Sizing Up Sandstorm Gold's Latest Acquisition
Seeking Alpha - Jan. 27, 2016 3:01 PM ET| About: Sandstorm Gold Ltd. (SAND)
Summary -
Sandstorm Gold purchased a bunch of royalties from Teck Resources.
A (painstaking) sum-of-the-parts valuation reveals the true potential of this latest deal.
We strongly believe that the recent sell-off was unwarranted, and see SAND as an even stronger BUY.
Consensus opinion had Sandstorm Gold (NYSEMKT:SAND) lying low for a while in order to digest the transformational deal the company had closed with Yamana Gold (NYSE:AUY) in late October. This deal had stressed the balance sheet, and most market observers were not expecting another large transaction anytime soon. And so it happened that Sandstorm Gold not only surprised your humble scribe on January 19 when the company announced yet another substantial acquisition, but also seems to have blindsided other market participants as well, extrapolating from how the share price dropped on relatively high volume in response.
Sizing Up The Carnage -
This time around the royalty and streaming company has bought a package of 56 royalties from Teck Resources (NYSE:TCK), for a consideration of $1.4M in cash, plus 8.37M shares in Sandstorm Gold. Using the 10 days VWAP prior to the deal values the acquisition at $22M, but using the share price post-announcement we arrive at a more modest valuation of $18.55M.
The share price had traded within a $2.50 to $2.70 range in the days and weeks leading up to the announcement, and seems to have stabilized around $2.05 in the aftermath. The gold price has held steady of late, and therefore, we conclude that the 20+% drop in share price can be attributed fully to the latest deal. We find the extent of this drop somewhat surprising since shareholder dilution amounts to only 7% (already adjusting for the cash component of purchase price) and the balance sheet was practically unaffected by the deal. Or put differently, the company lost almost $50M in enterprise value in reaction to announcing a $22M deal.
What gives? One is tempted to ask; but unfortunately, a coherent answer backed by numbers remains elusive when sifting through the discussion here on Seeking Alpha, as well as various analyst reports which all skim along the surface without providing a rational and reproducible valuation of this deal. Exacerbated by this void, we decided to sit down and dig deeper, and soon found ourselves immersed in an avalanche of data on dozens of projects in all stages of development. Very soon we understood why any kind of formal valuation remains absent in the public domain more than a week after the announcement. The present article summarizes our findings in order to fill this apparent gap, and also provides an update on our investment thesis for Sandstorm Gold.
The New Royalties - An Overview
Here are a few bullets summarizing some salient facts about the royalty package:
The newly acquired 56 royalties can be categorized into four producing and cash flowing royalties, nine royalties on development projects, and 43 royalties on exploration stage projects.
The counterparties for these royalties include a broad mix of companies, ranging from private companies, micro-cap explorers to certain mid-tier miners and all the way to major mining houses.
The royalties are predominantly on gold mining projects, but also include a mix of other commodities most notably copper, but also coal, silver, zinc, and lead. We note that the currently producing royalties are markedly weighted towards the non-gold commodities.
The majority of the projects are located in North America, but there is also a strong showing of 10 royalties on projects in Turkey, plus nine royalties on projects sprinkled throughout South America, and three royalties on projects located in Sweden. The map above shows the various locations (Source: company presentation).
In our attempt to value the package we have looked at the three categories listed in the first bullet point independently, and will summarize our findings in the following. We are also providing our notes and valuation tables as addendums at the bottom of this article, in support of the summary. We note that these valuations contain a certain amount of subjectivity, and we welcome the discussion about our choices to this regard; however, it should be noted that the sheer amount of individual royalties in this package provides a certain safety in numbers. We have tried to err on the side of caution, and have kept our assumptions conservative in nature. A seemingly optimistic call on our behalf is quite probably balanced by other conservative calls and we believe that our valuation in total yields a lower bound, rather than an optimistic projection.
Valuation Summary -
We estimated a risk-adjusted sum-of-the-parts value of $8M for the producing royalties; and we estimated a risk-adjusted sum-of-the-parts value of $25.6M for the development stage royalties.
The total value of the 13 producing and development-stage royalties alone therefore amounts to $33.6M - or more than 50% more than the consideration paid for the full package.
It has been noted before that most of the royalties are like lottery tickets and therefore cannot be valued. We believe that (i) this is not true for the producing and development stage royalties; and (ii) lottery tickets can be valued (see here).
A point can be made that the remaining 43 royalties on exploration properties within the newly acquired package have properties akin to lottery tickets, and we will not disagree at this point. Valuation in the context of this article becomes superfluous, because these tickets are essentially for free. We strongly believe that Sandstorm Gold's investors are getting an outstanding deal with the 13 producing and development-stage royalties already, and they are receiving a bonus in the form of the 43 lottery tickets.
Having said that, we argue that some of the exploration stage royalties are of the highest potential, and we are near certain that there will be winners among them in the long term - think the railroad project explored by Gold Standard Ventures (NYSEMKT:GSV) for example, or New Afton owned by New Gold (NYSEMKT:NGD) to name just two.
Teck Resources seems to continue its quest to raise money to finance its oil adventure at Fort Hill, a task that is becoming harder and harder to accomplish from cash flow as base metal prices continue to drop and with them income from its flagship mines. The diversified miner has already sacrificed a portion of future earnings from its Peruvian Antamina mine when it closed a streaming agreement with Franco-Nevada (NYSE:FNV) last year, and we opine that it was probably feeling the pressure from its balance sheet when negotiating the deal with Sandstorm Gold. The royalties can be considered non-core assets for Teck, providing strictly limited immediate cash flow, and Sandstorm Gold has taken advantage of a rare opportunity here in our view.
The value of the package has a strong bias on Canada (70% of producing and 47% of development), but also adds exposure to Turkey (24% of producing and 28% of development). We see this as a positive aspect since Turkey has developed into an attractive gold mining jurisdiction that has seen many successful operations come online recently. The following two diagrams illustrate the value distribution by jurisdiction within the producing and development-stage royalties in the package:
In terms of metal diversification, we observe a bias towards copper especially among the producing royalties, which should not come as a surprise given that the royalties were purchased from a base metals miner. Copper accounts for 58% of the value of the producing royalties, and 27% of the value of the development-stage royalties. Gold comes second within the producing royalties (24%) and leads within the development-stage royalties (53%). We note the introduction of exposure to coal into the company's portfolio, although at a very modest rate in the greater scheme. We also note a relatively high weighting of zinc within the new royalties (19% of development), which we welcome as well. And finally, we take note that gold clearly dominates the exploration-stage royalties within this package.
Takeaway & Investment Thesis -
After lengthy and careful consideration and discussion of various aspects with the company, we have convinced ourselves that Sandstorm Gold's latest acquisition is highly accretive for shareholders, provides welcome diversification, and deserves applause. The sell-off following the announcement of this deal was likely caused by investors disliking the issuance of additional shares, combined with a lack of understanding of the multitude of moving parts that make up the newly purchased royalty package.
The royalties within the package provide relatively little immediate cash flow, but will contribute immensely in the longer term. Our projections are not driven by speculation, and is based purely on the development-stage royalties which are mostly well documented. It takes substantial amount of time and work to sort through the long list of 56 royalties, and appraise their value. Knee-jerk sellers almost certainly did not invest the required time to arrive at an educated decision.
We say this with a laughing and a weeping eye: laughing, because we welcome the current share price low as a buying opportunity; and weeping, because we may have to wait a little longer before we reach our target formulated in our Top Idea article on Sandstorm Gold from just a few months ago.
In conclusion, we believe that Sandstorm Gold remains a strong BUY after the recent sell-off in our view, and we are taking full advantage of the opportunity ourselves.
Addendum A - Producing Royalties
We used discounted cash flow models to value the four producing royalties in the package. In these models, we applied current spot prices where appropriate, used technical data as published by the respective counterparties to estimate mine lives and production volumes, and applied a discount rate of 5% across all royalties in this category. We also studied the risks and upsides associated with each royalty, and accounted for these factors by adjusting our multiple accordingly. This multiple introduced a fair amount of subjectivity on our behalf, which we acknowledge.
Insufficient public information was available to compute cash flows from two of the royalties (Sheerness and Magmont), and we contacted Sandstorm Gold for clarification which was promptly provided (along with other valuable information that we had asked for). We have used Sandstorm Gold's cash flow projections in these two cases.
Here are summary assessments of these four producing royalties:
Copper Mountain Mining (OTCPK:CPPMF) is yet another copper miner groaning and moaning under its debt load, and it's not even the best-looking house in this particular street. The Copper Mountain Mine in British Columbia has gone bankrupt before under the name of Princeton Mining, and we would not rule out history repeating itself. On a brighter note, we observe that operations seem to be stabilizing after the installation of a secondary crusher. The Copper Mountain mine is a low-grade bulk mining operation with a 17-year reserve-backed mine life. The operating JV (Copper Mountain Mining 75%, Mitsubishi Materials Corporation (OTC:MIMTF) 25%) is presently studying an expansion scenario that would combine pits 1, 2 and 3 into one super-pit, with subsequent underground potential; this expansion does not include the Virginia and Alabama pits to which Sandstorm Gold's 5% NSR refers to. Sandstorm Gold projects $1M in cash flows from this asset, and we think this is a fair estimate. Our model considers 12 years of cash flows, and we apply a multiple of 0.5 in order to account for the elevated financial risk.
Westmoreland Coal (NASDAQ:WLB) is the operator of the two active open pits that currently constitute the Sheerness Mine in Alberta which supplies sub-bituminous coal to the Sheerness power station. The mine has been supplying coal to the station since 1984, and current average annual production is reported at 3.3M tonnes. Exploration of adjacent properties is under way in order to extend the mine life to the end of the expected plant lives in 2040. This is not a net smelter royalty, or NSR, as for most other royalties in the package, but a 5% gross revenue royalty, or GRR, which is typically used for bulk commodities. The royalty computes as a simple percentage of the value of the ore shipped from the mine before subsequent treatment charges, whereby a NSR also deducts treatment charges. Westmoreland Coal also has a lot of debt on the balance sheet, and concerns about the company's ability to service the debt are certainly justified. However, one of the company's recent acquisitions included an MLP which has been renamed into Westmoreland Resource Partners LP (NYSE:WMLP), and this MLP provides optionality for Westmoreland Coal as it can always drop down assets into the MLP and bolster its balance sheet with the proceeds if it needs to. We modeled cash flows of $80,000 until 2040 for this mine, and applied a multiple of 0.8 in order to account for financial and exploration risks.
A private company by the name of Doe Run Resources is the operator of the Magmont Mine in Missouri. Lead has been mined in this district since the 1960s, and despite the absence of published technical report, one can safely assume operations to continue for decades to come. Sandstorm Gold holds a 1.25% NSR for which we assumed a 20-year mine life and annual cash flows of $80,000. We applied a multiple of 0.5 in order to account for the lack of published financial and technical data.
And finally, we also get to report about a gold royalty, namely the 1.25% NSR on the Altintepe Mine in Turkey. This asset has just commenced production targeting output of 30,000 ounces annually. Sandstorm Gold lists a private Turkish company by the name of Bahar Madencilik Sanayi ve Ticaret A.S. as its counterparty for this royalty, for which we have been unable to find much information. However, the Turkish company is only the 55% owner of a JV for this mine, with the balance of mine ownership controlled by Stratex International, a London-listed project generator which has filed ample technical data on this asset.
We modeled annual cash flows of $400,000 for an eight-year mine life, and applied a multiple of 0.7 to account for risks associated with the small-cap nature of Stratex, the lack of information about the Turkish counterparty, and residual uncertainties regarding our mine life assumptions.
Addendum B - Royalties on Development-Stage Projects
As detailed below, we deviated in one case from Sandstorm Gold's classification, but kept the number at nine development projects within the royalty package.
Technical reports are available for most of the nine royalties on development-stage projects within the package. For our valuation exercise, we used data from these reports, and information gleaned from communication with Sandstorm Gold to estimate NAVs using DCF models as for the cash flowing royalties. We accounted for various project-specific risk factors again by applying a multiple much like we did for the producing royalties. Additionally, we took educated guesses at potential start-up dates, and discounted the NAVs to the present date.
Here are summaries of the notes which we took on the nine development stage royalties:
Sabina Gold & Silver (OTCPK:SGSVF) sold the Hacket River Project to Xstrata in 2011, which has since become Glencore (OTCPK:GLCNF). This polymetal mine in Nunavut is one of the world's largest undeveloped zinc projects, located in a very challenging location for mine development. Meadowbank is the only large operating mine in Nunavut, and Agnico Eagle (NYSE:AEM) almost bit off too much when it put this asset into production in 2010. This is not to say that Glencore will not develop this project into a mine, but we submit that it will not happen anytime soon - especially considering Glencore's zinc production cuts in late 2015, and the major's general drive to reduce costs and capex in order to control its debt. Glencore delayed submission of a draft environmental impact statement for Hacket River in 2014 and very little if any news flow has been observed since then. We concur with Sandstorm Gold's estimates of $8M in potential annual cash flows from the 2% NSR over a 15-year mine life; and we have modeled cash to start flowing from 2027. A multiple of 0.1 accounts for the fact that no economical study has been released, Glencore's stressed balance sheet, and for permitting and execution risks in the harsh Nunavut climate.
Teck Resources and Anglo American (OTCPK:AAUKF) sold the Lobo Marte Project in Chile to Kinross Gold (NYSE:KGC) in 2008. Kinross Gold operates the Maricunga mine not far away, offering the opportunity for synergies when the Lobo Marte project will eventually be developed, presumably into a heap leach mine. Development of the Lobo Marte project does not enjoy high priority at the moment, with Kinross Gold's focus clearly devoted to studying the Tasiast expansion, and a restart of operations at La Coipa. In absence of a published economical study, we assumed annual production of 300,000 ounces (slightly less than Sandstorm Gold's projections), and we estimated a 16-year mine life based on current resources and an assumed 70% reserve conversion rate, however, a $40M cap limits the benefits of Sandstorm Gold's 1.75% NSR to seven years in out model. Maricunga currently has an expected mine life to 2022, and our model assumes Lobo Marte to pick up production from that year. We assign a relatively high multiple of 0.3 to this project in recognition of the favorable development environment within the Kinross Gold portfolio.
No information could be dug up in the public domain on the Burhaniye Project in Turkey, developed by another private entity going by the name of Tümad Madencilik. Sandstorm Gold was again happy to provide information on this project. A non-public scoping study was apparently completed on the project in mid-2015 based on a 2M ounce resource (1.5M oz inferred). This study estimated a project with $155M capex for a 10 year, 100,000 ounce per year production scenario. Sandstorm estimates that this mine could reach production within 5 to 10 years, with the royalty kicking in after 300,000 ounces have been produced. We modeled this 2% NSR as starting to generate cash flows for Sandstorm Gold in 2027 following the data outlined above.
The Agi Dagi and Kirazli projects are a well documented part of Alamos Gold's (NYSE:AGI) portfolio. They are both near-term production open-pit heap leach projects with a PFS completed in 2012. Combined output is projected to 242,000 ounces per year on average (143,000 and 99,000 ounces respectively), with mine lives of five and seven years, respectively. SAND has purchased a $10/oz royalty on up to 600,000 ounces mined at Agi Dagi, and up to 250,000 ounces mined at Kirazli. Permitting has included a few twist and turns. The Environmental Impact Assessment, or EIA, had to be reinstated by the Turkish High Court after a run-in with local authorities, and final mining permits are still pending. In fact, permitting might still represent the greatest risk here. We modeled start of production in 2018 at the mentioned projected rates, and applied a multiple of 0.4.
The Öksüt Project in Turkey was discovered by Stratex International, a project generator which we already mentioned in context of the producing Altintepe mine earlier in this piece. Centerra Gold (OTCPK:CAGDF) eventually acquired the project and filed a FS in September 2015. This study considers a heap leach operation with an initial mine life of eight years and average annual production of 155,000 ounces from a 1.2M ounce reserve. Sandstorm Gold owns a sliding scale NSR which is based on cumulative ounces produced over the life of the mine. The FS "estimates the NSR to be 0.6% of total revenues". Centerra Gold targets a first gold poor before mid-2017. We prefer to err on the side of caution and modeled first cash flows from this royalty in 2018, using the inputs summarized above and we applied a multiple of 0.5. We note that our NAV estimate of the 0.6% NSR amounts to $3.15. This seems to compare very favorably with Centerra Gold's own valuation of this project, as the company has recently bought back a 1% NSR for $4.5M.
KGHM Polska Miedz (OTC:KGHPF) is the operator of the Ajax copper gold project near Kamloops in British Columbia. This company is perhaps not so well known among American investors, but a very prominent and well-respected name in European mining circles. The company has been expanding from its home turf in Poland in recent years and already operates assets in North America successfully (e.g. the Carlota copper mine in Arizona). The Ajax project is currently going through public consultations and permitting, and mine construction could start within the next couple of years. The main risk here is opposition from environmental groups, and also from Kamloops' residents who believe that an open-pit mine close to town is too close for comfort. This is a brownfield redevelopment of an old mine, with a projected mine life of 23 years, and average annual production of 109M lbs of copper and 99,000 ounces of gold. KGHM thinks that permits could be in place by mid-2016, and production could start in late 2018. We are doubtful that this schedule is realistic, given the current copper price environment and given the opposition to the mine. We therefore modeled the 1.5% NSR to generate cash flows for Sandstorm Gold starting in 2025, and applied a multiple of 0.15.
The Keno Hill silver district is an old, high-grade silver mining camp in the Yukon Territory, with Alexco Resource Corp. (NYSEMKT:AXU) currently controlling most of the area including a number of past-producing mine. This junior tried to put a number of these mines back into production in 2011, but had to admit defeat by 2013 and close the operation again. Since then, the company has been studying various scenarios, most recently documented in a PEA released in 2014. It is our distinct impression that this project will require higher silver prices, but mining could resume on relatively short notice once this recovery occurs. Sandstorm Gold has a 25% net profit interest (or NPI) on the Keno Hill mine, and Silver Wheaton (NYSE:SLW) also owns a silver stream on this property. We conservatively modeled production at pre-closure levels (2M oz per year) and assumed a total minimum profit of $1/oz to make reopening a viable scenario. We assumed mining to recommence in seven years' time, and applied a multiple of 0.1 in consideration of counterparty risk. Once in production we assumed a five-year mine life, discounting 80% of currently documented indicated resources.
Imperial Metals (OTCPK:IPMLF) is yet another distressed base metals miner, operating the Ruddock Creek Project (also near Kamloops) in JV with Mitsui Mining & Smelting (30%) on which Sandstorm Gold has acquired a 1% NSR. This is a zinc-lead project with a large resource and various technical studies performed on the property. The environmental assessment process was initiated by the JV in mid-2014; so far no economical studies have been released on this project. We have made some wild guesses, and have assumed annual cash flows of $1M starting in 2026, for a mine life of 10 years. Given the nature of these wild guesses, and considering the operational woes of Imperial Metals elsewhere in BC, we only felt fit to apply a multiple of 0.05 to this asset.
Minera Alamos (OTC:VGMTD) is junior exploration and development company currently in control of the Los Verdes Project in Sonora, Mexico. The company is currently re-working its 2012 PFS for the project, and has just released an updated resource estimate. We submit that this project is a very long way from going anywhere, especially since Minera Alamos has just acquired the La Fortuna gold project from Argonaut Gold (OTCPK:ARNGF), which we suspect will shift the focus away from Los Verdes. We have therefore decided to drop this project from our considerations under "development projects" and lump the royalty on this project in with the "exploration projects" discussed later in this piece.
And finally, we have decided to upgrade one royalty from Sandstorm Gold's "advanced exploration" classification to "development", namely the Hot Maden Project in Turkey, a very attractive high-grade gold copper project controlled by junior Mariana Resources (OTC:MRLDF) in JV with Lidya Madencilik Sanayi ve Ticaret A.S., a Turkish gold miner earning a 70% stake. This Turkish company is part of Çalik Holding, one of the largest industrial enterprises in Turkey, and it already partners with Alacer Gold (OTCPK:ALIAF) at Cöpler through its subsidiary Anagold. Sandstorm Gold appears genuinely excited about this royalty, and after careful consideration of publicly available data we have to agree. Exploration at Hot Maden is ongoing, a high-grade gold copper resource has been defined, but no economical studies are available yet for a potential underground mine. We strongly believe that the JV will push this project to production relatively quickly, and we model production starting in 2021 and speculate that it will yield $1M in annual cash flows over at least 10 years. We acknowledge the speculative nature of this call by applying a multiple of just 0.05.
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