Debenture and Hedging IssuesDebentures and Hedging
When EXN sold the debentures, it secured the price for its future silver production at US$5.5/oz (a discount of course to the average price in the US$7 range in 2004), and got the full amount of cash it needed in exchange for delivering 1.8 million oz of silver in June 2007.
After POS took off in the 3rd qtr of 2005 and into the teens, the widening gap between the debenture price and price one can fetch from the silver spot market became reason to fret about as management mistake, bad decision .....
It is obvious the benefits to the debenture holders are limited to only 1.8 million oz while shareholders have exposure to all future production that could be in the order of a thousand times or more. If you bought shares at that time at C$0.2, you now have a gain of 275%; on the other hand, the debenture holders have 124% (Ag @ US$12.3). Why are shareholders whining? If the funds were financed with equity issues, we would have something like 60 million more shares floating around today. Think about that.
Regarding the issue of Hedging:
For a silver producer, the risk is in the downward moves of POS - the legitimate hedge is to sell forward.
For a silver user, the risk is in the upward moves of POS - the legitimate hedge is to buy futures contracts.
Selling the debentures has similar protective benefit as selling futures contracts (i.e. to remove or counter the risk of silver price drops). To ask management to hedge, as some have suggested, against POS going up means they are going to hedge against the upside and the down side, hold long and short positions, or buy and sell futures contracts at the same time. It sounds funny and probably messy doesn't it?
As I see it, there is no risk to EXN when POS goes up and therefore no reason to hedge unless there is reason to believe that it will be unable to produce and deliver that amount of silver in the time frame up to maturity. When it drew up the debenture scheme, the possibility of foregoing some future profits was part of the equation in managing risks and benefits.
I find it hard to fault their judgment in the debenture arrangement and no reason to worry about the paper loses arising from the appreciation of POS. The higher the loses, the more fortune EXN has - it’s a blessing in disguise. The looses were incurred because the full amount of silver had not been delivered yet to the trust - this is again a balancing act of management between the amount of cash it deems desirable to have on hand and scheduling the fulfillment of the debenture obligation. When the time comes, they will disappear like magic.
In examining past events, it is good to remember:
1) Future courses were not charted with hindsight vision.
2) Nothing could have been a sure thing.
3) Everything was a give and take.
May we all be blessed with higher silver prices!
KT