Gold Landlords Look to Small Royalties for Big Payday

How Franco Nevada's founders built a 8,250 bagger and a new gold royalty startup following in their footsteps.

By Andrew Topf, Mining Reporter

The odds of a gold prospect ever becoming a mine are said to be one in a thousand. While many a junior mining investor will take those odds, biting the hook of a promoter luring them on the latest 10-bagger, the reality is the chances of success are stacked against both promoter and investor.

But what if a stockholder could buy a piece of the action on someone else's property - and let them take all the risk - while also exposing himself to potential upside if the miner ends up finding more resources or the prices of those metals shoot up?

That was the idea of Franco-Nevada (TSX:FNV) founders Pierre Lassonde and Seymour Schulich, who turned an upstart Nevada explore-co in the 1980s into the most successful precious metals royalty company in the world. If you, an average retail investor, had bought $1,000 worth of shares in Franco-Nevada in 1983, by 2003, when FNV did a deal with Newmont Mining (NYSE:NEM), those shares would have been worth $1.25 million. That, by the way, is a 1,250-bagger. Extend the timeline 10 more years, from FNV's second $15 IPO in 2007 to its $100 stock price today, and the gain is actually 8,250X.

Ah, but you say, Franco-Nevada is so big now, and the other royalty companies too - like Wheaton Precious Metals (NYSE:WPM), Royal Gold (NASDAQ:RGLD) and Sandstorm Gold (TSX:SSL) - that all the value has been squeezed out and there's no more upside left in their stocks. That is to some extent true, as I will demonstrate further down, but think about a royalty company that is small enough, and early enough in the game, to build itself up, through the gradual acquisition of royalties and metal streams, just like Franco-Nevada did? Right now there is a new company on the Canadian Securities Exchange that is doing just that: Metalla Royalty and Streaming Ltd. (CNSX:MTA).

But first, the Franco-Nevada backstory. In the early 1980s Seymour Schulich was working at legendary financier Ned Goodman's investment firm as an oil analyst. Schulich and Goodman would sometimes travel together to check out early-stage mining plays, none of which made any money. "An idea formed in my mind," Schulich wrote in his 2011 memoir "Get Smarter". "Wouldn't it be great to at least lose money in an area that was fun to visit?"

That area, of course, was Nevada. When Goodman hired Pierre Lassonde to be an assistant mining analyst, their fates were sealed. With $400,000 the pair formed Franco-Nevada, a riff on Lassonde's French-Canadian roots and their shared love for the gambling state. Their first exploration forays were all failures. After 43 tries in California and Nevada, the novice prospectors saw the writing on the wall.

"We realized that, like most junior exploration companies, if Franco-Nevada couldn't find a source of revenue, it was doomed," wrote Schulich. The answer was royalties, an idea Schulich borrowed from the oil business. He told the geologist working for a company drilling a prospect near Tonopah, Nevada that he was interested in royalties, which led another geologist finding an ad in the classified section of the local paper.

The asset was a package of royalties in the Carlin Trend being sold by a Texas company. Franco paid $2 million for the 3,416-acre land package, along with a $90,000 finders fee that went to the geologists. It turned out to be money well spent. A year later Barrick Gold (NYSE:ABX) paid $62 million to acquire the project that covered the royalties claims, and within three months made a major discovery: Goldstrike, which was to become the largest gold find in the world outside South Africa. Annual production at Goldstrike rose from 75,000 to 2 million ounces a year, and over the next decade produced over 40 million ounces from the lands on which Franco-Nevada had a 4% royalty.

"Goldstrike was our first strike of fortune in Franco. It gave us financial strength and the appetite for more properties and began Franco's transformation from an exploration play into the world's leading gold royalty company," Schulich wrote. It also made he and Lassonde rich. Very rich. Most FNV raconteurs like to describe Schulich as a corporate penny pincher who took parsimony into his personal life. Son of a Hungarian dress maker, Schulich in 2009 was still living in the same house he bought in northern Toronto in 1977 and was driving an eight-year-old Lincoln Continental. Lassonde on the other hand embraced his wealth, in 2002 reportedly owning a Ferrari and living in a new mansion in a tony neighbourhood of Toronto.

Some reporters refer to royalty-co execs as "Gucci shoe miners". At a February presentation in Australia, current Franco-Nevada CEO David Harquail reminded his audience that Franco isn't a mining company.

"We don't run any mines and don't do exploration. We even state in our core business principles that we don't want to be involved in any operations," Harquail stated.

"Our focus instead is to maximize our exposure to the exploration upside of geologically prospective properties. Our belief is that the real wealth comes from the ground. We avoid M&A, financial engineering or leverage as we see those more as reallocations of value. We believe that finding ore is the fundamental driver of overall real wealth creation in the resource business."

It's a quote that could have come straight from Brett Heath, Metalla Royalty & Streaming's CEO, who, along with business partner E.B. Tucker, started Metalla after realizing that investing directly in junior gold companies is no way to play the space.

Having worked together at asset management business KSIR Capital, Heath and Tucker felt the pain of a declining gold market in 2013. Like Lassonde and Schulich, they understood how tough it is striking it rich by punching holes in the ground. Heath is to Metalla who Schulich was to Franco - the day-to-day grinder who does all the due-diligence work on potential deals - while Tucker is the Lassonde equivalent. Maybe not as glamorous - no Ferraris yet - but certainly a relationship-builder with a flair for telling the company's story.

"We came to the same conclusion that those guys came to, because we realized that the royalty business is not a traditional gold business, it's a finance business," says Tucker, who cut his teeth picking stocks for Porter Stansberry (Stansberry Research) and currently writes a monthly analyst commentary for Casey Research.

"Most people in the business don't understand that. They look at the royalty companies the same way they look at an exploration company. They say, 'What are the chances this royalty company can discover there's something bigger on the deposit?' and that's not the way we look at the business at all. What we like about the business is that you can completely determine what the company is going to look like on the front end of a deal, and you cannot get that with an exploration company. You really have no idea what's on the other side of that mountain until you go spend $20 million and turn it into Swiss cheese. And probably there's nothing on the other side of that mountain."

"We wanted to migrate into a business that had greater certainty. And so, with the streaming deals, we get the benefit of having total greater when we enter into deals while retaining exploration upside. That was the turning point that we got to, and that's what put us on the road to Metalla."

"We were determined to become 'gold landlords' like Lassonde and Schulich, collecting rent cheques on the best projects."

Heath had formed his own royalty company, High Stream Corp., but needed a publicly traded shell to start Metalla. He decided to use Excalibur Resources. When the transaction closed in mid-2016, Heath renamed the company to Metalla Royalty & Streaming.

Within a few months, they made their first acquisition, a non-producing royalty portfolio in the Timmins Gold Camp in Ontario from privately-held International Explorers and Prospectors Inc. (IEP). That acquisition gave the company:

• 1.5% net smelter return (NSR) royalty on the West Timmins extension properties owned by Tahoe Resources (NYSE:TAHO);
  
• 1% NSR on the Hoyle Pond extension owned by Goldcorp (NYSE:GG); and
  
• 1.5% NSR on the DeSantis mine owned by Osisko Mining (TSE:OSK).
  
• Metalla has not communicated when these assets could come on stream.
  

In the New Year (2017), Metalla came out of the gate with a letter of intent (LOI) with Silverback Ltd., for 15% of a silver stream from Silverback's producing New Luika gold mine (NLGM) in Tanzania, plus an option for an additional gold stream. The transaction closed in May. The next month the company picked up five more royalties in Ontario, four of which are within established mining camps including West Timmins, Detour Lake, Geraldton Beardmore and Kirkland Lake.

Another agreement in May between Metalla and Matamec Explorations Inc. (TSXV:MAT) - a rare earths company with a handful of gold properties in Ontario and Quebec - consolidated royalties on the Hoyle Pond extension property being developed by Goldcorp (NYSE:GG) in Timmins. Metalla paid Matamec C$1.5 million for a 1% royalty on leased mining rights east of the Hoyle Pond gold mine, plus a 1% royalty on fee simple mining rights in Hoyle, 1% royalty on properties in Matheson township and a 1% NSR on the Montclerg property in Timmins.

"Those royalties are going to be phenomenal for the company in the future. It's on one of Goldcorp's biggest assets, and one of the premiere mining camps. It does about a half-ounce per tonne and the deposit's trending right towards this extension," Heath said, referring to Hoyle Pond.

But the most important deal for Metalla actually occurred just last month, closing a major royalty and streaming transaction with Coeur Mining (NYSE:CDE), one of the largest precious metals producers in the Americas.

Under the arrangement valued at USD$13 million - a combination of shares and convertible debentures - Metalla acquired three royalties and one stream:

• 2% NSR on the Joaquin project in Argentina being developed by Pan American Silver (TSX:PAAS);
  
• 1.5% NSR on the Zaruma gold mine in Ecuador operated by Dynasty Metals & Mining (TSXV:DMM);
  
• 1.5% NSR on the Puchuldiza project in Chile held by Regulus Resources (TSXV:REG); and
  
• Silver stream on the Endeavor mine in Australia currently operated by CBH Resources Limited.
  

Metalla estimates the Endeavor silver stream will generate USD$2.5 million for the rest of 2017 and between $3.8 and $4.2 million in 2018, based on an output of 987,500 silver ounces over the next two years. Metalla will have the right to buy 100% of the silver production up to 20 million ounces from the underground silver-lead-zinc mine.

"This acquisition provides an extraordinary amount of growth for Metalla. Our shareholders will benefit from the immediate increase in annual cash flow from the Endeavor Stream as it bridges us to our existing royalty portfolio that is expected to produce for us in the future," Heath said upon announcing the Coeur deal, later adding that the agreement positions Metalla to pay a shareholder dividend in 2018.

Putting it all together, in just under a year Metalla has assembled, through six transactions, 19 royalties and two metals streams, three of which are on producing mines, on track to produce between 6,000 and 7,000 gold-equivalent ounces in 2018.

The company's goal is to earn $10 million in free cash flow and push the market cap up to $200 million from its current $38 million, by continuing to acquire royalties and streams.

With forward looking cash flows currently of about C$5.5-$6.5 million, and at a market cap of $38 million, Metalla is trading at about 6X multiple.

Compare that to major streaming companies Wheaton Precious Metals, Royal Gold and Franco-Nevada, which had average cash flow multiples of 21, as of May 2017.

That means Metalla has 15X worth of multiple expansion value to go before it gets to the likes of the major streaming companies - who are at their upper bandwidth as far as being able to generate significant share price gains. For that reason, Metalla is targeting small royalties or streams that can create value on an accumulative basis.

Heath explains:

"We're not going to grow by doing bigger and bigger transactions because the second that we start to break into that higher end of deal size, the returns are screaming down. The whole strategy on Metalla is, the deals that made these big guys multi-billion-dollar companies are the deals that we're doing right now, and they like these deals just as much as the big ones. It just doesn't make any sense for them to do these deals because they're just too small and it doesn't impact their overall cash flow profile, because it takes just the same amount of management bandwidth on a $5 million deal in process as a $500 million deal. So, what's happened is the returns at the high end that Franco and Royal and Wheaton have been fighting over are really not that attractive anymore. I mean, it's typically single digit internal rate of returns, where we've been able to target a multiple of that on average."

Because Metalla, like other royalty/streaming companies, has a low overhead given the lack of exploring or mining activities, the general and administrative costs are low (around C$1 million per year), meaning nearly all the cash from royalty payments and metal stream sales go into growing the company and shareholder value - and potential dividends. If the price of the metals go up, so does cash flow, giving investors the chance to profit not only from the increasing multiple but also from rising commodity prices.

"The ultimate goal here is to give investors the best vehicle to get exposure to upside in precious metals. We do that by one of two ways," says Heath. "The first way is we reinvest the proceeds into more accretive deals, and generate internal value, and that adds value."

"But it's also important that we pay some of that cash back, because in order for shareholders to really have that direct link to gold and silver rather than owning an ETF or physical [metal] or any other type of metric, they need to participate in the upside. Therefore, we want to link a dividend. After tax and G&A, we want to link 50% of that pre-cash to a dividend, and that will be linked to the gold and silver bank. As the gold and silver banks go up or down, that will be the cash flow that is basically a direct conduit for these investors to get upside in precious metals; at the same time, to continue to create value by doing more of these accretive deals."

Circling back to Franco-Nevada, Metalla is more or less following the same strategy, although a bit differently considering that most of the deal-related expenses are milestone payments rather than up-front costs.

If Metalla keeps its current pace it could become a household name in the gold royalty business. While a rising gold price would boost the company's returns, it makes money today. That's rare for an early-stage company.

"That's the value proposition right now," Heath concludes. "You can buy a new royalty and streaming company that's still trading at a significant discount. I would say a quarter of what the big guys and about half of what the small guys trade at. More importantly, you're going to get the benefit of the bull market. We're building this company for ourselves and our shareholders as a way to take advantage of the next precious metal bull market."

There are similarities to Franco-Nevada's early days. If Metalla's founders follow the trajectory of Franco's, investors who own Metalla today could cash in on extraordinary gains.

Neither the author (Andrew Topf) or the publisher (Pacific Website Company Inc. DBA "CEO.CA") have any business or financial conflicts with any of the companies profiled in this communication.

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