Taylor MacDonald: Off the Beaten Path
Source: Karen Roche of The Gold Report 8/25/10
Taylor MacDonald, vice president of investments with Pathfinder Ventures Corporation in Vancouver, has a knack for discovering the undiscovered. In an exclusive interview with The Gold Report, Taylor drills down in the niche of innovative technology companies serving the resource sector and shares some names that most mainstream banks have never even heard of.
The Gold Report: You are currently with the family office, Pathfinder Ventures Corp., but you started off with major securities firms, like Haywood Securities, Raymond James Financial and Renaissance Capital. What investment "freedoms" do you have in a family office that you don't have at a larger security firm?
Taylor MacDonald: In a midsized family office like ours, we have the advantage of being nimbler than a larger bank-run fund. We are able to turn around investments quickly; but, more pointedly, we are able to invest in small-cap, micro-cap and even private companies.
This will probably change slightly as we start Pathfinder Asset Management Limited in the coming quarter. We are in the final stages of getting registered and creating and managing a mutual fund. We will also be registered for portfolio management services. We still hope to keep things relatively small so that we can take advantage of opportunities that larger funds can't.
TGR: What is the market capitalization makeup in the current portfolio?
TM: About two-thirds of the portfolio is invested in small caps. My definitions for mid and large cap are probably a little different from other investors. I consider $250 million-$1 billion to be midcap and anything above that to be large cap.
TGR: What sectors do you focus your investments on?
TM: In the resources space; we mainly invest in mining. We do have some investments in oil and gas. We tend to focus on new producers, developers and explorers.
We also like technology and special situations companies, especially those that fill a particular niche for the oil and gas and mining industries. If there is a problem that a lot of resource companies are encountering, we find a company that's able to fill a void or market space that hasn't been addressed. We gravitate towards that type of tech-special situation. We also have some investments in biotech.
TGR: Are you focused on mining because it's a promising sector in the current economic environment or because you've built an expertise in that industry?
TM: My background is pretty varied. I worked in research on industrial special situations and mining, then I moved to investment banking covering resources and, most recently, to institutional sales in emerging markets. This breadth of experience has prepared me for my current role where I look more for opportunity than focus on one specific sector.
That being said, there are a lot of small-cap resource companies in the Vancouver area where we are based. Naturally, we end up filtering through those and using our contacts here to learn about those companies. We like to find underexposed companies that haven't yet been touted by an investment house. We find a lot of value in doing our own research and due diligence and getting involved early.
TGR: As you move the new fund forward, will you remain focused on the resource sector?
TM: We will always be involved in the resource sector given where we are located. However, I also keep an active eye on tech and special situation deals and work with brokers who aren't involved with any mining companies. I often reach out to people on the buy side and sell side in other cities to share ideas and get exposure to companies that we wouldn't normally see in Vancouver.
TGR: It sounds like you have your fingers in a bunch of sectors and continue networking so you have more in your trap-line than just resource stocks?
TGR: The fund is heavily invested in the resource area right now. Is that because economic indicators are telling you that's where you should be, as opposed to consumer goods, for example?
TM: We really like the resource space because of the long-term fundamentals, especially for precious and base metals. The U.S. is printing more and more money, and like Voltaire said, "All paper money eventually returns to its intrinsic value-zero." Gold and its little brother silver have always been good stores of value and great hedges against currency debasement, economic uncertainty and upheaval. We like some large-cap names, but we tend to get good exposure in the junior sector.
TGR: You said you particularly like new producers, developers and explorers in mining. What opportunities do you see in those markets compared to large caps and producers?
TM: When you have a supportive market, you can get a lot of value out of the small caps compared to the larger caps-meaning you can get leverage you can't get elsewhere in terms of both development growth and exploration upside. The caveat is that the capital structure and the company's cash position must be well managed. This is inevitably tied to one of our key investing tenets: "Invest in good management and people who will steward the company in the best interests of the shareholders, not their own."
TGR: In 2008, poorly managed cash positions, in essence, made or broke many of these small caps.
TM: Absolutely. That's always a risk, but I'm a little more optimistic and constructive on the current market. There will be stumbles and slips, but there's only been one double-dip recession in the last century: 1908-1982. The chance of things going back to the way they were in early March of '09 is an outside probability.
TGR: Overall, how many of these companies do you believe have a well-managed cash position?
TM: They are few and far between. There may be 1 in 10 or 1 in 12 with a decent cash position, but even those will sometimes have a capital structure that has been blown up and mismanaged such that we will take a pass on the investment. There may be just 1 in 20 that has a solid capital structure.
For us, it always starts with people. We look for accessible management, which is why we end up sticking with a lot of Canadian companies. We also like to see strong insider ownership and participation. I monitor canadianinsider.com religiously. Finding quality assets and businesses is obvious, but that doesn't matter if you don't have management to operate them appropriately.
TGR: Those are features that every investor is looking for. How do you find investments with those attributes that aren't overbought at this point?
TM: That comes back to trying to get in early and seeing these as they're developing and following management and good stories. We've had a couple cases where we invested in a company because we knew that the assets were significantly undervalued because the company hadn't had exposure and that management changes were pending. When new management eventually came on board, you really saw their effect on the company.
TGR: What are some small caps that you're particularly excited about with these attributes?
TM: Well, one name that has treated us quite well over the last year would be Timmins Gold Corp. (TSX.V:TMM). It's a new producer in Mexico that's come to market with a pretty appetizing mix of production growth and exploration results. They're tracking more than 80,000 oz. per year now. Its Sonora-based San Francisco Mine could move to 100,000 oz. and cash costs should be just over $400/oz. for the life of the mine. There's some really good cash flow from a company like that, which just breached the $200 million market cap. I like this name and I think recent exploration success shows that they have potential to significantly add to the mine life.
TGR: They've had quite a run-up since the beginning of January 2009.
TM: True, but I still think they're undervalued compared to comps. By my numbers, they're only trading at about 60% of their net asset value (NAV) where comparable companies trade at NAV or at a premium. Looking ahead, Timmins will likely use its cash flow to acquire other small producers and developers, consolidating the Mexican gold space. I think it's easily worth a $3-$4 per share, with potential for much more than that over time.
We've also got a significant stake in a totally underexposed company called Andean American Mining Corporation (TSX.V:AAG; OTCPK:ANMCF), which is putting its Invicta Property in Peru into production. They could be in production by late 2011, with 97,900 oz. per year gold at a cash cost of around $450/oz. Using a gold equivalent production of 161,000 oz. gold per year, the cash cost is $275/oz. and negative $127/oz. on a byproduct basis. Roughly two-thirds of its revenue is gold, one-fifth is copper and the balance is silver, lead and zinc. The estimated capital expenditure for this will probably be less than $70 million, and at the current price, the mine pays for itself in year one.
The company is attempting to get Invicta financed through debt, subordinated debt and metal sales, and if it's successful, this could be one of the stories of the year. It also owns 60% of Sinchao Metals Corp. (TSX.V:SMZ; OTCPK:SIHXF), which is a large gold and copper asset in Peru. If Andean is able to get Invicta into production; then, from there, it could help move Sinchao along because Invicta is truly a massive asset.
The company recently got a new management team, which helped it through a metamorphosis. They brought in a new president, David Rae, a new chief financial officer and new vice president of corporate development-and the share price reflects their efforts. It's been hitting sequential 52-week highs for a while.
TGR: What's your target price on that upside?
TM: If they're able to get Invicta into production, you could see this stock move significantly because it's still cheap. I think the market will wait to see if they can extend their mine life past the five-year timeframe; but, if they can manage to convert all their resources and reserves and get a 10-year-plus mine life, then this thing could be trading at multiples of cash flow instead of just 1x future cash flow, where it is now.
TGR: What's the potential risk of getting Invicta into production?
TM: There's always teething pains that can happen but John Huguet, the chief executive, worked for Commonwealth Construction for many years sourcing equipment and building mines. They've already got a lot of long lead-time items ordered and I have faith in their ability to put this into production. There is a risk until they secure financing; and, despite having made significant progress on its permits, they still have to get some things through in terms of community agreements that unlock the remaining permitting. All that being said, I just got back from a site visit on Sunday and was very impressed with what the company has managed to do. I am quite confident that this will be a mine.
TGR: Any other particularly interesting holdings in your portfolio?
TM: Bayfield Ventures Corp. (TSX.V:BYV) is a recent favorite of mine. The company has a large block adjacent to Rainy River Resources Ltd.'s (TSX.V:RR) main gold zone. The earn-in wasn't completed until late 2008 largely because of the economic collapse, despite a number of holes showing gold in that location. But Bayfield retained its 100% ownership.
Bayfield recently financed, assembled a good war chest and has undertaken a 20,000-meter drill program, which is one of the most aggressive juniors I follow. The company said that its drill program intersected gold in four holes and confirmed that Rainy River's ODM 17 gold zone extends onto their property, and then just yesterday they reported a barnburner of a hole-9m grading 12.88 g/t gold with a high-grade zone of 3m grading more than 1 oz./ton. Assay results are pending on another 11 holes, and I'm very excited to see these and the other holes they are going to complete this season.
The debate is on whether Rainy River is an open pit, open pit with an underground portion or whether the deposit hangs together as a pure-underground mine. I expect eventually they will have to purchase Bayfield's block or the company as a whole, and if Bayfield manages to pull some more good holes out of the ground and discover new zones, this could be a very painful purchase for Rainy River.
TGR: Will Rainy River have enough cash to acquire Bayfield?
TM: I don't know if it will be cash or cash and stock, but the company does have some $60 million in the till. I can't speculate on that at this point; however, Rainy River does have a market cap of about $500 million, so they certainly have the paper to make an acquisition.
TGR: Yes. Are there any other highlights in your investments?
TM: I recently went on a site visit to Otis Gold Corp. (TSX:OOO; OTCBB:OGLDF) Kilgore gold project in Idaho. We have liked this name for a while-we participated in the last financing and we bought in the open market. Going to the site showed me they had solid infrastructure and great project potential. I believe the main deposit there will be more than 1 Moz. after they finish a 6,000-meter drill program with potential to grow beyond that. Assays from two-thirds of what they've completed should start dripping out over the coming weeks and months.
While there was some speculation that Kilgore could have been a high-grade, underground operation, it now appears to be a large, bulk tonnage operation. Going forward, when looking at assay results, remember the old adage-tonnage makes a mine, grade makes a mine manager. Truth by drill hole here, but I'm reasonably confident that they'll get the tonnage they need. A side note-Otis is earning-in on 75% of the property.
What really excites me is the potential they have on Dog Bone Ridge (part of the same property claim as Kilgore), where five large anomalies have been identified through a controlled source audio-frequency magnetotellurics (CSAMT) survey. Each anomaly is potentially the same size as the main Kilgore deposit, and two of them coincide with historical drill intercepts that showed significant gold mineralization. Management is planning to drill 2,000 meters on Dog Bone Ridge this season. I've been prodding them, and I hope they're getting more aggressive on that.
I would also point out that they've got one of the best share structures I've seen, good management, geological talent and a modest cash position that should see them through this exploration season.
TGR: When do they expect to release the drill results on Dog Bone Ridge?
TM: They should be starting in September and into the fourth quarter. So, we probably won't see results until late this year. But in the meantime, a lot of results will be coming out of Kilgore.
TGR: So far, we've talked about companies located in the Americas. Are you looking at other continents?
TM: We've done quite well with a few African gold names in our portfolio during the last year, including North Atlantic Resources Ltd. (TSX.V:NAC), Riverstone Resources Inc. (TSX.V:RVS) and Orezone Gold Corporation (TSX:ORE). The latter two have come off significantly from their peaks, but all three still present a great opportunity. We're very comfortable in certain West African countries, and those companies operate in Mali and Burkina Faso.
Orezone has the same management team that built the 5.3 Moz. Essakane mine, which they sold to IAMGOLD Corporation (TSX:IMG; NYSE:IAG) in 2009. Then, they spun out Orezone Gold with a bunch of the exploration development assets they had. It has a great team with a proven track record and a quality, growing asset base totaling 3.7 Moz. so far. This is a good story that just keeps getting better.
TGR: To what extent are you involved in non-gold-focused mining opportunities?
TM: The first one I am very fond of is a CNQ-listed company called Trevali Resources Corp. (CNQ:TV). It's a Peruvian silver, lead and zinc developer that is partnered with Glencore International AG. It comes from the Cardero Group, which is the same camp as International Tower Hill Mines Ltd. (TSX:ITH; NYSE.A:THM). Their asset is the past-producing Santander Mine in west-central Peru. The company has fast-tracked production targeted for startup later this year.
In exchange for life-of-mine offtake, Glencore is providing them with a 2,000-ton-per-day (tpd) plant contract mining and technical expertise, significantly reducing risks. The mine is expected to produce 40-45 million pounds (Mlbs.) zinc, 10 Mlbs. lead and 700,000 oz. silver per year, with projected cash flow of more than $25 million per year. Trevali, valued at roughly $60 million in market cap, trades at roughly two and a half times next year's expected cash flow, whereas most comps trade at significantly higher valuations. I'd expect Trevali to move well through the $2 mark by early next year.
Trevali is expected to transition to the TSX Venture Exchange in short order, which will open them up to a lot of buyers who previously couldn't participate due to exchange restrictions on the CNQ. You can have a lot of Canadian funds and U.S. funds that will finally be able to dabble in the name. That should boost liquidity and exposure. The finalization of the Glencore agreement is also a major catalyst and is expected imminently.
TGR: And number two?
TM: The other stock is Alderon Resource Corp. (TSX.V:ADV; OTCQX:ALDFF), which is developing the Kami iron-ore deposit in Western Labrador, Canada. It's located just six miles east and just across the border from Consolidated Thompson Iron Mines Ltd.'s (TSX:CLM) Bloom Lake deposit in Quebec. Alderon has a very similar project and, based on work to date, the company has up to a quarter of a billion tons of iron ore with grades ranging from 28%-35%. The summer drill program is attempting to delineate a resource double that size with ultimate potential to approach 900 million tons (Mts.) like Bloom Lake. The company has a $16 million cash position and only $8 million is being used on the current drill program, with the balance to be put toward fast-tracking a feasibility study.
Management is also a key selling point. Most of the team that put Bloom Lake together for Consolidated Thompson has moved over to Alderon, and the project is being optioned from Altius Minerals Corporation (TSX.V:ALS). Upon completion of $5 million of work and issuing 31.8 million shares, Alderon will own 100% of the project and the company will have a total of 73 million shares outstanding, giving it a market cap of about $100 million. Compare this to Consolidated Thompson, which is three-four years ahead, and has a market cap approaching $2 billion-and the upside is obvious, in my view. That being said, I'd keep in mind that they will likely have to take significant dilution if they are to put Kami into production themselves.
TGR: Tell us about your resource holdings outside of the mining space.
Taylor MacDonald: We have a number of oil and gas positions that I'd describe as a little off the beaten path, including Tag Oil Ltd. (TSX.V:TAO), Primary Petroleum (TSX:PIE), Pacific Rodera Energy Inc. (TSX.V:PRD), Realm Energy International Corp. (TSX:RLM), as well as Porto Energy Corp., which is a private Portuguese oil and gas company slated to go public later this year.
TGR: You said earlier that you also look for niche players, or "tech special situation" companies that are addressing a problem that resource companies are experiencing.
TM: We're quite fond of a couple of companies that solve problems for the sector. My best pick right now is a company called Cortex Business Solutions Inc. (TSX.V:CBX). Cortex has an innovative system that takes account payables, receivables and invoicing systems for oil and gas companies paperless. In an age where everything is done electronically, a lot of industries-oil and gas included-still use paper invoicing systems, which is prone to human error.
Cortex set up the central hub called the Cortex Network. They charge an initial setup fee, and then they collect a small "toll" every time a document is passed through the system. It's a great business model. A new management team took over three years ago and retooled, reworked and expanded the core technology . Then about a year ago, Husky Energy Inc. (TSX:HSE) mandated that all of their 10,000 suppliers had to be on the Cortex Network. From the people who do the wiring to the guys who make the meals for their employees to the pipefitters, any time they're going to be invoicing with Husky, they've got to be on the Cortex Network.
Husky signed on for an initial five-year term with an option to extend for five years. This announcement was quickly followed up by three other major hubs signing on-Apache Corporation (NYSE:APA), Bonavista Energy Trust Ltd. (TSX:BNP.UN) and Murphy Oil Corp. (NYSE:MUR).
Where this really gets interesting is when Cortex is able to move beyond the oil and gas space, which I hope will happen in the next year or so. There are still a lot of different industries that are using paper-based systems.
TGR: Does Cortex have competition?
TM: The main competition actually stems from people using internal systems: monsters in the industry like Safeway Inc. (NYSE:SWY) and Wal-Mart Stores Inc. (NYSE:WMT), and a few of the oil and gas majors that have their own proprietary systems. But there's a lot of potential room in this space for Cortex to move around and a huge market opportunity.
This is my best pick in the technology sector. If I could tuck away one name and not look at it and let it grow for a few years, this would be it, and it's my largest personal investment.
TGR: What is another example of a technology company helping to solve a problem for the resources sector?
TM: It's early stage, but Ridgeline Energy Services Inc. (TSX.V:RLE) is an illiquid, small-cap environmental service company for the oil and gas space. The company operates "green fill sites" that remediate contaminated oilfield soil to landfill standards. They have one site up and running now and expect to add another half dozen by the end of next year and then each year thereafter. It's a great way to have localized soil remediation sites that provide daily cover for landfills, reduce trucking costs and eliminate stockpiling of contaminated soils. Each site generates up to $1 million in revenue and margins of up to 45%. With a market cap of only $8 million, this is an attractive stock based on the fundamental business, but the key reason we're interested in this company is that they seem to have cracked the code on processing water contaminated in the production of oil and gas. Frac water is the current focus for Ridgeline, but the new technology has potentially great application to any water with high levels of hydrocarbons, chlorides and heavy metals, a big problem for the oil and gas industry. Initial trials have been successful with cleaning up water in British Columbia and they are in the process of setting up contracts with major oil and gas companies subject to additional field trials. Ridgeline also has very strong insider ownership and really good management.
TGR: Taking the toxic materials from oil production and somehow breaking it down in a benign way is exciting. This has been a fascinating conversation. We appreciate your insights.
Taylor MacDonald is vice president of investments at Pathfinder Ventures Corporation, a Vancouver-based family office. He graduated from the Wharton School, University of Pennsylvania, with a Bachelor of Economics in 2004. Prior to moving to Pathfinder, he worked in equity research at Raymond James Ltd. in Vancouver, investment banking with Haywood Securities (UK) Ltd. in London, England and institutional equity sales at RenCap Securities in New York. He has been a CFA Charterholder since 2009 and is a Level II CAIA candidate.
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1) Karen Roche of The Gold Report and conducted this interview. She personally and/or her family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report or The Gold Report: IAMGOLD, Alderon, Timmins, Otis and North Atlantic.
3) Taylor MacDonald: I personally and/or my family own shares of the following companies mentioned in this interview: Andean American Mining, Tag Oil, Cortex Business Solutions, Ridgeline Energy Services. I personally and/or my family am paid by the following companies mentioned in this interview: None.
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