Alternative Financing methods in mining:

'Alternative finance' has been a recurring theme in the mining industry for some time. With traditional funding sources like debt and equity becoming scarce, mining companies have had to seek financing elsewhere. This has led to the emergence of various players offering alternative funding models such as royalty providers and streaming companies. While this trend is not new, it's evolving in interesting ways.

Metal streaming and royalty agreements entail mining companies selling future production or revenues in exchange for an immediate cash payment. Although these contracts share similarities, they also possess distinctive characteristics. Streaming agreements typically revolve around specific commodities produced by a particular project, such as precious-metal by-products from base-metals projects. In exchange for an upfront cash payment, known as the "deposit balance," the streaming partner secures a portion of future production at a predetermined discounted price, either fixed or based on a fluctuating percentage of the prevailing spot price. Consequently, miners receive payment upon delivery of the streamed physical volumes. Conversely, royalty agreements are generally not tied to specific commodities and are based on overall project revenues. The royalty company does not physically handle the commodities produced by the mine but instead receives a portion of the generated revenue. In essence, streaming transactions involve the transfer of metal, while royalty transactions are settled with cash.

The concept of royalty ownership in the mining industry is commonly attributed to Franco-Nevada, which made its first royalty investment in 1986 by allocating half of its corporate treasury to acquire 4 percent of the revenues from a Nevada mine owned by Western State Minerals. This initial investment paved the way for Franco-Nevada to expand its royalty portfolio across various commodities, shaping the industry's royalty business model. The emergence of the precious metals streaming model is often credited to Wheaton River. In 2004, while seeking funds to bolster its core gold mining operations, Wheaton River conceived the idea of streaming silver by-product from the San Dimas gold mine in Mexico to its subsidiary, Silver Wheaton. This led to the world's first streaming agreement, where Silver Wheaton purchased yet-to-be-produced silver from Wheaton River's Mexican operations in exchange for an upfront payment and additional payments upon silver delivery.

In recent years, new players have entered the streaming and royalty sector, including Triple Flag in 2016, Nomad Royalty in 2019, and Deterra Royalties in 2020. However, the industry remains highly consolidated, with Wheaton Precious Metals, Franco-Nevada Corporation, and Royal Gold comprising approximately 80 percent of the total value of streaming and royalty contracts based on gold equivalent ounces (GEOs).

Royalty finance involves receiving payment based on a percentage of minerals or revenue generated from a mine. It typically entails an upfront payment from the royalty holder in exchange for a percentage of future revenue. This funding can be used for various purposes such as capital expenditure, working capital, or acquisitions.

Royalties can be granted at different stages of a mining company's lifecycle and for various purposes. They offer flexibility to mining companies, particularly in uncertain market conditions, as they are not obligated to make fixed payments like in debt financing.

While royalty finance offers benefits like operational flexibility and limited covenant packages compared to debt financing, it also has limitations. For instance, the quantum of funding provided may not be sufficient for large-scale projects, and it may not align well with other forms of finance.

From the perspective of royalty holders, royalty finance offers equity-like upside potential without direct involvement in company management. However, there are risks such as exposure to transfer issues and limited recourse tied to the success of a single asset.

As the royalty finance market matures, there are emerging issues to consider. Non-bank lenders are becoming more prevalent, offering composite financing solutions that include royalties alongside debt. Mining companies need to weigh the higher costs and long-term implications of such arrangements carefully.

Attractions of royalty finance for the mining company:

1. Flexibility: Unlike debt financing, royalty finance does not impose fixed obligations on the mining company to make payments unless it is actively producing and generating revenue. Similarly, it does not require fixed deliveries of specified production volumes, providing significant flexibility. This flexibility is particularly advantageous when royalty finance is used to substitute construction-phase debt finance, as it circumvents the need for challenging discussions with lenders if construction is delayed and fixed debt payments need adjustment. Given the volatile nature of commodity prices, the inherent flexibility of royalty arrangements can be more suitable for mining companies compared to debt.

2. Limited covenant package: Traditionally, royalty agreements have had concise covenant packages. These covenants typically revolve around obligations to operate the mine according to industry best practices, make decisions as if the mining company had full economic interest in the asset, and provide regular reporting to the royalty holder for auditing royalty payments. This streamlined approach offers significant operational flexibility and cost benefits during transaction documentation. It stands in contrast to the extensive scope of covenant packages associated with debt financing, especially in complex transactions like project financing. Although some argue that certain royalty agreements may lack comprehensive protection during distress, there's a real sense in streamlining these arrangements since the interests of the mining company and the royalty holder are often aligned.

3. No dilution or pressure to 'exit': Royalty finance allows mining companies to access capital without diluting existing shareholders or facing pressure to find an 'exit' as often experienced with certain forms of equity finance. As a result, the management of the mining company largely retains control over the operation, development, exploration, and expansion of their asset without external interference. This control is crucial for ensuring strategic decision-making aligns with the long-term objectives of the company, without the need to compromise ownership or control.

Drawbacks of royalty finance for the mining company:

1. Capital Limitations: Royalty finance typically ranges from $10 million to $50 million. While this amount may suffice for certain operational needs, such as expansion or exploration, it may fall short when a mining company requires a substantial influx of capital. For instance, funding the construction of a new asset often demands a larger investment than what royalty finance alone can provide. This limitation may compel mining companies to seek additional financing sources to meet their capital requirements adequately.

2. Compatibility Challenges with Other Financing Models: Royalty finance may encounter difficulties when interfacing with other forms of financing, especially without the guidance of experienced advisors in hybrid financings. For instance, if a royalty is structured solely based on revenue, project finance lenders may hesitate to accept another commercial institution effectively holding a senior ranking in terms of cash flow to any debt they provide. This discrepancy in seniority could pose challenges in coordinating different financing streams and may deter potential investors. While there are strategies to mitigate these challenges, such as through structured financial arrangements, the complexity involved may still discourage some investors from participating in royalty finance deals.

Attractions of royalty finance for the royalty holder:

1. Potential for 'Equity-like' Returns: The royalty holder stands to benefit from an 'equity-like' upside, as they typically receive a percentage of revenue from the mining operation. This means that during periods of upturns in commodity prices or when the mining company experiences growth, the royalty holder can enjoy increased returns without the need for additional capital investment beyond the initial upfront payment. Essentially, the royalty holder shares in the benefits of equity ownership without the need for active involvement in managing the company's operations.

2. Insulation from Production Costs: Depending on the terms negotiated, royalty holders can potentially shield themselves from escalating production costs. Since their returns are primarily based on revenue generated by the mine, they are less exposed to fluctuations in extraction and refining expenses. This simplified investment approach allows royalty holders to focus on revenue rather than production costs, streamlining their decision-making process. However, it's essential to note that while this insulation from production costs may mitigate short-term risks, prolonged increases in production expenses could still impact the mining company's overall financial health. In such cases of significant financial distress, it becomes challenging for the royalty holder to remain completely insulated from production-related issues.

Disadvantages of royalty finance for the royalty holder:

1. Transfer Risk: In specific jurisdictions, notably in North America, royalty holders may acquire an interest in the underlying asset. This grants them the ability to encumber a future buyer of the asset, extending beyond contractual rights to enforce payment solely against the mining operator who sold the asset. In jurisdictions where this isn't feasible, some royalty holders opt to secure payment obligations against the mining company's assets. However, this practice isn't uniformly implemented, and even with security in place, it doesn't always mitigate transfer or insolvency risks. For instance, if a mining company transfers its primary revenue-generating assets, the value of the security provided for royalty obligations may diminish. Additionally, determining the future value of a royalty for enforcement purposes can pose challenges unless the royalty is well-structured.

2. Limited Recourse: Royalties are often tied to a specific revenue-generating asset. Unlike acquiring equity in a mining company with diverse assets, royalty investments are typically linked to the success of a single asset. Consequently, the royalty holder's recourse may be confined to the revenues generated by that particular asset. If the asset encounters issues such as construction delays or rising operating costs, the royalty holder's investment could be exposed to heightened risk.

The dynamic between royalty holders and traditional financiers presents an interesting challenge, especially as the mining sector shows signs of recovery. It remains to be seen how competition and market liquidity will shape the strategies of royalty companies in the future. Nonetheless, royalty finance is likely to become a standard part of a mining company's financing toolkit in the years to come.

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