and GEO unfortunately suffers for high concentration, especially in the current environment. Fewer than ten customers make up roughly all of current revenues. Further research on these clients is warranted, and is in process. These companies are subject to the same pressures as other gold miners, so having an understanding of balance sheets and management teams is important.
Market cap, float, and volume
This opportunity is for smaller investors only, as market capitalization is less than $50 million, float is about 30% of all shares, and volume is very thin. Putting sizable money to work, from both an entry and exit perspective, will be difficult.
Below are current equity holders.
Notice that this group collectively owns 70% of the entire organization, leaving roughly 30% for retail investors. This group has held through the peak and trough, suggesting that share price is not adequately represented. Less than 30% of the stock is controlling 100% of current public price, which can quickly exacerbate price change and likely explains why the company has sold off much more than competitors.
Unknown and concluding thoughts on risk
Taking a page from Howard Marks’ theory of thought, the likelihood of being right is quite small in relation to being wrong given the number of other (wrong) outcomes that could occur. As investors, we should position ourselves to be rewarded if we are right, but not suffer painfully if we are wrong. The risk of capital loss due to unquantifiable factors not probabilistically weighted is often high and is what we want to avoid. Below are some thoughts for GEO investors. A very good way to avoid or lessen the pain of what we don’t know is to have a good approximation of intrinsic value and buy when there is a significant margin of safety. With GEO, we have approximated intrinsic value and given ourselves a 50% cushion. Investors should also consider the following.
- Size matters: Position size will be difficult to enter and exit. Thus, an investment in GEO should be positioned and controlled correctly.
- Diversity matters: We think GEO should be part of the buy list, but not the only company on the list. Unfortunately, there aren’t too many good drillers from which to pick, so GEO will need to be grouped in a portfolio accordingly.
- Margin of safety: Book value does seem to approximate fair value for many of the company’s rigs we have looked at, especially newer rigs. Market value is a better approximation of safety than book, and we think investors have sufficient downside safety considering the small level of debt. Rigs often last between five and seven years before a major rebuild is required. As such, margin of safety is a dynamic metric. In profitable times, fair value will be higher than in unprofitable times, but less profitable work will require the same CAPEX. Usage lowers rig value, deteriorating margin of safety.
- Watch the cycle: “Be right, sit tight” is an adage used by some very respected investors. We don’t follow this rule. Instead, we recommend thinking right, positioning accordingly, updating, and repositioning. Consensus among investors, management, consultants, and a number of other groups on the most recent bull cycle was five years. They were wrong. Following conventional wisdom would have caused painful losses. Many of these same groups speak of bear cycles that last two to three years. Don’t listen. Think right, update, and reposition. If the cycle looks to be turning, turn with it. Investors aren’t punished for doing nothing, but they can be severely hurt for swinging at the wrong time.
The Market Realist Take
A report released by PricewaterhouseCoopers in October last year stated that a drop in metal and mineral prices, alongside tight financing markets, has caused junior mining company valuations to decline and remain at rock-bottom levels. This has made it extremely challenging for juniors to raise money—an activity that can be crucial to their existence. The market cap for the top 100 junior miners on the TSX Venture Exchange (TSXV) fell 44%, to $6.49 billion in 2013, compared to 2012. The cash position of junior miners has also steadily declined. Among the top 100 on the TSXV, cash and short-term investments fell by $695 million in 2013 to $1.2 billion compared to 2012’s balance of $1.9 billion. The report added that as markets remain challenging for juniors, some will be forced to shut down operations, particularly at the exploration stage, or will decide their only survival tactic is to merge with another player, or accept a takeover offer. While merger and acquisition activity across the sector has also fallen as a result of the confidence crisis, juniors are targets for opportunistic senior players seeking future growth.
Analysts have advised to exercise caution while investing in junior mining companies in the short term because most of these cash-strapped companies are in survival mode.