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A tidal wave of turmoil for junior and mid-cap miners

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It's already been a tumultuous year for junior and mid-cap Canadian miners. Get ready for things to turn even nastier.

A wave of proxy fights, mergers, business closures and desperate attempts at financing is expected to inundate the industry before calmer seas return. Survival amid this severe economic downturn won't come easy.

A survey released in late February by the Fraser Institute provides a hint of what's to come. Four out of five mining executives predicted that at least 30 percent of global junior explorers would go out of business before markets recover; 40 percent said that more than half of the juniors would disappear. Meanwhile, more than 90 percent of respondents believed exploration and development activities at these companies would be further curtailed.

"Survey responses indicate this year that the mining sector expects dramatically decreased investment plans along with a large number of companies either reducing activity or going out of business all together," said Fred McMahon, the Canadian research institute's director of trade and globalization studies.

Blame the collapse in commodity markets and the hardship miners are experiencing in raising financing. It's clear cash has become king because of its scarcity. Some 28 of the top 100 mining companies on the Toronto Stock Exchange are sitting on less than $25 million in cash, according to a recent study by Ernst & Young. More than half of those 100 companies lost at least 50 percent of their market value between July 2008 and January 2009.

The nonferrous metals sector has been particularly hard hit, given the sharp declines in industrial production, but even precious metals players are faced with a precarious investment environment. Take Vancouver, British Columbia-based Eldorado Gold Corp., for example, which in late February had to ax plans for a Canadian $275-million ($224-million) stock offering after the company could not meet its financing targets as bullion prices retreated once hitting $1,000 an ounce. As industry participants learned at the Prospectors and Developers Association of Canada convention in March, some companies may have to turn to non-traditional financing to ride out the storm (AMM monthly, April 2009). These options include issuing debt that incorporates equity-based options, earn-in deals with majors, off-take agreements, royalty arrangements and export credit agency loans. A few companies may be able to obtain private equity financing, such as what NovaGold Resources Inc., Vancouver, secured with the private New York-based company Electrum Strategic Resources LLC at the start of this year. Many other companies will undoubtedly have to turn to mergers and asset sales.

The severe blow to market caps may mean a lot more turmoil at the boardroom level in the days ahead as well. Shareholders, angered by the money they've lost, will want to salvage what they can and take a more active role in management, and that spells proxy battles. Canada provides fertile ground for them, as domestic business laws allow shareholders the capability to replace boards of directors in between annual meetings.

Canadian lawyers are already bracing for a flood of new business. Some cases may involve shareholders pressing for a new business plan for a company; others could see hedge funds demanding companies with sizable cash positions initiate a share buyback or dividend payout.

The recent proxy battle between management of HudBay Minerals Inc., Toronto, and SRM Global Master Fund LP, a Monaco-based hedge fund that owns 11 percent of the mining company, is a case in point. SRM had been pressing HudBay to use some of its C$700 million ($572 million) in cash reserves to initiate a share buyback, but company management rejected the idea and instead focused on a proposal to take over Lundin Mining Corp. SRM then launched the proxy fight to oust HudBay's board of directors, which ultimately succeeded.

The HudBay case is particularly notable because it may wind up influencing the rules of corporate governance in Canada. The turmoil at HudBay started after the company proposed acquiring Lundin Mining without shareholder approval. Many voiced opposition to the deal because of its hefty C$672.4-million ($549-million) price-tag and the dilutive impact of a large share issue that was planned as part of the acquisition.

The Ontario Securities Commission later forced HudBay to call for a shareholders vote on the transaction—and the deal quickly collapsed. With the lessons learned from HudBay, boards of directors of Canadian mining companies may have to give more thought towards calling for special shareholder votes when planning acquisitions. Given the consolidation that appears poised to rock the industry, this could mean a lot of future shareholder ballots.

Amid these challenging times, however, there is a silver lining. A leaner industry is materializing and the heavy curtailment of exploration and development activity is setting the stage for a shortage of global raw material supplies once economies recover. Those lucky enough to find a life raft in these rough seas will eventually be rescued by the forces of supply and demand. The next cycle that awaits could be a particularly rewarding one.


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