Understanding Metal Royalties and Streaming: A Mining Industry Overview

Metal royalty and streaming companies fund minesMining Industry PrimerThe mining industry is involved with the extraction of precious minerals and other geological materials. The extracted materials are transformed into a mineralized form that serves an economic benefit to the prospector or miner. Typical activities in the mining industry include metals production in exchange for money or precious metal. Mines often have trouble getting funding through traditional routes, such as banks, because of the high costs and unpredictable revenueRevenueRevenue is the value of all sales of goods and services recognized by a company in a period. Revenue (also referred to as Sales or Income) associated with the mining industry. This is why they borrow funds from royalty and streaming companies. This is also beneficial for royalty and streaming companies, as they get exposure to precious metals profits without having to take on all the risk of actually operating a mine.

Quick Summary

• Metal royalty and streaming companies provide funds for mines in exchange for future payoffs.
• Royalty companies receive a fixed percentage of the revenue generated by a mine, while streaming companies receive physical metals.
• The benefit for these companies is larger profit margins, less exposure to risks, and diversification while still being in the mining industry.

Overview of a metal royalty company

A metal royalty company will give a mining company a loan and then receive a percentage of the revenue generated by the mine. Generally, the royalty is small, around 1% to 3 %. For example, Franco Nevada can give Kirkland Gold $400 million in loansLoanA loan is a sum of money that one or more individuals or companies borrow from banks or other financial institutions so as to financially manage planned or unplanned events. In doing so, the borrower incurs a debt, which he has to pay back with interest and within a given period of time. and, in exchange, they get 3% of the royalties on a mine. If Kirkland Gold’s mine produces 200,000 ounces of gold, then Franco Nevada will get 3% of the revenue generated from the 200,000 ounces. Assuming the spotSpot PriceThe spot price is the current market price of a security, currency, or commodity available to be bought/sold for immediate settlement. In other words, it is the price at which the sellers and buyers value an asset right now. price of gold is $1,200, that means the mine made $240,000,000 million. A 3% royalty would net Franco Nevada $7,200,000.

Overview of streaming companies

A streaming company also provides funding to a mining company to get a percentage of interest in a particular mine. For example, the streaming company, Franco Nevada, might give a $600 million loan to the mining company, Newmont Goldcorp. Newmont Goldcorp will use the loan to develop Mine A. In exchange, Franco Nevada will have a 7% interest in Mine A until 200,000 ounces of gold has been delivered by Newmont, and then receive 2% after.

When the deal is created, streaming companies also specify a price relative to the spot price to purchase the gold that the mining company produces. For example, if the deal was for 50% of the spot price, then Franco Nevada can realize quite a nice profit marginNet Profit MarginNet Profit Margin (also known as "Profit Margin" or "Net Profit Margin Ratio") is a financial ratio used to calculate the percentage of profit a company produces from its total revenue. It measures the amount of net profit a company obtains per dollar of revenue gained. by paying Newmont Godcorp $600 per ounce for gold when the spot price is $1,200 per ounce. If its agreement with Newmont enables it to purchase 14,000 ounces per year, Franco Nevada stands to net $8.4 million in profit.

Benefits of investing in royalties and streams

A royalty and streaming company has several advantages, such as diversificationDiversificationDiversification is a technique of allocating portfolio resources or capital to a variety of investments.The goal of diversification is to mitigate losses, wide margins, and lower riskRiskIn finance, risk is the probability that actual results will differ from expected results. In the Capital Asset Pricing Model (CAPM), risk is defined as the volatility of returns. The concept of “risk and return” is that riskier assets should have higher expected returns to compensate investors for the higher volatility and increased risk.. Since these companies invest in many mines at once, if one fails, they may still receive revenue from other mines. They can also diversify the risk by investing in mines in different stages. Instead of only investing in mines in the production stage, these companies also buy stakes in mines that are still being developed. By having multiple, some a much as 200,  mines in various stages of development, royalty and streaming companies are less impacted if a few of the mines are not able to generate revenue.

A streaming company gets to buy the metal at reduced prices, which guarantees a wide profit margin. The reduced price is significant enough that the margin will stay very profitable even if the spot price falls. If Franco Nevada is buying gold at $600 an ounce, then even if the spot price of gold declines from $1,200 an ounce to $900 an ounce, Franco Nevada is still turning a nice profit on its gold investments.

Risks of investing in royalties and streams

Even with the benefits of higher margins and consistent earnings, there are still risks with investing in royalties and streams. One of the main risks relates to the structure of the business. To invest in mines, royalties and streaming companies need a large amount of capitalInvested CapitalInvested capital is the investment made by both shareholders and debtholders in a company. When a company needs capital to expand, it can obtain it either by selling stock shares or by issuing bonds. Shareholders are people who have purchased stock in a company and debtholders are those who have purchased bonds.. The two most common ways of raising capital are through stocksCommon StockCommon stock is a type of security that represents ownership of equity in a company. There are other terms – such as common share, ordinary share, or voting share – that are equivalent to common stock. or debtDebtDebt is the money borrowed by one party from another to serve a financial need that otherwise cannot be met outright. Many organizations use debt to procure goods and services that they can’t manage to pay for with cash.. Companies that want a debt-free balance sheet will raise the money through stock issues. This leads to dilution of ownership stake for existing shareholders. If the investment leads to a successful mine, the investors will be rewarded with higher earnings.

A company can also get funding through debt and they will be responsible for the principal and interest payments. If the mine is profitable, then the cash flow will cover the debt payments. If not, then the company will incur the loss of having to fund the debt repayment on their own.

Spot pricesSpot PriceThe spot price is the current market price of a security, currency, or commodity available to be bought/sold for immediate settlement. In other words, it is the price at which the sellers and buyers value an asset right now. and mine production obviously impact the profitability of royalty and streaming companies. If the spot prices fall, royalty companies will receive less revenue and streaming companies can only sell their metals at a lower price. In the case of mine delays, both types of companies will be impacted by a delay of gold flow.

Additional Resources

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