1000% Gains: A Spectator's Guide to Private Placements with Rick Rule

Photo: 1000% Gains: A Spectator's Guide to Private Placements with Rick Rule

00:00:08 I'm going to be talking about Private Placement Investing today and apparently, I'm in some danger of violating both U.S. and Canadian securities laws are a trace on both sides of the boarder wanted to see my notes ahead of my speech so I didn’t prepare them and so that nobody could tell me what I couldn’t do. I have to disclaim conflicts of interest. I am a licensed securities person in the United States and that means that there are some things that I cannot do. I cannot do anything that appears to be research. Because on both sides of the border, if you do research, you can't do transactions. If you do transactions, you can't do research.


00:00:52 It turns out that transactions pay better than research so I do transactions, not research. Now, if I tell you something that I'm doing and you do it after me, that might constitute a conflict of interests. I'm proud to say that I'm party to numerous conflicts of interest and I'm actively soliciting more. If I tell you something that appears to you to be research, please understand that it isn't because that's illegal. It's a disclosure of a conflict of interest which is required. Do we all understand that? None of it makes any sense but nothing that comes out of Ottawa or Washington ever makes any sense anyway, so now, let's go on with it.

00:01:34 First of all, why private placements? That's easy. That's where the money is. That's where the money is. Everybody here know what a private placement is? Let's do it differently. Anybody here not know what a private placement is? One. Okay.

00:01:49 A private placement is a transaction that takes place between you, the investor and the issuer. Not from the market. You didn’t buy the paper from another investor. You bought it directly from the company's treasury. Two things to know about private placement. I'd say you do them to make money. That was too general.

00:02:10 You do them because you contribute equity to a company in a private placement if you do it correctly to answer an unanswered question that will have some potential catalytic impact on the company. If you structure a private placement correctly, you have had a discussion with the issuer and the issuer has convinced you that he or she will use that money to answer an unanswered question associated with their property or properties that if you get a yes answer, will result in a dramatic escalation of the share price.

00:02:50 The first thing to know about private placements if you're walking out there in the exhibit hall and somebody approaches you for a private placement and you say, what is the most important unanswered question that you proposed to answer. About 80 percent of them will say, 'Well, I never really thought about that.' That's a really good response because you can walk away and not waste another minute with that issuer.

00:03:11 Somebody who doesn’t have the use of proceeds that will not if it's successful result in a catalytic dramatic increase in the value of the company, if not the share price is not worth your discussing. Everybody get that? The second thing about private placements, why you do them, my friend Dudley will tell you this is true. You get a warrant.

00:03:34 A warrant is the right but not the obligation to buy more stock at a fix price preferably after the unanswered question has been answered. In the first instance, this is pretty simple. No warrant, no placement. You got it? No warrant, no placement.

00:03:55 If you don’t get a warrant, there's no sense doing the placement. You may as well buy the stock on market with no restriction. No warrant, no placement.

00:04:02 Second thing about the warrant. The warrant fuse that it is the amount of time that the warrant option is in the market, needs to be long enough that you answer the unanswered question. Let's say that you provide capital to an issuer to drill five or six drill holes in a nice surface anomaly. You think that this exploration work, got to take one field seasons but it's in Northern Canada where the weather is inclement and there's a reasonable probability that this work will take two field seasons, i.e., it will take 18 months to answer the unanswered question.

00:04:41 If you have an 18 month fuse on the question, and you have a 12 month fuse on the warrant, it's the same as not having a warrant. Everybody get what I just said. This is really, really, really important. The warrant duration needs to be sufficient to give you the option upon the successful answer of the unanswered question. It's critical that you do that.

00:05:06 We've done two things so far. We have establish first of all that you are contributing capital to answer an unanswered question and we have made sure that by way of contributing capital that you have a sweetener. You have the ability to capture some additional value that your capital has created with regards to the issuer.

00:05:30 Now, let's talk a bit about the process. Answering an unanswered question. You have gone to the issuer. You've asked this question to 20 issuers. 15 of them, for them the unanswered question with regards to the private placement is, will I still be able to pay my salary in 18 months? In other words, there is no fundamental question to be answered. That's all very admirable goal but it does nothing for you.

00:05:58 Five or six of the companies have presented a plausible use of proceeds. The first question that you have ask yourself is, is the person who is asking and answering the question qualified, let's say that the unanswered question that they're talking about is a technical question that has to do with exploring for copper, gold, porphyries in Peru. Let's assume that the CEO of the company is a plumber or worse, a stock broker, somebody who tells a story well but doesn’t really know much about Peru and can't spell porphyry. In this circumstance, you must discount the question because you discount the expertise of the person proposing the question and answering the question. Everybody still with me?

00:06:51 Those of you who heard me this morning heard me say that it's important to hang out with serially successful people. In addition to that, it's important that the people who are involved in answering the unanswered question have past successes that are directly related to the question at hand.

00:07:11 Many, many, many times in my career, hundreds of times in my career, people have introduced themselves to me or been introduced to me as experts in mining. People who have been successful in mining.

00:07:23 For those of you who have heard this illustration before, I apologize. It turns out that there are success in mining is that they operated a gold mine in an Archean terrain, in French speaking, Quebec. What they proposed to do is explore for copper gold, not produce explorer.

00:07:42 In tertiary volcanic, young rock and Spanish speaking Peru. It can be arguable that they have been a success in mining. They haven't been successful in a task that is similar to the test at hand. That's important to know.

00:07:58 The process of this is winnowing. You're going to be confronted in bull market which were in with hundreds of opportunities and your job is going to be to reject opportunities so that you can allocate your cash rationally. No matter how much money you have there is more "opportunity" than you have capital available in rationaling this capital is what's going to work for you.

00:08:24 We first of all decided that looking that the company has to have a plan. Secondly, that the person who is proposing the plan is credible. Now, the decision making process goes like this. Is the question that they're asking valuable? In other words, what's the size of the price?

00:08:43 Too many times, people go looking for small mines and unfortunately, they succeed fairly often. Because everything that can go with a big mine can go wrong with a small mine but a small mine and can never make big money. It's important if you take the risk that we take in this business that the size of the price associated with the unanswered question, be large.

00:09:07 If we like the question and we like the person asking the question, what we say is, is the data that was involved in asking the unanswered question relevant. In other words, do you agree with this opposition behind the question? Sometimes questions are asked simply because that question, although in probable is large enough that they can raise money to it. It's not a valuable question.

00:09:36 Is the thesis valid or is the thesis convenient? Everybody gotten his. I'm going fast because they're not giving us a lot of time.

00:09:46 The next process becomes, how do they propose to answer the question? Is the methodology by which they proposed to answer the question valid, in other words, will their answer matter and is it efficient? Everybody still with me? Good.

00:10:06 The next question becomes and they understand that mining entrepreneurs are invariably really optimistic, so you have to take the next one with a great assault. What is the probability of a yes answer?

00:10:20 We learn this morning that one in 3,000 mineralized anomalies becomes a mine. The truth is that ultimately the successful answer is very rear. What is the probability of the yes answer and the importantly, what is the timeframe required to get to an answer to an answered question? It's important that you align your expectation with how long you have to own the stock, with the reality of how long it will take to deliver the value associated with answering the unanswered question.

00:10:54 If it's going to take 18 months to get a yes answer and you're the time of speculator that has trauma holding stock over a long weekend, you can't be involved in a circumstance because it could be a success and you will still fail. It's important that you align your expectation with the reality associated with the project. This is the most common failure that I see among speculators.

00:11:20 The expectations that they have internally or inefficient expectations relative to the chances that they are taking. With me still? The next question becomes, let's say that the unanswered question is going to take 18 months. How much money is required to answer the question? Do you have it and if not, where are you going to get it?

00:11:43 I remember many years ago when they had the Boston Gold Show I think it was called. This is back in the late 80s. I had been speaking and after I was done speaking, before getting on a plane, I went upstairs and change out of my battle dress into more comfortable clothes , jeans and a shirt. I was walking around the exhibit hall one more time. One of these really great white shoe promoters. You know these guys. They sold drugs in college. They moved unto cars. Now they stocks. Really hyperbolic promoter grabs me. He had great lateral moves like a line backer. I could get away from this guy.

00:12:26 Boy he had this great spill. They're going to do this and they're going to do that. Everybody had already be a billionaire if the mule hadn't 100 years ago the first time in this project. He was going to rectify all of that.

00:12:37 I remember saying to him. Remember this is in the late 80s when money was hard to come by. I said, 'boy, that’s really aggressive, very impressive. How much money is this going to take?' I remember this guy looking at me. These guys are never at a lost for answers. This guy looks at me and says, 'money doesn’t matter.' Really? My money had always mattered. Tell me about how money doesn’t matter? This has to happen to all of you once. This is great.

00:13:03 The guys says, well there's really hot West Coast broker from California named Rick Rule. He obviously doesn’t recognize me. He says Rick really likes this project. He's going to give us all the money we need. The important thing to notice the stock is only at 50 cents and he only finances stock companies at $2. When the stock gets up to $2, if you buy at 50 cents you'll be able to leverage 4 to 1 off Rick Rule.

00:13:26 I pulled my driver's out of my wallet. I say I know this Rick Rule guy pretty well. I don’t like your chances. It's really important if in your business where people take pieces of paper and they paint dreams on them and trade of them for your pieces paper that has a picture of the Queen. It's real important that you say to the person how much money is it going to take to answer the question. How much money do you have? If there's a delta, how are you going to fill it?

00:13:53 The best expectations in the world if the people don’t have the money to answer the question, they aren't going to answer the question and you're going to get stiffed no matter what, okay? We're all through at this so far, right? We've decided that the only reason you do private placements is to answer unanswered questions.

00:14:09 No unanswered questions, no money. We do it because we want the warrant. No warrant, no money. Still with me?

00:14:18 People got to be great people. No great people, no money. Big target. Small target, no money. Good plan. No plan, no money. Good thesis. No thesis, no money. Are guys with me?

00:14:37 It really is pretty simple. It's just the doing all of this stuff is very, very, very tough. Let's assume just for fun that we've done a private placement. There's two or three possible outcomes.

00:14:53 Let's say that were in a bull market. Not a beginning bull market like this but a real bull market. Let's say that the unanswered question is of sufficient magnitude and because we're in a bull market, the expectation of the market is overwhelmingly greedy rather than fearful. One delightful thing that’s happened to me 60 or 70 times in my career is that the stock has given me the performance that I expected in the event of the yes answer before the question got asked.

00:15:31 Let's say that I'm doing a placement at a buck. I think that a yes answer will give me a $3 bid which by the way will do a lovely thing to my warrant. Let's say that the market has taken leave of it's senses which it does twice a decade. That I get the $3 before the questions answered. What do you do? This is like black church. This is participatory, okay? What do you do? You sell. For sure you sell enough that you recoup all your capital.

00:16:03 We call this situation where you have sold enough that you have no basis left in the stock. The point of no concern, it's important to remember the slogan because that differentiates it with loosing money which is the point of no return. If you have a circumstance where before the question has been answered, you sell enough stock that you have no capital left in the transaction. You're in the karma zone. This is really, really, really wonderful.

00:16:31 A second set of circumstances, you asked the question. The answer comes back. No. What do you do? Sell, correct. If the reason to own a stock is gone, the stock has to be gone. Hope is not a speculative strategy. It's a four letter word, a very, very, very bad four letter word. If the reason to own the stock is gone, you have to sell the stock. Many times in my career clients, new clients that have transferred in these huge laundry list of stocks, 45 stocks, 50 stocks, 60 stocks.

00:17:07 I try and go through the stocks with a new client to adjust each others expectation to the other. We'll start with A, Amalgamated Aardvark and the new client will say, well Rick what do you think of Amalgamated Aardvark? I have to say, well really frankly prior to this meeting I was blissfully unaware of the existence of Amalgamated Aardvark. You own it. What do you think of it? I don’t really remember. Why do you own it? Bob Bishop recommended it. Christ. He retired 11 years ago.

00:17:40 If that’s your best reason you got to sell it. The client invariably says I can't sell it. Why? I paid $4 for it and it's $0.40 bid now. If I sell it, I'll lose $3.60. You need to say no. You've already lost $3.60. The question is, what are you going to do with the $0.40?

00:17:59 When the reason to own a stock goes away you see it the stock, okay? Losing $0.30 on a dollar beats the hell out of looking $0.70 on a dollar. If you're employing hope as a strategy, your going to lose the 70 not the 30.

00:18:14 A much more interesting circumstance comes up. If you get a yes answer because now you have a choice. In the first instance, if you have a yes answer if the value has been established but you're in a bear market and the market doesn’t realize it. In other words, if the value has been created but the price action doesn’t follow. If you really are going to make money in this business and if you worked hard, you have to do something difficult. You have to buy disappointments. You have to buy more.

00:18:46 If you get a yes answer and the stock performs to your expectation, there're two schools of thought. Historically, if I got a yes answer and the stock performed on my expectation, I would sell at least enough that I had the rest for free and sometimes I would sell all. In my declining years which sadly I'm well into now, I've learned that the right thing to do if you get a yes answer is review the whole situation. Go back to the management team and say unlike most you asked the correct question. You got the correct answer. What question does this new data propose? You repeat the whole process. Is everybody with me?

00:19:28 The stock is now a $3 stock. What's the next question they're going to ask, how does that add value? You repeat the whole circumstance. If you do that in a market like this with high quality people, with opportunity and a bull market early on, you can and you will make money. One more comment on private placements. Increasingly, there are instruments in the United States, Canada and Australia where the warrants in private placements are detachable and trade. These things are worth their weight in gold, these tradable warrants because the market action is that private placement speculators have been trained to go for the leverage.

00:20:11 Sell the stock, reduce your risk, stripped the warrant. The consequence of the fact that 99 participants out of 100 in a market sell the stock and strip the warrants means that on a probabilistic basis, the warrants are overpriced and the stock is under priced. What I have taken to doing in circumstances where the warrants are trading at a 60 or 70 percent premium to what I think they're worth is sell the warrant. Sell the deteriorating time value asset and buy the stock. In other words buy the perpetual asset at a discount.

00:20:44 They say in this business when the ducks quack feed them. I say in this business, when the quacks duck eat them. If everybody is trying to do one thing that’s ducks quacking. If everybody wants to sell the stock and strip the warrant buy warrant. Pardon me. Sell the warrant and buy the stock. This part is fairly simple.

00:21:03 I got 30, 40 seconds left. Are you guys with me through this? We're answering unanswered question. We are getting a warrant. If we aren't getting warrant, there's another finger, okay.

00:21:19 We like the person who answered the question. We like the size of the question. We liked the size of the prize. That’s really the whole game. Those of you particularly who live in this community where private placements as ubiquitous as rain have no excuse not to participate in them. The idea that you would participate in this game without getting a warrant if you have the ability to get warrant is truly, truly insane.

00:21:52 Ladies and gentleman, that’s my pitch. I hope you employ it because if you do you'll thank me here next year.

00:21:58 Bye-bye.