I covered this teaser pitch from Marin Katusa as part of a Friday File for our Irregulars way back in February, and I’m getting buckets of questions about this “Forever Royalties” pitch again so I thought I should double check and update this — and share it with everyone, not just our paying members (yes, you Irregulars are still my favorite people, but we love all our readers here at Stock Gumshoe).

The ad is now being promoted by Ian Wyatt to his lists, using an interview that he did with Marin… and the ad is still for his Katusa’s Resource Opportunities newsletter ($2,500, no refunds). The ad is almost unchanged, though it has one or two little updates since the facts have changed, and, as you might not be surprised to hear, the answer is the same one I provided the last time Katusa pitched a royalty story, though my thinking about the company and its position has evolved a bit over the past year. Wyatt isn’t alone in this co-promotion, incidentally, Katusa has worked with several other publishers in the past month or so to re-promote this “forever royalties” idea as well (that kind of thing is very common in the newsletter world), but it’s Wyatt that’s hitting the inbox this week.

Last summer, Marin was promoting the idea of “Independence Day Royalties” with a tease that was very light on clues. I guessed back then that he was hinting at Lucara Diamond, the best match I could identify, and, to spoil the surprise right up front, I think that’s still the company he’s teasing today.

Why so? He doesn’t drop a lot of clues, but these are the ones I gleaned from his latest ad, which he calls “Forever Royalties” and says will be “my single biggest investment ever”:

“A disruptive new development—similar to a ‘toll-road’ crossing three continents—will completely turn a secretive $80 billion resource industry upside down….

“I call this opportunity ‘Forever Royalties,’ for two reasons:

“One, because this rare resource can truly last a lifetime…

“And two, because never before in history have royalties on this valuable commodity been available to anyone outside the industry—until now.”

He goes so far as to compare this to having a royalty on email, or on fracking… which is a pretty effervescent level of hype… but he does also drop a few more specific clues:

“It’s publicly traded… but it’s not a conventional royalty stock.

“If you ran a stock screen for ‘royalty companies,’ you’d never find it.

“Basically, it’s a ‘backdoor’ way to collect royalty checks from this $80 billion industry.”

And it’s well-established enough to have the backing of some big names…

“The investment and management team behind this secret ‘toll-road’ opportunity – all of whom I know and have personally worked with – are the 1-percenters of natural resource companies.”

So what does this company do?

“The company itself owns and runs one of the highest-margin and most valuable operations in the world.

On the surface, it looks just like a boring, well-run, profitable company.”

But, we’re told, the secret sauce hiding underneath the boring, well-run company is their new “toll road” business that will shake up the industry:

“In the current market, because this resource is so valuable, it always gets to where it’s going, from the mine to the end-user…

“But the ‘road’ it travels to get there is long, fractured, inefficient, and not at all transparent.

“Until now.”

More on this idea of a “toll road:”

“This newly developed technology will turn it into a modern super-highway with toll ‘checkpoints’ that will take just seconds, used by every single company in the sector.

“That’s why I refer to it as a ‘toll road’…

“Because by buying shares of this company, you’ll receive a little piece of every single ‘checkpoint’ transaction – a toll – in this entire industry… for as long as you want.”

That’s all pretty similar to the clues that were being dropped last June… so why am I more certain now that Lucara is the correct solution? Well, it still matches all the clues, but Katusa also drops a couple new clues:

“This isn’t some pipe-dream technology that may or may not happen in the future… or is still in the testing phase, with years before it’s a reality.

“This ‘toll-road’ is online right now—and it just completed its third run.

“Twelve major companies took part (that’s up from seven for the second run).

“These companies are not only joining in, they’re increasing the amount of product through this ‘pipeline’ WITH EVERY SINGLE RUN.

“The company is gearing up for run #4…

“And the latest royalty checks will be sent out in September 2019.”

So yes, that’s still a reference to the Clara diamond-trading platform that Lucara bought last year, and which, yes, did have its first test run late last year and did a couple sell runs so far this year — seven major diamond buyers participated in the first run, which is described in a press release here, and they haven’t had press releases for the subsequent sale runs but this is what they said about Clara in the Q1 results:

“Clara has continued to focus on building its customer base through the first quarter after its inaugural sale in Q4 2018. Two sales were completed during Q1 2019 with rough diamond sales of $1.4 million transacted through the platform. Clara expects to continue to grow its supply and demand concurrently through 2019 by adding third-party production to the platform as well as increasing the number of manufacturers who are buying on the platform.”

Clara is basically an electronic selling platform for diamonds that’s designed to get better prices for producers (like Lucara, which owns it and is so far the only producer participating) by doing stone-by-stone pricing that’s made more efficient by electronic matching, though they also (arguably) get a little gimmicky by using blockchain and a diamond “fingerprint” to ensure traceability and security.

So far, it’s just Lucara selling its own diamonds in this way instead of by bulk tender offers as has been traditional in the industry for eons, and they’re hoping to bring other miners onboard as well and say there is already some interest — the value of Clara, they hope, is not just that it’s a way to sell their own stones at slightly better prices, but that it’s a scalable platform that could generate some high-margin revenue for them if they can convince other miners to also sell their stones through Clara.

So far, though, Clara is a tiny part of the business and has little impact on financials — whether it takes off over the coming years and provides a meaningful new source of revenue for Lucara is an open question, and not one where I have any insight in handicapping the answer. That $1.4 million is 2.8% of the sales that Lucara had in the first quarter… and Lucara would have had some of those sales anyway (if they sold those diamonds in the traditional way instead of selling them through Clara), so it’s hard to argue that it has any impact at all just yet. This is a “maybe worthwhile for the future” bet.

The core business for Lucara, their actual Karowe diamond mine, is a bit more challenging — 2018 was a much worse year for them than 2017 was, partly because of higher operating costs and a shift to a new mining contractor, and partly because they sold one massive diamond in 2017 that swayed the results (that was the 1,109 carat Lesedi La Rona, which sold for more than $50 million and accounted for almost 25% of revenue that year). That’s been the story with Lucara for a while, though not to that dramatic extent — their performance varies a lot based on the number of “specials” they find and sell (“specials” are the crazy-large diamonds — 10+ carats, including a few dozen most years that are larger than 100 carats).

And that mine, in Botswana, is also in a bit of a transition phase — according to their latest investor presentation, they are now expecting to release a feasibility study sometime in the second half of 2019 for building an underground mine to extend the mine life (from 2026 to “at least 2036”), so we’ll know more about the potential economics of that before too long (back in January that study was expected “in a few months,” so as with all things in mining the promise is always a little ahead of the delivery). It is a profitable and pretty high margin mine at this point, but that might change if the underground operations are a lot more expensive… and, of course, if there’s a big capital commitment required they might go from debt-free to having to get a bunch of financing.

But for now, yes, you do sort of collect “royalties,” along with the insiders — that’s because Lucara pays a substantial dividend, currently 10 cents (Canadian) per year (2.5 cents/quarter). That dividend is based on the mining operation which generates essentially all of their revenue, not on the “maybe someday” revenue stream of the Clara platform, but it is real money… and it is generally a low-cost and profitable mine. And yes, the next dividend will probably be declared in conjunction with their earnings release on August 8, with an ex-dividend date in the first week of September and payment a couple weeks after that, so it’s sort of reasonable to say that “royalty checks” are being mailed then.

The ad even hints at yours truly (“This is one secret we don’t want spilling out to the general public by our favorite stock sleuth,”), and I’m more sure now than I was a year ago that Katusa’s new “royalty” company is Lucara Diamond (LUC.TO, LUCRF OTC in the US).

And my opinion hasn’t changed — the stock is down by about 25% since Katusa was pitching them last summer, including those dividends, but going by the financials it’s still a decent miner with established (if uneven) profitability and a meaningful dividend (up to 6.5% now, thanks to the falling stock price), so if you want to own a small single-mine diamond miner you could do worse. Just keep in mind that you’re also carrying the risk of a business that’s based entirely on one mine, so the operations and expansion capacity of that mine, along with wholesale diamond prices and the presence or absence of more mega-diamonds in their ore, will do more to determine whether any particular year delights or disappoints Lucara investors than will their new Clara diamond-selling platform.

This year seems to have brought a new wave of mega-diamond discoveries, which should be a positive… though maybe the worry about what that feasibility study might say later in the year is making folks more conservative. More likely, I guess, is that investors are worried about the state of the diamond market in general — revenue has been weak for all the miners as consumer demand seems to have fallen (De Beers had a 27% decline in earnings in the first half of the year and they’ve been uncharacteristically flexible with buyers in recent sales… I don’t really know whether the current “crisis” in the diamond market is going to persist or if demand will bounce back, but there’s an interesting analysis here if you’re curious).

Marin Katusa seems to believe that Clara will dominate the industry and begin to take a little slice of every diamond sale on earth, which might be possible, I don’t know, but in my eyes it’s not probable — this is not necessarily an industry that changes quickly or embraces technology… and it’s certainly not a given that other miners or traders will decide to just throw their lot in with Lucara instead of developing their own platforms or systems, particularly if falling prices make them ever more sensitive to margin pressures… so I’d guess that you’ll need to have a lot of patience on that part of the business. If you want to be conservative, probably just hoping that Lucara might improve Lucara’s selling prices for their own stones by 5-10% by cutting out some of the middlemen in the supply chain is a more realistic goal… and if you think about it like that, it might help you to sharpen your focus on the actual mining operation which generates all of their revenue.

So where does that leave us? With two big factors to consider: The state of the diamond market, and the cost and outlook for expanding their mine. The unique thing about Lucara is the heavy reliance on very large diamonds… so they have a little less of the downside impact of the commodity producers who rely mostly on mining the millions of little tiny diamonds for Kay Jewelers and their ilk, but they also have a lot more lumpiness as they sometimes find 500 and 1,000 carat diamonds and sometimes don’t, so I’m less worried about the diamond market more broadly when it comes to Lucara — for me the bigger risk is the underground expansion and the feasibility study they’re expected to release later in the year.

If you can live with that risk, then I can see why the current share price and the high dividend would be relatively appealing, particularly because the share price has been unresponsive to the relatively good mining news in their “big diamond” discoveries this year… it’s possible that Lucara is more appealing than many diamond companies because of those biggies, but is being dragged down by the general weakness of the diamond market. Just note that this doesn’t mean the stock can’t fall another 30% or more, or that it won’t continue to respond to a weak diamond market if that persists… and we’re working with pretty stale first quarter numbers right now because earnings are due out next week.

So that’s what I’ve got for you today — find the risk and reward balance appealing, or does something not sit right for you? I’ve written about this one a few times now (though have never owned it), so I’m guessing some of you have had a chance to ponder the stock, and perhaps some of you even own the shares… let us know what you think with a comment below.