Palisade Research - Fri, May 19, 2017

The Newest & Most Coveted Royalty & Streaming Company

picture of stacked gold bars

Don't tell them (but they know it) - the heralded royalty companies of precious metals are vultures.

Franco-Nevada, Silver Wheaton, Royal Gold, and Osisko Gold Royalties all deploy a royalty and streaming model. This model has outperformed the conventional mining company during the recent bear and bull markets in dramatic fashion.

line chart shows 5-year indexed prices of the top three royalty and streaming stocks versus gold, the HUI and the GDXJ ETF

Osisko Gold Royalties, not included in the above chart because of its more recent inception, has outperformed both the HUI and GDXJ by 8% since it began trading.

So, what is this royalty and streaming model?

A royalty dictates the right to receive a percentage of the value of minerals produced or a portion of the revenue or profit generated from a mining operation. Companies normally acquire a royalty in the early stages of a project for an upfront payment. This payment is used to fund development. The earlier a royalty is acquired, the less it is worth as the royalty company's risk is directly correlated to the time from production.

For example, in March 2017, Osisko Gold Royalties purchased an additional 0.75% net smelter return (NSR) royalty on Barkerville Gold Mines' Cariboo gold project for $12.5 million, increasing its total NSR royalty to 2.25%. When Cariboo produces gold, Osisko will be entitled to 2.25% based on the gross proceeds paid by a smelter or refinery to Barkerville. Osisko acquired the first 1.5% NSR in November 2015 for $25 million.

There are different kinds of royalties but the NSR is the most common. Another is the net profit interest (NPI), which is based on the profit after incorporating production costs. While the owner does not have to provide capital, the NPI is usually not paid until the capital costs are recouped.

The net value royalty (NVR) is similar to the NPI, but is based on profits after processing and related capital costs. The last royalty we would like to mention is the advance minimum royalties (AMR), where the owner is paid a minimum amount until the project is in production.

A stream is similar to a royalty; however, several nuances exist. A company buying a stream will still provide an upfront payment, but it is for a percentage of the value of metal production, and is purchased at a fixed cost per unit for the life of the contract. Streams are based on the gross value of the commodity produced, and most of the time, are applied to by-products of what is being produced. The structure of a stream is normally more complex than a royalty, with payouts based on thresholds of metal production.

For example, In January 2014, Franco-Nevada acquired a gold stream on Teranga Gold's Sabodala gold project in Senegal for $135 million. Franco-Nevada will receive 22,500 ounces of gold per year for the first six years of the agreement, after which Franco will purchase 6% of the gold produced from Sabodala. Franco-Nevada will pay 20% of the market price of gold for each ounce delivered under the agreement and will have a forty year term.

Since royalties and streams are not working interests in a property, the holder of them are not responsible for any operating or capitals costs, or environmental or reclamation liabilities. As a result, cash flow is still forthcoming during declining gold price. During increasing price environments, exploration discoveries, and periods of reserve growth, royalty companies also witness substantial upside.

Let's look at an NSR, NPI, and a stream using simple numbers. Assume gold is trading at $1,200/oz., and the gold project has an "all-in sustaining cost" of $500/Oz. Also assume that the royalty company has a 4% NSR, a 4% NPI or WI, or a streaming agreement and will pay 20% of the market price of gold. For the sake of comparison, the stream will be applied to 4% of the production.

table shows costs, margins and revenue for a NSR net smelter royalty, NPI net production interest or WI working interest, and a stream at 4% with US$1,200 gold per ounce.

Looking at the above analysis, the comparable percentage for the NSR is 2.7 times more valuable than the NPI and 1.7 times more than the stream. The NPI offers the most leverage to gold prices, while the NSR offers the most protection when gold prices are decreasing. The gold stream is more predictable as it is often agreed upon later in development than the NSR and NPI, and offers similar leverage to a low-cost mining company.

So why exactly are royalty and streaming companies vultures?

Royalty and streaming companies do their best deals when the markets are down and beaten, and mining companies are in desperate need of cash.

In the most recent bear market, the amount of money raised by mining companies in the TSX Venture and TSX dropped from C$22.19 billion to a paltry C$6.80 billion.

bar chart shows equity raised for mining in C$ billions on the TSX and TSV from 2009 to 2016.

With share prices also in decline, equity financings became extremely dilutive and undesirable. However, miners could not simply mothball entire operations and wait for equity markets to recover, instead looking towards streams as a source of non-dilutive financing.

During 2012-2016, the major streaming companies went on a shopping spree, and set numerous records. By the end of it, Franco-Nevada had committed C$4.6 billion, Silver Wheaton C$7.8 billion, Royal Gold C$2.8 billion, and Osisko Gold C$80.2 million with another C$43.2 million in investments. To put this into perspective, the top four streaming companies had committed C$15.3 billion, while the entire mining universe in the TSX and TSX Venture raised C$42.2 billion in aggregate!

bar chart shows capital commitment for mining in C$ billions by streaming companies from 2009 to 2016.

This period was headlined by mega deals, first set by Franco-Nevada's US$1 billion streaming deal with Inmet Mining Corp.'s (now First Quantum) Cobre Panama copper project in Panama, one of the world's largest copper-gold-silver-molybdenum porphyry deposits. This deal was eclipsed by Silver Wheaton's US$1.9 billion cash deal with Vale S.A. for 25% of the gold from its Salobo mine in Brazil, and 70% of the gold from certain of its Sudbury mines in Canada.

When markets are not depressed, streaming companies are still expected to grow, and do so by acquisition. This strategy was showcased in the years leading up to the recent recession, with Franco-Nevada, Silver Wheaton, and Royal Gold making over C$2.3 billion in acquisitions between 2009-2011.

Franco-Nevada made three acquisitions from 2009-2011, headlined by its acquisition of Gold Wheaton for C$830 million. Smaller deals included the purchase of Moydow Mines International for US$58 million, and Lumina Royalty Corp. for US$66 million. Silver Wheaton acquired Silverstone Resources Corp. for US$190 million, while Royal Gold outbid Franco-Nevada for International Royalty, picking it up for US$749 million.

This means we are headed into another period of M&A, but not before a phase of junior royalty and streaming growth. The reality is, there are only a handful of assets that will make the cut, and even less management teams that are able to find them and negotiate deals.

Juniors are companies with a market cap of less than $200 million, and scour for deals that are initially too small or early-stage for the majors. However, after a large enough portfolio is assembled and incubated, then it will be worth spending the big bucks on. This building and incubation stage can be very lucrative for investors, and the exit even more so.

Currently, there are just four junior royalty and streaming companies publicly listed and available to investors.

table shows four junior royalty and streaming companies with their EV enterprise value, NAV net asset value, and P/NAV price divided by NAV.

Maverix Metals is a relatively new company, formed in April 2016 by acquiring a package of 13 royalties and precious metal streams from Pan American Silver. This was followed up by acquiring 11 royalties from Gold Fields in December 2016. There is no doubt Maverix is in the royalty and streaming game to become a major player. However, it is majority owned by both Pan American Silver (40%) and Gold Fields (32%) and according to our analysis, overvalued. This may scare off potential suitors, but also benefits Maverix when it makes acquisitions using shares.

AuRico Metals is collecting royalties from four mines, including a 1.5% NSR on Alamos Gold's Young-Davidson mine. AuRico has dedicated the lion share of its effort in developing its Kemess Underground Project, which boasts an after-tax NPV5 of C$289 million and IRR of 12.6%. The initial capex for Kemess is projected at C$450 million, and we would not be surprised if AuRico monetizes its royalties to cover a chunk of the financing.

Abitibi Royalties' flagship royalties was acquired when it sold its 30% interest in the Malartic CHL project to Yamana Gold and Agnico Eagle Mines. The company now owns 3.5 million shares of Yamana and 4.4 million shares of Agnico Eagle for a total value of C$42.9 million. The majority of Abitibi's value is derived from these shares, but it has been innovative in its search for royalties. Preaching a mandate of 'closeology', Abitibi announced a contest where it would pay for claim fees in exchange for a royalty, especially for acreage near an operating mine. This was able to yield some NSRs that may be come valuable in the future. For now, Abitibi Royalties is generating value by buying back shares, which is often an indication of no deals in the pipeline.

Metalla Royalty and Streaming is the newest royalty company, recently completing its first cash flowing stream. The company's flagship NSR is the 2% NSR on Goldcorp's Hoyle Pond Extension. Hoyle Pond currently produces over 160,000 ounces per year and been in operation since 1985. The Extension has been subject to major investment by Goldcorp, and we estimate will provide MTA with over C$5.2 million per year for at least 10-15 years. Metalla also has royalties on properties owned by Glencore PLC, Osisko Mining, Detour Gold, Tahoe Resources, and more. Metalla has passed our due diligence, and is currently the only royalty and streaming company in our portfolio.

Metalla Royalty and Streaming (CNSX:MTA, FRA:X9CP, OTCMKTS:EXCFF) - Undervalued & Top Acquisition Target

Metalla Royalty and Streaming is by far the most undervalued junior streamer, and not surprisingly, also the newest, being formed earlier this year. Nonetheless, it is already on the radar of the majors.

President, Brett Heath, has been methodical in structuring this company. With a good vehicle and even better relationships, he has already secured an enviable royalty portfolio that would have taken others many years of dilutive financings to achieve.

Current Price: C$0.48
Shares Outstanding: 54.9 million
Market Capitalization: C$26.4 million
52-Week Range: C$0.105-C$0.88
Cash: ~C$1.6 million

The company's flagship royalty is the 2% NSR on Goldcorp's Hoyle Pond Extension, in Timmins, Ontario. Hoyle Pond has been in operation since 1985 and has been producing over 160,000 oz of gold annually. The Extension has been subject to major investment by Goldcorp, including a shaft and 80,000m of drilling. Metalla expects cash flow in 2020-2021, and according to our analysis, the Hoyle Pond Extension yields an NAV of C$54.0M.

Metalla's 1.5% NSR on the West Timmins Extension is also of value. West Timmins is operated by Tahoe Resources, and currently produces 50,000 oz. per year. Cash flow should kick in sometime 2018-2020, from 500-600 net ounces over 10 years. The NSR is subject to a buyback of 0.75% for C$750,000, which Tahoe will certainly exercise come time. While not as blistering as Hoyle Pond, the West Timmins Extension still bolsters value with an NAV of C$5.3M.

Metalla's most recent deal is also very accretive. The company recently closed a stream with Silverback, a PE firm based in London, to acquire 15.1% of a silver stream for US$2M, plus the option to acquire 16.7% of a gold stream also for US$2M. The silver stream covers 100% of the silver produced from the operation, and is purchased at 10% of spot through to 2026. In 2015, the mine produced 121,682 oz. of silver and 81,873 oz. of gold.

This transaction is definitely a milestone, being the first cash-flowing asset in Metalla's portfolio. On the silver portion of the deal, we calculate a conservative NAV of C$3.0M, or an IRR of 12%, versus the industry transaction average of 3-7%.

Its important to note, that Doug Casey is a significant investor, and in this deal, and a strong proponent to the royalty and streaming model. In fact, he was a founding investor in Silver Wheaton, and believes streamers are the safest, and most conservative way of investing in mining. Doug has derived a similar conclusion to us, and believes Metalla is the cheapest stock in the space.

The company has strong representation from the Casey Group, with EB Tucker, currently serving as an Independent Director. EB writes The Casey Report, which was founded by Doug Casey and is also heavily invested in the company.

Metalla currently has a market cap of C$26.4 million. The value proposition is very simple, Metalla is the only royalty and streaming company that is trading under its NAV. Utilizing peer comps, Metalla's intrinsic value should be C$1.50, or a gain of 213% from its current share price.

Doug recalls making a 600% gain on Silver Wheaton by investing early before selling too early. We believe the next year will see further high-calibre acquisitions and the continued growth of Metalla's royalty and streaming portfolio.

Palisade Global Investments Limited holds shares of Metalla Royalty and Streaming. We receive either monetary or securities compensation for our services. We stand to benefit from any volume this write-up may generate. The information contained in such write-ups is not intended as individual investment advice and is not designed to meet your personal financial situation. Information contained in this report is obtained from sources we believe to be reliable, but its accuracy cannot be guaranteed. The opinions expressed in this report are those of Palisade Global Investments and are subject to change without notice. The information in this report may become outdated and there is no obligation to update any such information. Do your own due diligence. publishes interesting contributor articles in addition to its own content. We have not verified any of the above details.

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