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Energold & Bought Deal Financing

|Includes:Energold Drilling Corp. (EGDFF)

Energold Drilling Company (OTCPK:EGDFF) just announced this week that they have entered into a "bought deal" financing arrangement with a syndicate of underwriters led by TD Securities Inc to the tune of around $20 million dollars (private placement of 3.9 million shares at $5.20). This deal also includes some options (585,000 options at $5.20 as well) that, if converted, would bring the total financing deal to around $23 million. This deal is to be closed on or around March 21, 2012. That being said, this is only slightly troubling, but it's worth noting why and why not.

To understand why, one must understand that "bought deal" financing is one of the more expensive ways of raising money, and Energold has engaged in this type of financing before in 2010. For an excellent overview of how "bought deal" financing works take a look at the Adventures in Capitalism article link at the bottom of this post about the 2010 financing deal by Energold. I would recommend it for a full understanding of what is taking place, as I am not going to explain all the details. Nor would I be able to as fluently as the author of that article does. To summarize as concisely as possible, bought deal financing is essentially a broker calling the company asking them if they want money, because they have a committed buyer willing to help raise capital, and that it would be of no effort to the company (as long as they agree to the brokers terms). The broker doesn't just offer what the committed buyer wants to invest, but rather a bigger sum that they can then sell to others that obviously include fees.

The troubling part of this deal comes in different forms. Some are characteristics of all equity issuances, but some are exclusive to bought deal structures. They go as such, 1) this will cause dilution of earnings for shareholders (like me), 2) bought deal financing is the lazier way of raising capital through share issuance, but the little effort on management's part to market the issuance comes with a sacrifice of some percentage points in pricing terms, and 3) one has to hope that the underwriter was able to find shareholders that genuinely believe in the fundamentals of the company.

The third part is the least important to me because it mainly concerns the short term price; and as you read the Adventures in Capitalism article you will note that with the short term price "damn near anything can happen" with deals like this. Like I said though, I am not concerned with the short term price which is because I am a long term investor, but I figured I'd point that out anyways. From my perspective, one should ignore the short term price fluctuations because they have nothing to do with the fundamentals of this company. For example, if there isn't as much demand as the underwriter assumed for this deal, then the underwriter will probably do anything to get the shares off their hands. This includes selling the shares to funds the will just end up flipping the shares.

So if the deal isn't popular then the shares aren't going to be going up until it has found a level where buyers become interested again. That's not to say that it won't be popular though, because Energold is in a great position to grow exponentially for a long time and it seems like many are starting to notice this. So these shares could get placed with a few large funds that intend to hold it based on fundamentals, but that is not something that I am willing to pontificate about.

It is the above reason that points why I believe that this is not necessarily a deterrent to my original thesis that this is an overlooked and undervalued company. This deal should be very accretive in that it will pay for itself through the growth of the company's revenues and market share. The reason they did this is due in part to their aggressive, and very visible, growth plan and potential. And they need more money than they have in unrestricted cash to do this. It is the same reason they did it in 2010, and the growth certainly followed (check their financials if you want proof). Sure, they chose the more expensive way of raising capital, but it also allowed management to focus more on the operations of the company rather than a road show and marketing campaign. Energold is in an industry that has very little viable competition combined with a large potential market to cater to. Frontier mining has many decades of above average growth ahead of it as the easily accessible mining lands become scarcer.

They are easily the best among the few competitors they do have, and they have the pricing power and reputation to back it up. I believe this deal will pay for itself, but I just wish they would have found a more lucrative and less costly way of financing their expansion. Then again, any sane investor wishes such things. I still believe that their earnings would have been able to finance their growth, as their earnings are getting stronger by the quarter, but I do not know what management has planned. So maybe their aggressive growth strategy necessitates this. I can't say with any certainty that taking on debt would have been a better idea, and maybe they needed to keep 100% of their attention on the operations rather than a marketing campaign that would have made raising capital more lucrative for the shareholders.

All in all though, this is still a very good investment for anyone who has a long term investment horizon as this company is the front runner in a very lucrative industry, and will continue to be for a long while. In a rush to mine precious metals, I would rather be an investor in the company that supplies the miner rather than the miners themselves. Because then the company is profiting on the exploration potential, rather than the actual precious metal recovery potential (i.e. successful and unsuccessful miners both add to Energold's bottom line). This might not be a terrific comparison, but it's similar to what Levi Strauss did in providing the miners with durable clothing that could withstand the harsh nature of mining during the mid to late 1800's California Gold Rush. And look where it got his business, as he cashed in on the necessities of the miners. Energold could do the same, but in the mining equipment segment of the industry, simply because of the fact that frontier mining is an extremely new industry that was brought into existence because of the kind of equipment that Energold created in response to the demand for being able to mine in areas previously unable to be mined.

Disclosure: I am long OTCPK:EGDFF.

Stocks: EGDFF