How Rick Rule Interviews Junior Mining Company Management

Interviewing mining company management is a critical step in the resource investor’s due diligence process. In the junior mining sector, most management teams will eagerly speak to prospective investors about their company. Through the process of interviewing the mining company’s management the investor will be able to obtain information not readily available on a company’s website and thereby get a better feel for whether or not a particular company might make a good investment.

A couple decades ago, the Colorado School of Mines launched the Mining Investment College which was a seminar-based course aimed at teaching prospective investors how to determine quality mining company investments. The Mining Investment College brought in qualified presenters to share their knowledge and experience. One such presenter was the well-known resource investor and stockbroker Rick Rule, who is currently the President and CEO of Sprott US Holdings, Inc.

Below you will find the interview, which Mining Stock Education has transcribed, of Rick being interviewed by the late Dr. Donald Gentry, who was then the Academic Dean of the Mining Investment College and Professor of Mining Engineering at the Colorado School of Mines. In the exchange, Rick shares how he interviews junior mining company management and what information he is seeking to obtain through the interview process. There is much to glean from Rick Rule’s insights and experience.

BEGIN TRANSRCIPT

Dr. Gentry: I’d like to conduct the rest of this discussion in those terms of your research template and the questions that go with that. And I’ve heard in the past that you refer to those as your ten nosy questions you like to ask junior mining companies. And having been on the receiving end of a couple of these, I remember them quite vividly. So let’s start with the first question, if you will. The first question is: “What is the current liquidation value of your company versus the market capitalization?” So before we pursue that when we take about current liquidation value let’s describe for the students what we are really taking about and what we are really taking about with respect to market cap.

What is the current liquidation value of your company versus the market capitalization?

Rick Rule: Sure. This is a really critical question. Most people who are investors are forward-thinking people. Particularly if they are engaged in the business as speculative as mining exploration and they focus too much on what could be on the good side to the detriment of what could be on the bad side. It is important to look at how good things could be otherwise nobody would ever accomplish anything, but you have to think in terms of what you could lose as well. This question really goes to that. You have to look at the liquidation value of the business that you are involved in. How do you get there? Well, I think you start at the easy points. You look at what are called the redundant assets in the business. The key redundant asset amazingly is cash. And while I have never found my own personal cash to be redundant, accountants treat it as a redundant asset. So you add up the cash. You subtract the debt and you get liquid assets. Then comes the hard part in effect, let’s call it alchemy. You try to figure out what the physical assets are worth. One of the difficulties here is that the investment community tries to use rules of thumb for all of these physical assets. And the rules of thumbs, as you know from the Colorado School of Mines, are more dangerous than they are useful.

Dr. Gentry: Much more difficult to estimate.

Rick Rule: If you have a producing asset in a junior producer or a senior producer, what I like to do is I like to look at the cash flows going forward using today’s prices and today’s costs and I like to discount that cash flow back the same way the SEC would at a ten percent discount. So I like to value these assets on a discounted cash flow basis. If, by contrast, you are involved in a junior exploration company the valuation become more nebulous so you need to ask the technical people in the company, “What could you sell this on the street for? If you had to sell this to Homestake or Newmont for cash, what could you get for it?” Another way to do it is, as an example, if a company has an exploration project that is farmed out (that means that somebody else is spending money to earn an interest in the project). Say as an example that a company is going to spend a million and a half dollars on your project over three years to earn 50% one way that you might assign that value is you might say if the person earning the interest is going to earn 50% for a million and a half dollars perhaps the carried interest similarly is worth a million and a half dollars. This is not an exact science. It is just so much closer than most people get because most people never ask the question. So you need to determine what the real value of the company is if it were liquidated versus what the market capitalization is; that is what the public is willing to pay for the assets wrapped in the story that is the company.

Dr. Gentry: So the market cap would be…?

Rick Rule: Market capitalization is all the shares outstanding times the price per share and if there is any debt adding debt for total capitalization.

Dr. Gentry: So you give us an idea of how to do the calculation. Let me ask you, to whom do you like to ask this question within an organization? Who do you target?

Rick Rule: I like to target, first of all, the CEO for several reasons: to see how candid this person is going to be with me and to see how realistic. That’s useful. But then I also like to ask the question of technical people, the geologists and the engineers, to see how their estimates of value differ from the estimates of the CEO. And one of my favorite places to ask the question is not of the company itself but rather of one of their peers. Ask the CEO, engineer, or a geologist from another public company that is familiar with the activities of the subject company. I think that is critical.

Dr. Gentry: And so presumably one would need to distinguish between tangible assets and those associated more with juniors which are not so many physical assets.

Rick Rule: Precisely.

Dr. Gentry: The real kicker I have found over the years is that tangible assets often only have value to that mine site for that deposit and to anyone else have substantially less value. Is that your experience as well?

Rick Rule: I think that is absolutely right. A lot of these questions come into play in exploration or development projects more than they would in a producing project where you have a Net Present Value calculation to make.

Dr. Gentry: Exactly. Those tend to be a lot easier.

Tell me about your management and directors, especially their past success in mining and markets.

Dr. Gentry: The next question deals with the company’s personnel: “Tell me about your management and directors, especially their past success in mining and markets.” What exactly are you looking for here with this question?

Rick Rule: Well, Don, you’ve heard the phrase, “Mines are made, not found.” The ore has probably been there for 35 million years. It takes people to find it and lift it and make it into money. This is just absolutely critical in the mining business. What you are looking for is past successes in many senses: technical successes and financial successes. I am reminded of the phrase, ‘Luck favors the trained observer.’ And for some reason, although there are hundreds of thousands of earth scientists in the world, I’ve heard estimates that there are between 10,000-12,000 economic producing mines. What that tells you is that most people and most teams of people never find one. And if you think about it, it makes sense. If as an example a management team has put a mine into production and a prospector has a good prospect, that prospector is much more likely to approach a team that has already been successful as opposed to some team that hasn’t been successful. Myself as a stock broker, if I am approached by a team that has been successful in the past, they will obtain capital from me more readily and on better terms than someone else would be. So luck favors the trained observers in many senses. It’s important to get very specific with regards to the resumes of the officers and directors. As an example, it isn’t enough to hear that somebody has been successful in mining. In what capacity were they successful? Were they an explorationist? Did they turn around a mine as an engineer that had been failing? Did they come from the land side–land acquisition–side? Was their success due to politics? What specific talents did they have to bring to bear on a project? Because the mining business is a very diverse business and one skill set is not necessarily suited to another task. I have found, as an example, that the range of skill sets involved in prospect generation or exploration could be and generally in fact are very different than the skill sets involved in mine production which are in turn different than the skill sets involved in mine construction. So it is very important to learn all of the range of skill sets. And the other thing that is important, I have found, is to find a group that has been successful in a financial sense before. As a minority shareholder, which is what most people who take this course are, it isn’t enough that the team makes a mine, they have to make you money making a mine. And so you have to find people who have been through the part of the business that you find yourself in before…people who can raise money, people who can access financial markets. You have to find people who have been successful in the financial part of the mining industry rather than just the technical part of the mining industry.

Dr. Gentry: I am reminded that all too often we often evaluate marginal properties, and my experience has been: if you put the right team of people in place, that mine will make you a lot of money; and if you put the wrong team in place, it is going to cost you a lot of money.

Rick Rule: And an even worse thing is if you get a bad group of people somehow in control of a good ore body they can either lose the benefit of the ore body or more commonly misappropriate the benefit of a good ore body and that is really infuriating.

Dr. Gentry: Precisely. One of the things I always listen for is those people who always talk about, “I did this…I turned this company….I did this” as opposed to “We or our team.” I think that tells you a lot about this notion of team concept because it is a very diverse business and you need so many different talents on a successful team in the mining sector.

Rick Rule: That is absolutely true.

How are you going to make me money on this deal and when will I make it?

Dr. Gentry: The next question on your template really hits home and that is: “How are you going to make me money on this deal and when will I make it?” So I guess my question to you is: how do you ask to get a real answer to a question like that? Isn’t that an opportunity to try to blow a lot of smoke? How do you sort that out?

Rick Rule: That is precisely what that is. This is the question that the financial public relations person or the promoter would like you to ask. And the idea is to begin to help them frame their explanation. Another useful part of this question is it will help you to determine whether or not you are being lied to. If somebody tells you a story that seems absolutely too good to be true, there is almost a guarantee that it is. But one of the important things is that after they have given you what I call the blue sky answer, the global answer, you ask them to say: what is that going to mean per share? What is that going to mean to me? The company is going to make $75 million but at that point in time how many shares will be outstanding, as an example. The other thing that I like to ask them for is, I like to say over what period of time? How long is this going to take? I think that is very critical. So that you begin to focus their question, narrow the question down because it sets the stage for so many nice questions to follow. The whole idea is for you to take control of the information process. Make it an information gathering process as opposed to an information dissemination process.

Dr. Gentry: Good approach.

What are the company’s goals and what strategies will it use to reach those goals?

Dr. Gentry: Your next question is: “What are the company’s goals and what strategies will it use to reach those goals?” What are you specifically listening for that question?

Rick Rule: I am asking really for the company’s business plan. What I have found in analyzing particularly the exploration companies is that probably 85% don’t have a plan. And failure to plan, I think, becomes planning to fail. Many of them have a plan with regards to getting control of a property, raising some money, and having a company; and that is the end of it. Now that is very good for them, but not so good for you. So I think that you need to understand the plan and you need to understand the timeline and you need to understand how the plan is going to affect you as a minority shareholder. What you are really asking them to do is to get much more specific with regards to the blue sky that they gave you from the prior question. Look at their critical path analysis as an example. They have a property that they are going to explore and they expect in the initial stage of exploration one of three or four things will happen. Ask them to explain those and then ask what happens if event “A” takes place, where do they go? What is “A prime” as an example? If event “B” takes place, where do they go? And get a timeline that lets you stay involved in the company and know whether, in fact, they are enjoying success or know whether, in fact, they are failing. It is critical. Once you’ve made these investment, once you’ve done your initial work that you understand how to keep up with the flow of information and if you don’t understand how the flow of information will take place or how it will impact the share price, you’ll have your arms tied in terms of analyzing whether this investment is, in an ongoing basis, a success or a failure.

Dr. Gentry: So depending on how they react to certain events tells you pretty much from your answers to that question what happened with that activity? In other words, it was successful or it wasn’t. We’ve gone to plan B. We’ve hit this critical decision point, now we’ve decided to do something else. But you need to know that. They need to know that.

Rick Rule: Precisely. You need to know ahead of time what you are going to be looking on an ongoing basis. And you need to know that they know. It is more important if they are running the business that they know. But you as an investor need to know for your own purposes.

Dr. Gentry: And that they’ve anticipated.

Rick Rule: Right.

Dr. Gentry: Let’s get back to budget for a minute. You’ve asked the question, how much money do you have? How much money do you need to make to make me rich? And how are you going to go about getting it? How often do they really answer that in your mind answer that truthfully?

Rick Rule: I try and force people to give me honest answers. One of my favorite old quips from the mining business, “When your outgo exceeds your income, your upkeep becomes your downfall.” I’ve never seen any of these companies go broke because they’ve had too much money. Or they didn’t spend enough money and it is really important to get to the financial part of the business plan. Look at what the company says they are going to accomplish and ask them how much money it is going to take to accomplish it. If you need to, get some second opinions from other people as to how much it would take to accomplish that. And then look at how much money the company has and ask them how they are going to fund the shortfall. Decide for yourself whether or not that is reasonable. These are absolutely critical things to do. One of the ways that you can really differentiate people who are going to be successful in the exploration business, in the junior business, is to look at past spending patterns. I like to look two or three years back or, if possible, five years back and see what the ratio of expenditures in the field as opposed to expenditures at the head office are. I like to see three times as much money spend in exploration as spent in administration. I think that is absolutely critical. Now very amusing things happen when you are asking this budget question. You alluded earlier to people, perhaps, misleading you. When you talk about the shortfall, because probably there will be a shortfall in developing situation, ask where they are going to get the money. If they say, “a Canadian brokerage firm” then ask “does this firm have a name? Would you share it with me? Who at this firm is going to raise the money for you? On what terms? In return for what? May I have this person’s phone number?” An interesting thing happened to me at the Boston Gold Show some years ago, about nine years ago. I was wandering around asking my nosy questions of mining companies and a man spun a wonderful tale of what was going to happen in the exploration business and I asked him how much cash he had on hand. And he said cash is not really important. And I said, “That’s interesting. I thought this was a capital intensive business.” He did not know me. I was not in my suit. I was in civilian clothes, if you will. And he said there is a really hot west coast broker named Rick Rule who is going to raise me all the money I need to carry this business plan out. And after I questioned him a while further, I pulled out my driver’s license and identified myself and said, “I’m Rick Rule and I am increasingly less interested.” So people, as you suggest, will mislead you. It is important that you get down what their plan is and then it is important that you check how real this plan is.

Dr. Gentry: And I think also probably to also have your own measuring yard stick, if you will. Do those numbers make sense? And are they realistic and are they in the right proportions? … There is an old adage people do like to collect information and some people get so involved with collecting information that they never generate knowledge. By that I mean it is only through the proper interpretation of that information does one generate new knowledge. And I think that is an important aspect.

Where is your owner?

Dr. Gentry: The next one is: “Where’s your owner?” Now, I am assuming we are talking about initial shareholders?

Rick Rule: Initial shareholders are important. I look at a range of shareholders. Certainly, the officers and directors are important, but also any strategic investors, institutional investors who have a habit of mining venture capital, underwriters, that type of thing. I am looking for a few things here. The most important thing to me is that the officers and directors, the management team in place here aren’t relying on their salaries to get rich. I have learned a hard lesson and that is that nobody is going to really strive to make me rich unless they are going to get rich themselves in the process. And so I want to deal with companies run by owners not companies that are run by managers. But it is a more important question than that. I want to know how much the officers, directors and strategic shareholders paid for their stock. I want to know when they bought it. I want to know when private placements are going to become free trading because a whole bunch of free trading stock newly on the market could lower my entry point if I want to get involved in the company. I want to know when the options are exercisable and at what price. I want to know the same things about warrants from different financings. And I also want to know the trading histories, the recent trading histories of insiders, officers and directors. As an example if the officers and directors subscribed six months ago to a private placement at somewhat higher prices than today’s price, that might say something very bullish about what they believe the prospects for their company are. If, conversely, they’ve been steady sellers at prices somewhat lower than this it says something about the confidence in the future too. And this is all information that they have available because if they’re a public company they have to file this with the appropriate agencies. If companies and their officers and directors aren’t willing to share this information with you and they aren’t willing to explain it to you, this is a very, very bad sign.

Dr. Gentry: Your research template speaks about promotion. How does that figure in?

Rick Rule: Well, mining is a capital intensive business and one thing that is almost certain in these companies is that eventually they are going to have to raise additional capital. One of the things that promotion does is it determines how much dilution existing shareholders face when it comes times to raise additional capital. Companies that have done a good job telling their story to the investment community and to the capital markets have higher market capitalization and so companies that have an effective promotional plan raise money with less dilution to existing holders. In the junior side of the business, I think a minimal promotional budget is $150,000 USD well spent. It is important that the company have a promotional plan just the way that they have a financial plan and a business plan. One of the things I’ve noticed in the last five years is that institutional investors provide capital and retail investors provide liquidity. So a promotional plan has to talk to both constituencies. There has to be in place a tour of the major institutional investors, as an example, perhaps, a property tour for analysts from these institutional investors and from retail firms. And participation in things like the gold shows and investment conferences is critical to involve the retail investor. The other thing that is important for mining companies is that most of the mining companies are domiciled outside of the United States but most the capital available for mining comes from the United States so compliance with US security laws is an absolutely critical component. Companies must have filed or must be about to file Form 20-F with the Securities and Exchange Commission. This seems like a very strange concern for a mining company but what it really has to do with is access to capital. Compliance with various state blue sky laws is something the investor must familiarize himself with particularly as it relates to Canadian, Australian and South African companies. These are companies that come from countries that have a lot of companies but not very many investors and they need to access the United States market which has a lot of investors but not too many issuers. In order to do that they have to domesticate their securities in the United States according to US securities laws. It is too easy for a Canadian company or an Australian company to rely on their own domestic securities laws and ignore the US markets. But they do that at their peril because they increasingly deny themselves access to US capital which is critical.

Dr. Gentry: How long does it take to do that? Is it a time consuming process?

Rick Rule: It is not particularly a time-consuming process. But many management teams find it dispiriting. They would rather be involved in exploration. They would rather be spending the $25,000 that this costs doing what they think they are in business to do which is finding minerals. Were it not for the fact that it was so critical, I would agree with them. But sadly, it is critical. In terms of the time this is something that shouldn’t take more than 90 days.

Dr. Gentry: Oh, so it’s not so long.

Rick Rule: It is not onerous at all. It’s just that it is boring, if you will, for somebody involved in a business like exploration.

What can go wrong?

Dr. Gentry: The next question I find very interesting. You ask, “What can go wrong?” I can think of a myriad of things that can go wrong with a mining venture. What did you have in mind with that question?

Rick Rule: This has become my favorite question. My grandfather told me when I got in the investment business that if I could not think of three things that could go wrong with an investment, I did not know enough about the investment to make it. And it has turned out to be very, very, very true. Again, you’re analyzing somebody’s plan and somebody’s knowledge of the business, so I like to ask the CEO, “What are the three things about this business venture that scare you the most from your point of view? And what are the three things that scare me the most from my point of view? What are you doing to anticipate the occurrence of these things? What are you doing to monitor whether or not they are taking place? What are you doing to mitigate the damage that could be done if these take place? And what are you going to do if despite your monitoring they take place anyway? How are you going to get us out of the problem that you foresee potentially getting us into?” And you need to get good answers to these. If a person says there is nothing possible that I can think about that could go wrong, it seems to me that this person is either a miscreant or a malcreant. He either does not understand his business, which is a possibility. Or he is trying to deliberately mislead you. Neither of those are good.

Dr. Gentry: So these can be as fundamental as land ownership issues in foreign countries, whether the land claims are valid, any number of things.
Rick Rule: As you say, there is an absolute myriad of things. I’ve asked this question of exploration companies and they have not owned up to the fact that they might not find something. That is a fairly fundamental flaw that they have overlooked. But certainly political risk in countries, the question of land title is a big one. One of the things that I find daunting in the case of small companies is the complete reliance of the companies on key personnel. Certainly, the reliance on capital markets to sustain them 18 months from now and to the extent that companies have not thought about these risks themselves and have not done anything to monitor their occurrence or plan for their occurrence exposes you to more risk than you should be exposed to.

Dr. Gentry: And the kind of things that go wrong can be very fundamental as we have suggested and they are not restricted to junior companies.

Rick Rule: That is very true. As you know from the senior companies, one of the things a mining company executive told me that was fairly amusing about exploring in these newly fashionable places in the world. He said, “One of the nice things about Nevada was that if a part broke in exploration, you went to Alco. And one of the things that’s wrong on other continents, you still go to Alco, but Alco is a lot further than it used to be.”

Dr. Gentry: Well said.

Who’s the promoter? Who’s buying the beer?

Dr. Gentry: The next question you ask is, “Who’s the promoter? And who’s buying the beer?” What is the objective here?

Rick Rule: The objective is that if you have been asking these questions and asking questions that they brought up you have channeled the conversation of the person giving you the information—the financial public relations operative, the president of the company, the geologist, whoever it is. You have taken control of the delivery of information. You’ve really systematized the process. Now what you want, you want the person to see you as a friend and you want to hear what they think is important. It is almost as though you ask, “What did I forget to ask you?” which is another very good question to ask. But in particular you want to develop a bond with this person so that when you follow up later, as an example, to monitor for risk or monitor for progress, that the person that you are talking to feels comfortable with you, feels familiar with you. Even the worst of the malcreants find it difficult to lie to or mislead a friend. And that is maybe the least reward you are going to get. You never know what type of information that you are going to get after you’ve systematized the person’s thought process in terms of their discussion of their company.

Dr. Gentry: Often times it is easy to get partial information, but not the entire piece of information … the half truths and so you really have to watch for that.

Rick Rule: That is very true and I find myself as an interviewer, or as the company would say an interrogator, allowing my last interview to determine the course of my present interview. In other words, I allow my thoughts from the process to get in the way of finding out about the company I am interviewing at this point in time. And sometimes after you’ve systematized the person’s thought for the information that you want, they can point out things to you about the company, point out questions that you should have asked, point out facets of the company that your normal range of question did not get to. And that is very important.

Dr. Gentry: And similarly some people believe that if you don’t know enough to ask the right questions, I am not going to volunteer any information about what you should have asked me.

Rick Rule: That’s usually when you talk to the company’s counsel.

Dr. Gentry: (Laughter) That is exactly right. And then it seems to me that we’ve come full circle here when you ask, “How can I learn more?” And you alluded to that. And I guess my question to you is how much more digging is there in this process?

Rick Rule: It is really a function of how speculatively involved the investor wants to be in terms of how much they want to know. Most of the people I would suspect who are students of the Mining College are involved in fairly high-risk, high-reward speculative activities. And there is simply never enough information. Look at the research reports that have been done by brokerage firms on the company. Admittedly, those are usually done to sell securities so they are sales documents. Look at the filing statements that they companies have done with the regulatory agencies. Quarterlies, annuals, look at the proxy statements; those are very important things in terms of how much the management is going to pay themselves and for what. I think that is critical. Ask the companies what newsletters have talked about them. Increasingly a good source of information on these companies is the internet. There are discussion groups often about individual companies.

What three other companies do you think are good investments?

Rick Rule: And a question that we alluded to earlier that I think is really, really, really important is to ask CEO’s, or promoters or geologists from a certain company to name three other companies that they think are good investments. It is a wonderful way to get leads on other companies to invest in.

What three other people can I talk to about your company?

Rick Rule: And conversely after you are done interviewing a company, ask the person who you’ve been talking to for three other people in the mining business to talk to about his company. I’ve found that that is absolutely critical.

Dr. Gentry: Good advice.

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How to Interview Junior Mining Company CEO’s presentation at 2012 San Francisco Hard Assets Show

At the 2012 San Francisco Hard Assets Show, Rick Rule, President and CEO of Sprott US Holdings Inc., shared how he approaches interviewing junior mining company CEO’s. The video is provided by Future Money Trends while the people at Kung Fu Finance have written a helpful summary of Rick Rule’s presentation which you can access by clicking the link below the video:

Link to Rick Rule Questions for Junior CEO’s compiled by Kung Fu Finance