Following the commodity downturn in 2014, many miners were forced to focus on cost-out initiatives, deleveraging balance sheets and returning cash to shareholders who had become disillusioned with the industry’s track record. Growth projects were inevitably over budget (and often behind schedule), and M&A deals were often completed at lofty premiums—but, in hindsight, they often were executed at the top of the market, resulting in value destruction. In the post-boom environment, many mining companies found it challenging to raise capital from either the public-debt or public-equity markets. As a result, many industry commentators predicted the emergence of private debt and private equity. While the growth in private debt and equity has been below expectations, one form of alternative financing that has blossomed has been streaming-and-royalty financing. Expansion in this form of alternative financing, coupled with increasing focus on growth by management teams, leads us to believe that streaming-and-royalty financing is poised for strong growth over the next decade.
Metal streaming and royalties: An introduction
Metal streaming-and-royalty contracts are transactions under which mining companies sell future production or revenues in return for an up-front cash payment. There are some distinct differences between the two types. Streaming deals are normally focused on specific commodities produced by a particular project, such as precious-metal by-products from a base-metals project. In return for this up-front cash payment (the “deposit balance”), the streaming partner secures a share of future production at an agreed-upon discounted price, which may be fixed or alternatively a floating percentage of the prevailing spot price. Thus, miners receive payment on delivery for streamed physical volumes. In contrast, royalty deals are normally commodity agnostic and based on overall project revenues; the royalty company never actually “sees” the commodities that the mine produces, but rather just receives a share of the revenue generated (the royalty). In effect, streaming deals are settled by the physical transfer of metal while royalty deals are settled with cash.
Royalty ownership in the mining industry is generally agreed to have originated with Franco-Nevada in the mid-1980s. The mining company’s first royalty investment in 1986 involved spending half the corporate treasury to acquire 4 percent of the revenues from a mine in Nevada owned by Western State Minerals. Following this initial transaction, Franco-Nevada went on to purchase royalties in various other commodities, further developing the mining sector’s royalty business model. The arrival of the precious-metals streaming business model is often attributed to Wheaton River: while seeking to raise funds in 2004 to expand its core business of gold mining, the company conceived the idea of streaming silver by-product from the San Dimas gold mine in Mexico to a new subsidiary company, Silver Wheaton. In the world’s first streaming agreement, Silver Wheaton purchased yet-to-be-produced silver from Wheaton River’s operations in Mexico in return for an up-front payment and additional payments on delivery of the silver. New players have emerged in the past decade in the streaming-and-royalty sector, including Triple Flag in 2016, Nomad Royalty in 2019, and Deterra Royalties in 2020. However, the industry remains very consolidated, with the top three players—Wheaton Precious Metals, Franco-Nevada Corporation, and Royal Gold—representing approximately 80 percent of the total value of streaming-and-royalty contracts as defined by volume of gold equivalent ounces (GEOs).
Benefits for mining companies
Since the inception in the 1980s and early 2000s of the mining royalty and streaming sectors, respectively, these alternative forms of financing have grown steadily from $2.1 billion in 2010 to more than $15 billion in 2019. Indeed, the acceleration over the past half-decade has taken place in an environment in which raising capital has been challenging within both the public-debt and public-equity markets as the mining and commodities sectors have been less favored by investors in comparison to the commodity supercycle of the 2000s. As a result, overall interest in alternative financing in the mining sector has grown.
Streaming as an alternative financing source has several advantages when viewed from a mining company’s perspective. When compared to debt-based deals, streaming-and-royalty deals often have a longer payment period; have no fixed obligations in cash, so they present less risk during periods of lower prices; have limited restrictions on the use of cash; have no debt covenants to maintain; and share production and operational risks across the value chain. When compared to equity-based deals, streaming-and-royalty deals are less dilutive because streaming and royalties are applied to a single asset only; are advantageous when share prices are trading below net asset value; do not have changes in ownership and none are implied on the management team; and usually have no additional costs such as brokerage or market discount fees. As a result, many candidates exist for which streaming-and-royalty deals present a potentially attractive form of financing, such as when a company is in need of capital to fund growth projects, engage in M&A, or further pay down debt. These deals are especially attractive for mining companies for which the streamed product is noncore or a by-product.
Different reasons exist for sellers to enter into streaming and royalty contracts, but these are usually related to market capitalization and project development status. In the case of large and midcap miners, the decision to enter into streaming-and-royalty contracts has historically been driven by the need to improve balance-sheet leverage; for small and junior miners, the decision is usually motivated by the need to fund the development of a specific project. The current structure of the streaming-and-royalty sellers market is quite fragmented: the top five sellers represent about 50 percent of the market, while small and junior miners make up 25 to 30 percent of the total market. To date, the majority of streaming deals have been focused on precious metals—gold and silver account for more than 90 percent of streamed volumes as of 2020 (Exhibit 1)—although there is increasing interest in streaming other commodities.
Benefits for streamers
For investors, royalty companies are increasingly attractive, and streaming companies even more so, because they provide commodity-price leverage and exposure to the underlying commodities and price movements, while delivery payments are predetermined and made only upon delivery. In addition, investors in streaming companies are able to tailor metals exposure more than royalty companies can. From a cost perspective, streaming companies provide stable and predictable costs in comparison to the mining companies themselves (and usually low-selling, general, and administrative costs, given their small staffing requirements versus those of the mine operators). Furthermore, because costs per ounce are contractually defined, this protects streamers from cost overruns. With the best contracts there is also an exploration upside, so streamers receive the benefit of mine exploration and expansion activities, typically at no additional cost. Finally, the ability to have exposure to a large asset base (as opposed to just operating a few mines) provides portfolio diversification and risk management. When executed well, this arrangement should benefit a streaming company via sustainable cash flows and dividends derived from predictable costs and lower risks. Accordingly, we believe the streaming sector will continue to see favorable returns relative to investments in gold equities or in physical metal itself, as witnessed over the past ten years (Exhibit 2).
The path forward: Primed for growth
The attractiveness of streaming contracts may be challenged if we see more competition in the space or if access to capital from other sources increases. Although the streaming-and-royalties sector has shown strong growth over the past five years, currently the sector represents only a fraction of total equity and debt financing for the mining industry: that is, an average 1 to 3 percent of debt and equity financing from 2017 through 2019. We believe there is room for significant growth in the industry, and several factors will drive tailwinds.
Currently, streaming-and-royalty contracts cover only a limited share of metals production. For example, in the most developed sector, precious metals, streaming deals cover approximately 14 percent of total gold by-product production and less than 6 percent of silver by-product production. In recent years, we have started to see streaming expand into other metals, such as cobalt and nickel, which are in large demand but short supply. The use of streaming may provide the financing required to unlock production for mines with such by-products.
Historically, the geographic focus for streaming-and-royalty transactions has centered on North and South America, with approximately 50 percent of all streaming deals associated with mines in Canada, Mexico, Peru, and the United States. Several potential reasons underlie this, including the geological concentration of base-metals mines, established mining industries and legal frameworks, and a receptive audience to alternative financing structures. However, outside the Americas, streaming deals are limited. Thus, even an increase to a level similar to the Americas would imply that significant opportunity exists for current players and new entrants in, for example, Australia and Southeast Asia. Furthermore, streaming deals may be used as an alternative form of financing in regions regarded as higher risk, which consequently attracts higher debt rates, such as in Africa or Southeast Asia.
A lack of exploration funding since the early 2010s by both majors and juniors has resulted in weak project pipelines and looming reserve crises across several commodities, including base and precious metals. Additional capital investment will be required to close the reserve gap and bring new production to market to meet future demand growth. Although public equity and debt markets are starting to ease for some miners and jurisdictions, these sources of capital will likely be too slow to materialize and be on less attractive terms. Therefore, alternative financing sources such as streaming and royalty will be presented with many investment opportunities—and may even result in increased exploration spend.
Finally, we are starting to witness renewed interest from investors in the mining sector, albeit often targeted at specific in-demand subsectors such as battery materials (including cobalt and nickel). Investors are increasingly looking for direct exposure to commodities while minimizing environmental, social, governance, and operational risks. Such risks can be greater with direct asset ownership or direct investment into mining equities and debt, and may be compounded by management-team missteps. The streaming-and-royalty business model provides exposure to commodities while minimizing many of these risks, as well as offering diversification across a larger portfolio of mining assets. The question is whether investors will stick with traditional investment options or shift to new investment opportunities that may arise.