Jim McKenzie sheds more light: Dilution and Growth ModelI had a few questions that concerned me moving forward wrt dilution, growth and share appreciation. Jim was kind enough to answer these questions as I'm sure many of you are wondering the same thing.
Here is what he replied:
Dear Mr. McKenzie,
I’m a long term shareholder in Ucore and have watched your evolution from a resource company to a technology-based enterprise. I read with great interest your response to a shareholder question regarding his ability to keep exposure to Ucore as the company considers spinning out separate businesses units to pursue various metals other than rare earths. Your notes were encouraging, and I have a couple of additional questions, if you wouldn’t mind answering.
1.
Dilution - If Ucore pursues spin outs, you mention a possible share award in the Newco, so there is a good possibility of exposure to the upside of the Newco. What about dilution? Would the “Newco” company likely start out with the same number of shares outstanding as Ucore has now? Ucore is a fairly mature enterprise, and I would hope that any Newco’s would have less shares right out of the gates.
2.
Growth Model – You’ve laid out a “hub and spoke” growth model that contemplates separate companies for each spoke (one for lithium, one for tungsten, etc). Has Ucore considered a more organic growth model? What I mean by this is, could Ucore pursue a path like a miniature Dow Chemical, where all divisions are wholly owned by the central company? This would avoid share price dilution across multiple companies, and increase Ucore’s overall market cap. Just wondering.
Sincerely,
XXXXXXX
Dear XXXXXXX,
Thanks for your questions. In truth, the widespread response to that post has been excellent and shows the level of shareholder interest in Ucore’s growth prospects. That said, the email contemplates scenarios that are not fact as of yet, and no decisions have been made as to our eventual course of action. Naturally, any decisions we do make would be widely distributed.
However, my musings in that communication represent what I believe to be a best-practices philosophy: assuring existing shareholders that they can reasonably expect exposure to the upside of any spin outs that Ucore may generate as we move ahead.
I’m also happy to report that we take your questions seriously, and while Mark MacDonald is the go-to for investor relations, I’m pleased to respond to you and offer my commentary, below. That said, we’ll likely be doing a series of media interviews in the foreseeable future, which will offer further insight into the possibilities as we move ahead.
1.
Dilution – You make an excellent observation regarding dilution (ie - the number of shares outstanding in a potential spin out). My example of a 1:1 share grant was for illustrative purposes, and to underscore that in a spin out scenario, it’s reasonable to expect that the proportion of a shareholder’s holdings in the mother ship be reflected in any theoretical share grant in a spin out (or “Newco”).
With this in mind, a start-up company / Newco will typically endeavor to have less shares outstanding than the more mature company from which it has been generated. For example, a spin out enterprise may elect to commence operations with 1/10
th of the share count compared to the company from which it has been generated. In such a case, however, shareholders in the mother ship typically receive a percentage ownership in the Newco that is
proportionate to their percentage ownership in the mother company
. So, in the 1/10
th example mentioned above, shareholders might reasonably expect to receive 1 Newco share for each group of 10 mother ship shares that they already own (a 10:1 share grant). However, their proportionate ownership in the Newco, before subsequent dilution, would be the same as their proportionate ownership in the mothership (irrespective of the exact share count they receive in the spin out).
The foregoing is very much to the shareholder’s advantage, since a “tight float” (less shares outstanding) can have a very positive effect on the Newco’s accretion in share price during the start-up phase.To be clear, once birthed, Newco’s are typically responsible for their own independent financings and go-forward dilution. So, the spin out strategy that we contemplate above offers shareholders excellent exposure to the upside of multiple offspring companies, without incurring exponential risk as the overall enterprise grows.
2. Growth Model – In truth, there are many growth models that Ucore could pursue, and certainly the centralized model that you set out is one worthy of consideration. My point in setting out the Spin Out model is that this scenario allows for rapid growth while insulating shareholders in the central company from undue growth risk. It also readily illustrates how shareholders in a mother ship can gain upside exposure for each spoke generated from the central hub, while mitigating risk.
As I’ve said above, we’ll likely expand on the foregoing through media Q&A’s. And while we welcome investor inquiries as to our growth possibilities, responding to individual email requests can be inefficient, if not onerous. For now, I can offer some broad commentary on the type of growth strategies available to us. Without writing a thesis on the various scenarios available to us, there are some basic growth models that are often contemplated in a Hub & Spoke structure. These are set out below, along with their relative merits and demerits.
Each of the below scenarios offers shareholders exposure to the upside share valuation of the subordinate ventures. In turn, while we have used the Spin Out model for prior illustrations, Ucore may draw upon a combination of each of these methods over time, based on our continued commitment to maximize shareholder value, while offsetting risk. For example, as you will see, the argument for centralized control applies more readily to core competencies (metals in which either IBC or Ucore has extensive marketing experience). Conversely, the argument for utilizing JV’s and Spin Outs gain additional traction as we attack metals that are farther afield from our historical experience.
i)
Centralized Model – This is the “Dow Chemical” approach that you’ve touched on in your questions. In this scenario, the mother ship owns all appendages outright (whether as operating divisions or wholly owned subsidiaries). The advantage is the maximization of size, buying power and influence, since all revenues are accrued to the mother ship; market cap is maximized; and economies of scale/borrowing power/etc. are similarly optimized. However, the risk of rapid growth is very real, as a central authority would be ranked on the cumulative risk of all subordinate ventures.
ii)
Joint Venture Model – This is a common scenario within the petroleum sector. The mother ship (in our case, the purveyor of the technology) will often take a direct equity stake in the subordinate company. In this case, as in the Centralized Model above, the central company benefits from direct ownership in the subordinate enterprise, and any increase in market cap accrues to the shareholder through their ownership on mother ship shares. The advantage here is that the growth risk is shared with other parties (the JV partners) and the market cap of the mother ship will typically reflect that percentage of the subordinate company that it retains. The down side is that the mother ship will not capture all of the market value associated with the success of the JV (a trade-off, given in exchange for the mitigation of risk).
iii)
Spin Out Model – This is the scenario originally contemplated in the discussion of dilution above. In this growth design, the mother ship propagates its technology by granting shares in the subordinate companies (in proportion to the percentage of ownership already held by existing shareholders). We’ve already discussed the relative benefits of this method, which include a fairly even balance between significant ownership in each subordinate company and the related risk.
XXXXX, thank you for your inquiry. Obviously, we have a wide horizon of opportunity ahead of us. And while I can assure you that we have not committed to any particular direction, we remain committed to shareholder dialogue and feed-back as to our thought process, and the relative merits of each growth scenario. Whatever tack we take, I can equally assure you that precedent (the prior experience of others who have successfully grown technology platforms) will play a major role in our considerations. Companies that have successfully propagated IP licensing platforms, such as Hitachi, DuPont, BASF, and others, are instructive in this regard, and we have a broad spectrum of inspiration from which to draw.
Sincerely,
Jim McKenzie
President & CEO
Ucore Rare Metals Inc.
TSX.V:UCU OTCQX:UURAF--