Why Precious Metal Royalty Companies
They now play an important role in the financing of new mining projects without forcing miners to dilute equity or access debt facilities. Up until recently, this has not been a common way to approach financing, in fact it was considered esoteric. But as metal prices have gone up, this is a less dilutive way to bring a project online. But this model has become more accepted over the last decade, seen through various royalty companies popping up left and right. Additionally this is often combined with equity and or debt financing, for companies whose projects require heavy initial capital outlays.
The Process
A Royalty or streaming company pays an upfront amount for the right to acquire some kind of metal (usually gold or silver) for a fixed price into the future for an agreed upon time period. In many cases this winds up being the life of the mine (SEE: Silver Wheaton’s business model). Silver is then usually purchased at or around $4/oz and gold is purchase at or around $450/oz. A royalty company essentially finances multiple mining projects (usually 1-4% for a royalty and 12.5-50% for a stream) to generate cash flows.
Advantages
As we all know the value of any asset is the discounted value of all the future cash flows into the future. A royalty company has no ongoing capital requirements unless subject to milestone payments as an alternative, therefore making net income the true profit generated by the company as it is equal to the free cash flow. Additionally, there are low Sg&a costs and limited tax liabilities(many of which pay between 0-5%). In other words, the cash flows of the company are fairly easy to estimate from an analyst’s prospective and gives investors leverage to the commodity price while also reducing the risk inherent in mining to a considerable degree. For the first time this vehicle is starting to be embraced by the retail investor as well as institutions representing them. This results in two things: A higher multiple which means a higher stock price and more growth opportunities as the banks recognize their numerous cash flows streams, making the more willing to issue debt. Coming back to the first point, an increased multiple/higher stock price means less dilution when these companies engage in equity financing as they don’t need to issue as many additional shares.
Differences among royalty companies
First we have the pure royalty companies such as Royal Gold or Franco Nevada who acquire very small stakes in a project. These can vary as well between GSR(Gross smelter revenue), NPI(Net Profit Interest), CGR(Contained Gold Returned), NSR(Net Smelter Royalty) and SSR(Sliding scale royalty). So not all royalties are created equal, which is definitely something to keep in mind. These types of royalties are cash settled as opposed to a mining company who must find a seller for their product. Streamers – These are much simpler as they receive the metal upfront in return for the predetermined price negotiated in the contract. They can then choose when to sell their metals or whether to stockpile them waiting for higher prices of the given commodity in the market.
Like any industry there are large players (Silver Wheaton, Royal Gold, Franco-Nevada) and smaller players (Sandstorm Resources, Gold Wheaton, Virginia Mines, Tanzanian Royalty Exploration). Summing everything up the aforementioned reasons is why they trade at a premium to other miners and are more suitable for everyday investors as they present a much more favorable risk profile.
