Bear market mauls venture exchange

Failing juniors causing TSX-V to collapse on itself, investors say
The TSX Venture Exchange is in danger of being dragged down by the widespread failure of smaller mining exploration companies, say analysts | blackdogvfx/Shutterstock

When a stock market crashes, public companies go bankrupt and disappear almost overnight.

But what happens when the crash happens in slow motion in the form of a bear market that lasts years, and public companies that should have gone bust are kept on artificial life support?

That’s what appears to have happened to the TSX Venture Exchange (TSX-V) since 2011, according to a number of resource-sector retail investors and equities researchers, and it’s largely a Vancouver problem.

It’s a Vancouver problem because half of the companies listed on the TSX Venture Exchange are based in B.C.

Since 2011, the S&P/TSX-V composite index has declined 70%; since 2007, it has declined 77%.

That decline is largely attributable to a flight of investment from mining stocks and – more recently – the oil and gas sector. And it’s not just because of lower commodity prices.

Junior mining companies make up about 57% of the TSX-V, and most of those companies – about 736 – are based in B.C. According to a growing chorus of retail investors, between 400 and 700 of the junior miners on the TSX Venture Exchange are “walking dead” that should not continue to be listed. At the very least, they say, many should be moved down to the NEX – the lowest tier of the exchange, where companies can go into hibernation.

Many small-cap exploration companies in the U.S. and Australia have been delisted or otherwise folded in recent years, but that hasn’t happened in Canada.

However, that’s not necessarily a good thing, according to Christopher Ecclestone, mining strategist at Hallgarten & Company, a resource-sector equities research firm based in the U.K.

He recently likened the TSX-V to a black hole, in which the gravitational pull of so much dead weight is causing the exchange to collapse on itself.

If the marginal companies on the TSX Venture did start folding, Vancouver would be hit hardest.

Because junior mining is such a high-risk investment niche, the Canadian business community may not have paid much attention to what has been happening to the venture exchange.

But they should be paying attention, at least in Vancouver, according to Ivan Lo of Equedia Investment Research.

“It’s a much bigger problem than most people believe it to be,” he said, “because … you have that trickle-down effect to the whole economy.”

Should hundreds of juniors go bust, Lo estimated the impact for commercial office space in Vancouver alone would be a loss of $1.89 million in revenue per month – $22.68 million per year. He estimated that 2,100 employees would lose their jobs if 700 juniors went bust – a loss of $60 million.

That’s not counting the impact it would have on law firms, accountants, brokers and other professional services.

“That’s just not going to happen,” said TSX-V president John McCoach. “You’re not going to have 1,000 companies disappear overnight.”

The exchange is not contemplating a mass delisting.

That might be good news for shareholders, who would lose their investment in a delisting, and for professional services that serve the junior sector.

But keeping those marginal companies alive by allowing them to stay listed on the Toronto Stock Exchange (TSX) and TSX-V is not helping the global mining sector because few of the marginal players are doing any real exploration activity, and investors are generally shunning all mining stock.

Mark O’Dea, founder of Oxygen Capital, which owns three junior exploration and development companies, pointed out that of 2,100 publicly listed junior miners in Canada, only eight are fully funded and building new mines.

“We’re at an all-time low of the value of the TSX-V,” O’Dea said. “It’s one of the deepest, longest bear markets on the TSX in the last 45 years.”

Lower commodity prices are only partly to blame. More importantly, investors have simply lost confidence in the sector.

Anyone counting on a rally being just around the corner needs to consider other factors, including a generational shift. Unlike their baby boomer parents, millennials seem to be investing in everything but resources, Lo said.

Tony Simon, co-founder of the Venture Capital Markets Association, has calculated that nearly 600 resource companies on the TSX and TSX-V have a combined negative working capital of $2 billion. He doesn’t understand how they can be meeting their continued listing requirements.

McCoach said the exchange has looked at the companies on Simon’s list to see if they’re meeting their listing requirements.

“We definitely did go in and look closely at these companies,” he said. “We are continuing to apply our policy. We are continuing to apply it consistently. Where a company fails to meet our continued listing standards, we are following through on that by giving them notice.”

Since 2011, 140 mining companies have been bumped from the TSX or TSX-V to the NEX, but 64 moved back up.

Since March, only 10 of the companies on Simon’s list have received delisting notices. Three have since been delisted, and one has moved down to the NEX.

As for the S&P/TSX-V composite index’s 70% decline, McCoach said it’s only part of the equation.

As he pointed out, the venture exchange was designed to help emerging companies grow and move on to the big board – the TSX, which, at $2.2 trillion, is the world’s eighth-largest stock exchange.

Since 2010, 157 TSX-V companies graduated to the TSX, 79 of them mining companies.

But Simon said there’s another missing equation in that 70% figure: it includes only the top-performing companies.

“None of these zombies qualify to be even included in the calculation,” he said. 

“It’s way worse than anybody thinks.”

Alternative to TSX launched

A confidence crisis that has caused an investor exodus from resource-sector stocks isn’t the only problem with Canada’s securities market.

According to Jos Schmitt, who recently launched a new Canadian exchange called the Aequitas NEO Exchange (NEO), says Canadian exchanges are overpopulated with companies that should never have been allowed to go public.

The investment dealer community is shrinking, and predatory high-frequency trading is shaking investor confidence, said Schmitt, the former CEO of the Alpha exchange, which is now part of the TMX Group Ltd. (TSX:X). “Put all that together, and you’ve got the ingredients for what will lead to some serious challenges in the entire capital formation process in Canada,” Schmitt told Business in Vancouver days before the NEO planned to launch its new listings platform.

Schmitt said the new Toronto-based exchange – whose backers include RBC Dominion Securities, BCE Inc. (TSX:BCE) and Barclays PLC – has higher standards, but lower costs. It will also use technological “speed bumps” to slightly delay trades to prevent predatory high-frequency trading.

One of the problems with the Canadian public markets is that they are overcrowded, Schmitt said. He pointed to the U.S., which, with a population of about 320 million, has 8,000 publicly traded companies. Canada, with a population of 35 million, has more than 4,500.

“Does that make sense?”

He said approximately 40,000 securities are traded in Canada, but the trading is highly concentrated.

“All the activity, all the trading, is taking place in about 250. Everyone else lacks liquidity.”

Schmitt said it’s too easy for Canadian companies to go public and start trading on Canadian exchanges. He thinks the Toronto Stock Exchange (TSX) and TSX Venture Exchange (TSX-V) have set the bar too low.

Schmitt said the NEO exchange will have stricter listing requirements. “When you look at companies, there need to be some standards. Either they need to have meaningful assets, either they need to make money or they need to have a meaningful capitalization.”

But how does a startup or a junior attain meaningful capitalization if it can’t get a public listing?

Schmitt said the NEO will help companies raise private equity through a special private securities market that will match higher-risk ventures with investors who have a high risk tolerance.

Few question the TSX and TSX-V’s importance in turning Canada, and B.C. in particular, into a global mining hub. But Schmitt and others question the current venture model.

“That model may have worked 10 years ago, 20 years ago, but I think that model is at the end of its life cycle.”

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