Silver Wheaton: Interesting Business Model

Founded in 2004, Silver Wheaton (SLW) is what is known as a metals streaming company.  SLW is listed on both the New York and Toronto Stock Exchanges.  Essentially, SLW purchases by-product silver and gold production from mining companies (base metal and gold companies), in exchange for:

  • an upfront cash payment and in some cases SLW warrants or other consideration; and,
  • a contracted delivered price per ounce of silver and gold settled at the time of the of the initial transaction.

Until a week ago SLW largely was a ‘silver streamer’ and received a comparatively small ‘gold stream’ from its mining and development stage partners.

That silver/gold streaming mix changed on February 5 when SLW announced the acquisition (subject to final approval by Vale’s Board) of:

  • a 70% share of Vale’s gold production from its Sudbury, Ontario mines for 20 years.  The principal output of those mines is nickel; and,
  • a 25% share of Vale’s gold production from its Salobo mine in Brazil for the life of the mine.  The Salobo mine’s principal output is copper.

SLW now has 15 ‘partners’ who collectively operate 19 mines and four development stage projects in ten countries (Argentina, Brazil, Chile, Canada, Greece, Mexico, Portugal, Peru, Sweden and the United States).

SLW’s Vale acquisition cost is U.S.$1.9 billion, 10 million SLW 10 year term warrants with a U.S.$65 strike price, and subject to inflation adjustments for Salobo, U.S.$400 per ounce of gold delivered by Vale to SLW over the term of the contracts.

I had the opportunity last week to speak with Randy Smallwood, CEO and President of SLW with respect to the Vale transaction.  The transaction is without question material (i.e. significant) to SLW.  In summary, Mr. Smallwood told me that:

  • SLW’s Board and Management believe that both gold and silver prices will trend upward from current levels as fiat currencies devalue;
  • the SLW Board and Management is cognizant of the current apparent attitude of financial markets participants toward precious metals exploration, development and producer mining company valuations.  They see that as presenting further opportunities for SLW;
  • irrespective of what SLW’s Board and Management themselves think gold and silver ‘base prices’ to be, at any given point in time SLW bases its business acquisition decisions on what they believe to be the then financial analyst price consensus for each of those two metals.  Today, SLW believes those consensus prices are U.S.$1,325 and U.S.$24 for gold and silver respectively;
  • SLW believes there is significant potential upside in the number of ounces of gold that will be delivered to it from both the Sudbury mines and Salobo.  This is because the Sudbury mines have, according to Mr. Smallwood, a long history of overachieving their stated production forecasts, and because SLW believes subsequent exploration and development at Salobo will result in escalated production from that mine going forward;
  • SLW had about $550 million cash on hand and virtually no debt at September 30, 2012, its last reported quarter end;
  • with respect to the financing of the Vale acquisition, Mr. Smallwood confirmed that SLW had arranged a $2.5 billion bank facility at an annual interest rate of 2%; and,
  • going forward, when questioned about strategy and metal preference, Mr. Smallwood said that SLW is ‘a little more bullish’ on silver because of its demand/supply dynamics, but that SLW would look to do further silver and gold streaming transactions that meet its acquisition criteria.

I am a shareholder in SLW, and like this transaction and the direction it is taking the company.  This is because I find gold somewhat easier to analyze and hence for me more predictable than I find silver, and as a result of this transaction SLW’s gold/silver weighting has changed in favour of gold.

As for SLW viewed overall, once one takes the time to review its business model, that business model is comparatively easy to understand.  SLW can be said to be a different form of royalties company.  In essence, what SLW does is:

  • provide up-front financing for its mining ‘partners’ in exchange for subsequent by-product delivery at ‘much below’ the metal prices that prevail at the date the streaming transaction closes;
  • takes the risk or the reward over the long-term on the gold and silver commodity price; and,
  • takes the risk or the reward with respect to the ongoing economic viability of its ‘partners’, quantity of mine output available to it, which quantity of mine output is dependent on existing and subsequently proven mine reserves, point in time labour relations, country risk, and long-term macro-economic conditions that could result in mine operating growth, decline or closure.

What SLW does not do is directly face mining risk related to permitting delays and related costs, escalating capital costs, operating costs, environmental costs, and closure costs.

I am specifically not recommending SLW to you.  I do suggest you do your own research and discuss the company with your investment advisor.  If you elect to do that, you might want to read Silver Wheaton: Major Miners are Knocking.

Topical References: Silver Wheaton to acquire gold production from Vale SA, from The Globe and Mail, from The Canadian Press, February 5, 2013 (reading time 2 minutes).  Also read:

Through the Economic Straight Talk Newsletter Ian R. Campbell shares his perspective on the world economy, the financial markets, and natural resources. A recognized business valuation authority, he founded Toronto based Campbell Valuation Partners (1976), Stock Research Portal (2007) a source of resource companies market data and analytic tools, and Economic Straight Talk (2012).

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