Assaying mining IPOs

PORTFOLIO POINT: A few simple rules can help determine the mining floats with the strongest prospects.

There is only one certain way of determining a successful IPO (initial public offering or float) in the resources sector or anywhere else: having your application funds are returned to you. It means the IPO was heavily over-subscribed, and such floats are the best ones to be in.

This observation may not assist you greatly, of course – as you were unable to obtain shares – but it does at least give investors a strong indication of the market for the IPO shares post-listing.

So aside from stating the obvious, what else should investors seek out in an IPO when deciding whether to invest?

The textbook rules for a successful mineral exploration company IPO are pretty straightforward, from both an investor and promoter perspective:

• First, pick a metal that enjoys positive market sentiment and fundamentals.
• Second, look for good projects including a near-term production play.
• Third, target a tight capital structure so that new shares are not in over-supply
• Fourth, seek a management team and board with good credentials that will enjoy the market’s confidence.
• Finally, look for drilling to start immediately upon listing so that the story doesn’t go cold in the aftermarket.

Simple really – on paper at least.

A few words of caution are in order, however, for those investors seeking to benefit when there is a strong appetite for IPOs in the junior end of the resources market.

Watch out for promoters lining their own pockets in the IPO process through over-generous vendor considerations, seed equity, royalties to insiders, joint venture agreements, free-carries and excessive option agreements (these can be found by looking through the prospectus in detail).

Let’s take a look at recent performance and the commodity focus of new ASX mineral resources IPOs. In 2010, there were 66 minerals-focused IPOs on the ASX (excluding mining service companies and oil/gas floats).

Of these, 14 companies – just above 20% – at least doubled the investment of their float subscribers.

Measuring the company’s share price at the close of trading at the end of the year, December 31, versus the initial float price for new shares in each company, the leading companies that gained 100% or more were as follows:

• Doray Minerals (DRM) 593%.
• Hunnu Coal (HUN) 568%.
• Forge Resources (FRG) 340%.
• Guildford Coal (GUF) 265%.
• Canyon Resources (CAY) 230%.
• Haranga Resources (HAR) 220%.
• Carabella Resources (CLR) 181%.
• Middle Island Resources (MDI) 160%.
• West African Resources (WAF) 150%.
• Minbos Resources (MNB) 150%.
• Hot Chili (HCH) 125%.
• Renaissance Minerals (RNS) 125%.
• Southern Hemisphere Mining (SUH) 104%.
• Southern Crown Resources (SWR) 100%.

The average return since listing of the 66 companies measured at December 31 for 2010 floats was 61%. The median return was 18%. Of the total, 47 companies (71%) either gained in value or held their IPO price whereas 19 companies (29%) fell in value.

These numbers are impressive but they still indicate the significant risk involved in participating. The weakest performances led to significant losses for investors, with three companies losing more than one-third of their list value.

During those periods when there is a strong market for IPOs, the rising “tide” (market) tends to lift all “boats” (IPOs).

One strategy used by some at such times is simply to apply for many resource sector floats, without being selective, and to just bank the gains before the market’s mood shifts against resources sector IPOs.

But the tide can always turn and in a weak market, IPOs are amongst the most susceptible of all companies to be sold off heavily.

How do investors spot whether the boom is getting out of control?

If you’ll excuse my tongue-in-cheek list, perhaps if any of the resource sector company names below appear as prospective IPOs in the near future it will be a strong signal to cut and run!

A list of upcoming floats – across all ASX sectors including mineral resources – can be viewed by clicking here. (Keep your eye out for Tim Treadgold’s assessment of which of these IPOs are worth applying for after the Easter break).

Dr Allan Trench is a geologist/geophysicist and business management consultant with over 20 years experience. This article is an extract from A Sharebuyer’s Guide to Investing in the Australian Mining Boom, published by Major Street Publishing.