Mineral Royalty Stream Financing


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Mineral Royalty Stream Financing

  1. 1.           MINERAL  ROYALTY  STREAM  FINANCING                 Aaron  Careaga   Research  Analyst         http://www.wealthmarkllc.com/research         WEALTHMARK  LLC.     1329  North  State  Street,  Suite  206   Bellingham,  WA  98225   September  2012        
  2. 2. ABSTRACT     Resource  streaming,  also  known  as  volumetric  production  payments  (VPP)  or  metal  purchase   agreements,  provides  commodity  exploration  and  production  companies  the  necessary  financing   to  bring  projects  into  production.  This  has  become  an  attractive  financing  option  due  to  the  fact   that  VPP's  are  cheaper  than  equity  (no  shareholder  dilution)  and  safer  than  debt,  making  this  a   "win-­‐win"  for  both  the  mine  operator  and  financing  company.  Streaming  agreements  allow  the   mining  company  to  capitalize  on  proven  reserves  before  the  operation  becomes  productive.     These  diverse  agreements  are  crafted  to  emphasize  each  party's  strengths  and  protect  against  the   others  weaknesses.  The  underwriting  financier  enjoys  the  resource  upside  while  avoiding  the   downside  risk  associated  from  operations.  Stream  financing  allows  the  mine  operator  to  leverage   proven  reserves  to  fund  production  or  expansion,  while  avoiding  many  negative  side  effects   associated  with  traditional  financing  methods.       Aaron  Careaga   WealthMark  LLC.     1329  North  State  Street,  Suite  206   Bellingham,  WA  98225   aaron@wealthmarkllc.com           2  
  3. 3.   1. Introduction     The  principal  objective  of  a  mine  streaming  finance  firm  is  to  maximize  shareholder  value.   This  is  done  by  selectively  investing  in  the  best  projects  that  will  provide  the  highest   return,  both  in  the  short  and  long-­‐term.  The  financing  company  needs  the  mine  to  become   productive  within  a  reasonable  amount  of  time  after  the  initial  investment,  otherwise  they   could  over-­‐allocate  capital  into  projects  that  might  never  succeed.  Beyond  the  initial  cash   outlay,  it  is  becoming  more  and  more  important  that  the  financing  company  actively   manage  their  mineral  interests,  as  the  mining  environment  and  commodity  market  can   greatly  fluctuate  over  a  short  period  of  time.  Active  portfolio  oversight  will  be  a  vital   element  of  the  underwriting  company's  success.     Opportunities  within  this  space  are  rapidly  expanding,  encouraging  more  traditional   finance  firms  to  start  resource  streaming  departments,  or  spin  off  entire  units  that  offer   services  targeted  at  mineral  streams.  The  evolution  of  this  specific  type  of  financing  in  the   resource  industry  is  expected  to  grow  significantly  in  the  coming  years,  likely  outpacing  the   commodity  demand  rate  of  growth.     Investors  in  the  underwriting  financier  will  benefit  from  exploration  upside,  dividend  yield,   and  the  ability  to  leverage  commodity  prices.  These  types  of  agreements  will  become  more   important  to  commodity  investors  because,  as  the  market  becomes  more  efficient,   investors  will  seek  higher  returns  on  less-­‐risky  assets.  Streaming  agreements  carry  the   potential  to  significantly  lower  the  risk  found  in  commodity  producing  investments.  The   inefficiencies  of  traditional  mine  financing  and  prevailing  disconnect  between  capital   sources  and  operations  have  led  to  many  projects  being  abandoned.  This  places  both   parties  in  an  advantageous  position,  as  the  auspicious  terms  in  mineral  resource  streaming   agreements  far  outshine  traditional  financing  options.     Existing  shareholders  and  new  investors  of  the  mining  operation  will  benefit  from  this  type   of  financing  due  to  lower  exposure  to  capital,  operating,  and  environmental  costs.  Holding   the  ability  to  finance  operations  on  a  project-­‐by-­‐project  basis  allows  the  firm  to  smooth  the   waves  of  volatility  associated  with  this  type  of  operation  and  financing  agreement.  This   puts  the  mining  company,  and  its  investors,  in  a  better  position  to  outride  industry   downturns.     As  the  economic  and  political  significance  of  commodities  continues  to  increase,  so  will  the   need  of  these  producers  to  receive  the  financing  necessary  to  bring  products  to  market.   Royalty  payment  streams  offer  an  innovative  and  relatively  lower  risk  vehicle  for  investors   to  utilize  by  matching  the  capital  supply  with  industry  demand;  capturing  commodity   spreads  and  market  fluctuations  without  the  risk  of  directly  operating  the  mine.           3  
  4. 4. 2. Overview     The  concept  of  royalty  payments  on  non-­‐renewable  resources  has  been  a  common   financing  tool  in  the  Oil  &  Gas  industry  for  many  years.  The  ability  to  monetize  reserves   while  they  are  still  in  the  ground  has  proven  to  be  very  rewarding  to  both  sides  of  the   transaction,  which  ultimately  inspired  the  application  of  royalty  payments  and  streaming   to  the  mining  industry.       HISTORY:     Early  pioneers  to  apply  the  royalty  payment  methodology  in  the  mining  industry  are   Seymour  Schulich  and  Pierre  Lassonde,  godfathers  in  the  resource  mining  space.  Schulich   and  Lassonde  met  at  the  Vancouver  based  firm  Buetel,  Goodman,  and  Co.  and  joined  forces,   later  starting  the  Franco-­‐Nevada  Mining  Corporation  in  1982.  The  firm  was  established   with  the  intention  of  exploring  and  producing  gold  throughout  Nevada  but,  after  a  couple   mediocre  attempts,  Schulich  and  Lassonde  transitioned  Franco-­‐Nevada  into  the  world's   first  gold  royalty  company.     Franco-­‐Nevada  applied  Schulich's  knowledge  of  the  royalty  space,  acquiring  their  first   royalty  stream  in  1986  for  a  cost  of  $2  million  dollars,  giving  the  company  a  4%  annual,  and   a  5%  net  profit  interest,  royalty  on  that  streams  production.    Lassonde  told  a  reporter  that,   "To  our  surprise,  we  couldn't  identify  a  single  company  in  the  business  capitalizing  on   hard-­‐rock  royalties.  That  was  our  cue.  That  was  the  real  start  of  Franco-­‐Nevada"  (Northern   Miner).  As  of  2002,  this  stream  alone  was  generating  $30  million  annually.  Throughout  this   same  period,  Franco-­‐Nevada  grew  from  an  initial  market  cap  of  $2.3  million  to  $3  billion,   prior  to  merging.     The  majority  of  resources  in  countries  across  the  globe  are  owned  and  controlled  by  the   government,  limiting  the  opportunity  for  future  growth  in  both  the  mining  and  mineral   resource  streaming  industry.  The  paradox  of  plenty,  also  known  as  the  oil  curse,  is  another   factor  considered  to  be  a  burden  on  countries  with  poorly  managed  governments  who   exploit  the  value  from  natural  resource  reserves  to  often  further  their  own  political   interests  (Economist).  The  resulting  discriminatory  regimes  create  an  operating   environment  that  is  not  cost-­‐effective  to  enter.  The  political  instability  and  corruption  that   is  often  associated  with  such  countries  significantly  increases  the  overall  risk  and  costs   related  to  mining.       BENEFITS:     Industry  participant,  the  Gold  Royal  Corp,  cites  five  major  benefits  from  stream  financing   that  improve  the  operations  for  both  parties  involved  (Kalt).  First,  the  ability  for  both  firms   to  mutually  share  the  risk  creates  an  agreement  that  would  normally  not  provide  as  much   of  a  diversification  opportunity.  By  spreading  risk  across  multiple  levels,  and  between  two   independent  firms,  will  allow  both  parties  to  attain  terms  that  might  not  otherwise  be   possible.     Second,  less  shareholder  dilution  allows  the  mine  operator  to  maintain  its  level  of   ownership  without  diluting  current  shareholders  value.  This  is  probably  the  greatest         4  
  5. 5. benefit  gained  from  the  mine  operator's  perspective  because  it  allows  the  mine  operator  to   maintain  ownership  rights.  Whether  through  a  privately  held  or  publicly  traded  company,   conserving  ownership  rights  allows  the  firm  to  operate  more  flexibly  and  creates  more   opportunity  for  future  growth  and  acquisitions.     Third,  royalty  streaming  allows  the  operating  company  to  finance  projects  on  a  location-­‐by-­‐ location  basis.  This  allows  the  firm  to  continue  exploring  and  producing  additional  streams   and  mine  multiple  commodities.  The  ability,  as  a  mine  operator,  to  explore  and  produce   additional  resources  can  minimize  risk  associated  with  the  long-­‐term  viability  of  a  less   diversified  portfolio.       Fourth,  mine  royalty  streaming  holds  accretive  value.  As  the  mine  grows  into  a  productive   state,  the  operator  receives  more  efficiently  priced  capital  and  the  ability  to  produce  sooner   than  otherwise  might  be  possible.  This  benefits  the  underwriting  financier  because  the   sooner  the  mine  produces  resources,  the  quicker  investors  will  receive  a  return.     TYPES  OF  AGREEMENTS:     There  are  currently  three  main  types  of  royalty  stream  financing  agreements,  which  are   either  based  upon  the  production  amount,  resource  market  value,  or  the  operations  net   profit.  Net  smelter  return  (NSR)  agreements,  or  royalty  streams  based  on  the  amount   produced,  appeal  to  mineral  rights  owners  because  they  are  able  to  capture  changes  in   production  as  the  stream  generates  additional  resources.         The  second  form  of  agreement  is  a  royalty  stream  based  on  the  value  of  production.  These   contracts  are  highly  correlated  to  market  fluctuations  as  the  value  of  production  changes   with  commodity  price  fluctuations.  The  third  type  of  agreement  is  a  net  profit  interest   (NPI)  and  is  a  contract  based  upon  profit.  NPI’s  are  the  most  popular  type  of  stream   financing  agreements  and  appeal  to  many  investors  because  it  allows  them  to  leverage   changes  in  commodity  prices  while  limiting  the  mines  financial  and  economic  exposure.   These  are  also  considered  to  be  the  most  profitable  and  highest  risk  contracts  in  the   resource  streaming  space  (Callinan).         Depending  on  the  current  phase  of  the  production,  royalties  are  categorized  as  key   producing  assets,  advanced  stage  assets,  or  exploration  assets.  The  intention  behind   structuring  operations  in  this  way  is  that  management  at  both  the  operating  mine  and   investing  firm  can  easily  track  the  highest  and  best  use  of  funds.  As  projects  develop  into   retirement,  management  is  able  to  efficiently  track  and  refocus  attention  on  the  most   profitable  projects.     WHY  SELL  A  ROYALTY  STREAM?     Mines  often  sell  royalty  streams  to  fund  production  or  expansion  by  capitalizing  on  proven   resources,  providing  a  significant  return  to  shareholders.    As  a  mine  grows,  so  does  the   operator’s  need  to  minimize  risk.  This  type  of  financing  allows  operations  to  expand  while   diversifying  the  financing  risk  derived  from  traditional  methods,  freeing  up  the  mine's   capital  reserves  for  future  investment  prospects  that  might  offer  a  higher  return.           5  
  6. 6. Managers  need  to  be  vigilantly  aware  of  the  use  of  capital  generated  from  stream  financing,   as  industry  participants  warn  that  investing  this  cash  flow  in  non-­‐core  activities,  like   general  and  administrative  costs,  greatly  lowers  future  return  (Kalt,  2).  Rather,  it  is  a  better   use  of  funds  to  invest  in  future  prospects  that  can  add  greater  value  and  generate  future   revenue.  Operating  managers  should  classify  royalty  streams  by  their  current  state  of   production  and  seek  resource  stream  financing  for  prospective  projects  to  free-­‐up  capital   and  provide  the  firm  with  consistent  growth  opportunities.         OPTIMAL  AGREEMENT:     The  optimal  stream-­‐underwriting  model  extends  traditional  financing  by  including   methods  learned  from  the  Oil  and  Gas  industry  to  expand  possible  investment   opportunities.  The  process  is  initiated  with  an  underwriting  financier  being  approached  (or   reverse  contact)  by  a  mining  exploration  and  production  company  seeking  capital.  The   mine  operator,  if  inclined  to  the  terms,  agrees  to  the  stream  agreement  and  uses  the  capital   to  fund  operations  on  the  basis  of  future  production.     Stream  financing  companies  must  maintain  a  vigilant  awareness  of  the  mine’s  rapidly   changing  operating  environment  and  adequately  research  management’s  background  to   achieve  premium  returns  on  prospective  stream  investments.    If  correctly  arranged,  the   streaming  agreement  should  allow  the  financier  to  purchase  the  commodity  at,  or  beneath,   the  lowest  cost  producer  in  the  market.  This  allows  the  investing  firm,  and  its  shareholders,   to  profit  from  the  spread  between  the  spot  and  forward  rate.         VALUATION:     As  with  many  commodity  related  assets,  it  is  increasingly  difficult  to  value  corresponding   financial  vehicles  as  the  market  environment  rapidly  fluctuates.  The  value  assigned  to   royalty  streaming  agreements  is  derived  from  the  mine's  total  production,  contract  royalty   rate,  and  remaining  life  of  the  mine.  Due  to  many  subjective  challenges  arising  from  the   valuation  of  individual  royalty  streaming  firms  operating  in  this  space,  I  will  discuss  the   basic  process  and  potential  risks  that  investors  might  face.       The  unique  opportunity  created  by  using  royalty  stream  financing  provides  investors  with   the  rare  chance  to  achieve  commodity  and  mining  exposure  while  remaining  significantly   more  insulated  (relative  to  traditional  vehicles)  against  direct  industry  volatility.    But,  the   nature  of  the  business  creates  many  challenges  when  comparing  financial  metrics  of   royalty  streaming  firms  with  other  mine  companies.       To  value  an  individual  firm,  or  even  a  specific  royalty  stream,  investors  typically  use  a  net   present  value  calculation,  or  by  discounting  all  future  cash  flows  back  to  the  present.   Critical  assumptions  must  be  made  as  to  the  proper  discount  rate,  time  period,  and  overall   likelihood  of  achieving  forecasted  revenues.  Many  assumptions,  based  on  everything  from   commodity  prices  to  the  cost  of  capital,  used  in  net  present  value  calculation  quickly   change  with  market  conditions.       If  the  prospective  royalty-­‐streaming  firm  is  publicly  traded,  investors  can  alternatively   utilize  its  market  determined  share  price  as  a  more  dynamic  valuation  method.  Stock         6  
  7. 7. markets  are  not  free  from  abnormalities  that  might  negatively  influence  price  performance   but  the  incomparable  dissemination  of  information  results  in  a  more  accurate  valuation.         Most  traditional  valuation  methods  fail  to  capture  the  true  value  of  royalty  streaming  firms.   Because  the  nature  of  industry  strategy,  streaming  companies  not  directly  operating   underlying  mine  projects,  investors  must  be  aware  that  financial  metrics  of  royalty  firms   will  often  show  wide  variations  depending  on  the  stage  of  production.  Investors  must  take   into  account  the  company’s  opportunity  for  future  prospects  and  a  slow  rate  of  initial   company  growth  as  quality  streams  are  acquired.  To  capture  the  highest  return,  investors   must  take  into  account  not  only  future  prospects  but  also  management’s  ability  to  navigate   potential  challenges.       Agreement  terms  are  often  unique  to  specific  projects,  increasing  the  total  number  of   potential  options  available  for  financiers  to  extract  greater  value  from  market  fluctuations.   Options  to  change  the  royalty  rate,  or  expand  production,  create  a  wide  array  of  potential   investment  catalyst  and  significantly  increase  the  challenge  of  valuing  specific  streams,  let   alone  entire  firm  portfolios.       Source:  Google  Finance  8/29/12       Using  current  market  data  as  the  main  metric  for  comparison,  Silver  Wheaton  is  the  largest   primary  operating  firm  in  the  royalty  streaming  space  with  a  market  cap  of  $12.24  billion   as  of  August  29,  2012.  The  smallest  primary  competitor  is  Gold  Royalties  Corp,  with  a   market  cap  of  $15.35  million  as  of  August  29,  2012.  As  witnessed  from  rapid  growth  in  the   number  of  industry  participants,  the  application  of  royalty  streaming  as  a  financing  tool  in   the  mining  industry  has  significantly  evolved  since  Schulich  and  Lassonde’s  initial  use.         7  
  8. 8. 3. Current  Environment     The  current  market  environment  has  revealed  a  substantial  challenge  in  the  mining  and   commodities  industry,  which  is  an  inability  to  efficiently  raise  capital.  Exploration  and   production  (E&P)  companies  are  restricted  from  traditional  financing  avenues  because  of   inadequate  cash  flow  and  the  high  degree  of  risk  associated  with  commodity  ventures.     The  possible  solution  to  this  problem  lies  with  royalty  stream  financing  companies.  These   firms  provide  the  options  necessary  to  bring  mining  and  precious  metal  projects  to  a  profitable   state  by  financing  low  cost  operations  and  highly  skilled  management  teams.  In  compensation,   the  streaming  company  typically  receives  a  guaranteed  principal  repayment  and  a  royalty  to   purchase  the  future  production  stream  of  the  mine  at  a  predetermined  price,  creating   significant  financial  upside  with  minimal  operating  risk  to  investors.     Mine  royalty  streaming  is  the  direct  result  of  Schulich  and  Lassonde’s  efforts  pioneering  the   space  and  creating  Franco-­‐Nevada  in  the  mid  1980’s.  They  overcame  initial  setbacks,  changed   strategic  direction,  and  then  heavily  reinvested  back  into  the  firm.  The  stream-­‐financing  model   allowed  Franco-­‐Nevada  to  rapidly  expand  through  use  of  its  consistent  stream  of  free  cash   flow,  a  benefit  that  is  difficult  to  achieve  with  traditional  financing.       In  April  of  2002,  Franco-­‐Nevada  went  on  to  sell  it’s  only  mine  (Midas,  aka  Goldstrike)  to   Normandy  Mining,  in  exchange  for  a  5%  lifetime  royalty  and  20%  of  Normandy's  shares.  After   continuing  to  acquire  additional  streams,  Schulich  and  Lassonde  instigated  a  bidding  war   between  Newmont  Mining  and  AngloGold.  Newmont  won  the  battle  and  ultimately  bought   Normandy,  in  addition  to  merging  with  Franco-­‐Nevada,  creating  the  world's  largest  gold   producer.     Newmont  held  the  original  Franco-­‐Nevada  Mining  Corporation  portfolio  until  it  spun  off  in   2006,  resulting  in  an  even  larger,  gold  focused,  royalty  and  streaming  company  under  the  title   of  the  Franco-­‐Nevada  Corporation.  The  2007  initial  public  offering  of  the  new  Franco-­‐Nevada   raised  $1.1  billion;  the  largest  mine  offering  and  second  largest  Canadian  IPO  of  the  decade.   Over  this  short  time  span,  the  industry  has  rapidly  grown  into  the  environment  we  have  today.         Operating  in  the  mineral  resource  industry  poses  significant  risks  due  to  the  nature  of  the   business,  but  Franco-­‐Nevada  COO  Geoff  Waterman  attributes  much  of  the  models  success  to   the  margin  of  safety  that  royalties  provide.  He  explains  that,  “as  commodity  prices  move  down,   you  get  very  little  change  in  your  royalty  streams…  the  margins  we  have  in  our  business  are   about  85  percent,  which  is  double  the  amount  that  a  typical  business  would  have”  (Canadian   Business  Journal).  With  global  market  volatility  remaining  elevated  and  no  immediate  solution   to  numerous  population  growth  related  issues,  demand  for  commodities  is  likely  to  continue   its  exponential  growth.       EMERGING  MARKETS:   Countries  that  are  considered  to  be  emerging  markets,  or  the  next  “up-­‐and-­‐coming”  economic   leaders,  hold  a  dominant  role  influencing  the  current  market  environment.  Investments  in   nations  such  as  the  BRICs  (Brazil,  Russia,  India,  and  China)  should  be  considered  as  an  integral   element  of  portfolio  strategies.  Although  the  majority  lack  the  necessary  government         8  
  9. 9. regulation  and  infrastructure  to  support  current  demographics,  economic  prosperity  derived   from  these  nations  is  already  noticed  as  a  major  influence  in  the  global  economy.       Capital  markets  greatly  affect  the  future  growth  of  countries  that  lack  the  proper  government   structure  to  otherwise  fund.  Developing  countries  need  the  proper  infrastructure  to  support   local  populations  and  future  investment,  without  which,  the  economic  climate  will  otherwise   remain  extremely  unstable.  Because  resource  location  plays  a  dominant  role  throughout  the   acquisition  and  production  phases  of  royalty  streaming,  maintaining  an  awareness  of  the   current  operating  atmosphere  is  highly  advisable.  As  a  leading  source  of  research  on  emerging   markets,  Goldman  Sachs  notes:     “The  vast  majority  of  financing  continues  to  come  from  public  sources,  with  the  private  sector   bearing  only  20-­25%  of  the  cost.  But  as  public  finances  are  more  strained  since  the  crisis,  the   BRICs  will  have  to  rely  more  heavily  on  private  infrastructure  funding.  To  access  this,  the   BRICs  have  to  continue  to  improve  the  business  environment  and  expand  financial   intermediation  in  local  markets”  (Burgi,  Carlson,  Wilson).     Prospective  investors  to  royalty  streaming  companies  should  be  aware  of  the  current   environment  and  underlying  risks  associated  with  local  financial  market  intermediation.  The   charts  below  display  both  the  number  of  infrastructure  projects  and  private  investments  as  a   percent  of  GDP  throughout  the  BRICs.  As  a  relative  basis  of  growth  comparison,  the  number  of   infrastructure  projects  funded  through  private  parties  appears  to  continue  along  its  increasing   trend.         Source:  Burgi,  Carlson,  Wilson     South  America  is  another  region  that  plays  a  significant  role  in  influencing  future  mining   projects.  The  economies  of  these  countries  are  quickly  adapting  to  increases  in  population   growth  and,  as  a  major  driver,  even  marginal  increases  in  commodity  demand  is  expected  to   attract  increased  investment  activity  and  royalty  stream  financing  demand.  The  opportunity  to   achieve  higher  returns  on  investments  in  economically  unstable  regions  should  be  carefully   weighed  against  the  increased  risks.         Resource  location  plays  a  dominant  role  throughout  the  acquisition  and  production  phases  of   royalty  financing,  as  the  majority  of  “new”  streams  are  discovered  in  underdeveloped  areas.         9  
  10. 10.     This  greatly  increases  the  risk  associated  from  stream  underwriting  because  the  often-­‐ inconsistent  political  environment  provides  little  regulatory  protection.  As  the  demand  for   commodities  increases  with  population  growth,  transitioning  economies  will  continue  to  push   exploration  efforts  farther  into  undeveloped  markets.     RISK  FACTORS:     There  are  many  risk  factors  associated  with  royalty  streaming,  ranging  from  counterparty   default  to  government  corruption.  As  discussed  above,  the  future  of  the  business  is  determined   by  the  quality  of  streams  in  the  portfolio  and  the  firm’s  ability  to  acquire  new  interests  or   expand  current  projects.  Due  to  the  nature  of  mining,  and  evolution  of  the  royalty  financing   space,  underwriters  are  often  faced  with  limited  information  on  underlying  projects  or   companies  and  often  relinquish  day-­‐to-­‐day  managing  control  of  the  project  in  the  terms  of   agreement.  This  limited  control  increases  the  firms  portfolio  risk  because  of  natural   disconnects  of  information  between  companies,  each  operating  on  distinct  motives.  It  is  critical   for  royalty  financiers  to  actively  manage  stream  portfolios  so  the  firm  is  not  blindsided  by   potentially  foreseeable  risks.       A  primary  concern  of  most  financiers  is  counterparty  default.  Royalty  agreements  are  crafted   in  a  way  to  limit  default  risk  by  backing  the  agreement  with  the  mine’s  resources,  equipment,   or  other  assets  as  collateral.  With  collateral,  the  financing  companies  seem  protected  against   counterparty  default.  But,  as  witnessed  through  the  2008  recession,  it  is  likely  that  any   defaults  will  end  up  costing  the  streaming  company  more  than  originally  estimated.  As  an   investor,  it  is  important  to  analyze  the  firm’s  robustness  when  investing  in  royalty  financiers   so  that  unforeseen  costs  associated  with  defaults  are  not  a  threat  to  long-­‐term  viability.       Litigation  costs  are  another  major  risk  factor  threatening  royalty  financiers.  Mining  creates   many  environmental  and  socio-­‐economic  problems  that  often  face  heated  opposition,  leaving   royalty-­‐financing  firms  open  to  liability.  In  order  to  protect  against  litigation  costs,  these   companies  must  craft  agreements  in  a  way  that  release  all  operating  liability  to  the  mine   controller.       Supply  chain  threats  also  continue  to  be  a  major  risk  in  the  mining  space,  both  at  the  financing   and  operating  levels.  Major  threats  to  supply  are  risks  derived  from  location  or  nature  of  the   specific  mineral  resource  and  include,  but  are  not  limited  to,  sovereign  risk  and  resource   scarcity.  A  current  example  of  sovereign  risk  is  witnessed  through  the  Euro-­‐zone,  specifically   across  the  PIIGS:  Portugal,  Italy,  Ireland,  Greece,  and  Spain.  Although  the  concentration  of   mineral  resources  is  low  in  this  region,  the  risk  of  governments  not  following  through  with   financial  obligations  poses  a  significant  threat  with  implications  ranging  from  the  terms  of   capital  to  daily  operations.       Commodity  market  cycles  also  pose  a  threat  to  a  royalty  streaming  firm’s  profitability,  due  to   the  fluctuations  in  spread  between  the  royalty  and  spot  rates.  To  minimize  this  risk,  firms  can   form  terms  that  either  base  the  royalty  on  a  less  highly  correlated  factor  of  production  (NSR)   or  arrange  the  terms  of  the  royalty  rate  to  track  current  market  conditions.  Also,  firms  can   hedge  resource  production  to  leverage  returns  or  minimize  the  downside  risk  associated  with   negative  shocks.  A  drawback  of  hedging  commodities  is  limiting  potential  return.  These         10  
  11. 11. suggestions  should  be  considered  as  possible  improvements  to  the  royalty-­‐financing  model   and  are  discussed  in  greater  depth  in  the  perspective  section  below.       STRATEGY:     As  the  royalty  financing  industry  becomes  increasingly  competitive,  the  evolution  of  firm   strategy  and  management  principles  prove  to  be  significantly  important  to  success  going   forward.  To  return  a  profit  to  shareholders,  management  must  seek  out  and  only  invest  in  the   highest  quality  projects  attainable,  in  terms  of  both  the  operating  company  and  specific  stream   resource.  The  firm  should  then  diversify  portfolio  holdings  amongst  a  variety  of  quality  assets   to  mitigate  risk  factors  discussed  above.       There  are  four  overriding  principles  critical  to  the  implementation  of  a  successful  strategy.   Many  firms  have  suffered  losses  by  “blindly”  entering  into  terms  that,  due  to  a  specific  lack  of   expertise,  leave  the  financier  unknowingly  vulnerable.  The  first  goal  of  the  company’s  strategy   should  be  to  acquire  undervalued  projects  by  specifically  investing  in  streams  where  the  firm   and  management  can  add  value.  Doing  so  will  limit  the  potential  for  losses  derived  from  a  lack   of  expertise.  As  discussed  previously,  another  critical  element  to  a  successful  strategy  includes   diversifying  the  portfolio  of  streams  by  operating  in  a  global  scope.  Holding  a  variety  of   projects  limits  the  firm’s  potential  losses  derived  from  regional  environmental,  political,  and   economic  risks.       Another  key  element  to  a  successful  strategy  is  maintaining  a  high  level  of  liquidity.  This  allows   the  firms  to  not  only  capitalize  on  opportunities  as  they  present  themselves  but  also  to  cushion   against  unforeseen  losses.  In  addition,  a  lean  operating  structure  will  prove  beneficial  on  many   levels  of  the  company.  This  will  allow  management  to  focus  only  on  value-­‐added  activities  and   cut  waste  as  the  company  evolves.  Firms  that  follow  these  principles  in  strategy  when  entering   into  streaming  agreements  position  themselves  to  achieve  higher  returns,  minimize  downside   risk,  capitalize  on  opportunities,  and  cut  waste;  allowing  for  continuous  improvement  in   operating  efficiency.     A  challenge  faced  by  many  royalty  financiers  when  considering  prospective  investments  is   what  scale  to  use  in  valuing  the  quality  of  streams.  Inconsistencies  across  term  agreements  and   the  wide  variety  of  characteristics  unique  to  each  project  challenge  a  common  scalability  of   quality.  The  mining  industry,  specifically  royalty-­‐streaming  space,  needs  to  create  a  set  of   standards  to  rate  the  overall  investment  caliber  to  lessen  both  the  firm  and  individual  investor   subjectivity.  If  a  quality  rating  was  utilized,  similar  to  the  credit  rating  in  the  bond  market,   royalty  streaming  firms  and  individual  streams  would  be  much  more  comparable.       MANAGEMENT:     The  growth  of  royalty  financing  firms  has  created  unique  opportunities  for  its  management   and  employees.  As  competition  amongst  firms  increases,  it  is  becoming  consistently  more   important  for  participants  to  have  adequate  capital  on  hand  to  capture  high  quality  projects  as   they  present  themselves.  If  management  overextends  the  firm’s  resources  or  ability  to  manage   its  current  portfolio,  the  company  will  be  poorly  positioned  for  future  growth.             11  
  12. 12. This  is  why  a  large  majority  of  firm  resources  are  directed  towards  researching  prospective   streams  and  actively  managing  the  current  portfolio.  Franco-­‐Nevada  COO  Geoff  Waterman   conveys  that,  “We’re  always  looking  for  new  acquisitions.  One  of  the  basic  premises  in  the   royalty  model  and  in  our  business  philosophy  in  general  is  to  make  sure  that  we’re  well  funded   when  others  aren’t…  that’s  when  you  get  the  best  opportunities”  (Canadian  Business  Journal).   Successful  companies,  regardless  of  the  industry,  share  the  common  tie  of  being  prepared  and   capitalizing  on  opportunities  as  they  are  found.  Franco-­‐Nevada  continues  to  successfully   execute  this  strategy  as  a  dominant  player  in  the  royalty  streaming  space.       ACCOUNTING  STANDARDS:     The  range  of  accounting  standards  in  the  royalty  streaming  industry  varies  from  country  to   country,  creating  an  environment  where  it  is  extremely  hard  to  value  both  royalty  firms  and   individual  streams.  A  convergence  to  International  Financial  Reporting  Standards  (IFRS)  is   taking  place  but  the  timing  of  when  the  transition  will  occur  is  unlikely  in  the  short  term.  The   complex  differences  between  IFRS  and  other  standards,  like  the  Generally  Accepted   Accounting  Principals  (GAAP),  have  greatly  slowed  the  process.       In  the  United  States,  under  GAAP,  mineral  financiers  state  the  royalty  at  cost,  net  of  any   accumulated  amortization  or  impairment.  The  asset  is  then  tested  for  recoverability  when  a   change  in  operations  indicates  the  carrying  amounts  are  unrecoverable.  If  the  amount  is   deemed  unrecoverable,  the  firm  then  writes  the  asset  down  to  fair  value.     GOVERNMENT  ROYALTY  TAXES:     Government  discrimination  in  the  treatment  of  royalty  taxes  is  common  throughout  the  mining   industry,  regardless  of  resource  type.  The  major  threats  from  this  to  royalty  streaming   companies  are  the  indirect  costs  of  discriminatory  government  regulation  being  passed  along   to,  or  even  preventing,  future  mine  operations.  A  current  example  of  this  is  the  Chinese   government’s  use  of  subsidies  to  regulate  mineral  production  within  a  certain  range,  in   exchange  for  preferential  tax  treatment.       Three  of  the  most  common  royalty  taxes  utilized  by  governments  are  ad  valorem,  unit  based,   or  profit  based;  notice  the  categorical  similarity  with  the  types  of  royalty  stream  agreements.   Ad  valorem  is  a  royalty  tax  based  on  the  value  of  production.  This  used  to  be  the  most  popular   tax  utilized  by  government  but  a  transition  to  profit  based  taxes  has  taken  place  due  to  that   fact  that  value  based  taxes  fail  to  fully  capture  what  the  government  considers  to  be  either   firms  taxable  activity  (Otto,  Andrews,  Cawood,  Doggett,  Gui,  Stermole  F.,  Stermole  J.,  Tilton).           In  recent  years,  a  major  point  of  contention  has  been  Australia’s  Resource  Super  Profits  Tax.   The  Australian  government  is  increasing  the  tax  on  profits  that  exceed  a  certain  bound,  $75m   profit  per  year  for  iron  ore  and  coal  producers,  to  retain  more  of  the  value  mined  within  the   country’s  borders.  With  mining  a  critically  important  industry  in  Australia’s  economy,  the   government  should  be  careful  not  to  drive  producers  away  with  increased  costs.  As  the   demand  for  resources  increases  and  government  deficits  bloat,  it  would  not  be  surprising  to   see  a  similar  “super-­‐profits”  tax  imposed  throughout  other  developed  economies.             12  
  13. 13. This  tax  also  poses  a  threat  to  future  exploration  activity  in  Australia.  Due  to  increased  costs  of   production  from  the  tax,  mine  operators  will  likely  be  pushed  into  new  markets  in  search  of   lower  costs  of  production  and  explorative  growth  prospects.  As  this  demand  for  new  projects   in  less  developed  regions  is  pushed  higher,  so  will  the  demand  for  royalty  stream  financing  due   to  its  efficiency  over  traditional  financing  routes.               13  
  14. 14.     4. Competition   Competition  amongst  firms  capable  of  providing  royalty  streaming  to  mineral  resource   projects  has  drastically  increased  in  recent  years.  From  the  creation  of  Franco-­‐Nevada  in  1982   until  the  early  2000’s  a  few  large-­‐scale  underwriters  have  dominated  the  space.  Variations  in   the  business  model,  from  target  resource  to  stream  terms,  have  taken  place  as  the  industry  has   quickly  grown.       For  discussion  purposes,  mineral  stream  financiers  will  be  categorized  by  there  focus  of   operations.  Primary  firms  are  characterized  by  their  sole  operating  purpose  of  acquiring   streams.  Secondary  firms  operate  in  many  spaces  with  royalty  stream  financing  only  a  small   portion  of  overall  company  focus.  The  final  category  of  firms  is  categorized  as  consultants,  a   separate  division  focused  on  advising  or  raising  additional  private  investment  for  resource   mining  firms  related  to  royalty  streaming.       Graphed  below  is  the  overall  market  performance  of  the  eight  primary  competing  royalty-­‐ streaming  firms,  from  January  2000  to  September  2012.  The  portfolio  graphed  includes  Anglo   Pacific  (APY),  Bullion  Monarch  Mining  (BULM),  Callinan  Royalties  Corp.  (CAA),  Franco-­‐Nevada   (FNV),  Gold  Royalties  Corp  (GRO),  Royal  Gold  (RGLD),  Sandstorm  Gold  (SAND)  and  Metals  &   Energy  (SND),  and  Silver  Wheaton  (SLW).     Source:  Google  Finance  8/29/12     Although  not  all  firms  existed  when  the  graph  initiates,  you  can  see  the  overall  industry  has   rapidly  grown  from  its  initial  roots.  Mine  operator  and  investor  interest  in  royalty  streaming   firms  over  the  past  decade  has  proven,  and  will  likely  continue,  to  remain  a  major  catalyst   driving  industry  growth.  As  more  junior  exploration  and  production  firms  learn  of  such   equitable  financing  agreements,  and  investors  see  the  return  opportunities  and  niche  industry   performance,  royalty  stream  financing  will  likely  become  a  common  and  integral  tool  utilized   by  most  operators,  in  need  of  capital,  in  the  mineral  extraction  space.               14  
  15. 15. Below  is  a  peer  comparison  of  major  competitors  in  the  royalty  streaming  space  using  the   enterprise  value  to  cash  flow  metric.  This  takes  into  account  the  company’s  capital  structure,   rather  than  just  equity  using  a  P/E  or  price  to  cash  flow  ratio,  and  provides  a  more  comparable   representation  of  the  industry.  All  of  the  firms  are  fairly  similar  with  an  average  EV/CF  in  the   14  to  16  range,  but  Sandstorm  Metals  is  the  outlier  due  to  the  current  phase  of  production   across  its  portfolio  streams.               Source:  Sandstorm  M&E   The  following  section  is  an  overview  of  the  primary  firms  competing  in  the  royalty  stream   financing  space  with  an  additional  summary  of  secondary  and  consulting  firms  in  the   appendix.           15  
  16. 16. Primary  Firms     Sandstorm:     The  Sandstorm  Company  operates  under  two  distinct  streaming  divisions,  Sandstorm  Metals   and  Energy  (SND)  and  Sandstorm  Gold  (SAND).  Each  business  segment  operates   independently  but  is  led  by  President  and  CEO  Nolan  Watson.       Sandstorm  provides  junior  mining  and  energy  exploration  and  production  companies,  in  both   diversified  metals  &  energy  and  gold  commodities,  the  funding  necessary  to  transition  projects   into  a  productive  state.  In  compensation,  the  firm  requires  a  guaranteed  principal  repayment   (~5  yrs)  in  addition  to  a  lifetime  royalty  on  the  production  stream.  This  allows  Sandstorm  to   buy  the  commodity  at  a  fixed  price  at  or  below  the  lowest  cost  producer  in  the  market.           Sandstorm  operates  in  a  favorable  business  structure  by  incorporating  in  Barbados,  leading  to   minimal  income  taxes  and  higher  revenues  generated  relative  to  tax-­‐abiding  firms.  This  poses   a  risk  to  future  operations  if  government  officials,  in  operating  regions  of  the  firm,  seek   recovery  of  unpaid  taxes.  Sandstorm  has  reduced  the  risk  associated  with  mining  E&P   companies  by  requiring  a  minimum  cash  flow  guarantee  that  is  typically  backed  by  a  senior   secured  lien.  This  guarantee  has  helped  the  firm  minimize  potential  losses  by  liquidating  the   borrower’s  assets  in  the  event  of  a  write  off.  Sandstorm  M&E  has  further  minimized  risk  by   diversifying  its  holdings  amongst  coal  (thermal  and  met),  oil,  natural  gas,  and  copper.       Sandstorm  Gold  currently  holds  seven  streams  including  the  Aurizona  Gold,  Black  Fox,  Santa   Elena,  Bachelor  Lake,  Ming,  Mt.  Hamilton,  Coringa  and  Cuiu  Cuiu,  Bracemac  McLeod,  and   Summit  Mine  projects.  Sandstorm  Metals  &  Energy  holds  a  portfolio  of  six  streams  including   Bracemac  McLeod  (Copper),  Gordon  Creek  (Natural  Gas),  Rex  No.  1  &  Rosa  (Coal),  and  Two   Creek  &  Strathmore  (Oil).       Nolan  Watson,  CEO  of  Sandstorm  Metals  &  Energy  and  Sandstorm  Gold,  has  provided   consistent  returns  and  opportunities  for  growth  through  his  influence  in  shaping  the  royalty   streaming  space.  Watson  started  his  career  with  Deloitte  and  Touche,  performing  business   valuations  and  merger  and  acquisition  support.  In  2004,  he  transitioned  into  a  controller  role,   becoming  the  first  employee  of  Silver  Wheaton  under  the  guidance  of  Ian  Tefler  and  eventually   the  youngest  CFO  to  ever  be  on  a  NYSE-­‐listed  firm.  During  his  tenure  as  CFO,  Watson  helped   grow  Silver  Wheaton  from  $200  million  to  a  valuation  of  $3  billion  in  2008.       Key  management  includes  Nolan  Watson,  President,  CEO,  &  Director,  David  Awram,  Executive   VP  &  Director,  and  Erfan  Kazemi,  CFO.  The  firm  is  based  in  Vancouver,  BC.     www.sandstormmetalsandenergy.com     www.sandstormgold.com           16  
  17. 17.   Silver  Wheaton  (SLW):     Silver  Wheaton  is  the  world's  largest  silver  focused  streaming  company,  with  17  operating   mines  and  4  projects  in  development  stage.  Silver  Wheaton's  profits  are  subject  to  minimal   income  taxes  due  to  its  incorporation  in  Barbados  and  the  Cayman  Islands.  This  poses  a  risk  to   future  operations  if  government  agencies  file  to  recover  back  taxes,  potentially  threatening  the   firm’s  competitiveness  in  the  royalty  streaming  space.       The  company  holds  notable  streams  in  Barrick’s  Pascua-­‐Lama,  Hudson  Bay’s  flagship  777   mine,  and  the  Constancia  project.  The  firm  is  able  to  provide  decent  shareholder  returns  by   maintaining  a  low  level  of  fixed  costs  at  $4  per  ounce  of  silver,  resulting  in  a  44%  gain  in  stock   price  over  the  past  two  years  (August  2010-­‐2012).       Silver  Wheaton  has  played  a  pivotal  role  in  developing  royalty  streaming  due  to  its  silver   specific  focus  and  innovative  business  model.  The  firm  extended  the  traditional  royalty  model   into  a  form  designed  to  cushion  volatility  through  a  net  of  current  profit  and  fixed  cost   agreement.  Former  Silver  Wheaton  employee  Nolan  Watson  left  the  firm  and  applied  similar   principles  in  starting  Sandstorm.       www.silverwheaton.com     Franco-­‐Nevada  (FNV):     Franco  Nevada  is  the  oldest  royalty  stream  financing  firm.  The  company’s  founders,  Seymour   Schulich  and  Pierre  Lassonde,  are  considered  godfathers  in  the  resource  mining  space.  The   firm  was  established  with  the  intent  of  exploring  and  producing  gold  throughout  Nevada  but   after  a  couple  mediocre  attempts,  Schulich  and  Lassonde  transitioned  Franco-­‐Nevada  into  the   world's  first  gold  royalty  company.   The  firm’s  stock  provides  a  better  alternative  than  traditional  investment  prospects,  a  more   efficient  vehicle  in  gaining  exposure  to  the  underlying  market.  Franco-­‐Nevada  holds  a  portfolio   of  royalty  assets  on  gold,  precious  metals,  other  minerals,  and  oil  &  gas  streams  (see  table   below).  The  firm  operates  with  a  strategy  of  acquiring  high  quality  and  high  margin  assets,   based  on  increasing  the  net-­‐asset-­‐value  of  the  firm  on  a  per  share  basis,  and  maintaining  a  high   level  of  cash  flow  to  capitalize  on  attractive  prospects  (Franco-­‐Nevada).  The  company  not  only   focuses  on  creating  new  royalty  streams  but  also  acquires  royalties  from  outside  investors.   Franco-­‐Nevada  holds  a  total  of  342  assets,  with  178  producing  and  25  in  the  advanced  stage  of   production.               17  
  18. 18. The  company  strives  to  include  only  the  most  attractive  assets  but  states  that  it’s  open  to   acquiring  new  resources.  Gold  remains  the  predominant  revenue-­‐generating  commodity  for   Franco-­‐Nevada,  accounting  for  75%  of  total  revenue.  Overall,  the  company  seeks  to  maintain  a   portfolio  of  asset  in  politically  stable  regions  to  avoid  increased  operating  volatility  by  only   holding  17%  of  revenue  generating  assets  in  major  mining  regions  other  than  the  United   States,  Canada,  Mexico,  and  Australia.       The  firm,  “anticipates  revenues  in  the  $430  to  $460  million  range  this  year,  and  it  has  $987   million  cash-­‐in-­‐hand,  $95  million  in  marketable  securities  and  an  undrawn  $175  million   revolving  credit  line”  (Keevil).  Franco-­‐Nevada  stock  has  had  ~65%  gain  over  the  past  two   years  with  a  market  cap  of  $7.51  billion.         Cosmos  Chiu,  an  RBC  World  Markets  analyst,  “believes  Franco-­‐Nevada  will  continue  to  grow  its   net  asset  value  both  organically  and  through  acquisitions,  where  recent  market  conditions   have  been  tough  on  mining  companies  and  their  ability  to  gain  financing.  One  pushback  from   investors  on  Franco-­‐Nevada  has  always  been  that  the  shares  are  expensive.  We  disagree  with   that  assessment,  but  rather  would  argue  that  the  share  price  outperformance  reflects  Franco-­‐ Nevada’s  ability  to  generate  shareholder  value”  (Keevil).  Although  the  company  has  become  a   dominant  intermediary  in  the  royalty  streaming  space,  Franco-­‐Nevada  still  appears  to  be  an   attractive  investment  based  on  its  growth  ability.       Franco-­‐Nevada  maintains  offices  in  the  United  States,  Canada,  Australia,  and  Barbados,  and  is   led  by  David  Harquail,  President,  CEO,  and  Director,  who  previously  held  executive  positions   with  Newmont  Mining.     www.franco-­‐nevada.com     Bullion  Monarch  Mining  (BULM):     Bullion  Monarch  Mining  is  based  in  Utah  and  operates  as  a  gold-­‐focused  exploration  and   royalty  company,  in  addition  to  managing  three  subsidiaries:  Dourave  Canada,  Dourave  Brazil,   and  EnShale.  The  firm’s  current  portfolio  of  properties  includes  the  Carlin  Royalty  (Nevada),   North  Pipeline  (Nevada),  Maggie  Creek  (Nevada),  Ophir  Property  (Utah),  and  Gold  Mountain   (Oregon).  Additional  operating  efforts  include  the  exploration  of  gold  and  bauxite  in  Brazil   through  its  subsidiary  Durave  Brazil,  currently  holding  four  major  projects.  The  company  is   also  working  to  develop  the  technology  to  extract  oil  from  shale  rock  through  its  subsidiary   EnShale.  In  2011,  the  firm  generated  $6.2  million  in  revenue  and  $0.05  earnings  per  share.       Bullion  Monarch  was  recently  acquired  by  Eurasion  Minerals  Inc.,  resulting  with  the  firm  being   a  wholly  owned  subsidiary  of  Eurasion  Minerals.  Key  management  includes  Don  Morris,   Chairman  &  CEO,  and  James  Morris,  President.  Mr.  Don  Morris  is  often  recognized  for  his   involvement  with  the  development  of  the  Carlin  Trend  in  Nevada.         www.bullionmm.com             18  
  19. 19. Royal  Gold  (RGLD):     Royal  Gold  currently  operates  with  a  focus  on  acquiring  and  managing  precious  metal   royalties,  with  a  predominant  gold  focus.  The  company’s  current  portfolio  holds  26  producing   properties  and  26  development  stage  properties.  Strong  financial  results  over  the  past  two   years  have  placed  Royal  Gold  in  an  advantageous  position  to  capture  a  larger  market  share  of   the  streaming  space.       The  company  has  produced  a  compounded  annual  growth  rate  over  the  past  decade  of  28%  in   revenue  per  share,  37%  in  EBITDA  per  share,  and  35%  in  earnings  per  share  (Royal  Gold).   Over  the  past  two  years,  Royal  Gold  stock  has  achieved  a  73%  return  and  currently  trades  at  a   stock  price  near  it’s  52-­‐week  high  of  $85.  The  firm  is  based  in  Denver,  CO.  Key  management   includes  Tony  Jensen,  President  and  CEO,  Stefan  Wenger,  CFO,  and  Karen  Gross,  VP  and   Corporate  Secretary.  Mr.  Jensen  has  a  wide  array  of  industry  experience,  previously  working   on  the  Cortez  Joint  Venture  and  Placer  Dome.     www.royalgold.com     Anglo  Pacific  Group  (APY.TSX):     The  Anglo  Pacific  Group  holds  a  broad  portfolio  of  royalties  on  commodities  in  raw  materials,   precious  metals,  and  uranium.  Company  strategy  includes  the  acquisition  of  royalties  on  long-­‐ life  minerals  that  are  located  in  politically  stable  regions.  Major  producing  streams  are  located   in  Brazil  (Iron  Ore),  Europe  (Gold),  and  Australia  (Coal).  The  firms  current  portfolio  allocation   includes  53%  of  assets  in  Coal,  21%  in  Iron  Ore,  11%  in  Gold,  4%  in  Chromite,  3%  in  Copper,   3%  in  Uranium,  and  the  rest  spread  amongst  platinum,  nickel,  and  other  commodities.       Anglo  Pacific  currently  trades  at  a  stock  price  of  $4,  with  a  $438.42  million  market  cap.  Out  of   all  primary  competitors  in  the  royalty  streaming  space,  the  Anglo  Pacific  group  is  positioned   for  strong  growth  due  to  the  majority  of  assets  being  in  the  development  or  pre-­‐development   stage.  The  firm’s  head  office  is  based  in  London,  UK.  Key  management  includes  Peter  Boycott,   Executive  Director  and  Chairman,  and  John  Theobald,  Executive  Director  &  CEO.       www.anglopacificgroup.com     Callinan  Royalties  Corp.  (CAA.V):     Callinan  Royalties  Corp.  is  one  of  the  newer  competitors  in  the  royalty  streaming  space,  with   Canadian  mining  roots  dating  back  to  1927.  The  firm  split  into  two  separate  divisions  in  2011,   creating  two  distinct  companies  that  are  focused  purely  on  exploration  and  royalties,   respectively.  The  firm  is  known  for  its  dominant  acquisition  of  a  royalty  on  the  Hudson  Bay   777  mine.       The  company’s  stock  has  produced  a  40%  return  over  the  past  two  years.  Key  Management   includes  Roland  Butler,  President  &  CEO,  and  Tamara  Edwards,  CFO.  Mr.  Butler  held  a   dominant  role  as  co-­‐founder  of  Altius  Minerals  Corp.  and  is  currently  the  director  of  Millrock   Resources  Inc.             19  
  20. 20. www.callinan.com       Gold  Royalties  Corporation:     Gold  Royalties  Corp  is  a  mining  royalty  company  focused  on  acquiring  both  operating  and   prospective  interests  throughout  Canada.  The  current  royalty  portfolio  includes  agreements   on  seven  producing  and  exploratory  streams;  comprised  of  commodities  in  gold,  nickel,  silver,   zinc,  lead,  platinum,  copper,  and  other  precious  metals.  The  Gold  Royalties  team  is  led  by  Ryan   Kalt,  founder  and  CEO,  and  sources  multiple  industry  advisors  to  consult  on  prospective   acquisitions.  The  firm  was  founded  in  2012  and  is  based  in  Calgary,  Alberta,  CA.       www.goldroyalties.ca     *  See  appendix  for  an  overview  of  secondary  and  consulting  firms  in  the  royalty  streaming   industry.             20  
  21. 21.   5. Perspective   Through  a  critical  analysis  of  the  royalty  streaming  industry  it  becomes  clear  where  the  true   value  of  the  operation  is  derived.  Without  a  portfolio  of  quality  reserves  and  proven   management  at  both  the  financing  and  operating  firms  the  underwriter  will  be  left  vulnerable   to  numerous  threats  that  otherwise  are  manageable.  Future  successes  in  the  royalty  financing   space  are  contingent  upon  the  project’s  true  value  and  the  quality  of  resources  and  operators.       Richard  Karn,  managing  editor  of  the  Emerging  Trends  Report,  conveys  the  importance  of   producers  to  hedge  future  production  by  stating:     Difficulty  arranging  financing…  has  been  an  issue  for  small  companies  since  at  least  2006   or  2007  and  was  exacerbated  by  the  global  financial  crisis  and  its  aftermath.  What   complicates  the  financing  picture  considerably  for  specialty  metals  companies  is  that   many  specialty  metals  cannot  be  hedged  by  selling  production  forward.  From  a   commercial  point  of  view,  if  you  cannot  hedge  your  protection  to  protect  the  bank,  your   terms  –  if  you  can  get  them  –  will  be  very  onerous.  I’d  prefer  a  company  to  hedge  15-­20%   of  its  production  to  guarantee  its  mine  goes  into  production”  (Sylvester).     Royalty  stream  financing  has  gained  more  attention  because  it  allows  the  mine  operator  to   hedge  the  acquisition  of  capital  with  future  production  and  allows  end-­‐users  to  set  the  terms  of   agreement  and  maintain  a  higher  level  of  price  secrecy  (Sylvester).  Because  these  assets  are   illiquid  and  not  heavily  traded,  prices  are  determined  from  each  party’s  interest  in  the  terms  of   agreement.       COMMODITY  HEDGE:     From  a  royalty  financier’s  perspective,  depending  on  the  terms  of  a  streaming  agreement,   future  cash  flow  remains  subject  to  fluctuations  in  underlying  commodity  prices.  Royalty   streaming  companies  fund  mine  production  with  an  initial  capital  outlay  and  then  benefit  from   a  later  royalty  on  the  production  amount,  resource  market  value,  or  operations  net  profit.  Even   though  royalty-­‐streaming  companies  rarely  take  hold  of  the  physical  resource,  negative  price   movements  in  the  interim  threaten  future  cash  flow.       As  an  improvement  to  the  royalty  financing  strategy,  it  is  advisable  to  structure  derivative   contracts  that  capture  upward  price  mobility  and  protect  against  unforeseen  interest   rate/commodity  shocks.  Because  the  space  is  relatively  young,  finding  counterparties  to  take-­‐ on  the  risk  associated  with  illiquid  resources  poses  a  challenge.  Another  downside  to   commodity  hedges  is  potentially  limiting  upward  price  movements.  If  effectively  crafted,  the   royalty-­‐streaming  firm  can  lower  its  portfolio  risk  while  increasing  potential  revenue.       The  Chicago  Mercantile  Exchange  (CME)  offers  futures  and  options  contracts  on  only  the  most   heavily  traded  and  liquid  metals,  not  including  many  of  the  resources  that  royalty-­‐financing   companies  often  stream.  Although,  major  firms  competing  on  the  fluctuation  of  gold  or  silver   pricing  can  benefit  from  the  wide  array  of  financial  products  offered.  Below  is  a  chart  of  the   current  metals  contracts  offered  by  the  CME:           21  
  22. 22.   Source:  Chicago  Mercantile  Exchange     The  use  of  a  commodity  hedge  not  only  increases  financing  costs  but  also  raises  the  regulatory   compliance  burden.  Increased  financing  costs  are  incurred  from  the  active  management  of  a   portfolio  of  contracts  and  increased  regulatory  burdens  arise  from  compliance  with   heightened  accounting  standards  and  government  oversight.  Royalty  streaming  firms  must   weigh  the  increased  costs  of  using  these  contracts  against  the  benefits  gained  from  decreased   volatility  in  price  movements.  Consulting  with  an  advisor  to  arrange  outside  sources  as   counterparties  to  take  on  such  risk  could  lead  to  more  amiable  terms,  relative  to  the  standard   contracts  listed  above.       As  an  alternative  to  traditional  streaming  agreements  with  commodity  hedges,  industry   participants  could  move  to  spot  based  pricing  in  contract  terms.  Spot  based  pricing,  without  a   hedge,  would  protect  financiers  against  negative  fluctuations  because  the  royalty  rate  would   follow  current  market  conditions,  but  leave  the  mine  operator  subject  to  negative  price   adjustments.  With  this  type  of  agreement,  the  increased  costs  of  spot  based  pricing  would   benefit  the  financier  greater  than  the  operator,  leading  to  a  less  equitable  royalty  rate.  But,  if   the  terms  of  agreement  only  include  spot  based  pricing,  the  royalty  streaming  company  could   utilize  an  additional  hedge  against  the  market  to  arbitrage  price  fluctuations.             22  
  23. 23.   STREAM  SECURITIZATION:     Additional  improvements  to  the  current  model  include  the  possible  securitization  of  royalty   streams  to  diversify  the  financier’s  portfolio  risk.  The  limited  liquidity  across  the  majority  of   mining  companies  restricts  available  financing  options.  If  royalty  financiers  bundled  and  sold   streams  in  tranches,  similar  to  the  securitization  of  mortgages  as  collateralized  debt   obligations  (CDOs),  this  would  create  a  more  liquid  market  to  trade  resource  vehicles  and   propel  the  number  of  firm  acquisitions.       This  could  create  an  active  market  where  investors  would  buy  and  sell  bundles  of  royalty   streams.  Projects  might  be  categorized  by  resource  quality,  mine  location,  or  length  of   forecasted  production.  The  pools  of  illiquid  streams  would  be  converted  into  financial   instruments,  potentially  lowering  industry  volatility  and  increasing  liquidity,  financing,  and   term  opportunities  for  both  parties.  Below  is  a  graphic  of  risk  and  return  characteristics  for  the   mortgage  securitization  process  that  could  be  similarly  applied  to  the  mine  financing  space.     Source:  Splettstoesser         23  
  24. 24.   Looking  Forward   Developed  economies  tend  to  be  the  major  consumer  of  resources  and  undeveloped  economies   largely  hold  the  producing  assets.  Population  growth  continues  to  increase  exponentially,  yet   the  available  resources  and  infrastructure  to  support  a  society  of  this  size  remains  fairly   unchanged,  forcing  many  governments  to  continue  to  increase  resource  regulation  in  attempt   to  sustain  their  citizens.       The  majority  of  developed  economies  will  likely  maintain,  or  even  decrease,  current  mineral   production  due  to  increased  regulation  and  environmental  costs,  while  undeveloped   economies  are  likely  to  increase  mineral  production  through  foreign  investments.  A   convergence  between  developed  regulatory  standards  is  likely  to  take  place,  as  the  lack  of   consistent  and  transparent  policies  allows  for  exploitation.  A  favorable  regulatory   environment  should  accelerate  this  transition  in  mine  locations  from  developed  to   undeveloped  markets.     INVESTMENT  OPPORTUNITIES:     Opportunities  for  future  investment  within  the  space  continue  to  expand  due  to  increases  in   global  resource  demand,  commodity  price  volatility,  and  volatility  across  financial  markets.   The  current  supply  of  resources  is  limited  by  the  economic  feasibility  of  mining  projects.  Due   to  this,  as  demand  pushes  resource  prices  higher,  the  required  return  that  makes  the  project   economically  feasible  (cost-­‐benefit  trade  off)  is  pushed  lower.  Projects  that  were  unfeasible   before  are  now  profitable,  spurring  increased  exploration  and  mine  expansion.       The  commodities  market  has  seen  drastic  growth  over  the  past  two  decades,  with  much  of  the   skyrocketing  demand  for  metal  and  mineral  consumption  attributed  to  emerging  markets.   China  has  become  the  largest  consumer  of  refined  metals  through  its  growth  in  infrastructure   spending,  with  metals  consumption  today  17-­‐times  higher  than  in  1990  (The  World  Bank).  As   the  graphs  below  display,  China’s  metals  consumption  and  intensity  relative  to  GDP  have   drastically  increased  over  this  period.             Source:  The  World  Bank       24  
  25. 25. High  demand  in  China  has  been  instrumental  in  driving  the  commodity  super-­‐cycle  over  the   past  two  decades  (Cuddington,  Jerrett).  To  protect  against  price  volatility  associated  with   super-­‐cycles,  investors  must  constantly  seek  more  efficient  vehicles  that  offer  higher  returns   and  lower  risk.  Mineral  resource  streaming  allows  for  this  opportunity  while  maintaining   flexibility  in  the  terms  of  agreement.       Another  key  factor  driving  demand  for  mineral  resource  streaming  are  the  unstable  global   financial  markets.  They  have  been  driven  by  crisis  and  uncertainty  over  the  past  five  years,   starting  with  the  crash  of  the  housing  market,  leading  to  global  government  stimulus  and   bailouts.  Ramifications  stemming  from  these  events  have  compounded,  allowing  for  drastic   fluctuations  in  prices  as  markets  clear.       The  funding  of  large-­‐scale  conglomerate  mine  operators  typically  comes  through  internal  or   partner  sources,  like  a  separate  financing  division  or  independent  financial  institutions  that   can  lend  to  these  borrowers  given  their  massive  scope  and  amount  of  assets  held  as  collateral.   Their  ability  to  acquire  capital  is  less  challenging  relative  to  smaller  operations.  Junior   exploration  and  production  companies  struggle  to  receive  capital  through  traditional  financing   routes  due  to  the  high  risk  associated  with  explorative  ventures  and  overall  limited  company   scope.           GROWTH  OUTLOOK:     In  the  short  term,  the  potential  for  growth  in  mineral  resource  streaming  is  restricted  by  a   supply  of  quality  mines.  Increases  in  metal  demand  support  explorative  and  expansive  activity   by  driving  commodities  prices  higher.  The  cost-­‐benefit  of  individual  mines  adjusts  as   underlying  markets  fluctuate,  resulting  in  some  projects  that  were  previously  economically   unfeasible  now  being  profitable.       Main  drivers  of  industry  growth  for  royalty  streaming  companies  are  the  underlying   commodity  prices  and  the  prospects  for  future  acquisition.  Commodity  prices  will  likely  slow   in  growth  relative  to  performance  over  the  past  decade  but,  as  discussed  above,  major   population  shifts  among  emerging  markets  will  be  the  main  driver  of  consumer  demand  and   ultimately  increase  the  capital  requirement  necessary  for  mine  operators  to  expand.  The   robustness  of  a  royalty  streaming  company  significantly  influences  these  growth  drivers  and   future  expansion  opportunities.       A  challenge  for  royalty  streaming  firms  is  managing  operating  and  capital  expenditures.  As  a   firm’s  portfolio  of  streams  grows,  industry  participants  have  noticed  consistent  increases  in   both  of  these  costs.  In  order  to  provide  consistent  and  strong  company  growth,  management   will  need  to  control  these  increases  to  maintain  profitability.       Large  mining  firms  typically  hold  the  highest  quality  projects  and  are  offered  the  best   explorative  ventures  before  smaller  companies  because  of  established  firm  networks  and   resources.  These  larger  firms  often  categorize  the  funding  of  projects  by  the  type  of  operation,   either  Brownfield  or  Greenfield.  Brownfield’s  are  usually  less  costly  and  considered  the   expansion  of  an  already  claimed  mine.  Greenfield’s  are  the  exploration  of  a  completely   separate  region  and  often  result  in  the  formation  of  a  smaller  exploration  subsidy  of  the  larger   company.  Small  scale  mine  operators  are  left  to  extend  on  previously  mined  claims  or  to         25  
  26. 26. explore  regions  not  already  claimed  by  larger  operators.  This  restricts  growth  in  the  short   term  by  confining  industry  potential  to  the  current  supply  of  quality  projects.       An  additional  factor  that  significantly  influences  growth  in  the  short  term  is  government   interference  through  royalties,  subsidies,  and  the  nationalization  of  private  firms.  Government   royalties  are  a  tax  on  the  mining  of  a  resource  intended  for  the  larger  good  of  the  country.   Increased  costs  of  production  will  drive  companies  to  enter  new  markets  in  order  to  remain   competitive.  It  is  important  for  governments  and  mining  firms  to  work  together  throughout   any  implementation  process  so  they  do  not  debase  the  investment  climate.  Local  operating   firms  create  the  mining  industry;  the  government  should  utilize  their  knowledge  and  resources   when  analyzing  the  effects  of  a  royalty  (Otto,  Andrews,  Cawood,  Doggett,  Guj,  Stermole  F.,   Stermole  J.,  Tilton).  As  a  source  of  growth,  certain  government  royalty  schemes  can  be   implemented  in  a  fashion  that  holds  greater  benefit  to  both  sides  and  remains  attractive  to   future  investment.       Governments  have  gone  so  far  as  to  nationalize  firms  or  subsidize  resources  to  promote   political  and  social  objectives.  The  nationalization  of  private  firms,  like  YPF  Oil  in  Argentina,   threatens  the  investment  climate  of  certain  regions  due  to  fears  of  similar  policies  being   applied.  Richard  Karn,  managing  editor  of  the  emerging  trends  report,  notes  the  challenges   faced  by  miners  in  parts  of  Southern  Africa,  Indonesia,  and  Mali.  Karn  believes  that:     “Nationalization  risk  is  the  biggest  single  threat  facing  the  industry  in  the  years  ahead…   mining  projects  are  easy  targets  for  corrupt  politicians  intent  on  enriching  themselves  and   their  cronies  by  cloaking  their  greed  behind  nationalist  rhetoric  about  how  mining   projects  exploit  the  peoples  resources”  (Sylvester).     Governments  should  be  careful  not  to  degrade  market  integrity  by  over  taxing  firms  or  to   heavily  subsidizing  resources,  manipulating  the  economy  by  forcing  disequilibrium  between   resource  supply  and  consumer  demand.  Erratic  government  interference  will  inhibit  industry   growth  and  drive  investors  to  enter  more  appealing  markets.       In  the  long  term,  recovering  financial  markets  will  push  demand  for  royalty  streaming  higher   as  mine  operators  in  search  of  capital  choose  this  option  as  their  most  equitable  financing   route.  Although  upward  price  mobility  is  limited  by  streaming  agreements,  the  mine  operating   environment  over  the  long  term  is  expected  to  maintain  pace  with  forecasted  consumer   demand  increases,  also  raising  the  need  for  alternative  financing  avenues.       Shifts  of  mid-­‐level  and  major  mining  firms  turning  from  traditional  financing  options  to  royalty   streaming  are  already  becoming  more  predominant,  as  one  of  the  latest  deals,  “Inment  Mining   Corp…  plans  to  raise  roughly  $1  billion  from  a  stream  deal  to  fund  a  portion  of  the  construction   costs  for  it’s  $6.2  billion  Cobre  Panama  copper  project  in  Central  America”  (Rocha).  As  mine   operators  search  for  the  most  efficient  borrowing  terms  to  fund  production,  a  shift  away  from,   or  blend  of,  the  traditional  financing  model  should  continue  to  drive  royalty  stream  financing   demand.             26