After pretty much inventing the precious-metal-stream business back in 2004, Silver Wheaton (TSX: SLW; NYSE: SLW) has noticed the landscape getting more crowded.
Speaking to a lunchtime crowd at Toronto’s King Edward Hotel, Silver Wheaton CEO Randy Smallwood noted that not only have traditional royalty companies such as Franco-Nevada (TSX: FNV; NYSE: FNV) and Royal Gold (TSX: RGL; NASDAQ: RGLD) added precious metal streams in a big way, but even private equity firms have been getting in on the action.
“Truthfully, I enjoy the competition,” Smallwood told the crowd. “And I’d be a little worried if we were getting every asset we were going after. It would indicate that we were paying too much.”
Unlike a royalty company that buys existing royalties on a gold mine or a development project, metal streams give a prospective miner upfront cash — usually for developing or expanding a project — in exchange for precious-metal production at a later date. Silver Wheaton still pays for the metal when it is delivered, but it pays a predetermined and discounted price.
The business model works because the initial “balloon” payment made to the company and the later discounted payments for the metal are fixed costs, which in today’s volatile price environment are attractive to investors.
The model can also exploit arbitrage, which is especially evident in silver production, as most silver comes as a by-product of base-metal mining. When a base-metal company mines the precious metal, however, market valuations are not as robust as when a pure play or a precious-metal company takes hold of the production.
The anomaly leaves room for a “win-win,” Smallwood explains, because Silver Wheaton would pay a producer more for its silver production than its value in the market, and by virtue of being a precious-metal company, Silver Wheaton would get a higher valuation on the same production once it moves into its portfolio.
“So what you will see is that the stock prices for both companies will go up after one of our deals is announced,” he says. “It is a unique situation in the mining business, as usually there is one winner and one loser.”
And while such an arbitrage opportunity has invited more competition, as arbitrage opportunities always do, Silver Wheaton’s first-mover status has it entrenched as the undisputed heavyweight in the space.
The company’s $8.8-billion market cap is almost bigger than Franco-Nevada and Royal Gold’s combined, and its $204 million in earnings during the first half is a good deal more than Franco-Nevada and Royal Gold’s combined total.
The companies also pursue different metals. While Silver Wheaton has ventured into the gold space, it is still a silver company, with 75% of revenue coming from silver and the rest from gold. Both Royal Gold and Franco Nevada have a gold bias.
Unlike its competitors, specializing in silver means Silver Wheaton also gets to be one of the biggest players in the metal, with over 1.6 billion oz. global resources (a combination of reserves, measured and indicated resources, and inferred resources). It ranks second only to Fresnillo (LSE: FRES; US-OTC: FNLPF) in terms of total reserves and resources.
“And all of those resources are active,” Smallwood says. “We have no stagnate ounces in our portfolio.” (A stagnate ounce is one that has been outlined in a resource estimate, but is not part of an active mine or development project.)
Its ability to acquire so much metal is at least partly responsible for the company’s market success. Whereas back in 2004, in the early days of the company’s founding, it had 1 oz. silver behind every share of the company — now there are 6 oz. And Smallwood assures that future deals are only made if they can add to that amount.
Silver Wheaton has built up ounces by emphasizing low-cost projects — the type of mines with margins large enough to ensure operations will hum along, even when the inevitable slump in the commodities price arrives.
Such is the case today. But with an average production cost in the US$4 per oz. range, the company has plenty of wiggle room, even with silver at US$20 per oz.
The main points of vulnerability are the price it pays for the metal and its upfront payment to mining companies. Smallwood says that the discounted cash flow model valuing a given amount of mine production is based on current spot prices and the forward price curve.
An advantage of the method is that it takes the risky game of forecasting metal prices out of the equation. The downside is that when prices fall below spot, Silver Wheaton can get hurt on a deal done at a specific level. To mitigate against such downside, Smallwood says that the company searches for projects that have resource-expansion upside, with the idea being that future growth in resources — ounces that are not priced into the current valuation of a project — will make up for any losses on the spot price.
Another form of protection is to not always be acquiring.
While Silver Wheaton has carved out a reputation for aggressively pursuing assets — the company has 19 metal-stream deals in its portfolio — Smallwood points out that two years passed since the deal with Augusta Resource (TSX: AZC; NYSE-MKT: AZC) for its Rosemont mine in January 2010 and its deal with Hudbay Minerals (TSX: HBM; NYSE: HBM) on its Constancia project in January 2012. “We don’t always want growth,” he says. “We are patient enough to wait if the prices are high and the sentiment is overly optimistic.”
Silver Wheaton has been scouring the globe for projects with low-cost potential.
Smallwood says that Silver Wheaton has grown its staff recently, and that its appetite for doing deals increases as prices retreat.
While many in the mining industry worry about job security during the downturn, it is good to know that a few companies have a model that calls for adding employees when times are tough.
If only it didn’t take so few people to run a metal-streaming company. Royalty companies and streaming companies are known for having small staffs: Silver Wheaton has just 28 people at its head office in Vancouver.
So don’t expect its recent spate of hiring to have too much of an impact on the national unemployment numbers.
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