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Fond Memories of Mining
I must be a genius! I thought to myself in the summer of
2010 (Ryan here). I had just made an investment in Yukon-
Nevada Gold Corp. The investment thesis was simple: for less
than $200 million you could buy a quality mining asset with
large reserves in the safe jurisdiction of the United States. Better
yet, it was on the verge of huge production expansion with
a margin of safety backed by its one of a kind roasting facility,
a scarce tangible asset with a value estimated at over a $1B.
After completing a turnaround facilitated by Sprott, one of
the worlds top resource investors, Yukon-Nevada was going
to ramp production steadily and exit the year at a steady
state production level approximating 150,000 gold oz. per
year. The resulting cash flows would be almost $100 million.
This means that we lucky investors could buy this mine
backed by a $1B dollars worth of assets at less than 2x cash
flow! To make things even more interesting management
was predicting that within five years, Yukon-Nevada would
be in a position to produce up to 1 million oz. per year,
a level of cash flow that would be over 7x its estimated
near-term run rate! Sounds like a bet worth making no?
Regardless, I was in good company, as many other skilled value
investors had performed similar levels of due diligence. They,
too, agreed on the promising potential and large margin of
safety. In fact, crazily enough, I wasnt even the only member
of the Portfolio Ops team that felt this way, as (unbeknownst
to me at the time) my co-editor and proverbial brother in
arms Eugene was invested right along with me and by and
large for the exact same reasons.
A Perfect Storm
in Metals & Energy
Portfolio Ops
Above Average Odds Investings
Portfolio Ops Sandstorm Metals & Energy (SND) March 4, 2013
Briefng Box #002
Action to take: Buy Sandstorm Metals & Energy (SND.V, STTYF) up to 50 cents per share.
Target: $1.202.00+ per share over 3 to 5 years
Risk: Low
Synopsis: After building Silver Wheaton and Sandstorm Gold into billion dollar companies, Nolan
Watson created Sandstorm Metals & Energy along similar lines. It earns streaming royalties on min-
ing & energy assets. The stock trades at absurdly low multiples our estimate is less than 4 times
free cash fow from existing royalties.
March 2013 Issue 002
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Within a few months the stock had rocketed up over 300%,
with plenty more upside left to go. What could possibly go
wrong with this investment?
When Genius Failed, Redux
Oh, let us count the ways!
Yukon-Nevada suffered a harsh winter. The company needed
millions of dollars to fix all the damaged facilities. Since the
mine was not producing enough to generate positive cash
flow, management had to raise cash by issuing more shares
and warrants.
Over the next several months things got even worse, as
equipment breakdowns caused further production delays.
To try to provide a short-term fix, management agreed to
let other mining companies use their roasting facility to help
them bridge the gap. Yet, in their desperation, the deals
they struck actually caused Yukon-Nevada to lose money
in the process.
The company had to raise even more cash. It signed an agree-
ment that would give up a significant portion of their future
production to an investment bank. By the end, these moves
diluted shareholders by over 50% and Eugene and I were left
with some cheap tuition and a newfound appreciation for an
age old saying amongst industry guys, namely that whatever
can go wrong in mining, will go wrong.
I guess age-old sayings are age-old for a reason. That, and
while success is a lousy teacher, the reality of the mining
business and owning 2nd and 3rd tier resource assets, not
so much. Hopefully the last time I find myself needing to
relearn what the fish have always known, its the shiny flies
that often have lethal hooks!
Scarred by Battle, But
Valuable Lessons Learned
The lesson here is that mining is simply a horrible business.
The management of Yukon-Nevada was not entirely incom-
petent. They had a large mine that had fallen into disarray
and had to fix an endless list of problems. Even worse, dur-
ing this turnaround effort they were barraged by numerous
additional problems that were outside their control. All of
this costs money, lots and lots of it. Management was so
busy putting out fires that they couldnt focus on growing
production and without production (at least of the profit-
able variety) they quickly kept running out of cash. The result
was a vicious circle, a negative feedback loop that gives way
to what in industry parlance is referred to as a the death
spiral. Sounds fun doesnt it?
The mining business is even worse than the airline business.
Suffering from many of the same type of problems, Buffett
often talks about how he has experienced a similar level of frus-
tration with airline investments, with their large fixed costs,
endless capital expenses, volatile fuel costs, extreme cyclicality,
constant cost pressures (labor unions), lack of pricing power etc.
and how in the end (all things considered), investing in busi-
nesses with these type of characteristics is essentially a suckers
bet, at least it has been in his experience and historically. We
agree. Their very nature makes generating
sizable profits, at least consistently and over
a full cycle, a tough slog. I mean you know
somethings wrong when an industry hasnt
made a dollar of profit in aggregate in ~100
years. Such an astounding fact breathes life
into Buffetts witty, sarcastic, and always
amusing partner Charlie Mungers
comment that, There are answers worth
billions of dollars in a thirty dollar history
book. Indeed!
So the problem with owning a miner is
that its generally an unattractive proposi-
tion (investment wise) regardless of the
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price. With the exception of low cost producers, as businesses
they are entirely unpredictable even worse, they can accu-
rately be described as low return cash-consuming black holes.
By this, I mean the type of business where a high percentage
of its cash flow must be plowed back into its assets simply to
keep it from losing ground. And even if they do manage to
grow, any growth will inevitably be accompanied by a large,
risky upfront cash investment where the return of capital is
often more of a concern than your return on capital. Its the
stuff that haunts this value investors dreams.
As a quick aside, I couldnt help but laugh the other day when
a tweet framed miners as akin to businesses that invest in lotto
tickets, and that on the rare chance they win, they just plow
those winnings right back into even more lotto tickets. Theres
a lot of truth to that.
Your editors think Charlie Munger expressed our sentiment
perfectly when he said, These are businesses where you just
constantly keep pouring (cash) in and pouring it in, but where
no cash ever comes back. One of the things that keeps our
life interesting is trying to avoid those and trying to get
into the other kind of business that just drowns you in
cash Amen! As Munger points out, the question is why
would you even want to own a business that has to work so
hard simply to keep its overall revenue and profits flat and
where the investment required to do so year in, year out, is
not only sizable, but prone to capital destroying hiccups by
its very nature?
So who cares if a business like that is statistically cheap, if
over the long-run it will have such a hard time producing
economic value for its owners. By economic value we mean
owner earnings or the amount of money an owner can take
out of the business after all costs without injuring its earnings
power and competitive position (its basically the cash we can
utilize to either pay ourselves or reinvest to grow our total
profits in the future). Why risk ones hard earned money
if your ability to benefit from value creating dividends is
a long shot at best? The point is that an unpredictable low
quality business that has difficulty generating free cash is sim-
ply a business not worth owning pretty much by definition.
Luckily Eugene and I eventually woke up and started to ask
ourselves what a business like that was worth? Experience
informed answer? Not much, often zero actually and even if
there is a lot of value there unrelated to the resources in the
ground, like with Yukons roaster asset, that value is more
likely than not to be eroded away over time. Its actually
rather astonishing how fast it can happen. And that leads to
a related question, namely whether such businesses will even
be around in a couple of years, let alone in 10 and again,
even if it is, will investors have been diluted into oblivion at
that point? Who knows, and thats the problem.
Anyhow, like Buffett, your editors make a habit of avoiding
businesses of the resource extraction variety on principle, and
that extends really to all bad businesses in general. The lesson
for me in this saga was simply that lifes to short. Ill pass on
all the heartburn, and just stick to buying wonderful busi-
nesses on the rare occasion they get cheap.
Better to spend our time looking for the next epic investment
for posterity like GEICO or Gillette, than the next Yukon
Nevada, investments with the exact opposite attributes of your
typical miner: low fixed costs and expenses, a permanent cost
advantage, the ability to generate large increases in revenues
and profits without requiring large sums of cash, and most
importantly: a huge runway of growth to continually reinvest
these profits at ever increasing rates of return allowing your
investment to compound upon itself for decades. In other
words, the secret ingredients of wealth creation.
Yet many smart investors today are drawn to the resource
and mining industries because they see so many problems in
the current state of the world, problems only compounded
by ineffectual politicians and misguided central bankers. We
get it, and we think that fear is warranted. We also get that
in theory investing in the resource and mining sectors is one
of the few ways investors can go about protecting themselves
from the above issues.
But as you can see, the answer is not to buy a mine, at least
directly. What we want here is exposure to this sector by
finding the proverbial GEICO of resources and mining.
Like GEICO, were looking for a business with very low
market share in terms of the total addressable market,
attractive cash economics, a tremendously long runway for
growth, hard to replicate cost advantages, and compelling
incremental economics. In less jargony terms, we want to
find a well run business where its competitors cant eat away
at its profit generating capabilities and where it has a long
runway to invest its money at high and increasing returns.
A business that provides us with a substantial amount of
low-risk leverage to rising commodity prices so a business
defined by having pretty much the opposite characteristics,
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at least qualitatively, that one would expect to find in a
miner. In short, a resource-based investment where the
risk-averse investor can have his cake and eat it to.
And that brings us to our recommendation: Sandstorm
Metals and Energy (SND).
Briefing Summary
Truth be told, your editors got a bit weak in the knees (in the
figurative sense) when we started running the numbers on this
one, especially given Sandstorm has nearly all the qualities we
look for in a great long-term investment. These are:
1. The stock is unsustainably cheap, both in the absolute
sense and relative to similar businesses.
2. It is run by a smart, proven, and properly incentivized
management team.
3. It possesses a highly attractive long-term business model
with massive opportunities for future growth.
4. There is a high likelihood of meaningful improvements
in near term profitability and cash flow.
5. We have multiple, high probability, catalysts in front of
us that we expect will unlock substantial amounts of value
in the near to medium-term.
In other words, we expect to make a substantial sum of money
with very little risk, and sooner rather than later. Indeed, for
many reasons we think investors stand to earn anywhere
between 2x to 10x their money on Sandstorm Metals &
Energy over the next 5 years. Better yet, the odds of losing
money at the current price are practically non-existent.
Wed be remiss not to mention that this initial overview only
scratches the surface of this hidden gem. It provides merely
a foundational blueprint of sorts on why we believe at the
current quote, an investment in Sandstorm represents such a
remarkable opportunity for the long-term, risk-averse investor.
While a complete, detailed analysis of each of the compa-
nys assets is beyond the scope of this briefing, rest assured
we will continue to peel the layers back of this one of kind,
multi-layered onion in our alerts going forward. Stay tuned
and keep an eye out for coming updates.
The Business Model
Simple yet Stunning
What does Sandstorm do? Sandstorm is a streaming royalty
company. It provides a source of financing to metal and energy
companies to bring development stage projects into production.
In exchange for a large upfront payment, Sandstorm gets to
purchase a future stream of their production at an agreed
upon fixed price usually at far below market prices, thus
ensuring a source of high-margin recurring revenues.
The streaming business model was first pioneered by
Seymour Schulich and Pierre Lassonde, godfathers of the
resource mining space. Together they started Franco-Nevada
Mining Corporation in 1982, initially intended to explore
for gold in Nevada but later transitioned into the worlds
first gold royalty company. (Technically speaking, a stream-
ing model is slightly different from a pure royalty, which
typically gets 23% of the gross revenues produced by the
mine. A more detailed explanation of the streaming model
will be illustrated below.)
The streaming model is a particularly attractive source of
financing for both the resource company and the streamer.
This symbiotic win-win relationship is why we believe that
streaming companies like Sandstorm will be able to capital-
ize on tremendous runway of growth and value creation for
years to come.
Call it a break-through value proposition
For the resource company, many attributes make a streaming
deal far superior to traditional forms of financing like issuing
equity or debt.
1. Streaming is a flexible source of funding, spreading the
risks of mining mutually between both companies.
2. The resource company can immediately capitalize and realize
part of its mines value upfront before production. Obtaining
a quick source of financing enables faster time to produc-
tion yielding a quicker return for shareholders.
3. Streaming is safer and less restrictive than traditional bank
debt. Any bumps along the road to production (which are
inevitable in mining) can imperil the company because
banks are usually inflexible in their covenants and will
move to seize the assets bankrupting the company.
4. Streaming is cheaper than issuing equity. It is less dilutive
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to shareholders who will still maintain ownership rights
allowing more future opportunities.
5. Streaming enables resource companies to finance projects on
a location-by-location basis. They can tailor a streaming deal
to one particular mine, or one particular commodity. It
allows room for additional streaming deals in the future
for the companys other assets. In other words, it does not
tie up the entire companys assets like debt or equity.
For the streaming company, these deals provide a highly
attractive business model.
1. Leverage to underlying commodity prices. We believe that
the future is much more likely than not to see higher prices
due to inflation and emerging market population needs.
Streaming companies offer an excellent investment vehicle
to gain exposure to rising precious metal, base metal, and
energy prices.
2. It is low risk, unlike the mining business itself. Usually, after
providing the initial funding, the streamer is not responsible
for: any further capital expenditures, cost overruns in devel-
oping the mine, escalating operating costs of the mine once
its in production, nor any further exploration costs. As long
as the mine is producing, this model almost ensures the
streamer is cash flow positive with little risk of bankruptcy.
3. Massive operating leverage. Streaming is a low fixed-cost
business model. The core operation of a streaming com-
pany is a handful of key employees evaluating potential
deals. There are very few physical assets or costs. This
enables maximum leverage of the firms intellectual and
financial capital.
4. Huge potential upside. In addition to the streaming deal
itself, the streaming company usually also gains exposure
to any future exploration discoveries and production
upside. If a world-class asset is carefully selected, and if
the deal is properly structured, this attribute can generate
a literal snowball of growing cash flow for decades. This
essentially-free call option cannot be underestimated, and
it is the reason why shareholders of streaming companies
like Franco-Nevada, Royal Gold, and Silver Wheaton
have realized multi-bagger returns.
An Inside Look at a
Blockbuster Streaming Deal
To fully appreciate the sheer power and hidden levers of the
streaming model, lets take an in-depth look at an exemplary
deal by one of the pioneering companies of the industry:
Silver Wheaton and the Penasquito mine.
We did not choose this example at random. Nolan Watson is
the CEO of both Sandstorm Gold and Sandstorm Metals and
Energy. Prior to founding Sandstorm, Watson was one of the
key players and founding members of Silver Wheaton. Watson
was promoted to CFO of Silver Wheaton in 2006 where he
was instrumental in the companys strategy and financing until
he left to start Sandstorm in 2008. At Silver Wheaton, Watson
helped engineer the Penasquito streaming deal, which was
signed in July 2007.
The Penasquito open pit mine is one of the crown jewels
of Goldcorp, which owns and operates the mine. It was
the largest undeveloped silver mine in the world. In July
2007 Silver Wheaton entered into a streaming deal where
they paid Goldcorp an upfront payment of $485 million.
In exchange, Silver Wheaton received the right to buy
25% of the silver production for the entire remaining life
of the mine at only $3.90 per
ounce. At the time: the price
of silver was about $13 per
ounce, ensuring a healthy $9
margin per ounce of almost
pure profit.
Penasquito had plenty of ounc-
es too with 860 million ounces
of proven and probable silver
reserves (215 million ounces
attributable to Silver Wheaton).
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The expected production was 5.5 million ounces per year with
a 17-year mine life. Therefore, this deal should produce about
$50 million per year in cash flow, yielding a respectable 10%
return on invested capital.
Furthermore, Silver Wheatons streaming deal had downside
protection: no further funding obligations, no responsibility for
any capital expenditures, and no obligation to fund any future
expansion costs associated with the mine (even though they
now had a right to 25% of the entire mines production forever).
The risk was also reduced by obtaining cash guarantees that
Goldcorp would complete the mine by certain milestone dates.
Production ramped up in 2010, and Silver Wheaton received
3.8 million ounces generating over $50 million in operating
cash flow, which was higher than initially expected due to
higher silver prices. The Penasquito silver was purchased
from Goldcorp at $3.90 per
ounce and sold for an average
price of $21.60.
It is currently estimated that for
fiscal year 2012, Silver Wheaton
will receive over 7 million ounces
of silver yielding over $150 million
in operating cash flow a stun-
ning 30% annual return on capital
invested of $485 million. As of
September 2012, the Penasquito
mine had cumulatively delivered
over 12 million ounces, resulting
in cumulative operating cash flow
of over $300 million. Thats right:
within 3 years of starting production, Silver Wheaton had
already recovered over 60% of their initial investment back.
Even better, these tremendous returns carried very little risk.
Whereas mining itself suffers all of the potential problems
we discussed above, the streaming companies can prosper
even in bad times. Lets imagine a horrible year where silver
production falls in half to 3.5 million ounces, and simulta-
neously silver prices crater in half to $15 per ounce. Even in
this scorched earth scenario, Silver Wheaton would still have
approximately $40 million in cash flow yielding a still
respectable 8% return.
Time is the friend of the wonderful business,
the enemy of the mediocre.
Warren Buffett, 1989 Annual Letter
What makes the streaming model such a fantastic business is
the very likely possibility of huge future expansion of the mine.
When the Penasquito stream was executed in 2007, the deal
looked quite decent on paper: world-class asset, little downside
risk, and very respectable returns of about $50 million or 10%
per year. But what absolutely crushed the ball out of the park,
was the huge future upside built into the deal:
1. Leverage to metal prices: Since the deal was signed, silver had
skyrocketed from $13 per ounce up to $30, peaking as high
as $45. This has tripled the profits that were originally mod-
eled, since cash costs are fixed at $3.90 per ounce.
2. Future exploration upside for the entire life of the mine: For
a well-selected world-class asset, the mine will have huge
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potential resources that will be developed into reserves as the
mine is further explored. Within two years, the reserves at
Penasquito had been revised upwards by 25% to over 1 bil-
lion ounces (over 260 million ounces attributable to Silver
Wheaton). The expected life of the mine had increased to
over 25 years, significantly higher than the originally mod-
eled 17 years. Even these increases significantly understate
the future potential, since they do not even account for the
additional vast underground resources, of which Silver
Wheaton is entitled to 25% of all future production.
3. Production growth: If a streaming deal is reached with the
right mining partner, over time, their successful execution
can result in significantly greater returns. The Penasquito
deal originally modeled 5.5 million ounces of production
per year. For 2012, its now estimated that production
will be over 7 million ounces. For 2013 and beyond, its
estimated that Penasquito should produce well over 8.5
million ounces per year for at least 25 years.
Lets chew on these numbers for a moment. If Penasquito
delivers 8.5 million ounces to Silver Wheaton, thats over
$200 million of operating cash flow at recent silver prices.
Thats a 40% annual return on capital! For over 25 years!
Quick quiz: whats the net present value of a 25-year bond
that yields 40% ?!?
Consider further, that of the $485 million paid to Goldcorp,
Silver Wheaton financed this deal with a loan of $446 million.
So technically speaking, less than $40 million of equity capital
was invested, and the theoretical annual return on equity
approaches an astronomical 500%!
Back to Sandstorm Metals
and Energy
Sandstorm Metals and Energy was spun off in 2010 from
what is now Sandstorm Gold. It was initially capitalized with
$100 million, and raised an additional $50 million in 2011
by issuing equity. Nolan Watson decided to spin out Metals
and Energy to capitalize on what he (and we) believe will be
a huge growing market providing financing alternatives for
metals and energy companies, not just precious metals miners.
At the moment, they are the only player in this highly attrac-
tive niche, as no other streaming company has a primary
focus on the non-precious metals space.
Sandstorm has invested a total of approximately $125 million
diversified among four different commodities. Below is a brief
snapshot of their portfolio. In future issues we will delve into
the details about some of these streaming deals and why even
just one of these deals can justify the value of the entire com-
pany today.
1. Copper: Brace-McLeod mine, with Donner Metals
and Xstrata. Invested $27 million for 25% of life
of mine production.
2. Natural gas: Gordon Creek property, with Thunderbird
Energy. Invested $25 million for 35% of production.
3. Palladium: Serra Pelada, with Colossus Minerals. Invested
$15 million for 35% of life of mine production.
4. Copper: Oyu Tolgoi, with Entre Gold. Invested
$5 million for 2.5% of production.
5. Coal: Rex and Rosa mines, with Novadx.
Sandstorm is Ridiculously Cheap
Based on conservative estimates, we believe that Sandstorm
Metals and Energy will be on track to generate run-rate cash
flows of a minimum of ~$25m within two years. At its cur-
rent price of $0.39 per share, the enterprise value of the entire
company is only ~$120 million that is after accounting for
a current market cap of $125 million and the ~$5 million in
excess cash in the companys coffers (so after adjusting for all
of its potential commitments).
That said, the capital light nature of the company should
ensure that all of the cash generation in the interim should
drop straight to the bottom line and considering that, we
think it makes sense to subtract another ~$21m from the
present Enterprise Value (which is stock market value plus
debt less cash; think of it as the theoretical value the market
puts on the whole company) to arrive at an implied normal-
ized EV come year-end 2014.
Taking that adjustment into account were looking at a pro
forma YE 14 EV that should approximate ~$99m. Keep in
mind our back of the envelope estimate assumes SND only
generates ~$25m between now and then, which is very con-
servative. Once weve subtracted the companys operating
expenses were able to arrive at the ~$21m debit used above.
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Yes, rub your eyes, this high quality asset-light company with
massive growth potential is trading for approximately 4x nor-
malized cash flow. For some perspective its streaming peers
such as Silver Wheaton, Royal Gold, and Franco-Nevada all
trade at over 12x to 15x estimated 2015 cash flows.
Lets consider just one stream, the Brace-McLeod copper
stream with Donner Metals and Xstrata, which is set to
ramp up production in the imminent future. Notably,
this one stream is poised to conservatively generate ~$16
million + in operating cash flows for many years, perhaps
decades, to come.
At todays stock price, you will be getting this one enduring,
high-quality streaming asset for only ~7x normalized cash
flow, plus you get all the other streams and their huge future
potential for nothing. Thats like being dealt Aces, plus you
get to simultaneously play at least four other hands of pocket
pairs for free!
Granted, we love having multiple ways to win and little risk
of loss with our investments as much as the next guy, espe-
cially when they possess an imminent hard catalyst like we have
here with first production at the Brac-McLeod mine expected
to come on in the imminent future. Candidly, that alone
would be enough to get us interested given the implied valua-
tion, the quality of this asset, and the reality that production
is literally right around the corner. I mean come on, when
Sandstorms largest and perhaps most lucrative stream comes
online the companys cost of
capital should start to rapidly
decline pretty much by defini-
tion. As it does, its multiple
will naturally expand, offering
investors positioned ahead of
time the type of low-risk lay-up
were all constantly digging for.
Yet its the fact we are getting a
bevy of additional high margin
annuity like cash flow streams
with tremendous embedded
growth potential, streams we
should add that by our calcula-
tion are likely worth several
hundred million dollars that
really blows our mind. The
opportunity to purchase a won-
derful asset with contractually
guaranteed senior security at an attractive price, while getting
similar assets worth a couple of multiples of that value for
free just doesnt come around very often. We think its wise
to seize them when they do.
Huge Upside, but Low
Downside Risk
What ultimately makes Sandstorm Metals and Energy such a
uniquely compelling investment, is not just the huge potential
upside trading at an extremely low valuation. Its that all this
upside comes with very little downside risk. Based on our
above discussion of the streaming model in general, this kind
of business doesnt have any of the risks usually associated
with mining.
Even more specific to Sandstorm in particular, Nolan Watson
has carefully crafted each streaming deal to provide maximum
protection with a keen eye on minimizing risk of permanent
loss of capital. Each streaming deal is structured as a senior
secured agreement, fully collateralized by all of the assets
of the mine itself including both the world-class resource
deposits and the mining infrastructure. Each deal is carefully
designed so that Sandstorm can get back its principal payment
within 5 to 7 years, with annual cash repayment guarantees of
over $80 million among its portfolio projects. In other words,
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at the current enterprise value, you are almost guaranteed
to get all of your investment repaid in cash.
Furthermore, Sandstorm Metals and Energy is not a lever-
aged company, at least not in the traditional sense. It has
well over $30 million of cash on hand presently to fund
its commitments, corporate operations, as well as to deploy
towards future opportunities. This is a huge cushion of
liquidity, especially when you consider that this is a business
with very low fixed costs and very few physical assets
primarily just a handful of key employees. Remember as
well that SNDs operations should start generating another
~$12m in cash per month in the near-term as its natural
gas stream continues to ramp and its copper and (perhaps)
met coal streams come online. Because corporate level
expenses are only ~$2 million a year, Sandstorm will be able
to both generate large amounts of excess cash regardless of
where we are in the current economic cycle and can contin-
ue to operate/sustain itself for many years, regardless of the
economic environment.
The Jockey
Nolan Watson is the Real Deal
As you know, at Portfolio Ops our resolve is to concentrate
our investments in great businesses run by extraordinary,
proven managers with substantial skin in the game. While
this doesnt guarantee success by itself, it certainly stacks
the odds of market beating returns in our favor. Rest assured
your editors have and will continue to spend countless hours
studying their track records, incentives, operations, and pick-
ing their minds on site and/or in the office. The goal being
to develop maximum conviction that they have what it takes
to both protect and grow per share value over the long run.
Given the weight that we place on the quality of management
then, it is still very rare that we are as impressed by a CEO as
we are with Nolan Watson.
To point out a few highlights, Watson graduated from
Canadas elite University of British Columbia and quickly
thereafter became a chartered accountant and CFA while
beginning work at Deloittes corporate finance department
doing business valuations and M&A.
Watson was soon taken under the wing of mining legend
Ian Telfer, and in 2004 became the very first employee at
a brand new company called Silver Wheaton. Watson was
promoted to CFO at Silver Wheaton in 2006, which is a
notable achievement considering Watson, at the ripe old
age of 26, was the youngest CFO in the NYSEs history.
As CFO, Watson was instrumental in its growth on both
the strategic and financial front, raising over $1 billion in
debt and equity over the course of his tenure.
Silver Wheaton, armed with a Watson raised treasure chest,
proceeded to practically invent the commodity streaming
business model as we know it not to mention make
a fair amount of coin for themselves and their shareholders.
Actually, they proceeded to make an almost indecent
amount of money during Watsons tenure, but whos
counting (we certainly are!). As evidence, note that Silver
Wheaton grew from an obscure $200 million micro-cap
into a ~$3 billion wealth creation juggernaut.
Not bad for a mid twenty something guys first gig, no?
In 2008, right in the teeth of the great recession, Watson
decided to leave Silver Wheaton to start his own company
Sandstorm Resources. A value guy and entrepreneur at heart,
and fully aware that the most significant fortunes are often
built when theres blood in the streets, Watson and fellow
partner David Awram hit the road looking to raise money for
his new venture.
Armed with an innovative, winning model, along with a fanati-
cal devotion to building a truly great, enduring business, Nolan
planned to hit every bank or potential source of financing in
every city in North America to make it happen. In fact, thats
not an exaggeration, as thats exactly what he and Awram did.
The two pledged to literally not return home to Vancouver
until they had the requisite money in hand.
As an aside, besides being bold, remember, this was in the heart
of the worst financial crisis in a generation so besides being
just all around awesome we it offers us a glimpse of the type
of gritty, nose to the grindstone passion and raw determination
to succeed that is the hallmark of all true great entrepreneurs
and business men. Not only that, it must have taken a tremen-
dous amount of courage to leave a cushy job at the preeminent
stream finance company in the world and attempt to stand on
his own two feet, especially with the global financial system
shaking beneath them.
The intention here isnt to lionize the guy, just to point out
that the above example provides some real insight into the
10 www.portfolioops.com
mans competence, character, courage and overall determina-
tion to succeed. Which is why we couldnt be more fired up
to partner with him as he goes about growing the business over
the long-term. Point being, hes smart, proven, motivated and
not the type of guy that will give up (hes got it all on the line)
and considering that, its hard to imagine a reasonable scenario
where he doesnt grow the value of this business over the next
3, 5, 10 years from today.
Turning back to the topic at hand, the pair succeeded raising
the money and it wasnt long before Nolans money-making
magic was once again on full display as he was able to grow
his baby into a billion dollar company in less than four years.
Along the way, Sandstorm Resources was renamed Sandstorm
Gold, after spinning out Sandstorm Metals and Energy.
Its also well worth keeping in mind that Watsons salary
at Sandstorm Metals and Energy is only $89,000 a year!
Comparisons to Warren Buffett and his shareholder-based
stewardship of Berkshire Hathaway are more than fair, we
believe. And thats because of a variety of policies, perhaps
the most obvious being that nearly his entire net worth is
invested in both of the Sandstorm companies. Like most
great stewards of capital, Watson puts his money where
his mouth is in more ways than one.
Insiders continued to purchase more shares in the open market
last year between $0.32 to $0.35. (Because of the event-driven
nature of the streaming deal business, its very difficult for
management to purchase shares without violating insider-
trading regulations.) From our discussions, they would love
(and expect) to own a lot more because they believe that the
future of Metals and Energy will be especially tremendous
with a first mover advantage, basically zero competitors and
the requisite street cred and rolodex vis a vi both the opera-
tional and financial sides of the business, its hard to argue
with that conclusion, especially taking into account the sheer
volume and range of potential investments that will come
across their desk in the months and years ahead.
For what its worth, Watson is actually on record stating that
he believes SND will eventually grow to be a $50 billion
dollar company (and yes, thats $50 with a B)!
For those taking score, Sandstorm M&Es present market
cap is only $125m.
The Importance of
Management and Moats
Demonstrating the economic power of the streaming/royalty
business model, the success of Silver Wheaton and others like
Franco-Nevada and Royal Gold have not gone unnoticed. In
the coming years, there will be lots of competition from new
royalty companies, financial institutions, and private equity.
Being an asset-light business, the primary assets of a streaming
company are its people. In an industry where lots of people
can simply provide capital and write contracts, the quality of
management will be the key differentiating driver of success
(not unlike insurance). The presence and durability of an
economic moat, if any, will emanate directly from the quality
of management.
In this regard, once again we believe we are especially fortunate
to have the opportunity to partner with someone of Nolan
Watsons caliber. Not only is he a proven and capable manager,
but we also believe he has the vision and foresight to stay at the
leading edge of the industry.
But what possible innovation could there be in financing
a mine, you ask?
The reason that we started Sandstorm is that we strongly
believe that streaming is an attractive alternative to debt
and equity financing for mining companies of all sizes
across the globe, and that it complements other forms of
traditional project finance. When building a mine, every
companys finance needs are different and I think one of
the weaknesses in resource finance has been that the
industry has taken an unimaginative and plain
vanilla approach to funding a mine, despite each
mine and its funding requirements being unique. What
we endeavor to do at Sandstorm, is to work with
our mining partners to determine the best way to
finance their project into production. Streaming
finance will always be at the core of what we do at
Sandstorm, but we have found that being flexible in
our approach has increased our deal flow and given
us access to opportunities that we would not have had
otherwise. Streaming finance is very much in the early
stages of its evolution but I believe that Sandstorm is going
on the forefront of what will be the best financing solution
that the mining industry has ever seen.
Nolan Watson, Sandstorm Gold, 2012 Annual
Report (emphasis added)
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As Watson sees it, the industry of resource financing is
undergoing a paradigm shift. The days of writing a simple
life-of-mine stream for a fixed percentage of production
at a fixed purchase price is coming to an end. In the early
days, the streaming companies structured deals that would
extract maximum profits at the expense of the mining com-
pany. But a stream is often not the best form of financing
for a particular resource asset.
Watson believes that the future of the industry will be in
creating innovative win-win financing solutions. Mining
is an incredibly complex and difficult business, and each
resource will require its own specific set of needs. Watson
wants Sandstorm to be viewed as a true partner with not only
financial capital but also intellectual and creative capital.
They want to be the very first phone call when a mining com-
pany needs financing. This flexibility and speed can form the
kind of moat that a great manager can create in this space, not
unlike the moat Ajit Jain created with Berkshire Reinsurance
Group in the commoditized reinsurance industry. We believe
that Watson is innovating, not only to head off the competi-
tion, but also to truly provide its partners with the best
possible solution to create value for all parties.
In the future, we will see Sandstorm on the cutting edge of
financing innovation. Sandstorm may elect to mix in a small
equity stake or a small amount of senior secured debt. The
most recent deals at Sandstorm Gold offer a glimpse. In their
deal with Mutiny Gold, Sandstorm will give an upfront cash
payment as usual, but will also provide: an additional lump-
sum payment if production hits a milestone, an option to
repurchase up to half of the stream under certain conditions,
and an offer to contribute towards the capital expenditure
costs of developing neighboring mines in return for a stream
of their production.
Sandstorm is also starting to do small royalty deals where the
assets are too early in development to warrant a full streaming
deal. By providing a small amount of development capital in
exchange for a royalty, Sandstorm can also secure the right of
first refusal to any future streaming deals. This is a very low
risk approach to building a pipeline of future streams.
In another brilliant move demonstrating the Sandstorm
managements ability to look forward and around corners
with we deem unusually creative foresight, they purchased a
majority interest in Premier Royalty, which is a much smaller
royalty company. Sandstorm Gold was getting swamped
with a deluge of potential deal flow, but often these projects
were too small to contribute meaningfully to Sandstorm
Golds bottom line. By partnering with Premier Royalty,
Sandstorm not only removed a future competitor, but also
found an avenue to pass along their unusually attractive, but
smaller-sized deal flow that should not only help Premier
Royaltys business but better yet, ensure the company will
continue to profit in the future from the typically more
lucrative smaller end of the stream finance investment spectrum.
As youd expect from Sandstorm, this transaction created
a mutually beneficial win-win for both parties and will ulti-
mately help grow the value of both companies faster together
than apart. In other words, it appears a 1+ 1 = 4 dynamic.
This video highlights Watsons view on the future of
resource financing, and why we believe that Sandstorm
will be at the forefront of the industry with massive growth
opportunities ahead.
Heres another on Watsons charity Nations Cry. This won-
derful TedX speech entitled Compassion Kills discusses
how we can reform charitable giving in order to become
more effective humanitarians.
If you can teach a man to fish
12 www.portfolioops.com
Why Is It Mispriced?
Given that the present valuation stands at less than 4x our
estimate of the companys normalized cash flows within the
next two years, we need to start by asking ourselves a very
simple question. Why are we so lucky?
This valuation is typically reserved only for a truly terrible
business in a terminally declining industry. So there has to
be something wrong with Sandstorm, right?
Well, the short answer is no, not at all. As natural skeptics,
your editors abhor the thought that wed end up the prover-
bial Patsy at the poker table, because usually if something
appears too good to be true
However, in Sandstorms case, we believe that this is the
exception to the rule. In a nutshell then, we think Sandstorm
is mispriced because:
1. Its an illiquid Canadian micro-cap spinoff with little
institutional coverage. Its not surprising to us that the
majority of intelligent investors are completely unaware
of the companys existence.
2. Its operating history is practically non-existent.
3. Streaming companies are often mispriced, especially in the
beginning. Most traditional valuation measures fail to cap-
ture the true value of the streams. Financial statements offer
a very limited view of Sandstorms future earnings power
because it takes time for production to result in revenues
and profits that fall to the bottom line. Indeed, to date the
financials have only shown the cost of acquiring the streams,
but almost no revenue and cash flow given the natural lag
between Sandstorms initial investment and production.
4. Traditional financial metrics fail to consider the considerable
future growth prospects, especially during the beginning
stages. Financials also fail to capture the most critical key of
success: managements ability to select the right deals, struc-
ture them correctly, and navigate the potential setbacks
along the way.
5. Finally, Sandstorms partners are junior resource com-
panies, and this is arguably the worst environment for
commodity finance in decades and unlikely to improve
in the near future.
However, we would like to let in you in on a little secret
(sssshh!) the miners pain is Sandstorms gain. While
somewhat counterintuitive, what most others view as a nega-
tive, the contrarian souls of your editors see as a magnificent
positive. For example, the difficulty in the current environment
to raise debt and/or equity capital has left most companies, even
those with world-class assets, in dire straits.
Alternative financing like streaming, or a creative combination
of solutions such as Sandstorms recent offerings, is unsurpris-
ingly becoming more and more attractive to resource compa-
nies both large and small. In our view then, this negative is
actually hugely positive as turmoil within the capital markets
improves the companys terms of trade and improves their
deal-flow. Said another way, difficult times in mining land
helps lay a foundation for the company to underwrite more,
much more lucrative deals than would otherwise be possible.
Hard to complain there ;)
In summary, what we have here is a temporary situation where
a few hiccups within the companys earliest streams, a pro-
longed period of turmoil within the resource capital markets,
and the companys (backwards-only looking) financial state-
ments have come together to temporarily mask the companys
ability to generate copious amounts of revenues and cash flow.
In other words, we have a perfect storm that has temporarily
obscured this remarkable hidden gem from view temporarily.
Notably many of the greatest wealth creation stories of the
last century also suffered a perfect storm of events. Think
of GEICO near bankruptcy, or American Express after the
salad oil scandal of the 1960s. It was precisely this type of
perfect storm that offered savvy long-term investors like
Buffett who where willing to dig deep in order to discern
the difference between perception and actual reality with
one of his defining investments of his lifetime. For context,
the salad oil scandal provided Buffett with the impetus to
take the time to really look under the hood of what was by
any sane measure a wonderful business priced as if it was
the opposite (read on the road to bankruptcy). Once hed
concluded the issue facing the company wasnt permanent,
and likely to recede in relatively short order, Buffett was
able to take advantage and exploit the temporary window
of opportunity given him to generate truly massive risk-
adjusted returns. Thats exactly the type of situation we
think we have with Sandstorm Metals & Energy.
Better yet, SND is rapidly approaching a game changing inflec-
tion point, as its on the cusp of realizing prodigious and
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(continue)
growing cash flows from a variety of its past investments. As
weve highlighted here and there throughout this report, the
Brace-McLeod copper mine is set to start production within
a few weeks. In other words, its time to get ready, as this will be
just the first of many hard, high probability catalysts over the
next few years that we expect will close the gap between todays
price and intrinsic value, with this one in particular set to
drive a swift, upward re-rate in the value of SNDs stock.
Like Gretzky, at Portfolio Ops we aim to go where the pucks
going to be, not where its been and hence tend place a high
premium on getting in position ahead of time. So the slot is
open, but remember that time is running out, the proverbial
pulled goalie set up we have currently wont last forever.
So How Much Can We Make?
Lets finish up this briefing by looking over some scenarios
On an absolute basis, companies such as Sandstorm Metals
and Energy with 50%+ profit margins that operate in large and
growing markets with zero maintenance capex requirements and
no tax liabilities (based in Barbados) deserve to trade at very high
multiples of cash flow and should be priced accordingly. These
businesses should be reasonably worth a multiple of at least 12x
to 15x cash flow. Given that Sandstorm is still very early in its
evolution, we believe that a 12x multiple of enterprise value to
cash flow is reasonable, if not somewhat conservative.
A 12x multiple of Sandstorms
estimated $25 million normal-
ized cash flow by the end of 2014
implies an enterprise valuation of
$300 million. This is about 3x
higher than our implied YE 14
enterprise value of $97 million.
At an unreasonably cheap 10x
multiple, this would imply a
$250 million enterprise value, or
a return on investment of 2.5x.
On a relative valuation
basis, Sandstorm appears even
cheaper. If we use the average
of appropriate comparable
streaming and royalty compa-
nies (Franco-Nevada, Silver
Wheaton, and Royal Gold),
Sandstorm should trade at 14x cash flow. At 14x, the
company would be worth $350 million, or over 3.5x
its current value.
Not to nitpick the details here, but we believe our $2530
million in cash flow estimate in two years time will prove to
be too conservative. Remember the hidden levers behind the
substantial cash flows and value creation in Silver Wheatons
Penasquito deal? Those same principles will apply to many
of Sandstorms current streaming deals, and in future issues
we will dive deeper into the details of some of these world-
class assets.
Conclusion
Whats not to love? In fact, we dont think its at all hyper-
bolic to state that the underlying economic characteristic of
Sandstorm M&E make it the type of enterprise that should
fan the flames of any self respecting capitalists desire. Of
course, its also run by a superb, visionary owner operator
with a long paper trail of success and substantial skin in the
game, not to mention it comes with a price tag so cheap we
cant imagine how we can lose.
In short then, its the type of opportunity that your editors
live for. We advise taking advantage, opportunities like this
wont last, they never do
14 www.portfolioops.com
Summary Recommendation
Buy Sandstorm Metals & Energy (SND.V) up to 60 cents
per share for a wonderful business that boasts excellent
management, generates fantastic returns on capital has
massive growth potential and yet is currently trading at
less than 4x estimated cash flows come year end 2014.
Your Portfolio Ops Team
Ryan OConnor, Editor
Eugene Huang, Co-Editor
Chris Mayer, Managing Editor
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