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Jan 2005 - Red Flag Warnings

Ignore Red Flag Warnings at your Peril !

This column has been based on observations that I have made in more than 20 years’ in the stockbroking industry and remain amazed that they still occur especially by mining companies raising additional capital. The following comments are my observations, other reasons could be given for what has transpired or appeared to have transpired.

Given the rebirth of the mining industry and a number of new mines being commissioned or old mines recommissioned, there are possibly 5 types of Red Flag Warnings that companies should be aware of when dealing with stockbrokers.

Red Flag Warning Type 1 is where a company is approached by a broker with “significant” demand for the company’s stock such that even if the company is considering an issue it is encouraged to issue more than it was intending to – the red flag warning is that demand for the stock is completely filled resulting in a vacuum. Agincourt (AGC) has experienced this twice, initially with its first placement in March 2004 when it raised about A$8m at A$1.65 per share (compared to its original intention of raising about A$5m to $6m), such that the share price initially dropped and then later recovered.

However, it is the most recent placement by Agincourt at A$2.00 which appears to have resulted in it falling to its current share price of about A$1.65 apparently due to violating Red Flag Warning Types 1 and 2. Agincourt (AGC)’s placement/raising of 8m shares at A$2.00 per share on 1 December 2004 occurred after it closed on the 30 November at AS$2.09 per share, raising A$16m (mainly from institutional investors) amidst rumours of significant demand (hence AGC apparently raised more than they originally planned – Red Flag Warning Type 1 ).

In addition, the new issue was executed wholly by Broker A who had not previously been one of the original broking supporters (Brokers B, C etc) of the stock (through raisings / placements) – namely Red Flag Warning Type 2. Since the raising, AGC has steadily tumbled to A$1.67 per share, as there was steady general selling largely from Brokers B and C with little buying from Broker A as demand had apparently been completely filled

(Note : AGC’s share price should be able to recover since as far as we know, the fundamentals have not changed, and the company’s future probably depends on installing an additional mill to treat its Williamson ore).

By comparison Bluestone Tin (BTX) raised additional funds and essentially stuck to their plans such that the “significant” demand was cut back with the net result that the share price initially rose after the placement by almost 30% from 69c to 89c on 12 November 2004 (30m shares were raised at 62c), and BTX is currently trading (17 January 2005) at about 87c per share.

Red Flag Warning Type 2 is where a company accepts the demand offer from a new broker (Broker A) but does not consider the original broker(s) B, C etc that supported the company when it was a more junior player. The company should offer part of the raising to the original supporting brokers. Should those brokers (B, C etc) say “no” then at least they have been invited to participate, whereas leaving them out can (and often appears to) result in them selling the stock.

Agincourt is not the only example. Hill End (HEG) also appeared to execute both Red Flag Warning Types 1 and 2 with their first placement and SPP at 22c in February 2004. HEG had a very difficult IPO which only succeeded after about 4 or 5 attempts. Consequently it was with some surprise that the first placement by HEG’s Broker A was apparently made without any consulting of HEG’s original supporting brokers B and C. HEG is now trading at about 10.5c.

There are other examples of Types 1 and 2 with minor variations.

Red Flag Warning Type 3 relates to a company buying shares in another company and then selling them through two different brokers at the same time. I have seen this occur both in South Africa and in Australia. The rationale is usually along the lines of looking after shareholders’ interests, in that the initial order is given to one broker, and either another broker gets wind of the deal and offers to do it at a cheaper rate or another broker is approached to try and do it at a cheaper rate.

The net result from both times was that the deals were done through the second brokers and no one in each market ever trusted the company’s again.

Red Flag Warning Type 4 relates to a broker having an idea and doing all the ground work and thinking that they are going to do the deal (eg say merger / acquisition) and then hear the same deal announced by another broker. It does appear to happen, based on what I have seen it a few times, and results in reduced coverage of particular companies.

Red Flag Warning Type 5 tends to occur when the usually new industry participants have become larger. It relates to a company’s attitude to analysts that write either a SELL or REDUCE recommendation on their company. There are two choices for the company : either remove the analyst from all contact with the company, or try and convince the analyst that they are wrong. A few years ago, Newcrest took the latter approach of trying to convince analysts that they were wrong – and look at Newcrest now.

Brokers are analogous in some ways to elephants in that they never forget – dud them and you tarnish your reputation for ever, keep loyal to them and you should receive their continued support.

Disclosure and Disclaimer : This article has been written by Keith Goode, the Managing Director of Eagle Research Advisory Pty Ltd, (an independent research company) who is an Authorised Representative with Taylor Collison Ltd, and with his associates, holds interests in the stocks mentioned in this article. The opinions expressed in this article should not be taken as investment advice, but are based on observations by the author. The author does not warrant the accuracy or completeness of any information and is not liable for any loss or damage suffered through any reliance on its contents.

  • Written by: Keith Goode
  • Saturday, 01 January 2005

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