Equinox Partners Precious Metals, L.P. - Q2 2020 Letter
Dear Partners and Friends,
governance
Junior gold and silver mining companies have a governance problem. Their board rooms are clubby, and their insiders are accustomed to profiting at minority shareholders’ expense. While there are numerous exceptions to these sweeping generalizations, in our opinion the industry’s reputation for poor governance is well deserved. Governance amongst junior gold and silver mining companies is on average far worse than what we have encountered in other sectors.
The gold mining sector’s entrenched insiders with poor track records of value creation and scant stock ownership would be particularly vulnerable to pressure from shareholders if any were applied. Unfortunately, activists have shown little interest in this capital-intensive, technically-challenging, cyclical sector. In many ways, gold and silver mines are the mirror image of the sectors to which activists are naturally drawn.
For all these reasons, John Paulson’s successful proxy fight at Detour Gold was a big deal. Paulson won control of the board in December 2018, changed management, and sold the company at a 100%+ premium from the point at which control changed. Relative to the GDXJ index, Detour’s shares outperformed by 85% over the 11-month period from the board change to the announced sale. While the deal was far from perfect, the Paulson-appointed board and CEO Mick McMullen created real value by running a competitive bidding process.
At the time, we hoped this success would engender additional activist campaigns in the space. This has not happened. Mick McMullen has not taken another job since stepping down from his positions as Detour’s CEO. Worse still, not a single one of Paulson’s nominees to the Detour board joined another public mining company board this proxy season. While we still expect Mick McMullen to resurface at some point given the value he created at Detour, it is regrettable that this year’s proxy season did not include any proxy fights in the gold mining space.
Despite activists remaining largely on the sidelines, a meaningful change in governance is underway within the junior gold mining sector. Passive funds have gone from a non-issue in the board room to the single most important influence over the past two years. Blackrock, State Street, Vanguard, et al, are top-five shareholders in many of these companies and are making their presence felt. Our experience in this regard is firsthand. The chairman of one our largest holdings, MAG Silver, just stepped down as a result of pressure from these so-called “passive shareholders”. His resignation letter in the management circular got right to the point:
“I will not stand in 2020; and other long-tenured Directors will leave in the medium term. In replacing Directors, we will focus on new gender and diversity objectives.”
The removal of directors, and especially the removal of a chairman, is a particularly high-profile way to make your presence felt. And, the information circular announcing Jonathan Rubenstein’s departure was refreshingly direct. Rarely does the behind-the-scenes tension in the boardroom spill into the public domain so clearly, let alone in a regulatory filing. Most of the governance action is private and most of the signals are more subtle. One increasingly useful tell in this regard is the declining percentage of the vote received by directors running unopposed for reelection.
This proxy season, seven directors across three of our portfolio companies received 90% or less of the recorded vote. While 90% may sound good, it’s not great when you are running unopposed and have the support of both major proxy advisory firms, ISS and Glass Lewis. In this context, the 90% figure reflects some serious reservations on the part of shareholders. Those most vulnerable to such pressure are long-serving board members and also those who serve on too many other boards. Accordingly, it’s no surprise that five of the seven directors targeted at GT Gold, Dundee Precious Metals, and Alamos were on four or more boards and three had served on the board in question for more than a decade.
Insiders interested in making a career out of their board service are easily scared off by a low vote total. If they stick around and lose a contested election, they become an easy target for removal from their other boards and an undesirable nominee for new boards. Accordingly, they usually bow out as quietly as possible. And, for every director who retires after receiving a low vote total in an uncontested election, there are more who retire without standing for that first, difficult reelection.
With over-boarding and length of tenure being used to drive turnover, the vacancies are being filled with an emphasis on gender and racial diversity. Blackrock, State Street and Vanguard are all supporters of the 30% Club, “a group committed to increasing gender representation on boards and in senior management.” These same large asset managers are also committed to increasing racial diversity in the board room. With proxy advisor ISS now collecting the ethnicity of directors, shareholders will soon have the data necessary to advocate for greater ethnic diversity in the board room as well. [1]
Given that gender and race neither determine one’s beliefs nor abilities, we are confident that the identity politics animating the large passive shareholders are not going to solve what ails the junior gold mining boards. By leaving it up to existing insiders to recruit new board members within the designated categories, passive shareholders are all but making sure that the new additions to the boards are not going to rock the boat. No public mining company, for example, has picked up the particularly well-qualified woman, Dawn Whittaker, that Paulson advanced for the Detour board.[2] According, don’t expect new board members to advocate too vociferously for consolidation or against abusive compensation packages.
That said, given the junior mining sector’s poor governance starting point, increased board turnover is generating some improvements in the short term. MAG Silver is a case in point. Blackrock’s successful effort to remove Jonathan Rubenstein as chair paved the way for the elevation of our 2012 nominee, Peter Barnes, to the position. Needless to say, we are particularly pleased with this outcome. Peter’s demonstrated track record of astute capital allocation should drive the further rerating of MAG Silver’s shares.
Longer term, however, we have serious misgivings about the governance strategy of the passive shareholders. Their explicit lack of focus on stock outperformance and extreme portfolio diversification deprives them of the financial incentive necessary to fix any particular board. Their interest in the boardroom, instead, runs toward virtue signaling that can be used in their marking campaigns. Moreover, their attachment to the financial status quo creates an obvious conflict with most other shareholders of gold and silver miners.
Take Blackrock for example, a money manager that literally works for the Federal Reserve buying corporate bonds in an effort to muffle the markets’ price signals. Surely, this same firm should not be in charge of revamping the board rooms of gold and silver mining companies. After all, investors who own gold and silver mining companies have implicit reservations about the Fed’s ever-expanding role in capital markets. Why would we want an asset manager with such an obvious conflict of interests to be actively involved in our companies’ boardrooms?
Lest this concern seem too hypothetical, we offer Nick Holland, CEO of Goldfields, as a real-world example of what can go wrong when a CEO and board do not believe in their product. Despite Goldfields’ stated policy of “remaining unhedged to the gold price,” Nick lost hundreds of millions of dollars over the past twelve months shorting gold on behalf of his shareholders. Officially, Nick collared the gold price so that he could execute on the company’s business plan even if the price of gold fell precipitously. [3] Nick’s board—which is long credentials and diversity but not much of Goldfields’ stock—supported Nick’s decision[4]. In doing so, they failed to represent the interest of Goldfield’s shareholders who own the company in anticipation of higher gold prices or protect shareholders from the permanent dilution suffered when Goldfields issued equity as the gold price rose.
Only through a greater connection between the active shareholders and corporate boards can the agency issue be solved. Long-term shareholders of junior gold and silver mining companies need to cajole and force their way into the boardroom, pushing for representation and well as regular engagement. For our part, we fully recognize this obligation, and we’ve participated in the restructuring of a handful of boards. Prudently managing the related time commitment and trading restrictions that come with such engagements is a core skill for us. We are happy to see a growing number of other shareholders doing the same. As the junior gold and silver mining sector generates more free cash flow, we expect conversations about governance and capital allocation to intensify and companies with well-aligned boards to seriously outperform.
Sincerely,
Sean Fieler
ENDNOTES
[1] Financial Times, Edgecliffe-Johnson and Nauman, 7.13.20, Proxy Adviser ISS increases pressure for disclosure of directors’ ethnicity
[2] Wall Street Journal, Thomas, 12.13.18. Investor Paulson Deposes Five Detour Gold Board Members
[3] See this and Goldfields 2019 annual report, pages 86-87. Estimate includes realized 2019 losses and our estimate of 2020 losses.
[4] The board owns a cumulative 0.09% of the company. See annual report, page 19, for a full listing.
