This article was first published on Gold Investing News on August 25, 2014.
It’s been 10 years since the first streaming and royalty company, Silver Wheaton (TSX:SLW), was handed its first deal. Since then, investors have no doubt come across the handful of streaming companies that increase investor value through exposure to a wide variety of companies within the precious metals sector.
To find out more about what streaming and royalty companies do, Gold Investing News (GIN) caught up with Nolan Watson, CEO of Sandstorm Gold (TSX:SSL), who gave a good overview of the history of streaming/royalty companies and the changes the resource sector can expect on the horizon.
GIN: For investors, streaming and royalty companies aren’t exactly a new thing, seeing as they have been around for a decade. But it might be worth it for investors to understand just how streaming/royalty companies come into being.
NW: It’s actually kind of an interesting story. There have probably been 50 to 70 streaming companies that attempted to start up over the last five years, and there have only been a handful of us that have been successful.
Sandstorm’s a bit of an aberration as a streaming company in terms of how it started off. That’s because virtually every company that has started with a shell company and said, “I want to be a streaming and royalty company, and I’m going to raise money on the back of a deal, or I’m going to raise money and then deploy those deals” has failed.
Streaming companies have a bit of a chicken-and-egg problem. If you don’t have capital, then it’s very challenging to get any company to take you seriously. Likewise, if you don’t get the deal, you never get the capital.
Even if someone puts a pile of capital in a bank account, if you’re not experienced in how streaming deals work or how the tax structure works, and every time you talk to a company someone like Sandstorm has already talked with them, you’ll find it very difficult to be taken seriously. Therefore it’s very difficult to get started up, and people tend to give up — so that’s why virtually everyone who’s tried this has failed.
The companies that do exist in the industry, all of them except for Sandstorm, were started with existing royalty portfolios and/or spin outs of royalties. Silver Wheaton, for instance, was created by Wheaton River Minerals, which spun out a stream on its own assets. Being created by a parent company that provided its first assets helped with getting around the chicken-and-egg problem.
Franco-Nevada (TSX:FNV,NYSE:FNV) was created — in its most recent iteration — through the spin out of a royalty package from Newmont Mining (NYSE:NEM). Then you have Osisko Gold Royalties (TSX:OR), which is an up-and-coming royalty company. It was created from a royalty and spin out from what was then Osisko Mining (TSX:OSK).
GIN: That’s interesting. Now, you mentioned that Sandstorm is different. Can you explain how?
NW: Premier Royalties, which was the company that we bought, was created out of a royalty package from Premier Gold Mines (TSX:PG). Sandstorm is really the only company that started with a shell saying, “I want to be a streaming company” and actually was able to make it happen. We went out, we found deals first and convinced people to talk with us. I think they were willing to do so based on our reputation, and once we found the deals, we went and found the money.
GIN: Once a company like Sandstorm has put up a chunk of capital into another company, how is the wait for repayment and how do you rest easy when the markets are difficult?
NW: It was challenging for us at the very beginning because you’ve got to deploy all this capital and then sit there and wait, and you’ve got no capital coming in. It didn’t help that the share price at the beginning of our history languished quite a bit. We didn’t get any major share price appreciation until those assets got into production, and once they got into production, it took awhile for the assets to get commissioned properly and start working.
In the six years since the start of Sandstorm, the average gold mining company in the industry is down probably 40 percent. Sandstorm is up probably about 200 percent, but it certainly did not happen at the beginning of the story until we got cashflow.
GIN: To the casual observer, streaming companies seem to perform quite well in the market. Can you explain why that might be?
NW: There’s a bit of survivorship bias there in the sense that the streaming/royalty companies that exist have performed better. Partially this is because the streaming/royalty model avoids some of the downside risks of mining, such as cost overruns and CAPEX overruns. Also, the very nature of what a streaming/royalty company does means the investors of a direct mining company are taking on more risk when they buy equity in a company than when we buy a royalty on that same mine.
At the same time, I would say that there have been streams and royalty companies that have started up and have tried to stay in the business and effectively have not done well or have failed, so it’s not as easy as it looks.
GIN: I doubt there are many things that are as easy as they seem. Another thing that I’ve noticed is that streaming companies typically focus on gold and silver. Is there any particular reason for that?
NW: One of the reasons that you don’t see base metals streams is because for base metals mines — good base metals mines — you usually need substantial scale. Base metals mines tend to be huge, earth-moving operations with CAPEX in the high hundreds of millions and usually billions of dollars. Thus, in order to be a relevant financial provider to a base metals mining company, you have to be able to offer them huge streams. Historically, there hasn’t been anyone who has been able to start up a base metals royalty company with $3 billion in cash to start to actually make a true and honest success of it. That is going to be a very high hurdle for anyone wanting to start. We tried to do it earlier with Sandstorm Metals & Energy, but the reality is that you need billions of dollars to make that business model work.
GIN: Would that be why you see more offtake agreements for base metals? Because bigger downstream companies are more able to fund the projects?
NW: The offtake agreements tend to be by and large smelter owners and conglomerates. But yeah, they’re large entities with a lot of capital that are looking to secure sources of supply. They’re willing to put up capital to be able to get that source of supply. But in the end it’s got to be big players with deep pockets.
GIN: What is the difference between streaming and having a royalty?
NW: Well, it’s pretty basic. Royalty is a percentage of revenue, and a stream is the right to purchase a percentage of the production at a fixed price. Whereas a 1-percent royalty will give me 1 percent of your revenue, a 1-percent stream will mean that at $500 an ounce I get to buy 1 percent of your gold produced.
GIN: What happens to the original shareholders of a company when you do a stream? Do they gain money or lose money?
NW: The reason that a company would do a stream is if they wanted to build a mine and they needed capital to do it. Companies look at their various potential sources of capital. Debt is one form of capital, and it has interest. But debt is the most risky form of capital because bankers are inherently nervous beasts and they like to call in loans and send you to bankruptcy if things don’t work out well.
Another alternative is obviously equity. Equity shareholders tend not to like to get diluted because if you’re issuing new shares to raise money to build your mine, then an equity holder who used to own 10 percent only owns 5 percent if the share float of the company doubles. Finally, there are streams and royalties. What we do is we give a company money up front on day one to help go build that mine in exchange for a stream, so it’s a non-dilutive form of financing. It’s less risky for them.
GIN: So then you are saying shareholders should be more accommodating to streaming deals because it doesn’t dilute their shares. That makes sense. What about contingencies? Is there a contingency plan for you as a streaming/royalty company if a company can’t repay that loan?
NW: All Sandstorm has is a right to purchase a certain percentage of what they produce, whatever that production may be. If production is lagging during a period of time, we’re purchasing less gold under the stream. Generally speaking, we try to work with them to raise the capital one way or another to get the mine up and running. Sometimes it doesn’t work. Sometimes the mining company never gets there and the mine fails — their shareholders lose money and so do we.
GIN: Understandable. Is there a certain percentage of gold Sandstorm typically purchases?
NW: It’s case by case depending on the robustness of the asset. We are very sensitive to not over-stream a mine. So sometimes someone comes up and asks to do a 25-percent stream with us and the answer typically would be “no, that’s too much.” Our goal is to ensure that their shareholders are the primary beneficiary of the cashflow of the asset. We have run into it in the past where things have been over-streamed and mining companies started losing incentive to actually extract value from the asset, so we try to stay in the low teens to below the 10-percent range.
GIN: Basically just reducing the risk on your side. Is there a certain recipe for success when it comes to streaming deals? What is it that you look for in companies?
NW: We analyze both the asset and the company individually. With the assets, what we are looking for is robust economics. You want to ensure that the ratio of the value of the mine to CAPEX is high so that you’re not putting up a tremendous amount of capital for a small return when you do build that mine. We are also looking for low-cost operations, so once they do build it, the question is whether the company is going to be able to produce at below the industry average all-in cost of production. And the third thing that we are looking for with a mine is exploration upside. We want to find situations where the mine life can double or triple.
On the company side, what we are looking for is obviously good management teams, but other things we are looking for are capital structure and balance sheets. Every now and then we will come across management teams that will want to avoid all forms of equity dilution, and plan to lever the company up with senior secured debt, then they are going to go through a convertible debenture — subordinated or unsecured — and finally do a stream thinking that will give them all the money they need to go build the mine. But that situation is almost certainly going to end with everyone inevitably losing their money because they are just too indebted. And when you get too indebted, when you have hiccups in your operation, which invariably happens in the mining industry, equity investors tend to walk away and the debt holders are left in doubt.
We try to stay away from those types of situations and we want to focus on companies with credit-free balance sheets.
GIN: Investors typically like to put their money into companies working in safe jurisdictions. Does supporting a broad portfolio of companies allow Sandstorm to take a chance on more risky ones sometimes?
NW: We look at risk as a whole, so economics, risks and the robustness of the project are all considered. Then there is jurisdiction. Will we go to West Africa for a mediocre asset? Probably not. Would we do it for a good asset? Yeah, we probably would.
You really look at the risk involved and there are some countries that are on our “don’t go there” list.
GIN: Speaking of West Africa, Sandstorm recently teamed up with Franco-Nevada for a $120-million streaming deal that will fund True Gold Mining’s (TSXV:TGM) Karma project. Can you tell me more about the transaction? What is it about True Gold that caught your attention?
NW: True Gold is a company I’m very familiar with because I’m on the board of directors. The company has a management team that is experienced, knows how to raise money and it’s an asset that should be a reasonable to a low-cost producer and there is a bunch of exploration upside to it. It checks all those boxes that I previously mentioned from the asset point of view. And we were very pleased to deal with Franco-Nevada on it. Franco is not only a great company to invest in, but also they really were a pleasure to deal with in the process.
GIN: It seems that the Sandstorm/Franco-Nevada partnership is the first time two royalty companies have joined forces. Can you talk about what this means for the market? Will we see more of these transactions in the future?
NW: Yes, I think you will see more of these. With streaming companies, it’s quite interesting. Historically, we’ve always been very competitive with each other. More recently — probably about 18 months ago — we started to hear whispered rumors about streaming companies being willing to share the risk of larger deals, so the concept of syndication came about. You see syndicated deals for example with a bank. When a bank is doing a large loan and doesn’t want to take all of that risk, it’ll bring in a whole bunch of other banks and spread out the risk collectively.
For streaming deals, we started having conversations about sharing that collective risk as well. These conversations were happening behind the scenes, but no one had ever done this before. So we just decided to work with Franco-Nevada, just to try to get it done for the first time. I think that we have demonstrated now that it can work, and it can be easy to do and it does make sense, especially on the larger transactions.
GIN: I saw in the Financial Post that banks are stepping away from single-asset miners, a role that seems to be getting filled by royalty companies, at least as far as debt financing is concerned. As the CEO of a royalty company, do you see this as a possibility for the future?
NW: I think it makes sense. I believe that true debt is a very bad idea for a one-asset company. That’s because if you have any technical problems, or any permitting problems on that one asset, and you can’t pay back your debt, you violate your debt and go insolvent immediately. If you are a one-asset mining company, you need to have financial providers whose interests are aligned with yours. The most aligned are equity investors, and the second best would be streaming and royalty providers. And you need to finance with a combination of those two things.
Debt, I just think is a bad idea. However, I think debt has a place in the market for the right company. I think it makes a lot of sense for Rio Tinto (LSE:RIO,NYSE:RIO,ASX:RIO) or BHP Billiton (ASX:BHP,NYSE:BHP,LSE:BLT) or Goldcorp (TSX:G,NYSE:GG) to have debt on their balance sheet, but I don’t think it makes sense for the junior mining companies.
GIN: So you are saying that streaming companies are more helpful for juniors?
NW: Yes, and a lot more forgiving. In an industry that currently has a lot of debt, we are a financing mechanism for it.
It doesn’t help that the industry has a bad reputation because a lot of investors lose money every time these investments go bankrupt. Although we are not a perfect solution for it, I think it’s a step in the right direction.
I think the streaming business model, being young, is going to change — it is going to evolve and get stronger. It’s going to get better for the industry going forward. We’re in the process of that evolution and I think that 20 years from now you are going to see the streaming model become much better for the industry than it is today.
GIN: That’s good to hear. Thank you Nolan for sharing this insight with our readers.
Securities Disclosure: I, Vivien Diniz, hold no investment interest in any of the companies mentioned.
Editorial Disclosure: The Investing News Network does not guarantee the accuracy or thoroughness of the information reported in the interviews it conducts. The opinions expressed in these interviews do not reflect the opinions of the Investing News Network and do not constitute investment advice. All readers are encouraged to perform their own due diligence.