Solving Frank Curzio’s “The NEXT Royal Gold” Teaser

Sniffing out the latest Phase 1 Investor tease

By Travis Johnson, Stock Gumshoe, October 9, 2012

“The last time this happened, early investors had an opportunity to make a fortune. Now one team of researchers thinks it’s happening again… with an unusual, little-known mining stock.”

That’s the opening of the latest teaser from Frank Curzio for his Phase 1 Investor newsletter, and it’s not the first time we’ve heard the promise of the “next Royal Gold” — which makes sense, since the royalty business they’re in is still fairly new to the public markets, and it has been so incredibly successful for them as they’ve grown from a weak mining “penny stock” into a near-$100/share royalty collossus over two decades.

The companies that I remember hearing pitched as the “next Royal Gold” over the years have been Virginia Mines (VGQ in Canada, VGMNF on the pink sheets), International Royalty (later bought by Royal Gold), and, more recently, Sandstorm Gold (SAND). And the list of gold royalty companies is a short one, though there are other up-and-coming companies trying to build businesses in this area.

But this time Curzio has something else in mind — I suspect that his Phase 1 is probably still recommending Sandstorm Gold, which is my largest holding and an old favorite around these parts, though it had had 25% drops since he first touted it so he may have been stopped out, but it’s not the one he’s teasing today, and neither is Virginia Mines … so this must be something new.

As is typical of Phase 1 pitches, he says they’ll be having a conference call for subscribers, and as they often do they’ve gotten the CEO of the company to participate in this call, which will take place on October 11, and he shares a few more clues that we’ll use to sniff out the name of the company for you … but first, let’s get his spiel for why you would want to buy the “next Royal Gold.”

“A Way to ‘Cash in’ On Large Mining Discoveries — BEFORE they’re Discovered

“… everyone knows you can make a ridiculous amount of money investing in small mining stocks…

“Throw money into the right exploration company just before it makes a huge discovery, and BAM! Just like that, you can make a killing overnight.

“When Afriore Ltd discovered platinum in South Africa, its share price jumped 1,952%.

“When Silvercorp Metals discovered silver in China, its stock spiked 3,710%.

“The problem is… for every thousand exploration projects underway, maybe one results in a big discovery…

“I don’t know about you, but those odds don’t seem too appealing to me.

“They didn’t seem too appealing to Stan Dempsey either. So he found a way to change the game—to stack the odds in his favor.

“Instead of going ‘all in’ on low-probability exploration projects, Dempsey decided to spread his capital across a variety of projects…

“Here’s one example of what I mean—the ‘deal’ that changed the game for Royal Gold…

“In 1991, Dempsey invested one million dollars with Placer Dome and ECM—two small companies looking for gold in Nevada. These guys needed extra capital to do some drilling in a town called Elko.

“In return, if those guys found any gold, Dempsey would get a percentage of sales.

“As it turned out, the companies struck it rich – a 3 million ounce discovery, known today as the Pipeline complex.

“Royal Gold received a royalty in return for its initial investment—a steady and regular stream of revenue over the life of the mine. In the first year of the agreement, the company’s share price climbed 10,733%.

“When the mine started producing, Dempsey’s company started raking in the cash. Revenues shot up 476% in a single year.

“Royal Gold had become a new type of gold company – it had transformed from an explorer into what’s known as a mining royalty firm.”

So that’s the shorthand for why folks love royalty companies — you get rid of much of the exploration and production risk but get a nice dose of the upside if big discoveries are made, and the royalties and passive income can keep rolling in for decades if large mines are built. I can’t argue with that, and I’ve said over and over that I don’t usually have the stomach (or geology smarts) for investing in junior miners, but I do think royalty firms can be a great way to get exposure to those hard rock commodities.

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He goes on to shed light on a few other companies that have made it big in the royalty space to make sure we understand that while successful firms such as this are rare, Royal Gold is not the only one — so we hear a bit about the founding of Franco-Nevada (FNV), which actually pioneered this business before Royal Gold really got going, and about Silver Wheaton (SLW), which is by far the largest of the passive/royalty companies (Silver Wheaton was recently teased by Curzio’s colleague Matt Badiali, I wrote about it here if you’re curious).

So … daydreams firmly in place about what you’ll do with your riches once you find the next big royalty company? We’ll move on then — next we get some clues about the specific pick from Curzio:

“We learned this new company has quickly secured six royalty deals in some of the safest and most desirable locations in the world…

“And that some of these deals are on early stage projects that haven’t ramped up to full production yet.

“Why is this a big deal? Well, as we were shown, this company’s cash flow is expected to explode – as mines reach production – making a few investors very rich. Perhaps, most importantly, we also learned why we couldn’t find this company mentioned in any mainstream source for financial information.

“Why? Because the company is still incredibly small, trading for well under a dollar a share.”

OK — so six royalty deals, under a buck a share, no big political risk … some more clues?

Yes, thankfully, Curzio gets into some of the details on those streams, giving us something to feed to the Thinkolator:

“Royal Gold went from a 3-cent penny stock to over $90 per share by signing smart deals with honest and efficient mining operations, with projects in stable countries.

“And that’s exactly what the ‘Next Royal Gold’ has done too.

“For instance, one of their royalty agreements gives them royalties to 35% of the first two and a half years of production of palladium – in one of the highest grade gold, platinum, and palladium deposits in the world. And that’s just one royalty.

“These guys signed another contract with a very successful mining company. I won’t name it here… but this company owns property that could potentially contain well over 2.000 tons of copper.

“Thanks to this royalty agreement, our royalty company is legally entitled to 17.5% of copper from their latest mine, which we estimate – could produce over 1,800 tons the first year alone.

“Even better, in the next 12-24 months, the amount of royalties this small company is going to collect should skyrocket.

“For example, if nearby mines are any indication, this deposit could produce more than 7,000 estimated tons of copper for the life of the mine. That’s a lot of copper – roughly $52 million worth at today’s prices. And it’s just getting started…

“Our small royalty company has signed a contract giving them access to a large portion of this copper for 80 cents a pound for as long as this mine is in operation. So, even if copper jumps to $4.50 or $5 per pound, the Next Royal Gold is entitled to legally buy it from this mine for just 80 cents a pound.

“Best of all, this mine isn’t even producing yet! It’s supposed to be in full production by 2013!

… this company has 30% of its market cap in cash – and zero debt.”

Is that starting to sound a little bit familiar? Yes, I think you’re right — this has the whiff of a company we’ve covered before. But the deals don’t match exactly, so let’s just check to see if there are any more clues first.

Well, we get more chatter about the potential blue skies ahead for this company — with the “conservative estimates” being that it might either become the “next Royal Gold” as a gigantic royalty firm with hundreds of deals, or that it will get bought out at a premium by a growth-thirsty company, either of which obviously sounds quite delightful.

And then we do get one more clue about the management team, when Curzio pitches his conference call:

“Joining us on the call will be the brilliant young CEO of the company.

“Get this: He helped grow his last company from a $300 million firm to $3 billion with gains of well over 2,500%. ”

So that’s enough to give us great confidence in the answer spun out by the Thinkolator: This is Sandstorm Metals & Energy (SND in Canada, STTYF on the pink sheets).

And yes, I own this one, too — though it’s not as large a position as I have in their sister company Sandstorm Gold.

Sandstorm Metals & Energy is taking the same basic business plan as Silver Wheaton and Sandstorm Gold, and applying it to energy and base metals — what they do is called “streaming,” and it basically means that they invest up front for the right to buy a portion of future production at below-market prices, usually in perpetuity … so it’s not that they get a 3% royalty on the copper, it’s that they get the right to buy 10% of the copper for $1 a pound, which means they take a bit of the pricing risk (though they can’t lose money) and they do still guarantee some future cash flow for the miner. (That’s just an example, it’s not one of their deals).

Sandstorm Metals & Energy was spun out of Sandstorm Resources (now Sandstorm Gold) a couple years ago, taking with it a nearly worthless uranium royalty stream on a project that will probably never be developed, and a chunk of cash … but also keeping a shared management team, including CEO Nolan Watson. And make no mistake, Watson is a large part of the appeal of the Sandstorm companies — you’re betting on management acumen when you place a bet on a royalty company, since you need them to make good deals, and he was the CFO when Silver Wheaton became a monster, helping them grow that silver streaming firm to, as teased, $3 billion in market cap before he left to found Sandstorm (and Silver Wheaton has kept growing just fine without him, it’s now a $13 billion company).

And those two deals are close matches to recent ones Sandstorm Metals has made — they have a deal with Donner Metals on their Bracemac-McLeod zinc-copper mine that does indeed get them 17.5% of the copper, and they should be producing in the first quarter of next year (with recent announcements that they’ll ramp up production faster than expected — Donner is actually a junior partner on this mine, too, it is being build and will be operated by giant Xstrata). That’s their crown jewel streaming deal right now, and the one that’s likely to provide good news soonest.

And the other one teased, for Palladium, is an example of how sister Sandstorm Gold is helping them out — SAND made a deal for some of the gold and a large chunk of the platinum from the Serra Pelada mine, and tacked onto it a deal for Sandstorm Metals to get the palladium from that same mine in a smaller deal. The news of that deal really inspired Sandstorm Metals & Energy shareholders, helping to drive the shares up significantly from the doldrums where they hade been resting. (That clue threw me off the scent for a moment, since I don’t think I’ve seen any note to the effect that their interest is limited to 2-1/2 years of palladium production, which would probably be a lousy deal if true, so I expect that’s just an error in the ad).

Though really, it might just have been a sigh of relief that Sandstorm Metals is coming out of their “disaster” period — this has been a weak investment since I bought it, and since I suggested it to the Irregulars a bit too early about a year and a half ago, when it was trading at between 55-60 cents a share. I’ve been in and out of the stock a couple times, taking tax losses, but I do currently own the shares — and I also own some of the warrants, though those strike at 70 cents and only have a couple months to go, so I expect that gamble will end up being a losing one. If Curzio is successful in driving the shares up a bit with his enthusiasm, I’ll certainly sell the warrants if I get a chance (though not, of course, within the next three days, per my trading rules, so we’d need some sustained buying for me to get lucky on that front).

But as I mentioned a couple months ago in updating my thoughts on Sandstorm Metals for the Irregulars, I will continue to hold the shares — the stock is in the dumps because they’re heavily reliant on coal and natural gas deals for their near-term revenue (or lack thereof), and because one of their first large partnership deals is getting crunched because their partner is going through bankruptcy, and at least one other of them is in default on their agreement and awfully close to as bad. There’s a reason that of the six deals Sandstorm Metals has done, Curzio calls out the palladium and copper ones — their oil deal is suffering from delays at their partner and a current funding crisis, the two coal deals have been clobbered by weak coal prices, the natural gas deal has obviously suffered from low nat gas prices and has gotten an extension on their agreement … so we’re left with copper and palladium to shine some light on the future. In fact, one of the coal deals has gotten so ugly, with the bankruptcy, that Sandstorm Metals (though they’ve been honest in their communications with shareholders regarding the problems) no longer covers it as an “active” deal, listing just five deals on their website.

The good news, then, is that even with one disastrous deal and three very weak or delayed ones, the company has some excellent potential for the future on the back of their best deal, the copper one (the palladium deal is brand new, and the mine is still a closed book so we don’t really know what it might produce — we have to have faith in management on that one, which I do). Here’s an excerpt of what I said about the company in my update to paid members in August, when the shares were in an ugly trough before the recent recovery:

“Can we close our look at Sandstorm with some good news? The Donner Metals steaming deal, for the Bracemac Mcleod copper mine that’s operated by Xtrata, seems to be moving along very well — Sandstorm gets 17.5% of the life-of-mine copper produced from this mine at a sliding price that’s well below copper’s current market price (right now they’re obligated to pay 80 cents/pound as long as copper is above $2.75, and it’s around $3.40 right now), and the mine is now going to be expanded faster than expected. And it’s not tiny Donner Metals that’s doing the work or being relied on to finance the project, it’s mining giant Xstrata. This deal is their second biggest, and it generates substantial cash flow — the minimum guaranteed cash flow is for $5.7 million in 2013, with similar amounts for the next three years after that, but it’s likely to generate far more. If the mine produces the 3,000 tonnes per day that are expected, then the potential is there for many, many times that cash flow — the deposit reserves note that the deposit is 1.26% copper, so that would mean between 35-40 tonnes of copper per day. I’ll call it 35 tonnes to be conservative. 35 tonnes is about 77,000 pounds, and Sandstorm gets 17.5% of it … so about 13,500 pounds. they will pay $10,800 for that copper (80 cents/pound) and sell it for, let’s guess the price 20% below current prices and call it $2.75/pound, so they’ll get about $37,000/day for a net of about $27,000/day in cash flow to Sandstorm. Assume they can keep production up at this level for 300 days a year (also conservative, I think), and you can turn that speculating into just shy of $10 million in annual revenue to Sandstorm. They say they have reserves to provide a mine life of four years, and they should continue to expand reserves as they develop, so as long as copper doesn’t go through the floor they ought to do just fine with this deal, generating anywhere between $5-10 million per year starting in 2013 would go a long way to making up for significant weakness at Sandstorm’s other assets.

“At the corporate level they’ve been burning through anywhere between $1.5-$2.5 million in cash per year, so call it $2 million and assume that the other streams generate no revenue in 2013 (they will probably generate some, though there also may be writedowns) but that Donner produces roughly as I sketched out above, and you’d have a company with a market cap of $100 million, cash of $33 million (so net enterprise value of $67 million), and earnings of $8 million ($10 million from Donner minus $2 million in overhead), roughly 8.5X projected earnings if you back out the cash. That’s obviously a sketchy valuation, and the fact that they’ve had four of their five significant deals run into dramatic amounts of trouble is very unpleasant, but at this point the call on Sandstorm Metals is basically a speculation first on copper and Xtrata’s performance at the Bracemac-Mcleod mine, and second on the potential that at least one of their other deals — Thunderbird Energy, Terrex, or NovaDx, – will recover and start generating revenue over the next two years. They have a lot of obligations on hand from those firms, but all three are either in default or in significant danger of defaulting on those agreements — they are real assets, but there’s also no guarantee that Sandstorm will recoup any healthy percentage of their initial investment in any of these projects.

“… the current valuation and the current assets, with the Xstrata/Donner project looking more valuable and everything else looking less valuable, make the current $100 million valuation for the company seem reasonable. It’s not a bargain unless you have some insight into recovery at Thunderbird, Terrex or NovaDX, but it’s arguably reasonable, which is enough for me to hold and see what CEO Nolan Watson can do now that he has this nasty year under his belt.”

The market cap is now closer to $140 million after the recovery, which is partly due to optimism over the palladium deal and largely due to increased visibility on the copper deal, I expect, though if Curzio suggested this to his existing subscribers a couple weeks ago that could also have provided a near-term bump for the share price. Still not cheap, and their three existing “weak” deals are still in what I would describe as disaster mode — Terrex has hope that they’ll find a buyer or backer to shore up their enhanced oil recovery projects, but they also have received their official default notice from Sandstorm and the share price is collapsing; Thunderbird has made a bit of progress on their delayed gas projects; and Sandstorm is still helping NovaDX with their restructuring, none of them are likely to be making Sandstorm Metals & Energy shareholders particularly happy over the next few months … but expectations are also extremely low, and you can still make a reasonable valuation argument based on the residual value of these three nasty deals, their cash on hand, and the great potential of the Bracemac-McLeod copper stream … as long as you’re willing to give management a head of steam and let them work through those broken deals and, as they’ve done recently with palladium, make new deals with what we hope will be more financially stable partners.

I still have much more affection for Sandstorm Gold than I do for its weaker sister, not surprisingly — since we all do love our extremely successful picks more than our weaker ones — but you can certainly make a case that this is a relatively low-downside investment if you believe that the bull run in commodities will continue over the next decade … and if coal or natural gas prices improve substantially, or copper spikes in price, it might be that they’ll “surprise to the upside” even within the next year or so. So my opinion hasn’t changed on Sandstorm Metals, and I’m still holding the shares and think there’s a possible scenario for very good returns over the long term — but whether or not it becomes the “next Royal Gold,” well, that I don’t know.

Great success will depend on surviving the four very weak streaming deals they’ve made (well, not weak deals but weak partners, to be fair), ideally helping those companies to recover and start producing, and building on the one very successful-looking deal with future deals that they make out of their cash pile and their future cash flow … but given the relatively low incoming cash flow over the next twelve months and their need to keep some buffer to protect the share price from those clobbered deals, I’d guess that it’s not going to be rapid growth unless they can capitalize on Sandstorm Gold’s halo to raise a lot of money in the next year to make bigger deals to replace their sagging ones.

But that’s just what I think — it’s your money you’re investing, so it’s your call to make … whaddya think?



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