Silver Wheaton: Upcoming Golden Ages
The Ivey Business Review is a student publication conceived, designed and managed by Honors Business Administration students at the Ivey Business School.
What Streams Are Made Of
Stream financing, or streaming, is used to provide capital to mining companies, often to accommodate the construction of mines or, in recent occurrences, to reduce debt levels in exchange for interests in the future production of the mine. This style of financing allows mining companies to receive an upfront, one-time payment in addition to ongoing payments at a fixed price per ounce on a portion of the mine’s production. A similar type of financing is a royalty, where a mining company receives an upfront, one-time payment for a portion of the mine’s net revenue, commonly known as a net smelter return (NSR).
With a fall in precious metals prices during 2015, mining companies saw depressed earnings. Subsequently, investors, specifically on the credit side, began to lose their appetite for financing miners. In turn, the global metal streaming and royalty industry experienced a record year. The number of streaming and royalty transactions increased from 11 in 2014 to 27 in 2015 with deal values increasing three-fold to $4.0 billion. This industry boom spurred fierce rivalries among streaming companies in unanticipated and competitive bidding processes, predominantly due to the recent introduction of alternative buyers of streams, including mining-focused private equity firms, pension funds, hedge funds and smaller streamers through the use of syndicates. Moreover, with this increase in both the number of transactions and the value of the deals, some streamers are facing difficulties in financing the potential acquisitions of streams as debt levels rise and companies exhaust equity offerings. With the increasing competitiveness of the industry and limited financing flexibility, streamers like Silver Wheaton Corp. could cease to exist in the industry they worked to create.
Tremendous growth in deals has led to the entry of diverse competitors including mining-focused private equity firm X2 Resources, with a fund of US $5.6 billion, hedge fund Elliot Management, backing Triple Flag’s billion-dollar fund, and state-owned investment funds like China’s Silk Road Fund, with $40 billion in capital. These entrants are few of a growing number of players in the streaming and royalty industry. Investment funds, with an abundance of capital from individual investors and smaller funds, are beginning to make active moves in the industry such as Pretium Resources Inc.’s US $150-million stream sale to private equity firms such as Orion Resource Partners and Blackstone Group in September 2015. A finite number of streams and the competitive nature of bidding processes mean an increase in players alarming for even established firms like Silver Wheaton.
A Golden Opportunity
Silver Wheaton faces a particularly unique challenge as it is one of the most levered streaming companies compared to large competitors. It must continue to finance acquisitions while remaining competitive with new entrants.
Streaming companies typically finance the acquisition of streams using traditional financing, a combination of cash and debt. Cash can be generated through ongoing operations or raised through previous or concurrent equity offerings. Silver Wheaton’s unique challenge resides in the company’s ability to consistently and sustainably secure financing for stream acquisitions. As of Sept. 30, 2016, the company has $1.3 billion in total debt due to a recent $800 million stream acquisition in August. With total debt-to-capital of 21.32 per cent, compared to the average of top five streaming companies at 9.53 per cent, Silver Wheaton is more highly levered than its peers and could face difficulties going forward in securing public and bank debt.
Silver Wheaton, however, has performed well over the past 10 months as precious metals prices have risen, lifting its share price 44 per cent YTD, following a 25 per cent decline after the announcement of third quarter results. The company capitalized on this performance with a $500-million equity offering in March 2016, using proceeds to pay down debt, the second follow-on offering in the past 18 months (previous offering in March 2015). Despite strong investor appetite for the offering, with underwriters exercising the 15 per cent over-allotment, it is unlikely Silver Wheaton will access the equity markets in the next several months given its recent trend of March offerings. This is largely a result of a recent 25-per-cent decline in the company’s share price, dampening investor sentiment and disincentive follow-on offerings at the current share price.
Moreover, Silver Wheaton has experienced difficulties in the past with a lackluster $800 million bought deal offering in March 2015, with sources reporting that the initial three per cent discount offering was only one-third sold until the underwriters re-priced to a substantial 11 per cent discount. Continued equity issuances can have a dilutive effect on shareholders’ equity, straining Silver Wheaton’s future financing flexibility.
Silver Wheaton is also challenged by limited financing flexibility. To combat these issues, it should look to adopt an alternative financing method that allows itself to position as a direct competitor to streaming-focused investment funds. Under this strategy, Silver Wheaton would create a $500-million fund, Fund 1, that would be exclusively used to finance the acquisition of approximately five to seven streams in the coming years. Investors would commit capital towards Fund 1 and receive a specific percentage of each mine’s production based on the allocation of stream financing from Fund 1 used in the acquisition, as well as the investor’s initial investment.
NAV-igating The Future
Silver Wheaton would structure Fund 1 similar to that of private equity funds, targeting alike investors including high-net-worth individuals, wealth managers and small pension funds. Fund 1 would also target current shareholders through a dividend reinvestment plan that would allow quarterly dividends to be committed to Silver Wheaton’s next fund. As opposed to typical private equity funds with approximately two per cent management fees and a locked -in commitment, Fund 1 will be vastly different with 0.5 per cent management fees and the introduction of a buyback option to provide further liquidity from an investor perspective. With this option, Silver Wheaton would have the ability to buy back each investor’s interest in Fund 1 for the Net Asset Value (NAV) per unit sold to them. This would allow Silver Wheaton to gain further exposure to the funds’ mines, and allow investors to liquidate their position.
The fundraising process would begin with Silver Wheaton strengthening relationships with small-scale pension funds, asset management funds and wealth managers to attract capital. It would also begin the outreach process with existing shareholders and high-net-worth individuals to redirect capital flowing into the investment funds to Silver Wheaton’s Fund 1. Despite the long-term nature of most fundraising processes, Silver Wheaton’s experience within the streaming industry would imply a shorter fundraising timeframe, likely in the 12-month range.
Fund 1 does not aim to provide immediate financing flexibility. Instead, it aims to supplement traditional financing within one year by providing sustainable and consistent capital for stream acquisitions throughout a one- to three-year period. With increasing debt levels, the unpredictability of the equity markets and Silver Wheaton’s share price in twelve months’ time, stream financing allows Silver Wheaton to remain competitive in each bidding process with continued access to capital.
Silver Wheaton’s fund strategy will focus on maintaining its current metal allocation of 60 per cent silver and 40 per cent gold. Silver Wheaton will look to strengthen relationships with major mining companies with solid credit ratings, a long-term strategy of debt reduction and high quality assets in stable, mining-friendly jurisdictions.
The fund will aim to deploy capital across five to seven stream acquisitions with fund contributions less than $150 million (30 per cent) per acquisition to reduce portfolio risk.
For example, this could involve partaking in approximately two transactions in each of the $100-150 million range, $75-100 million range and $25-75 million range.
Due to the long-term investment horizon in the industry of 10 to 20 years and unclear or non-existent exit strategies, streaming returns are often unavailable, undisclosed or projected based on a number of operating assumptions provided by the seller and mining technical team. Additionally, the very recent entrance of streaming-focused investment funds leads to a limited number of transactions that have been completed and returns have yet to be realized. As a result, Silver Wheaton may face difficulty in marketing the fund using realized returns in the streaming industry. CEO Randy Smallwood has stated the historical rate of return for Silver Wheaton’s investments has been 24 per cent, which provides substantial returns for both the company and investors. Further, Silver Wheaton will rely on previously projected returns from their past three acquisitions, which range from a rate of return of five-17.5 per cent, as well as the company’s target range of six-10 per cent.
The primary benefit to investors is the stability of the cash flow from the streams. This provides investors with fixed income like cash flow generation for a long-term period with a targeted rate of return between six per cent and 10 per cent. Investors also benefit from this fund through the diversified investment offering, technical knowledge of Silver Wheaton, and the unique structure of the fund. By investing in Fund 1, investors would diversify their portfolio with a geographically diverse set of streams from major mining companies, commodity leverage through price fluctuations and production exposure to each mine. Investors gain access to Silver Wheaton’s technical experience in the streaming industry, serving as a unique competitive advantage to alternative investment funds with limited transaction and relationship experience. Further, the structure of Fund 1 provides investors with above-average returns, a stable stream of cash flows, low management fees and a buyback option for increased liquidity.
Fund 1 also benefits Silver Wheaton by being able to strategically position itself to compete directly with investment funds for capital, targeting alike investors in an attempt to redirect capital into its own fund as opposed to other investment funds. This strategic positioning resolves the secondary challenge of consistently and sustainably securing financing for acquisitions. By providing a unique alternative form of financing, the company will expand its financing options and can achieve further flexibility moving forward in this increasingly competitive industry.
Silver Wheaton’s shareholders also benefit from the non-dilute nature of this solution, since raising more equity to finance future acquisitions could dilute shareholder value.
The raising of a fund may signal that Silver Wheaton has strong interest in acquiring several new streams, leading to investor confidence and share appreciation and benefiting in line with the fund strategy, Silver Wheaton should look at purchasing high quality gold or silver assets operated by major mining companies. In focusing on mining companies with debt reduction strategies, most notably Vale and Glencore, Silver Wheaton can foster and maintain a long-term relationship with further acquisitions under the fund. For example, currently on the market is Glencore’s Vasilkovskoye mine in Kazakhstan, a producer of numerous minerals. The Vasilkovskoye mine, valued at $2 billion, has been on the radar of numerous streamers and investment funds, specifically China’s Silk Road Fund and provides a potential stream acquisition in the neighbourhood of $500 million. Despite significant potential demand for the asset, the mine has been on the market since the beginning of the year, mitigating the risk of overpaying. An acquisition like this for Silver Wheaton would use a combination of traditional financing, typically debt and cash, and alternative financing with approximately $150 million from Fund 1. Although the debt financing will increase leverage, it will only increase moderately due to the use of Fund 1 and will fit within the company’s revolver.
A Stream Come True
With the addition of an alternative form of financing for Silver Wheaton through the establishment of Fund 1, the company would be able to strategically compete with new entrants and benefit financially with consistent and sustainable financing. Private equity fundraising for natural resources increased to a record high in 2015 with 74 funds raising a total of $67.8 billion. Despite the metals and mining industry only closing two funds in 2015 and raising a total of $400 million—likely due to suppressed base and precious metal prices—metals and mining is the second most sought-after natural resources private equity investment. In 2016, 50 per cent of investors are seeking investments in the sector, while mining -focused funds are looking to raise $3.8 billion. Given the expected increase in mining-focused private equity fundraising, recent increases in precious metals prices and the unique use of streaming-focused private equity, Silver Wheaton will have the scale to sustainably source capital for Fund 1.
With the strategic positioning of Fund 1 to compete with streaming-focused investment funds and the additional capital to support future stream acquisitions, Silver Wheaton has the ability to remain one of the streaming industry’s dominant players.