We first heard the “Chaffee Royalty” pitched a little more than five years ago, back when Chris Mayer was touting the “next Franco-Nevada” with a pitch about passive mining royalties — and, as you’ve probably guessed if you’ve read this far, it’s baaaaack!
The basic idea of royalty investments is familiar to most Gumshoe readers — I love the concept of royalty investing and have bought (and sometimes sold) many of these stocks over the years, and we’ve certainly covered plenty of different royalty stocks as they’ve been teased by pretty much every natural resources newsletter. In essence, royalty companies are financiers of natural resources projects — they put up capital to help build a mine or drill a well or explore a property, and in exchange they get some kind of “cut” of the production, usually in perpetuity and typically with no further obligation to put more capital into the project.
Generally speaking, mining royalties are often for very small portions of the net return of the mine, perhaps between 1-5% of the net smelter return of produced gold or silver or copper or whatever, and they’re usually held either by original landowners or explorers or by companies who finance early exploration — a royalty doesn’t cost that much on land where there aren’t yet large proven reserves, and it’s a compelling way for junior miners to raise cash without diluting their shareholders by selling more stock.
Streaming deals, which are similar, are usually done on more advanced properties these days — they involve buying a right to a usually larger slice of the production, often 10-30%, and there’s also usually an ongoing payment that’s well below the market rate. These are usually larger deals that help a company get over the hump to actually construct a mine and start producing, or to expand a mine, long after the initial exploration phase and when the mine is much more likely to actually get built. Those aren’t rules, there are lots of different ways in which mines are financed, but it tends to be the way it works at the public royalty companies.
In oil and gas it’s usually a little bit different, with royalty companies and trusts more often being spun out of producing energy companies who want to monetize a steadily producing asset (they can sell a large royalty interest in a producing oil field to a subsidiary, spin that company out to investors who are interested high dividends, and use the cash they get from the deal to keep exploring or developing new reserves). But it’s the same basic concept — you own some kind of share of the top line of a resource company, so you get a cut of the revenue without worrying (much) about ongoing costs, like labor and energy costs that are rising rapidly for many miners. It’s not perfect, because in exchange for that lack of exposure to costs or operating expenses or hassles you are turned into a passive investor in the asset, with little recourse if they decide to shut down the mine because it’s too expensive, or isn’t producing as expected, or because the operator goes bankrupt, or for any other reason.
Last time around, Chris Mayer was using the “Chaffee Royalty” term to pitch a specific royalty company called International Royalty (ticker was ROY), which probably worked out pretty well for most of the investors who were interested at the time, since ROY was bought out by Royal Gold (RGLD) after a bidding war with Franco-Nevada (FNV) … incidentally, that deal also worked out very well for a company I own and have written about for you a few times, Altius Minerals (ALS in Canada, ATUSF on the pink sheets), a more “grassroots” royalty company that had opportunistically built up a position in ROY shares as well.
But ROY is long gone now, so what’s Mayer pitching?
Well, I’ll give you a little taste of his ad — this is how it starts:
“Closed to New Investors 11 Years Ago…
“The ‘Chaffee Royalty Program’ That Turned Every $1 Into $50
“In 2002, the royalty “paycheck program” that paid out $50 for every $1 invested… decided to shut the door to new “members.”
“In 2013, a new door has opened… and it just got easier than ever to “make money while you sleep”…
“But there’s no telling when it could close again…So you’d better collect your own “Chaffee Royalties” right NOW!”
That “closed to new investors” line has been used to tease royalty stocks before, too — that refers to the fact that Franco-Nevada was taken private in 2002, though it went public again in 2007. Mayer mentions Franco-Nevada a bit later when he gets around to teasing his new idea:
“… by the time Franco-Nevada got snapped up in 2002, it had ballooned from a tiny $2.3 million firm… to a company worth the $3.0 billion shelled out by Newmont Mining… which saw the writing on the wall and bought up Franco-Nevada’s whole portfolio of royalty deals in one grab.
“With the buyout, your chance to get in on the original Franco-Nevada pool of ‘Chaffee Royalties’ ended.
“But that’s not the end of the story…
“Because there’s another ‘Chaffee Royalty’ opportunity opening up right now. It’s still very small. Just as Franco-Nevada was at the beginning. Which means you can still get in at that early, easy entry stage.
“Because it’s so small, I can’t possibly name it here. That wouldn’t be fair to the small group of individuals who pay to follow this research on these specialized, lesser-known opportunities.”
So what is Mayer now calling the “Next Franco-Nevada?” He does eventually get into a few clues for us:
“In our new report, Big Energy Money Without the Big Risks: How to Build Resource Royalty Wealth While You Sleep, I give you everything we’ve found — after nine months of deep research — on the best of the ‘Chaffee Royalty’ opportunities open to you right now.
“But the one I recommend first to our readers and friends is one I can’t resist telling you a little more about right now.
“If you’ve ever flown cross-country, say from Los Angeles to New York (or vice versa), there’s a good chance you’ve seen it. Looking down from your plane window, you might have missed the significance…
“Because it looks like miles of mountains and wasteland. But underneath the elephant-skinned outcroppings, there’s a “Chaffee Royalty Program” of unbelievable proportions…
“It’s called Mancos Shale. And underneath it in the Rocky Mountains, you’ll find the equivalent of 59 billion barrels of oil.
“However, I doubt many oil investors have even heard of this shale play — and for good reason. Because what’s mostly buried in the Mancos Shale is not oil. But natural gas.
“And it’s the natural gas that should make many more people very rich. Including anybody who holds a ‘Chaffee Royalty’ deal on those same vast natural gas deposits.”
Hmmmm … intriguing, no? I hadn’t ever heard of the Mancos Shale before. Will it make us rich? Apparently there’s a little company operating in the Mancos Shale, and there’s someone who holds a royalty on their operation too … more clues:
“… hidden deep in Mancos Shale, you’ll find one of the most promising natural gas finds in the country. There’s easily enough energy here to make this one find a cash cow for the next 20– 25 years.
“If you want to own just the direct operation, you can look to a Canadian company — Thunderbird Energy Corp. — which owns and works the property.
“Not long ago, Thunderbird soared more than 220% in just a short five-month span.
“That’s pretty good.
“But what most people don’t know is there is a “Chaffee Royalty Program” that can get you into the very same gas deposit… but also offering you even more gains, with less risk.”
I think I know where this is going now. Straight to a company I sold a little while ago. And I sold it partly because the Thunderbird Energy deal has been one of many train wrecks in their early years of developing a royalty portfolio (Thunderbird is all but bankrupt right now, their market cap is $2 million. Million, with an “m.” They did have a 220% climb, partly because of the royalty deal they got with this “next Franco-Nevada” company, but that was back in late 2011 and early 2012, they’ve since had a fall of close to 95%).
Let’s keep going through the clues here to make sure I’m not getting ahead of myself. Here’s more from Mayer:
“It’s not so difficult today to find other companies offering “Chaffee Royalties.” But it’s not as easy to find one in as early a stage as this one. With a share price that’s still this low… and five royalty contracts either already producing or about to produce potential gains for new shareholders….
“This next future blockbuster royalty opportunity is already on the move.
“On the Mancos Shale deal alone, this newest ‘Chaffee’ play should collect minimum royalties of $25 million. That’s just the bare minimum, which they’ll get even if natural gas prices today don’t budge another inch.
“But what happens if, thanks to increased demand from exports and trucking, natural gas surges back to high prices we saw back in 2008? Well, that would mean triple the price of natural gas.
“And conceivably, that’s at least another $25 million in royalties going straight to this little company’s bottom line.
“That might not sound like much for a big, well-known company…
“But for a tiny company like this — still undiscovered and valued at only just $7 million on the stock market — this is enormous. And just based on that, I already calculate that this could be an easy way to triple every dollar invested over the next two years.”
OK, so that’s still a match — except for the $7 million bit, even after a pretty thorough collapse the company I’m thinking of is considerably larger than that. Could it be someone else instead? Let’s check …
“Not Just Energy But also Palladium, Copper, Zinc and Lead Gains – All With Much Less Risk…
“On top of the ‘lock’ this company has on Mancos Shale energy in the Rocky Mountains… it’s also taking in piles of “Chaffee Royalty” cash for itself and its shareholders in Brazil, in some of that land’s highest grade gold-platinum-palladium deposits.
“Not to mention even more royalties on one of the most productive copper mines in Mongolia… .another huge “Chaffee Royalty” stream on more than 3,000 tonnes per day of Canadian copper… and another 1,000 tonnes of Canadian zinc.
“Some of these pay huge royalties now, and some promise huge potential royalties as they steadily come online. And more are expected on the way….
“Take this company’s royalty rights on a hugely profitable copper deposit, located near Matagami Lake, in northern Canada.
“Multinational mining giant Glencore Xstrata and their partners do all the work to get the metal out of the ground. This one mine alone should churn out as much as 3,000 tonnes of copper every day.
“That’s more than $68 million in sales.
“Now, owning the companies involved in this project directly isn’t a bad move. Keep in mind copper prices have taken a break lately. But it’s only a matter of time before China starts gobbling up copper again…
“That said, starting and operating a mine like this isn’t cheap. The entire project will cost Glencore Xstrata and its partners as much as $163.7 million. That’s just to get it off the ground.
“However, the little company I’ve been telling you about owns the ‘Chaffee Royalties’ on the same copper mine. It paid only $27 million, very early on, as a one-time fee.
“And here’s the really, really exciting part…
“At current copper prices, it gets a $2.50 ‘Chaffee Royalty’ per pound of copper produced by the mine.
“This means, if the mine were to produce 15 million pounds at these prices, we’d be talking royalties of $37 million. If the mine produces 30 million pounds, now we’re talking $75 million in royalties. Double it to 60 million pounds and royalties double to $150 million.”
OK, there’s no getting around it — yes, Mayer is now teasing Sandstorm Metals & Energy (SND in Canada, STTYF on the pink sheets), a company I sold in July after featuring it for the irregulars years ago and owning it personally during a very long decline. It has also been teased over the years by other folks, notably by Frank Curzio’s Phase 1 about a year ago (I’m sure he must have stopped out of it by now). Sandstorm Metals was spun out of what is now Sandstorm Gold several years ago, with the intention of creating a streaming company for base metals and energy producers akin to what Sandstorm Gold was doing with gold miners. And yes, I do actually still own a handful of Sandstorm Metals shares in one of my small accounts, but it’s less than a $50 position that I received as the initial spinoff when SND was created out of Sandstorm Gold, and it’s not worth the commission to sell so I just let it sit.
Commodity streaming is a great idea, I think, and they started out with some good-looking streaming deals: some potential large coal mines that looked like a nice play with coal demand still high from Chinese steel mills (until coal got crushed by cheap natural gas, and the companies Sandstorm had deals with went under); the Thunderbird Energy deal that should have been producing a steady stream of natural gas revenue by now — if the wells hadn’t had water problems and Thunderbird hadn’t run out of money just when it became near-impossible to raise money; the Terrex deal for oil on some enhanced oil recovery projects in Alberta that fizzled away for lack of financing until Terrex merged with another flailing little company called Anterra and Sandstorm ended up with a small settlement and a near-total loss (so far) on their investment.
That’s basically the short story of how I lost faith in Sandstorm Metals — they wanted to be a streaming company for base metals and energy, but because they were so tiny when they started they made seemingly cautious relatively-small deals with other tiny companies, and they failed to make deals where their streaming deal was the last bit of financing a mine needed. All of their partners needed substantially more capital to get through to real development and make those streaming deals/royalties worthwhile, and none of them could get reasonable financing in the last few years as financing dried up for junior resource companies. A situation that hasn’t improved with the current weak commodity prices.
That’s arguably a lesson that they’ve now fully learned, and their CEO Nolan Watson is a smart guy — he was part of the team that built Silver Wheaton (SLW) into the first “streaming” company when Watson was a very young CFO for SLW, and that turned into what is now by far the largest publicly traded “royalty” company. He has also done far better with Sandstorm Gold (SAND), which I still own and bought a wee bit more of not long ago — their partners have generally been much stronger, and they had the advantage of getting a fairly good amount of cash flow and production going before the recent gold price collapse.
But Sandstorm Metals & Energy has been, in retrospect, a near disaster — every single deal they’ve made has either disappeared at a substantial cost to SND, has been delayed, or has been disappointing in some other way (or is brand new — their latest deal, signed just a few months ago, has not generated any bad news yet … knock on wood). Some of that’s bad luck or poor timing, some of it’s management mistakes — I don’t know how much to attribute to luck and to error, but I don’t think a company with a track record of failure on these fronts is worth buying unless it’s really cheap.
When you buy a royalty company you’re buying a pool of capital, a set of deals that are already on their books, and management acumen and decisionmaking, so if you want to consider buying Sandstorm Metal you should look at those three aspects of the company and see if they seem like a good deal to you. There isn’t much capital left at the company, and management has basically been working to rescue the company from some weak deals over the last couple years, so if you find value in the stock it will probably be in their existing producing or nearish-to-producing streams (Bracemac-McLeod for copper is producing now, more on that in a moment, Serra Pelada for palladium maybe next year or the year after, Canadian Zinc for lead maybe by 2015 or so — they’re waiting on their last permit now) — I wouldn’t hold my breath on Thunderbird or their small Oyu Tolgoi exposure generating any cash in the next few years, though they may work out eventually. Sandstorm’s cash position has withered away now, so unless some of those current deals start generating meaningful cash flow they won’t be able to make any new deals to fund future growth, they really need a revitalized junior mining economy for at least a little while so they can raise some more money (but they need junior miners to still be at least kinda weak, so they’ll make good deals with Sandstorm).
The latest news, out just yesterday, is that their partner in the Bracemac-McLeod mine (that’s Glencore-Xstrata’s copper mine that was teased) has effectively forfeited its 35% participating ownership in the mine — Sandstorm’s deal was with that junior partner, Donner Metals, and Donner didn’t have the cash to cover its obligations for mine development costs and couldn’t get the cash, even with the mine already producing as of a few months ago, so they were in default to Sandstorm. Sandstorm had the right to buy in and cover Donner’s obligations and earn that 35% share themselves, but they don’t have that kind of money to throw at the project either, so this was all negotiated out with Glencore-Xstrata, and it ends up that Sandstorm Metals now has a 2.4% NSR royalty on the Bracemac-McLeod mine, the streaming deal is gone, and Donner is out of the picture.
I haven’t looked at the company to re-evaluate what that royalty might be worth — my previous assessment, a couple months ago when I decided to sell my shares, was that the copper streaming deal was likely to bring in roughly $10 million in revenue over the next 12 months and bring in close to $50 million during the mine’s life based on current reserves and copper prices, the main reason why I thought the shares could be considered reasonable at C$2 even though I was selling them.
The royalty is presumably on all metals from the mine, not just the copper (it’s primarily a zinc mine), but using the same rough base case calculations (conservative, but not worst case) I gather that the royalty on just the copper portion should bring in roughly $1.5 million a year. I assume that the zinc would bring in at least that much, and the gold brings in a little bit as well, but I haven’t looked at all at what the royalty revenue would be. If someone wants to chime in with an assessment of the value of this deal now, feel free to do so — I’m guessing it’s likely to bring in less cash in the coming year than they anticipated from the streaming deal, but that’s just a guess until I actually look at the details. I hadn’t ever looked at the zinc production of the mine because it didn’t matter much to my assessment of the value of the copper stream. This mine has had disappointing grades as production started, but that could well average out as they get into better seams.
And Sandstorm Metals does have other deals — next to production is probably a palladium stream on the Serra Pelada mine being built by Colossus Minerals. The mine is being developed now but palladium and platinum production weren’t expected until sometime next year, that may be pushed off again because they’ve had delays in dewatering the mine for initial gold production too. After that the most likely to move to production is a small NSR royalty on the Prairie Creek mine by Canadian Zinc that’s well advanced in permitting but must be at least a year away. And they do have a deal on a small part of the Oyu Tolgoi mine, production that could happen as soon as two years from now but is more likely to be several more years away based on the current development plan for that massive mine — the argument for that deal, with Entree Gold, is that the deposit is so huge that it was worth a small investment to secure that growth for Sandstorm in the next decade … even if it won’t do much in the near term and it made everyone scared of the Mongolian political risk.
And the Thunderbird Energy deal for natural gas is still presumably up in the air — I have no idea what their current status is, but if they keep the stream rights they owe Thunderbird another $7 million, last time I checked. Generally stream owners are set up as creditors as well, so presumably Sandstorm will have a strong claim on the assets if Thunderbird goes under — always a strong possibility with a company that has a market cap of $1.5 million, serious operational challenges, and hasn’t issued any press releases or updates in many months (as far as I know, they’re still dealing with water pressure impeding their gas wells).
So what’s that worth? I don’t know. I just decided in July that the likely production (from Bracemac-McLeod) and cash flow from that made it perhaps reasonably valued at just under C$2 a share — but not cheap. With a history of failed or bad streaming deals and my personal loss of confidence in their plan, “reasonable” didn’t seem good enough, and so I sold. Now it’s down to C$1.50, so you can decide for yourself if you think that’s cheap enough. That’s a $50 million market cap, so it is indeed a very small company now and some good news could go a long way toward rejuvenating the shares. You can see the last quarterly report here, it included a $12 million writedown to reflect the sorry state of the Thunderbird stream.
They do still have some cash on hand, and some potential deals that might pay off reasonably well, but it’s hard to see a huge upside over the next couple of years unless commodities prices (lead for their Canadian Zinc deal, copper and zinc for Bracemac-McLeod, Palladium for Serra Pelada) really bounce back strongly or those companies start to finally have better-than-expected results instead of nasty surprises. Given the performance of their streams so far, I’m still a bit more worried about the risks and I see better opportunities in more stable companies — but Chris Mayer has some pretty good value investing insight so that might just mean that Sandstorm Metals is a bargain if you’re able to look past the current problems … that’ll have to be your call.
P.S. The ad for Mayer’s service also mentioned two other royalty stocks he’s recommending, though there aren’t as many clues. I haven’t looked at the details on those yet, but I should be able to figure them out and write ’em up for you later this week.
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