SND.to - Sandstorm Metals & Energy

[kevin4u2]

 

I agree. I would also short sandstorm gold.

 

I never understand the logic of a company raising capital, buying some assets, and voila they are now magically worth a multiple of the purchase price. Beyond this is the inherent risk is the exposure to the underlying commodity prices.

 

Sure many of these guys appear brilliant when commodity prices are rising, but skill is often confused with luck. As buffett would say, "A rising tide lifts all boats." If Mondays action in the gold market is any indication of what is about to come, the tide may be on its way out.

 

I think you need to look at this business model.  Its not dependent on the rise in commodities prices (like most producers) to make substantial profits.  The contracts they set up are purchase agreements to a percentage of future production at a fixed price which is at or below the low cost producers cash cost. I'm a bottom up investor but I think you'd be hard pressed to convince me that owning future rights to a diverse basket of commodities at a fixed price below cost of production is a bad thing.  I'm ok purchasing nat gas @ $1 / Mcf, copper at $0.80/lb or $0.55 if Cu is < $2.75, and Palladium for $100/oz for years to come.

 

Wow. Don't take this the wrong way but this sounds like it's too good to be true.

 

Why are the companies they are making these agreements with so dumb? They are literally giving away money. Why not get financing from a bank or some other conventional source? If management of these companies are so stupid to give away such value I don't want to do business with them. If they cannot obtain conventional financing there is substantial operational risk. Let's not kid around. What these guys are doing is like sub prime housing, financing the most risky projects.

 

These contracts require the time value of money and assumptions regarding the forward strip for the underlying commodity. I wouldn't discount the commodity price risk. Let me be clear. If commodity prices fall the mines will be worth nothing and the cf streams are worthless. Given the marginal nature of the projects all works well while the music is playing. When the music stops, these get nasty.

 

Sorry I fret too much about the downside.

[AAOI]

No offense taken. Like I said, I can't really speak on the particulars anymore but practically every single assumption in the above paragraph is wrong and yes, I too worry about the downside (rest assured).

 

As Burry say's, check your premises!

[ItsAValueTrap]

Why are the companies they are making these agreements with so dumb?

For the most part, the deals aren't dumb.  Usually when these companies make deals with each other, they don't do anything too stupid.

 

Fundamentally, here's how it works:

1- Companies lie about future production and the economics of their project all the time.  They will usually miss their production targets and so forth.  There are few legal repercussions for giving inflated numbers because all this stuff is subjective.

 

2- Lie about your asset, go pump your stock, raise capital, rinse and repeat.  Many companies in the resource space do this. 

 

3a- If your project is really marginal and/or you are distressed, you might actually give Sandstorm a good deal.  If your project is really marginal, it will be hard to convince a bank to lend you money.  It's usually hard to raise financing.

 

The other thing is that you badly need to raise capital.  Without capital, you can't extract the resource.  If you can't extract the resource, you can't unlock the value of your asset and will bleed to death from your overhead costs.  Juniors have overhead costs from consultants and professional staff.  Maybe they can mothball their project and wait for commodity prices to rise, but this may not be the best idea.  If their stock is overpriced, then they should keep the charade going so that they can sell stock.  (Also... the part-time CEO's pay has to come from somewhere.)

 

And depending on how far along they are in development, stopping/starting costs some money.  So sometimes you want to keep plowing ahead.

 

3b- Sometimes juniors will extend warrants (this is like giving away money) because they need financing so badly.  Extending warrants has low costs compared to selling stock through underwriters/brokers... plus it makes the brokers' clients happy when they get something for free.

 

4- Sometimes a company will continue to extract a resource even if it's not economic to do so.  Yukon Nevada Gold / Veris Gold might be an example of this.  This can occur if the company is able to use other people's money to fund operations and to pay the (part-time) insiders' salaries.  Right now juniors are getting killed so the financings probably aren't going to happen.

 

If you own a royalty on this kind of thing, you will make money off their uneconomic behaviour.  So that is a way to get something for nothing.

 

 

What Sandstorm Metals & Energy is doing might actually be smart.  But I think they got really unlucky.  We'll see what happens.  I have no position in this, and have no plans to go short or long this thing.

[luck]

i'd use caution shorting anything run by nolan watson.  check out what happened to sandstorm gold. 

 

you might be right though, value trap, great manager mixed up in a few unlucky deals.  i believe he took donner stock in a deal and is down 75% or so in not too long.  i don't think the stock deal was that material, but given his early mistakes with coal in sandstorm metals and energy, probably best to approach this stock with a degree of healthy skepticism.  also, important not to forget his insanely positive longterm record with sandstorm gold and silver wheaton.

 

as for the stock itself, down almost 45% year to date.  not sure what's happening for such a drastic move downwards beyond recent pressure on miners.  perhaps illiquidity.  there also could be something that i'm missing.

 

as for the insider buys, i don't think it's a feint.  watson seems to truly believe in the potential of the company.

[Otsog]

Bracemac production underway

 

http://donnermetals.com/wp-content/uploads/2013/05/NR16May2013.pdf

[GrizzlyRock]

Just cracking into Sandstorm Metals over here. Basically you have to do a deep dive on each project to get a reasonable valuation of what they have now and then layer over a sense of management & capital allocation.  My guess is not all the guys on this thread have not done that (besides AAOI). Achievable yet you'll get a very wide range of outcome values...

 

So the largest risks I see off the bat are as follows (in no particular order):

(1) Projects blow up - as seen recently with Terrex and the coal assets

(2) Management issues shares at inopportune times

(3) Bankruptcy of project partners

(4) Commodity price declines

(5) Foreign expropriation of assets

(5) Market participants hating the juniors & junior financing (effects trading price not IV)

 

Did I miss any?

[ItsAValueTrap]

(2) Management issues shares at inopportune times

Either:

 

A- Management is bad or unethical for selling shares when they are undervalued.

B- Management really knows what they are doing and are selling shares because they are *overvalued*.

 

I think that Mr. Nolan is one of the smarter CEOs out there.  (Though he is promotional... e.g. I can see they spent money on their website and on corporate videos.)  He understands the Ponzi nature of most juniors... that's originally why he liked streaming deals in the first place.  And he understands that mining investors can be more profitable than mining for ore.

 

Sandstorm has a lot of cash on hand so they don't need to raise capital.  They don't have to spend money on exploration to hold onto their claims (unlike other undercapitalized companies which are in trouble).  It is likely that Nolan is raising capital because the shares are overvalued.

 

[GrizzlyRock]

Alright - after a week of study I have a reasonable understanding of the projects, risks, and can reasonable make both the bear and bull arguments.

 

As I mentioned above, the first steps to understand Sandstorm Metals & Energy is to understand the current projects. This will not only enable the analyst to understand the basics of the future cash flow streams. In so doing, the analyst will get a sense of how management thinks and structure's deals.

 

So I'll try to lay out each project this week (one per day) and then post some wrap-up thoughts over next weekend.

[GrizzlyRock]

Let's start with the easiest project Sandstorm has (and the only project that is currently cash flowing).

 

Bracemac-McLeod Copper Mine in Quebec, Canada

 

Sandstorm’s first project to reach mine completion and begin generating cash flow for the company is the copper stream at the Bracemac-McLeod project.

 

Sandstorm signed a streaming deal with Donner Metals Ltd (CVE:DON) in 2011 while investing $27 million in the project ($20 million in 2011 and 7 million in 2012). In return, Sandstorm receives 24.5% of all the copper produced at the mine for life while basically paying minimal ongoing extraction costs (no additional capex or operational costs) for the copper (Cu).

 

At Bracemac-McLeod, Donner (market cap of ~38 million) developed the project in a JV with mining giant Xstrata. Donner owns 35% of the JV with Xstrata owning the remaining 65%. Xstrata and Donner started developing Bracemac-McLeod in 2010 as a zinc mine. This is important for 2 reasons: (1) Sandstorm Metals was able to structure an intriguing stream on the copper assets as the copper assets were fairly ancillary to the project’s success form Xstrata and Donner’s perception and (2) zinc is a relatively stable commodity in terms of demand and price. This increases the likelihood that the Bracemac-McLeod project will be run continuously until depleted.

 

Mining operations just commenced and Sandstorm expects to be receiving their initial cash payment in late June with production reaching the run rate of 21 million Cu Lbs by the late summer or early fall.

 

Sandstorm will purchase the fist year’s worth of copper (specifically 20.8 million pounds) at $0.80 if the spot Cu price > $2.75 per pound and $0.55 is Cu < $2.75. Afterwards, Sandstorm will pay $1.05 per pound if the spot Cu price > $2.75 per pound and $0.80 is Cu < $2.75. Of note is the gross margin contractually built in to Sandstorm’s agreement – this will become a theme as we walk though an analysis of each project.

 

Estimated DCF Valuation

 

The most recent resource report indicates a minimal mine life of 4 to 5 years. After speaking with multiple involved parties, I can assure you that Xstrata and Donner didn’t build this mine to last 5 years. Current fairly conservative estimates are in the range of 8 to 10 years.

 

Using a 11.5 year mine life, steady copper prices of $3.55, steady production rates at 21 million Cu Lbs, and a 15% cost of capital for Sandstorm, Bracemac-McLeod is worth $75 million in present value terms (before taxes) to Sandstorm. This represents a value of $2.3 per share and is triple Sandstorm’s book carrying value of the project.

 

In a downside scenario of $2.25 Cu and a 6.5 year mine life, the project is still worth $33.5 million or $1.00 per share. In an upside scenario of increased mine life and or increased copper prices (both of which are possible), the Bracemac-McLeod project is worth more than the entire EV of Sandstorm at current price ($3.26 per share).

 

[matts]

Fantastic analysis GrizzlyRock. I'm looking forward to the rest of the posts. I have a small position in SND and I'm down a bit so I'm trying to decide whether to add or get out.

 

 

 

[GrizzlyRock]

Serra Pelada Palladium Stream in Carajas, Brazil

 

Anticipated to be the second completed cash-flowing project for Sandstorm Metals, the Serra Pelada project is a gold mine in which both Sandstorm Gold and Sandstorm Metals have invested. Sandstorm Gold paid $60 million for the rights to 35% of the precious metals stream (gold and platinum) while Sandstorm Metals paid $15 million in September 2012 for a 35% stream of the mine’s total palladium production. (Note: the commentary herein includes Sandstorm Gold as this “back to back” type of arrangement whereby Sandstorm Gold invests and receives the precious metals stream and Sandstorm Metals invests and receives the base metals stream will be a theme of the Company).

 

The Sandstorm entities signed an agreement with junior miner Colossus Minerals Inc. (TSE:CSI) (market cap of $170 million) in September 2012 to provide completion financing for the mine. Colossus has partnered with the Brazilian government with Colossus owning 75% of the project with the Brazilian government owning the remaining 25% of the project. Between 1980 and 1986 Serra Pelada was host to the largest precious metals rush in Latin American history. However, most of the mining was done open pit style with human labor as the main effort. Colossus’ effort is substantially greater in scope and scale with modern mining techniques being applied to the underground mine.

 

This project highlights two of Sandstorm Metal’s desires when negotiating a stream: (1) Invest in stable political climates whereby the government is supporting of development. In this case, the foreign government in question is a resource owner and jointly incentivized to see Serra Pelada succeed. (2) Invest the last (or at least the next to last) chunk of capital necessary to bring a mine project to production. At Serra Pelada, this actually did not occur.

 

The mine build out was incrementally more costly than anticipated and roughly $25 million was needed to complete the project. Did Sandstorm invest the additional capital? No Was Sandstorm’s stake diluted in any way? Nope. Just last week, Colossus raised the requisite $25 million in a bought deal financing. This capital is sufficient bring the mine into production in late 2013. With 80% to 85% of the mine buildout complete and clear visibility to the end of the year both from the financing and mine completion perspective, I have a high degree of confidence this project will be up and running in early 2014.

 

Note that Sandstorm Metals will begin receiving cash roughly 1 year after the Serra Pelada project commences operations due to the ancillary hard metal extraction process for which Colossus must build extra equipment. So While Sandstorm Gold will begin receiving cash from their gold stream in early 2014, both the platinum (Sandstorm Gold) and palladium (Sandstorm Metals) steams will be pushed back ~12 months until cash is flowing in a material way.

 

Estimated DCF Valuation

 

While Serra Pelada is the second easiest project to value due to the near term (18 months out) nature of the cash flow, nearly completed project, stable political environment, and fair market for palladium – a DCF of Serra Pelada remains highly subject to assumptions. As of today, there is no publicly available resource report at Serra Pelada. In fact, a resource estimate is in progress and will be completed later this year. Of course, this could be either an upside or downside catalyst.

 

Ok here is what we know for sure about the mine:

- The mine test drillings have produced very high grade samplings.

- Serra Pelada was the site of the largest non-organized gold excavation in history due to the amount of metal deposits accessible.

- Brazilian government is investing (likely a highly knowledgeable party regarding local geology).

- Sandstorm Metals and Sandstorm Gold sent their mining ops “drop team” to the site for intensive due diligence and then invested $15 million at Metals for the palladium stream and $60 million at Gold for the platinum and gold streams.

 

And now here is where the assumptions begin. Without a formal resource report to model the cash flows, we are only able to make high level statements.  So let’s model this project off the Brace-McLeod: if the base case value is 3x invested capital over the life of the project that would be $45 million or $1.39 per share. (I have seem upside estimates of $10 million in cash flow to Sandstorm Metals) Book value of $15 million would be $0.46 per share. So to estimate the value of this project you have to lean on management’s analysis at Sandstorm. At some point, analyzing Sandstorm will boil down to this assessment yet that is another discussion for another day.

 

[GrizzlyRock]

Now we are getting to non-core and troubled projects – where the rubber meets the road for Sandstorm Metals…

 

Hugo North Extension Copper Stream in Mongolia

 

Sandstorm Metals’ most recent new deal (Q1 2013) is a $5 million copper stream in the Hugo North Extension & Hergua project in Mongolia. The project is a JV between Entrée Gold Inc (TSE:ETG) (Market cap of $56 million) with 20% ownership, the Mongolian government, and Rio Tinto as project manager. Sandstorm will receive 2.5% of Entrée Gold’s 20% portion of the entire mine copper mineralization for a total of 0.5% of the mine’s copper. Sanstrom will pay the lesser of $0.50 and the spot copper price for their first 45.5 million copper pounds and the lower of $1.10 and the spot copper price thereafter.

 

This deal was unique – even for Sandstorm – in the following ways:

• The project will not cash flow for up to 10 years – a far cry from Sandstorm’s desired project timing of 18 to 24 months from investment to mine production and cash flow to Sandstorm. While management indicates this was a “one off” project for Sandstorm Metals predicated on resource quality and an easy “back to back” execution with Sandstorm Gold, the time duration does make me think more about the business model. Are we junior miner investors or near term flexible financing to finish mines and get them cash flowing?

 

• The project was financed by a share sale to Sandstorm Gold at an effective price of $4.5 per share. By not using cash, Sandstorm issued equity above book value for a project they like. Upside remains without impairing Sandstorm Metal’s ability to execute more typical near term cash flowing deals.

 

Sandstorm indicates this opportunity was simply to impressive from the standpoint of potential amounts and quality of metal extracted. They got comfortable enough with the political / country risk to do the deal. My guess is that the Mongolian government being involved didn’t hurt (akin to the Serra Pelada project in Brazil)

 

My thoughts on the project are mixed. On the positive side: opportunistic project in a core metal of copper, flexible financing based on the strength of the larger Sandstorm Gold balance sheet, and partnership with a reasonable junior miner in Entrée Gold and an excellent project partner in Rio Tinto.

 

On the negative side: the time to cash flow is concerning and non-strategic in nature and the project contains more geopolitical risk. This is much more of a speculative junior miner play than is core to Sandstorm’s process and it gives me concern that project opportunity may trump near term cash flow in the minds of management. Perhaps when there are 20+ projects at Sandstorm Metals taking a small flyer on project cash flowing in 10+ years. But for now this is non-core to Sandstorm’s thesis and certainly doesn’t increase investor confidence in Sandstorm’s stated plan of investing in near term projects with a high degree of visibility.

Estimated DCF Valuation

 

Given the 10+ years to cash flows I’m not going to present details here. Based on current copper prices, a 15% discount rate, and a conservative mine life the DCF indicates a figure above $5 million. However, my thought on this project is that given the uncertainty both positive and negative the best guess of value as of now is the $5 million invested which also matches book value. ($0.155 per share)

 

[ItsAValueTrap]

Nolan Watson owns about 1.0% of SSL (Sandstorm Gold) and 3.42% of SND (Sandstorm Metals & Energy).  A deal between the two companies is more likely to benefit SND than SSL.

 

If SND is using its shares as currency instead of cash... one might infer that SND shares are overvalued.  From a cost-cutting perspective, it would take less paperwork and costs would be lower if SND paid in cash instead.  Selling shares requires SND to get approval from the exchange and there are presumably legal fees involved.

- Both SND and SSL have an excess of cash on their balance sheets from raising capital.

- For SSL to own shares of SND can cause some legal problems down the road due to conflicts of interest.  (You could also make the argument that having two separate companies creates lots of conflicts of interest whenever SND and SSL do deals with each other.)  This means lots of unnecessary legal fees.

[GrizzlyRock]

SND didn't have have excess cash during Q1 2013. With $11 million on the balance sheet and $7 million earmarked for the Thunderbird project that leaves only $4 million. So your point regarding SND's "excess cash" to do the Hugo North deal is incorrect.

 

However, it will be interesting to watch how Nolan issues SND stock in Q4 2013 and beyond when the business will be producing positive FCF.  My guess is that he will still issue shares predicated solely on intriguing projects when available vis a vis incoming FCF. (This will be even more interesting once Serra Pelada comes online in Q4 2014) Since SND wants to do 1 to 2 deals per year and the deals have been between $5 million and $27 million the needed yearly cash is $5 million to ~$50 million.

 

Issuing shares is accretive if invested in a good project and dilutive if the project is poor. We will only know in 10 years if the Q1 2013 share sale was accretive or dilutive. When issued above book value I don't see a big issue with this ~3% increase in shares outstanding.

 

The "one management team and two companies" item is potentially problematic. To date, the benefit has flowed to SND based on the ability to access SAND's balance sheet. However, this view may be myopic. The projects that SND benefited from SAND's balance sheet have been "back-to-back" deals in which SAND was investing more than SND. In fact, it could be argued that using SND to stream base metals is a competitive advantage compared to other gold royalty / streaming firms who are less interested in base metals. In my opinion this 2 companies one management is neither positive nor negative.

[matts]

Nolan Watson owns about 1.0% of SSL (Sandstorm Gold) and 3.42% of SND (Sandstorm Metals & Energy).  A deal between the two companies is more likely to benefit SND than SSL.

 

If SND is using its shares as currency instead of cash... one might infer that SND shares are overvalued.  From a cost-cutting perspective, it would take less paperwork and costs would be lower if SND paid in cash instead.  Selling shares requires SND to get approval from the exchange and there are presumably legal fees involved.

- Both SND and SSL have an excess of cash on their balance sheets from raising capital.

- For SSL to own shares of SND can cause some legal problems down the road due to conflicts of interest.  (You could also make the argument that having two separate companies creates lots of conflicts of interest whenever SND and SSL do deals with each other.)  This means lots of unnecessary legal fees.

 

Remember that SND (100MM cap) is a much smaller company than SSL (670MM). So 3.42% of SND is actually half Nolan's exposure to SSL in absolute terms. I would think the incentives are actually reversed and Nolan would advantage SSL over SND.

[Otsog]

Based on absolutely no concrete evidence what-so-ever, but after extensive reading and interview watching it seems that Watson plans for SND to be the flagship company down the road.  He has stated in interviews SND has higher potential and they are the first taking the business model to commodities.  I get the impression SSL was merely a tool being used to allow him to be able to do SND, which was the endgame the entire time. 

 

 

Thanks for sharing your analysis GrizzlyRock.

 

 

 

[valuecfa]

However, it will be interesting to watch how Nolan issues SND stock in Q4 2013 and beyond when the business will be producing positive FCF.  My guess is that he will still issue shares predicated solely on intriguing projects when available vis a vis incoming FCF. (This will be even more interesting once Serra Pelada comes online in Q4 2014) Since SND wants to do 1 to 2 deals per year and the deals have been between $5 million and $27 million the needed yearly cash is $5 million to ~$50 million.

 

Issuing shares is accretive if invested in a good project and dilutive if the project is poor. We will only know in 10 years if the Q1 2013 share sale was accretive or dilutive. When issued above book value I don't see a big issue with this ~3% increase in shares outstanding.

 

I briefly looked over the company and its unusual business model.

 

Just reading over this last comment. Are you kind of suggesting that the company will be a serial issuer of shares of the medium term in order to fund its business model?

 

If so, do you think the company's fair value is approximately book value, since you don't see a big issue with share issuances above book value to fund its business model?

 

 

[GrizzlyRock]

However, it will be interesting to watch how Nolan issues SND stock in Q4 2013 and beyond when the business will be producing positive FCF.  My guess is that he will still issue shares predicated solely on intriguing projects when available vis a vis incoming FCF. (This will be even more interesting once Serra Pelada comes online in Q4 2014) Since SND wants to do 1 to 2 deals per year and the deals have been between $5 million and $27 million the needed yearly cash is $5 million to ~$50 million.

 

Issuing shares is accretive if invested in a good project and dilutive if the project is poor. We will only know in 10 years if the Q1 2013 share sale was accretive or dilutive. When issued above book value I don't see a big issue with this ~3% increase in shares outstanding.

 

I briefly looked over the company and its unusual business model.

 

Just reading over this last comment. Are you kind of suggesting that the company will be a serial issuer of shares of the medium term in order to fund its business model?

 

If so, do you think the company's fair value is approximately book value, since you don't see a big issue with share issuances above book value to fund its business model?

 

Given that Sandstorm Metals desires to be a multi-billion dollar streaming firm I do expect share issuance in the near and intermediate terms. Again, share issuance will be accretive if invested in quality projects and dilutive if projects fail. While true, I do feel better if shares are issued at or above book value than below. In terms of growth one point to keep in mind is that as Sandstorm scales their number of cash flowing projects across various base and bulk metals the significance of one project hitting a snag is reduced.  As such, I would expect the company's cost of capital to reduce over time...

 

Book value is one conservative proxy but does not capture future project upside. For this reason, I do think a DCF valuation with a range of conservative estimates gives the best proxy for intrinsic value. I will note that the range of estimated intrinsic value at Sandstorm Metals is much wider than a "typical" firm which produces produces or services due to the uncertain nature of future asset value extracted from the ground. Lastly - as an anecdotal point - many royalty firms have historically traded above book value (including Royalty Gold and Silver Wheaton to name a few)

 

I plan to post more expansive thoughts regarding book value and what may justify the business selling below, at, or above book value.

[valuecfa]

However, it will be interesting to watch how Nolan issues SND stock in Q4 2013 and beyond when the business will be producing positive FCF.  My guess is that he will still issue shares predicated solely on intriguing projects when available vis a vis incoming FCF. (This will be even more interesting once Serra Pelada comes online in Q4 2014) Since SND wants to do 1 to 2 deals per year and the deals have been between $5 million and $27 million the needed yearly cash is $5 million to ~$50 million.

 

Issuing shares is accretive if invested in a good project and dilutive if the project is poor. We will only know in 10 years if the Q1 2013 share sale was accretive or dilutive. When issued above book value I don't see a big issue with this ~3% increase in shares outstanding.

 

I briefly looked over the company and its unusual business model.

 

Just reading over this last comment. Are you kind of suggesting that the company will be a serial issuer of shares of the medium term in order to fund its business model?

 

If so, do you think the company's fair value is approximately book value, since you don't see a big issue with share issuances above book value to fund its business model?

 

Given that Sandstorm Metals desires to be a multi-billion dollar streaming firm I do expect share issuance in the near and intermediate terms. Again, share issuance will be accretive if invested in quality projects and dilutive if projects fail. While true, I do feel better if shares are issued at or above book value than below. In terms of growth one point to keep in mind is that as Sandstorm scales their number of cash flowing projects across various base and bulk metals the significance of one project hitting a snag is reduced.  As such, I would expect the company's cost of capital to reduce over time...

 

Book value is one conservative proxy but does not capture future project upside. For this reason, I do think a DCF valuation with a range of conservative estimates gives the best proxy for intrinsic value. I will note that the range of estimated intrinsic value at Sandstorm Metals is much wider than a "typical" firm which produces produces or services due to the uncertain nature of future asset value extracted from the ground. Lastly - as an anecdotal point - many royalty firms have historically traded above book value (including Royalty Gold and Silver Wheaton to name a few)

 

I plan to post more expansive thoughts regarding book value and what may justify the business selling below, at, or above book value.

 

Thanks. I'd be particularly interested in thoughts as to the near term business model, which is to sell cheap shares to buy cheap mines.

(or stream interest in the mines i should say).

 

This (shares for mines) worked with his past streaming efforts, in other companies, as the respective commodity exploded higher and higher over the years.

(besides the stream being at a discount)

How will this business model work out if shares stay undervalued, and/or commodity prices stagnant.

 

Perhaps i am wrong, but it seems that the simplified hope or  thesis here it that the company gives up expensive shares, for cheap streams in mines.

 

At what values is the tradeoff of shares for mines not a good one?

 

Thanks

 

 

[GrizzlyRock]

Alright – Sandstorm’s troubled nat gas play. Time to scrape the bottom of the barrel and feed the Sandstorm bears!

 

Gordon Creek Natural Gas Stream in Utah, US

 

Sandstorm Metals spent $15 million in 2011 and $3 million in 2012 to acquire a 35% stream on Thunderbird Energy’s (CVE:TBD) (market cap of $6 million) Gordon Creek project in Utah. Sandstorm agreed to pay C$1.00 per Mcf of gas plus 20% above $4 per Mcf for the gas. The original deal was for Sandstorm to invest $25 million dollars to fund build-out of 50 wells ($500K per well) in Thunderbird’s leased acreage adjacent to in the Drunkard’s Wash area of Utah which has produced massive amounts of gas over the years for Conoco.

 

While the January 2012 resource report indicated a nat gas value of $70 million for the project, Gordon Creek began having problems early on during Sandstorm’s investment. The majority of the issue simply came from declining natural gas prices.  After starting 2011 priced at $5, gas ended 2011 priced at $3.50 and spent most of 2012 chopping around this level. At this level, many projects reduced or ceased output and Gordon Creek was no exception – choosing to delay drilling and wait for better prices.

 

Yet at some point Thunderbird needed cash flow from its resources to continue operations and Sandstorm wanted to begin receiving cash from the investment.  As such, the deal between Sandstorm and Thunderbird Energy was recast last summer with Sandstorm taking the rights to more acreage and investing $3 million (of the planned $10 million) so Thunderbird could drill 8 wells during the fall of 2012.

 

Thunderbird dug the 8 wells and announced in December they were receiving 4,200 Mcf/day raw gas (3,970 sales gas). This was nearly 10x the anticipated first year average raw gas production rate of 460 Mcf/day per well. Happy days! Right? 

 

Wrong. In May, Thunderbird admitted that the vast preponderance of this gusher of gas was coming from one well (NE5-14-8) with the other 7 wells essentially flooded with water. While not a super poor hit rate, to make matters worse the gusher well had seen its lower and middle zones flooded with water as well and was only producing from its top section. Oh boy…

 

Across the canyon at Drunkard’s Wash, Conoco has struggled with high water wells for years. Typically there is heavy infill of water which peaks after a year or two (depending on the well) while the gas starts flowing more strongly after the water infill subsides. Yet, the gas is down there. Out of 610 wells dug in Drunkard’s Wash historically, 610 have produced gas.

 

Alright, so the gas is down there and gas prices have increased significantly during 2013 to $4.1 per Mcf. Now we just need to de-water the wells, get ‘em cash flowing and get back to drilling other wells with the cash! OK that’s doable, right?

 

Wrong again. This time the issue is money. Thunderbird is out of money. Welcome to the world of junior miners (aka lighting $$$ on fire). Thunderbird is upside-down probably $2 million in working capital and can’t even afford to buy the $150,000 high volume water pumps. Yet both the management / equity investors in Thunderbird and Sandstorm could provide the $3 to $5 million needed to right the WC deficiency and fund the pumps. Thunderbird thinks they can get some sort of a deal reached (although it will cost a chunk of flesh) and be cash flowing from the 8 wells by late summer or fall 2013. What will happen? Who knows.

 

Discounted Cash Flow

 

Good one. The project is too fraught with complexity for a DCF to mean much here. While there are massive amounts of extractable gas in the ground ($70 million as of the last resource report), the gas is currently not recoverable due to the aforementioned water and money problems. Given Sandstorm’s senior position I think a recovery of capital is a fair assumption yet may take some doing (Note: there are also $10 nat gas linked debentures due in October 2013). Sandstorm doesn’t want to take the project and sell it if they don’t have to and they have no capacity or desire to operate the project. After speaking with Thunderbird’s management, I don’t think they are ready to walk away from the asset. So with a giant caveat, I expect Thunderbird to scrape together the money to at least get the equipment to de-flood the 8 dug wells and then we’ll see where we are. Sandstorm is definitely paying attention but we (from a public info standpoint) aren’t going to have the details we might want to know.

 

So what’s it worth? I think Sandstorm can recover a good portion of their $18 million investment in a downside and the upside of a producing stream could be worth significantly in excess of this amount IF gas prices rise.  Call option on commodities – regardless of probability – is one of Sandstorm Metals’ more attractive qualities.

 

[GrizzlyRock]

valuecfa - taking a step back and looking at SND from a cash flow perspective as opposed to a mine asset value perspective may help structure your thinking on this one. Nolan isn't buying mines - rather future cash flows that are contractually protected by the reduction of SND's costs if/when commodities are selling for low prices. In so doing, Nolan has created a much more robust stream of cash than a miner could ever hope to create. The embedded optionality is significant both on the upside and downside for commodity prices.

 

If commodity prices stay low, SND will receive their capital back from the minimum cash guarantees and not make an economic profit. Yet as SND's projects multiply and the number of commodities grow - the likelihood that all commodities are in the dumps at one time reduces.  This conversely creates a more robust cash flow stream to SND the company when the projects are aggregated.

[valuecfa]

valuecfa - taking a step back and looking at SND from a cash flow perspective as opposed to a mine asset value perspective may help structure your thinking on this one. Nolan isn't buying mines - rather future cash flows that are contractually protected by the reduction of SND's costs if/when commodities are selling for low prices. In so doing, Nolan has created a much more robust stream of cash than a miner could ever hope to create. The embedded optionality is significant both on the upside and downside for commodity prices.

 

If commodity prices stay low, SND will receive their capital back from the minimum cash guarantees and not make an economic profit. Yet as SND's projects multiply and the number of commodities grow - the likelihood that all commodities are in the dumps at one time reduces.  This conversely creates a more robust cash flow stream to SND the company when the projects are aggregated.

 

Ok. While I probably sound like a bear on the company...I rather like the optionality in it...and am trying to look for obvious reasons not to take a stake in it.

[valuecfa]

I think the big question over the next few years with this investment (aside from commodity prices and mine quality) is the value of the shares shareholders will be giving up in large quantities vs the quality of the cash flow streams. What u give vs what u get. A very expensive cost of capital for a potentially very lucrative stream of cash flows.

[GrizzlyRock]

valuecfa - sure I hear you. The obvious reasons not to invest are the horrific investments in nat gas and met coal.

[GrizzlyRock]

SND's announcement this morning  of a lead and zinc royalty on Canadian Zinc's Prarie Creek property is a small deal in size with large implications. In another back-to-back deal with SND and SAND, SND invested $3.6 million for a 1.2% net smelter royalty on the mine's lead and zinc with SAND investing $3.2 million for a 1.2% NSR on the silver.

 

In addition, SND now has first right of refusal on a royalty or stream at Prairie Creek. Another wrinkle is Canadian Zinc's right to repurchase the NSR royalty at face if SND executes a stream of at least $90 million.  Per Canadian Zinc's February 2013 presentation, they need between $200 million and $240 million (inclusive of contingency) over 2 years to bring the mine online.

 

Sounds like SND is lining up a $90+ million dollar deal which will be struck after Canadian Zinc receives their final permitting this summer (it already been applied for with many requisite steps completed). From what little I know about the project to date, it fits squarely in the base metal development, last leg of bringing a mine to production, cash flowing in 18 the 24 months that SND focuses on. Lots of optionality & little upfront expenditures.

 

Suffice to say this is a better deal than Hugo North project (too developmental) or another energy project (poor track record to date). Would be interested to hear other's thoughts if/when they speak with SND or Canadian Zinc...