Recognizing the Need to Sell Non-Core Royalties: Where Mining Companies and Royalties Part Company
All mining executives are cognizant of the difference between core assets and non-core assets. However, from a mining royalty perspective, it is often the case that mining companies hold on to non-core royalties too long and miss an opportunity to monetize a royalty, be it an NSR, NPI or metal stream royalty, for cash that could otherwise be put to a superior use. Recognizing the need to sell non-core royalties can result in significant shareholder value and it becomes important to consistently and periodically review whether a precious metals or base metals royalty owned by your company is still a core asset (particularly if your company has a growing market capitalization).
At the outset, for most mining companies, a mining royalty is likely to be a by-product of a previous corporate transaction as opposed to an asset purchased with the intention of receiving or booking a royalty stream. In short and in aggregate, our experience has shown that royalties are often non-core assets from the beginning. This is particularly true where mining companies and prospectors alike have found a third party to explore and drill up a property but, as part of the structure of that transaction, also elected to retain a royalty, such as a net smelter return (NSR) or a net profit interest (NPI). Some mining companies have scores of royalties on prospective lands, most of which will never reach production or cover economic deposits.
However, there are occasions where a mining company holds a royalty over one or more economic projects that reach or soon will reach resource production. At this point, we recommend differentiation between royalties that pertain to operated projects and those that relate to non-operated projects. From time to time, a royalty, such as an NSR or NPI, will relate to a project whereby the original prospect generator has a right to back-in. Royalties that are repurchased by the project operator can increase the rates of return found in feasibility studies. Royalties of this nature are royalties that may offer the mining companies who intend to produce a deposit sound business strategy to retain.
For the most part, a mining company is not likely to have back-in rights on a project. Alternately, a single royalty or portfolio of royalties, may have been included in a basket of assets acquired, such as when one corporate entity acquires another. Thus, the royalty in question often becomes an asset on the balance sheet as opposed to a strategic exploration or production linked mining asset. Producing or near-producing royalty assets are no doubt worth a certain sum and may have materially increased in value as exploration and project financing stages on a prospect progressed. However, mining executives should be asking whether a particular royalty relates to the day-to-day or strategic growth plans of their enterprise. Where the answer to this inquiry is in the negative, the royalty most frequently can be categorized as non-core.
It is worth mentioning enterprise growth as a key catalyst for a mining company to recognize that a royalty has become non-core and that the royalty and the company should part company. Take a hypothetical example of a junior gold company that held a portfolio of exploration prospects and some NSRs. The NSRs relate to a project operated by another mining company that ultimately reaches production. In our example, assume at the time of initial capitalization that the royalties and prospect lands were of similar value. Over time, the prospect lands turn into an economic deposit and the market cap of the company grows substantially. Investor interest will increasingly focus on the economic gold deposit discovered by the company and the exploration news surrounding those lands will almost exclusively drive its' enterprise value. The NSRs that were once thought material, become small on a relative scale and cannot serve to meaningfully create an expanded market cap. When a royalty such as an NSR or NPI relates to a deposit for which the resource is relatively certain and subject to minimal growth, the proceeds for the sale of such a royalty might be re-deployed with significantly better accretion into growth prospects. Cash from the sale of royalties can often be much better put to work in the buyback of stock, partial contribution of financing for a mine or expanded capital budgets for exploration. When a royalty is non-core and the cash proceeds from its sale have better growth prospects, management should monetize and sell that royalty. Where a mining company is fortunate to have a high quality prospect with an expandable resource, an additional dollar of drilling can almost always be multiplied into more than a dollar of market capitalization. This generates far more value for shareholders much more quickly than a royalty stream ever could. Investors in royalty companies have different risk profiles and are willing to accept lower rate of return versus investors focused on a high-potential junior mining company. Senior executives at mining companies will find capital redeployment into their own mines far more accretive than a small stake in someone else's. Plus, more often than not, the market assigns little to no value to a non-core royalty augmenting the rationale for redeploying capital otherwise tied up in a non-core royalty eleswhere.
Fundamentally, monetization of a cash flowing royalties is important anytime the proceeds are better deployed. Be very wary of the situation where royalty cash flow becomes a G&A carry for this does not build shareholder value. Take as example a gold royalty that produces $1 million of annual cash and with a ten year mine life carries a net present value of $6 million. The mining company that holds that royalty focuses on the exploration of a highly prospective gold project unrelated to the royalty. Nonetheless, because the junior gold company has roughly a $1M of annual G&A, management elects to retain the royalty to finance the proverbial burn-rate. This is not always sound business logic and in many cases is opposite to creating value. As previously mentioned, the return on exploration dollars is typically many fold, i.e. $1 of exploration creates much more than $1 of market cap. Short-term cash flow exchanged for much larger long-term value is the right direction and a clear sign that a company should sell a royalty, despite near-term changes to cash flow. A management team that sells that royalty turns an asset of static and determined value into additional exploration work of comparatively infinite value. It is far more productive for shareholder wealth to monetize a royalty so that a mining company can increase exploration budgets, buy-back stock or avoid future dilution. Doing so often vastly improves the capitalization of the company such as by having had the benefit of additional exploration work on a key mining prospect. In addition, it sends a clear signal to the marketplace that the core of the business is undervalued if management still seeks to re-allocate capital into primary assets. If additional equity is raised in part to cover G&A down the road, that can be far less dilutive than needing to raise money in the short-term because funds were needed this year for exploration or drilling budgets not as large as they could have been. One of the best times for management of a mining company to part ways with a royalty is when they are confident about exploration/future mine prospects and can use that cash to significantly boost enterprise value through drill results. Remember, a royalty is more or less fixed in value compared to finding and proving up a substantial new deposit which can grow and compound market attention.
Gold, silver, copper, or other metals royalties can all become non-core based on the timing of underlying mine production. First, a royalty cash flow stream that will quickly be replaced by cash flow from an upcoming mine becomes of minimal importance to the revenue line. Furthermore, if you are a copper company for the majority of your revenue, a market multiple expansion for say a gold royalty is highly improbable given the materiality issue. Second, as it concerns timing around disposition, royalties themselves have economic fluctuations. In a high commodity price a royalty will yield greater cash flow than in a low commodity price environment. Recognize that there are times when a royalty company can finance royalty purchases and treat a metals royalty owned by your company like securities in another mining company. After all, a royalty is an economic interest in an asset not operated by you. There will be periods of time when a high price can be achieved and deeming a royalty non-core at those points in time can generate significant capital for your other operations. Keep in mind the life of your royalty. Mines are terminal. At some point, the remaining life of a royalty may become too short to be of interest to others and the option of monetization may fall off the table.
The final reason to part ways with a royalty is that it makes the capital structure of mining junior more transparent for analysts to cover. When modeling a mineral resource, particularly where the resource is vastly larger than an NSR or NPI, analysts may have difficulty assessing the value of a royalty and might assign it little to no value. In that case, a reduction of the share float enabled by the sale of the royalty may lead to significantly higher share price targets and a better return than having that royalty asset on the books. Let's be plain, when you are not a royalty company to begin with, cash is easier to value than a royalty stream. Mining companies looking for increased analyst coverage may find that the disposition of royalties can lead to increased price targets on their stock. Of course, where a company is looking to sell itself to mining peer, the disposition of royalties in advance can also make for better takeover metrics and a cleaner transaction.
Ultimately, the date that a royalty becomes non-core is part art, part science. Nonetheless, there are frequently signs that royalty value can be better redeployed. Pay attention to NSRs and NPIs and you might find yourself with a unique mechanism to raise cash today and allow another party to take on commodity and mine risk over the long-run. Too often mining executives miss opportunities to monetize royalties by converting the resulting cash proceeds into higher-returning prospects. Evaluating your royalty with a third party such as Gold Royalties Corporation can often generate immediate and substantial value for your shareholders.
About the Author:
Ryan Kalt is the CEO of Gold Royalties Corporation.