Harfang Exploration Inc. Competition Case 2024 MBA PDF

HARFANG EXPLORATION INC. – EXPLORING OPPORTUNITIES FOR GROWTH Philip R. Walsh wrote this case solely to provide material for class discussion and use as part of the 2024 MBA Case Competition. It is not intended to demonstrate either an effective or ineffective handling of a managerial situation. Th...

HARFANG EXPLORATION INC. – EXPLORING OPPORTUNITIES FOR GROWTH Philip R. Walsh wrote this case solely to provide material for class discussion and use as part of the 2024 MBA Case Competition. It is not intended to demonstrate either an effective or ineffective handling of a managerial situation. This publication may not be transmitted, photocopied, digitized or otherwise reproduced in any form or by any means without the permission of the copyright holder. Copyright © 2024 Introduction Rick Breger, CEO of Harfang Exploration Inc., had just returned from a leave of absence and was sitting at his desk in his home office wondering what direction the company might make going forward. As a publicly-traded junior mining exploration company, Harfang had just completed a successful summer 2024 exploration program resulting in announced discoveries at its Serpent- Radisson exploration property near James Bay in the Province of Quebec. The first discovery was related to the element lithium, a highly reactive metal that has value in its use to make rechargeable batteries. The value of lithium was expected to increase as demand for its use in electric vehicle batteries was also expected to grow. The second announced discovery was actually five high grade gold discoveries on the same Serpent-Radisson property. With gold prices reaching historical highs in 2024, the company had expanded its gold footprint in the region with the identification of these new gold-bearing structural trends. However, Rick remained concerned about the fact that the market had not responded as favourably as might be expected from these discoveries as Harfang’s share price continued its downward trend from highs achieved in 2021. With a declining share price that could limit the ability to raise additional capital through an equity raise, even one with the benefit of flow-through shares, and no positive cash flow from operations, funding future growth could be problematic. Certain questions came to mind. Will the recent discoveries be significant enough to encourage additional equity raises? With numerous small-cap mining exploration companies active in this area could Harfang compete with them for that capital? What opportunities existed to allow the company to grow in value? Finally, in its desire to be financially sustainable had Harfang inadvertently ignored certain stakeholders? Rick decided it was time to take a long bike ride to consider how he might address these questions or more importantly how would others answer them? The Company Harfang Exploration Inc. was incorporated on March 30, 2010 under the Business Corporations Act (British Columbia) and on June 22, 2017, in conjunction with a reverse takeover, continued under the Business Corporations Act of Quebec. Harfang’s head office was moved to Montreal and its shares are listed on the TSX Venture Exchange. It operates as a mineral exploration and evaluation stage company; its purpose is to acquire and explore mineral properties in Canada with a focus on the exploration and evaluation of gold and lithium mineral properties located in the James Bay area of the Province of Quebec. Exhibit 1 identifies the current equity ownership structure of the company and Exhibit 3 provides a longitudinal financial analysis of the company. 1 Exhibit 1: Equity Ownership Structure1 As a mineral exploration and evaluation stage company its assets are exploration and evaluation properties whose value is determined based on whether those properties contain mineral reserves or resources that can be economically mined. The ability of Harfang to achieve a return on its deferred exploration and evaluation expenses depends on: 1. The discovery of economically recoverable lithium and gold reserves and resources 2. Securing and maintaining title and beneficial interest in the properties 3. The ability to obtain necessary financing to continue the exploration, evaluation and development of its properties 4. Obtaining certain government approvals 5. Receiving proceeds from the disposal of properties The company was clear about possible disruptions facing the industry when its Auditors disclosed that “Changes in future conditions could require material impairment of the carrying value of the exploration and evaluation assets. The Corporation will periodically have to raise additional funds to continue operations, and while it has been successful in doing so in the past, there can be no assurance it will be able to do so in the future. Although the Corporation has taken steps to verify title to its mining properties on which it is currently conducting exploration and evaluation work, in accordance with industry standards for the current stage of exploration and evaluation of such 1 Corporate Presentation to Investors 2024 2 property, these procedures do not guarantee the Corporation’s title. Property title may be subject to unregistered prior agreements and non-compliance with regulatory requirements.”2 Canadian Mining Industry Overview3 Canada is one of the leading mining countries in the world and one of the largest producers of minerals and metals. The Canadian mining industry is a significant contributor to the country’s economy. It employed directly over 403,000 people and indirectly employed an additional 263,000, a combination representing one in every 31 people in the Canadian labour force. This includes activities related to mineral extraction, smelting, fabrication and manufacturing. The industry is also one of the largest private sector employers of Indigenous peoples. The total value of mineral production in Canada exceeded $55 billion in 2021 and accounted for 22% of total exports. The financial importance of the industry to the country is reflected in Toronto, a global hub for mining finance and the home of both the Toronto Stock Exchange (TSX) and the TSX Venture Exchange, which combined, constitute the world’s premier listing venues. Over the past five years, 37% of all global mining equity has been raised through those exchanges. The mining industry in Canada is comprised of three levels of mining activities. At the top are the major producers of minerals who operate mines and who typically develop their own mines. The second tier is represented by development companies who acquire promising mineral properties and undertake further development work to prove up the potential for producers to construct a mine. In some cases, a developer may construct the mine themselves. The third tier is the mineral exploration and evaluation companies. Their principal strategy is to explore mineral claims and to evaluate their potential for development and construction of a producing mine. Exhibit 2 provides an overview of the various segments of the industry. According to Natural Resources Canada there was a total of 1,423 Canadian mining and exploration companies active across the country in 2022 with capital expenditures of approximately $4.1 billion dollars exploring their mineral properties. Of that number, junior companies represented 83% of active companies, 76% of all ongoing projects, and 57% of the capital expenditures.4 The consulting firm, EY, found that the three top issues (in order) currently facing the mining industry5 in 2024 are: 1. Environmental, social and governance (ESG) In terms of investor scrutiny, a 2023 survey of 150 mining executives by EY of the ESG factors facing the most scrutiny from investors, local community impact was the most significant (64% of those sampled) followed by specific environmental impacts associated with mining operations (46 to 55% Ranking 2nd through 4th). Diversity, equity and inclusion also remained a key ESG factor (31% Ranking 5th). Surprisingly indigenous trust and reconciliation ranked near the bottom of the list (20% Ranking 14th of 17 factors) with 2 Harfang Exploration Inc. 2024 Annual Consolidated Financial Statements 3 Mining Association of Canada 2023 Annual Report 4 Natural Resources Canada – Mineral Exploration 2023 infographic 5 https://www.ey.com/en_ca/mining-metals/risks-opportunities 3  only 20% of those surveyed indicating they felt investors gave this ESG factor their attention. Exhibit 2: The Lifecycle of a Mineral Discovery6 2. Capital It is important that companies are well-capitalized in order to fund projects that respond to increasing demand for minerals of importance as part of the energy transition to more electrification, such as copper, lithium and nickel. Competing companies seeking to secure additional financing are facing flat levels of capital investment making it more difficult to acquire new capital although mineral exploration continues to see budget increases. Capital currently is directed mostly to iron and steel, gold, and coal. Investment in nickel and lithium projects are also experiencing increased capital attention. In terms of exploration budgets the jurisdiction with the greatest increase over the period 2018 to 2022 has been Canada, followed by Australia and the U.S., signaling a preference for investment in low risk geographical regions. In addition to lower jurisdictional risk, investors are rewarding companies that practice capital discipline but EY warns that companies in the mining industry will need to convince investors that their future goals need to “balance continued economic returns with more investment in digital, decarbonization and ESG.” 6 https://www.visualcapitalist.com/visualizing-the-life-cycle-of-a-mineral-discovery/ and author. 4  3. License to Operate As indicated in the ESG survey responses there is greater oversight by investors of a mining firm’s relationship with the communities in which they operate. The concept of the license to operate remains a difficult one to integrate into the strategy and operations of a mining or mineral exploration company as it involves a myriad of stakeholders and issues that broadens year after year. This greatest challenge for companies is determining which matters need to prioritized in order to create a more sustainable relationship between themselves and the communities so as to contribute longer term value for both. Competition Harfang is one of hundreds of mineral exploration companies active in Canada. With its principal focus on exploration in the Province of Quebec, it faces competition for mining claims and investment capital from a number of fellow mineral exploration and evaluation companies as well as developers and producers. They include publicly-traded companies such as: Arcadium Lithium7 Arcadium Lithium is a large vertically integrated global lithium chemicals producer with operations in South America, Western Australia and Canada. Their primary products include battery-grade lithium hydroxide, lithium carbonate, spodumene, butyllithium and high purity lithium metal. The company explores for lithium in the Province of Quebec in two areas located in the James Bay region of the province. Their Nemaska property is a 50% owned project that is currently in development with their 50% partners, Investissement Québec, an investment arm of the Québec government. The other property is their 100% owned Galaxy project, located approximately 100 kilometers from the Nemaska property and currently in development. The company is based in Ireland and trades its shares on the NYSE:ALTM. At the end of 2023 Arcadium had recorded annual revenues of approximately $US 880 million and more recently it was announced that Rio Tinto, one of the world’s largest mining companies, had agreed to acquire the company for $US 6.7 billion. Azimut Exploration8 Azimut is a publicly traded Canadian mineral exploration company listed on the Toronto Venture Exchange (TSX-V AZM) with a significant multi-commodity (Gold – Copper – Nickel – Lithium) exploration portfolio in the Province of Quebec. Although the company is currently not generating revenue from its operations they claim to maintain rigorous financial discipline and a strong balance sheet with $13 million in cash. Its most advanced project is the wholly-owned Elmer gold project in the James Bay region. Brunswick Exploration9 Based in Montreal, Quebec, Brunswick is a junior exploration and evaluation company with assets in numerous locations across Canada. Primarily focused on lithium exploration, the company holds extensive mineral claims in the James Bay region of Quebec, along with other areas of the Province. It also has interest in other mineral properties in Nova Scotia and Saskatchewan. 7 https://ir.arcadiumlithium.com/investors/overview/default.aspx 8 https://azimut-exploration.com/investor-hub/overview/ 9 https://brwexplo.ca/ 5 Brunswick promotes itself as “among the only public companies aggressively and systematically conducting grassroots exploration for lithium in Canada using state-of-the-art exploration technology”. At the time of the writing of this case it was reported that the company had an end cash position of approximately $4.9 million. 10 Recently, the company announced it had discovered lithium potential on its James Bay properties immediately to the southeast of Arcadium Lithium’s James Bay properties. Newmont Corporation11 With its headquarters in Denver, Colorado, Newmont is one of the world’s largest gold producers. In 2023 its annual revenue was $US 11.8 billion and its assets totaled $US 55.7 billion as at June 30th, 2024. The company owns the Éléonore gold mine located in the James Bay region of the province of Quebec. The mine is associated with 368 mining claims and 1 mining lease covering an area equal to approximately 19,500 hectares. Newmont maintains process facilities at the Éléonore property that includes a conventional mill where the gold is recovered, smelted, and shipped. Newmont maintains a project pipeline of exploration and evaluation projects throughout the world but aside from its operating mine in Quebec, the company does not promote or highlight any other mineral exploration opportunities in the province. The Future for Harfang? Although the market response to Harfang’s 2024 exploration results was tepid at best, perhaps further evaluation of those results would encourage investors to step up and fund continued exploration and development of Harfang’s properties. At a cash burn rate of 50% per year of existing cash on hand, time was limited and answers to the questions Rick Breger had left himself to consider were more important than ever. It was going to be a long bike ride. 10 https://ca.finance.yahoo.com/quote/BRW.V/cash-flow/ 11 https://s24.q4cdn.com/382246808/files/doc_financials/2023/ar/newmont-2023-annual-report.pdf 6 Exhibit 3: Harfang Exploration financial data Financial Analysis Company: Harfang Exploration in $000 CDN Period 1 2 3 4 5 Year 2020 2021 2022 2023 2024 Trend CAGR Current Assets $ 3,033.3 $ 8,683.1 $ 7,385.6 $ 7,897.6 $ 7,069.2 24% Current Liabilities $ 318.4 $ 1,303.4 $ 931.4 $ 198.7 $ 611.2 18% Fixed or Non-Current Assets $ 876.5 $ 1,249.4 $ 1,538.90 $ 9,288.7 $ 9,522.3 82% Long Term Debt $ - $ - $ - $ - $ - - Shareholders Equity $ 3,591.4 $ 8,715.9 $ 7,993.2 $ 16,987.7 $ 15,869.8 45% Sales or Revenues $ - $ - $ - $ - $ - - G&A $ 605.4 $ 562.5 $ 863.2 $ 1,321.4 $ 1,656.9 29% Exploration Expenses $ 947.7 $ 1,794.3 $ 3,533.6 $ 2,180.0 $ 1,706.0 16% Loss on disposal of exploration and evaluation $ - $ 600.0 $ - $ - $ 7.20 - assets Interest Income $ 61.5 $ 13.9 $ 35.9 $ 206.6 $ 323.8 51% Deferred income taxes recovery $ 255.7 $ 464.3 $ 1,120.1 $ 402.1 $ 396.4 12% $ - -$ 385.0 -$ 166.3 -$ 641.3 $ 45.5 - Other Expense (Change in fair value of shares) Net Income (Loss) -$ 1,235.90 -$ 1,663.6 -$ 3,407.1 -$ 3,534.0 -$ 2,590.0 -20% Cash from Operations -$ 1,553.1 -$ 2,356.8 -$ 4,396.8 -$ 3,501.4 -$ 3,362.9 -21% Net Working Capital $ 2,714.9 $ 7,379.7 $ 6,454.2 $ 7,698.9 $ 6,458.0 24% Return on Equity (EBITDA/ SE) -43.24% -27.04% -55.01% -20.61% -21.19% 16% Return on Assets (EBITDA/Total Assets) -39.72% -23.73% -49.27% -20.37% -20.27% 15% Debt to Equity 0.00% 0.00% 0.00% 0.00% 0.00% - Current Ratio (Current assets/Current liabilities) 952.67% 666.19% 792.96% 3974.64% 1156.61% 5% Operating expenses as a % of Total Operating 38.98% 23.87% 19.63% 37.74% 49.27% 6% Loss per share -$ 0.04 -$ 0.08 -$ 0.11 -$ 0.07 -$ 0.04 0% 7