Creating Royalties for Value Creation
Empress Royalty Corp. (CVE:EMPR) is the latest mining royalty and streaming company to come to the market, listing on the TSX-V in December 2020.
Empress is a precious metal royalty company with a portfolio of 14 royalties. The company is focused on writing royalties and streaming agreements on development to production stage mining projects (Figure 1), rather than acquiring existing royalties, where there is a higher level of competition and the value generated is, as a result, lower.
The company is targeting small to mid-tier sized mining and development companies and plans to invest between US$500,000 to US$20mln per deal. While focused on precious metals (Figure 1), Empress plans to access projects all over the globe.
Figure 1 - Empress' Strategy
Source: Empress Royalties
Separating the company from its peer group is its strategic relationship with Endeavour Financial, Terra Capital and Accendo Banco. These relationships not only allow Empress to access global investment opportunities, where competitors may not be able to but also bring unique mining finance expertise, deal structuring and access to capital markets.
Empress is financially disciplined in its approach to investing, only examining cost-effective operations with strong experienced management teams and excellent exploration potential.
Of the current portfolio of 14 royalties, the most advanced royalty is a 1% net smelter return royalty (NSR) over the Pinos Gold-Silver Project, located in Zacatecas, Mexico. Pinos has all required permits in-place for production and is currently being moved towards construction.
Empress also has two deals in progress, both with exclusivity agreements in place, and is assessing a portfolio of nine other potential deals that could be executed in the first half of 2021 (H121).
Empress currently has C$7.5mln in cash on its balance sheet giving it the funds required to begin to implement its strategy. The company is currently negotiating on over US$50mln of potential investments and can leverage its strategic relationships to assist in sourcing any additional funds required to complete these deals.
The team behind Empress has an impressive pedigree with over 250 years (in aggregate) of proven management and board experience in mining finance and has completed over US$6bn in transactions.
Strategic partners, board and management own 55% of the company. Empress plans to implement a dividend policy, paying out a percentage of gross profits to shareholders, once the company has reached critical mass.
What are royalties and streams?
Mining royalties and streams represent a highly attractive asset class where large cash flow generating assets can be managed by a small low-cost team, resulting in a very high-margin business.
Royalties
A royalty agreement typically involves the holder providing upfront finance to the mine or project and in return, the holder of a royalty is entitled to receive a payment that can be based on many operational or financial metrics.
The holder of the royalty has no ongoing liability to the mine, or owner of the mine, and is therefore exposed to the positive cash flow from the operation without any additional negative cash flow requirement beyond that originally outlaid.
Royalties can also be created in return for consideration in a corporate transaction, including from the sale of a mineral property, as a backstop to a dilution clause in a joint venture arrangement, or as an adjunct to a debt or equity financing arrangement.
Royalties can take several forms, including:
- Gross Proceeds Royalty (GPR)
- Gross Smelter Return Royalty (GSR)
- Gross Value (GV)
- Milling Royalty (MR)
- Net Profits Interest Royalty (NPI)
- Net Smelter Return Royalty (NSR)
- Net Value Royalty (NVR)
Streams
Streams are agreements to buy a product from the mine at a substantial discount to the mineral or metal prices prevailing at the time the stream agreement is entered into, giving the holder significant upside to any uplift in the streamed metal. Streams are often focused on a by-product of mining such as silver produced from a base metal mine.
The holder of the stream will normally make an upfront payment to assist in the development or expansion of a project, reducing the amount of debt and equity the projects owners require to advance the asset.
Advantages
Mining royalties and streams have many advantages when compared to traditional equity investments, including:
- Ranking senior in the capital structure and can often be secured
- No exposure to increases in capital cost or operating costs of the mine
- Exploration expense and capital investment made by the owner of the operation add value to the holder of the royalty at no cost or dilution
- They provide direct exposure to commodity prices
- Royalty and streaming companies trade at attractive valuation multiples
- Increased scale and diversification enhance value
- Ability to increase returns through low-cost leverage
Figure 2 - Royalty Peer Group
Source: Mining and Metals Research Corporation
Peer group
There are currently 24 listed royalty and streaming focused business, and these have market capitalisations that range from US$7mln to US$23bn (Figure 2). This peer group can be divided into four groups based on their market valuation and the development stage of their business.
The majors range in size from US$7bn to US$23bn. These are well-established businesses with annual revenues greater than c. US$580mln, substantial operating cash flows of more than US$380mln per year and are, in general, profitable with underlying earnings (EBITDA) margins between 68% and 81% and price/earnings (PE) ratios between 51 and 63.
The large-tiers are mostly listed in North America and are also mainly focused on precious metals with the only exception to this being Deterra Royalties Limited (ASX:DRR), which is diversified.
The large-tier companies range in size from US$1.3bn to US$2.0bn. These businesses generate annual revenues greater than c. US$80mln and annual operating cash flow greater than US$60mln. They have EBITDA margins between 54% and 79% and PE ratios between 14 and 113.
The mid-tiers range in size from US$326mln to US$778mln. These companies pursue a mixture of strategies such as expanding profitable businesses and backing businesses that have created a significant royalty or streaming portfolio and are moving towards profitability in the near to medium-term.
The annual revenue levels from these businesses range from c. US$25mln to c. US$50mln, with moderate levels of operating cash flows, between c. US$15mln and c. US$35mln. The mid-tiers are mostly listed in North America, and some are diversified with assets in precious metals, bulks, base metals, battery metals and energy, while some are precious metals focused.
The juniors range in size from US$7mln to US$485mln. These businesses are not currently profitable, with limited revenues and are building a portfolio of royalty and streaming assets. The juniors are also largely listed in North America and are more diverse in terms of their commodity exposure.
Figure 3 - Strategic Partnerships
Source: Empress Royalty
Strategic partnerships
Empress Royalties has strategic partnerships with Endeavour Financial, Accendo Banco and Terra Capital (Figure 3), which makes the company unique within its peer group and gives it several strategic advantages.
These relationships give Empress access to a global mining finance network that can be leveraged for generating deal flow, including exclusive access to Mexican royalty & streaming deals. The partners also provide significant mining finance expertise, deal structuring and access to capital markets on a global basis.
Endeavour Financial
Endeavour Financial is a global mining finance business with global experience in developed and emerging markets across all metals and minerals.
The company specialises in the junior to mid-tier end of the markets, advising its clients on over 80 mergers & acquisitions (M&A) transactions and related financing deals, valued at over US$28bn. Endeavour has been involved with more than US$500mln of royalty and streaming financing giving them significant experience in the space.
The team covers every aspect of mining deal-making from identification, structuring and negotiation of transactions to financial analysis and technical due diligence.
Accendo Banco
Accendo Banco is an active investor and lender in the Mexican mining industry, focusing on mid-tier mining companies seeking growth capital. The team has extensive experience in the Latin American mining industry and is composed of experts in all areas of mining, including geologists, engineers and financial analysts.
By working with Empress, Accendo can offer a balanced approach to project funding, providing debt & equity combined with a royalty or stream sourced from Empress.
Terra Capital
The Terra Capital Natural Resource Fund provides investors with exposure to small and mid-sized global mining and energy companies. The fund is structured to maximise capital appreciation while maintaining appropriate levels of risk.
Since the fund’s inception in June 2010, it has outperformed all benchmarks and become a leader amongst its peers. Stock selection is a key distinguishing factor for the fund as it aims to continue to produce superior absolute returns over the medium and long-term.
Also, the fund has several key investors who have been highly successful in mining and energy companies in their own right. These contacts provide useful expertise on geological, metallurgical and engineering matters pertaining to due diligence.
Figure 4 - Pinos Project
Source: Empress Royalty
Figure 5 - Historic Plant
Source: Candelaria Mining
Figure 6 - Resource Estimate
Source: Candelaria Mining
Current investments
Pinos Gold-Silver 1% NSR
The Pinos royalty is a 1% net smelter return royalty that covers all production from the Pinos Gold-Silver Project, located in the State of Zacatecas, Mexico (Figure 4).
The project is being developed by Candelaria Mining Corp. (CVE:CAND), which secured the final portion of the debt funding required to develop the underground mine in June 2020 in the form of a US$9.0mln loan facility with Accendo Banco, S.A. and is now seeking the equity component.
Historic operations at the project (Figure 5) terminated at a depth of 180 metres below the surface, due to reaching the water table, but drilling has demonstrated that the mineralisation continues at depth.
The project has a current NI 43-101 compliant indicated resource estimate that stands at 20,586 ounces (oz) of gold and 267,745 of ounces of silver at a grade of 3.6 grams per tonne (g/t) gold and 47.4 g/t silver (Figure 6), and the inferred resource estimate stands at 60,657 ounces of gold and 811,082 ounces of silver at a grade of 3.6 g/t gold and 47.4 g/t silver. Overall, this is an indicated resource of 26,358 ounces of gold equivalent (Au eq) at a grade of 4.7 g/t of Au eq and an inferred resource of 56,146 oz Au eq at a grade of 4.6 g/t Au eq.
A preliminary economic assessment (PEA) for the project, completed in 2018, defined average annual production levels of c. 12,700 oz Au eq over an initial life of mine of seven years. The deposit has the potential to be expanded at depth and along strike, and it’s estimated that 80% of the district has yet to be explored, so the mine life could be extended with further successful exploration.
Pinos has all required permits in-place for production and will begin construction of a 200 tonnes-per-day (tpd) mining operation with a path to ramp-up to 400 tpd within two years of initial production.
Empress acquired its royalty at the project for a total consideration of US$1.5mln. The acquisition was a combination of a newly created 0.5% NSR royalty on the project for consideration of US$750,000 and the purchase of an additional 0.5% NSR royalty on the project from an existing royalty holder on the same terms.
Figure 7 - Exploration Portfolio
Source: Empress Royalty
At a gold price of US$1,750/oz and a silver price of US$18/oz, the royalty would generate US$213,000 per year in cash flow to Empress.
Exploration Portfolio
Empress also owns a portfolio of 13, 0.5% to 1.0% NSR royalties, over a series of exploration to resource stage gold projects, located in Canada (Figure 7).
Companies operating these projects include Osisko Mining (TSE:OR.WT), Big Ridge Gold Corp (CVE:BRAU), Wesdome Gold Mines Ltd (TSE:WDO) and Sanatana Resources Inc. (CVE:STA).
Figure 8 - Empress' Share Register
Source: Empress Royalty
Investments in progress
Empress is currently in active negotiations creating two investments, both of which have exclusivity agreements in place. These are excellent examples of the type of investments Empress is looking to structure and execute.
The first potential investment is a 2.25% royalty over a gold project, located in Mozambique. The mine is expected to produce c. 30,000 a year for three years, of which Empress's attributable interest is c. 690,000 oz a year for three years, though there is the potential that satellite deposits will add additional upside with further exploration.
The acquisition has an estimated cost of US$2mln and could potentially generate US$1.2mln per annum in cash flow to Empress, assuming a gold price of US$1,750/oz.
The second potential investment is a silver stream over a near-term production project located in Mexico. The stream would cover 146,000 oz of silver production per annum over a period of ten years. The project has a time to production of six to nine months from the finalisation of funding.
This acquisition has an estimated cost of US$4mln and could potentially generate a cash flow to Empress of US$2.1mln per annum assuming a silver price of US$18/oz.
Deal pipeline
In addition to those deals in progress Empress is currently assessing the creation of royalties and or steams on an additional nine projects that vary in size from less than US$1mln to US$10mln. While there is no certainty that all or any of these deals will close, the pipeline demonstrates Empress's aggressive approach to building its portfolio.
Share register
Empress has 71,699,385 shares in issue with no warrants or options. Empress has an impressive share register with its three strategic partners holding 51% of the company (Figure 8), institutional investors holding 20% and board and management holding 5%. This gives the company a free float of 24%.