Sandstorm Gold Ltd (SAND) is a growth-focused resource-based company that seeks to complete gold purchase agreements with gold mining companies that have advanced-stage development projects or operating mines. A gold purchase agreement involves Sandstorm's making an upfront cash payment to its partners, and in exchange, Sandstorm receives the right to purchase a percentage of the gold produced for the life of the mine, at a low fixed price per ounce. Sandstorm helps other companies in the resource industry grow their business, while acquiring attractive assets in the process. Sandstorm is a non-operating gold mining company and the only 100% pure gold-streaming company.
Sandstorm Gold is headed by CEO Nolan Watson, one of the pioneers of the streaming model (first adopted by Silver Wheaton). Mr. Watson was the first official employee of Silver Wheaton and was an integral part in creating what has become the largest streaming company, boasting a market capitalization in excess of $10B. He is also the youngest to become the CFO of a company listed on the NYSE. Mr. Watson, following his success at Silver Wheaton, left the company in early 2009 to found his own company, Sandstorm Resources, which later split into Sandstorm Gold and Sandstorm Metals & Energy, the latter being the first company to adopt the streaming concept in metals (other than precious metals and energy).
Despite the incredibly tough market environment, one in which raising money was and still is comparably difficult to being able to make it rain on demand, Sandstorm Gold was able to engage in several equity offerings. However, the overall success of essentially every public financing was meager (except the most recent one), to say the least. Despite this fact, Sandstorm Gold has been able to create significant shareholder value via allocating capital extremely efficiently. Early investors as well as those who have been invested for even just the last nine-18 months have seen this efficiency both through a large spike in operating cash flow and a significant upside in all of its core assets.
What separates Sandstorm Gold from its larger rivals is the fact that its acquisitions focus on acquiring relatively unknown and smaller assets, having significant production and exploration upside. Sandstorm Gold is another example of one of the benefits the streaming model has, relative to the classic royalty model-that being the ability to create a large company in a shorter amount of time. This is primarily because the sizes of the deals are much bigger with streaming transactions, compared to something like an NSR. In other words, Sandstorm acts as a bank to the mining sector, with its success determined by the quality of its "loans."
Notwithstanding a relatively quiet 2011 and first part of 2012, things have been extremely busy on the deal front. In the last year, Sandstorm has acquired a handful of royalties as well as three precious metal streams, including the largest deal to date. The precious metal streams acquired in recent months were not only transformational but also instrumental in ensuring a continued robust growth profile from immediate and longer-term perspectives. In this process it acquired its second Brazilian stream in the world-class Serra Pelada Mine, soon followed by the first streaming deal ever completed in Australia in Mutiny Gold and its Deflector Project. Sandstorm wasted no time in proceeding to acquire a majority stake in smaller rival, Premier Royalty Company (currently owns 60%), adding cash flowing and exploration stage NSRs.
Within just days of this being written, the company invested in Entrée Gold's world-class copper complex, which has significant precious metal byproducts: the Hugo North Extension is one of the world's richest porphyry copper-gold deposits, and the Heruga is a world-class, copper-gold-molybdenum porphyry deposit. Both projects are discussed more fully later on in this report.
Sandstorm's Gold Streaming Projects
Aurizona Stream (Brazil) - Sandstorm acquired a 17% interest in Luna Gold's Brazilian Mine in exchange for $17.8m in cash and 5.5m shares of the company upfront (total considerations amount to approximately $24m at that time). Initial mine life was projected to be eight years but Luna has since increased reserves 250%, equating to a 20-year mine life (although this will decrease with the phased expansion plan). Annual production was initially estimated to be 80,000 ounces for the life of mine but has since been revised upward. The first revision amounted to approximately 100,000 ounces annually followed most recently by a two-phase, much larger expansion plan. Luna's BOD approved the first phase expansion to 125,000-130,000 oz., due to be completed by Q3-Q4 2013. It is expected the second phase of the expansion plan will commence immediately after Phase I is complete, bringing total production to 240,000-260,000 oz. Assuming this expansion does take place, production for 2016 (the first full year Aurizona can operate at new capacity) and beyond will increase to 42,500 oz. p.a. for an ongoing per-ounce purchase price of $450/oz. There is vast potential to implement a Phase III expansion but likely the company will wait on any further plans at least until Phase I is complete, and there is reasonable chance this may include areas on the property outside those subject to the streaming agreement. Sandstorm paid a mere $24m for nearly 500,000 ounces over the life of the mine for all-in costs of $451 per attributable ounce assuming no additional reserves or resources are added (which is highly unlikely). Luna produced 40,000+/- ounces in 2011, 70,000 ounces in 2012, and forecast to produce 100,000-110,000 ounces in 2013. In September 2012, Sandstorm remitted $10m to Luna Gold for the first phase of the expansion process per the streaming agreement.
Santa Elena (Mexico) - The Santa Elena Mine is operated by SilverCrest Mines Inc. and is located in northern Mexico approximately 150 kilometers northeast of Hermosillo in Sonora State. Santa Elena is an open-pit heap-leach operation. Santa Elena is classified as a high-level, low-sulphidation epithermal system, and further exploration of the mine is focused on a single relatively wide vein with increasing grades as it plunges. Sandstorm acquired a 20% streaming interest in SilverCrest's Santa Elena Mine at $350/oz. Santa Elena's original forecast was to produce 30,000 ounces for 10+ years, prior to a four-phase expansion plan announced in mid 2011. Sandstorm Gold, however, will be subject to pay an additional 20% of the capital costs, should it wish to obtain a 20% stream on the underground mine. All-in costs based on the current mine life are $492/oz.
- 2012: Phase 1 - Increase the current run rate of 1,650 tpd to 2,500 tpd, increasing annual Au production from 26,000 oz./yr to 39,000 oz./yr (7,800 attributable ounces)
- Phases 1-2 - Installation of a CDC processing facility, increasing mill throughput 52%
- Phase 3 - Development of an underground mine
- Phase 4 - Further increase mill throughput by an additional 40%, bringing production to 55,000-60,000 oz./year
- Total estimated capital expenditures for a new processing facility and development of an underground mine: $84 million (back of envelope)
- Estimated cost of a new processing facility: $47 million
Silvercrest will begin its phased expansion at the end of 2012, which should have a material impact on production in 2014.
Black Fox (Canada) - The Black Fox Mine is located outside of Matheson, Ontario, Canada, in the Timmins Gold District and is 100% owned and operated by Brigus Gold Corp. The Black Fox Mine includes both open-pit and underground operations that are running concurrently and the ore is being trucked to the Black Fox Mill. Sandstorm acquired two streaming interests from Brigus Gold in late 2010. In exchange for an upfront payment of $56.3m plus an ongoing per-ounce cost of $500/oz., Sandstorm has the right to purchase 8% of the life of mine gold production on the main Black Fox Property plus an additional 6.7% on the life of mine gold production of the Black Fox Extension (Grey Fox and Pike River).
The Phase I expansion, though small, has been completed and has been seen in increasing attributable production to Sandstorm Gold. Black Fox reached the production target of 65,000-70,000 oz. in 2012, jumping to 90,000-100,000 oz. forecast in 2013. It remains to be determined whether Phase II expansion will occur; however, it is likely, should it be undertaken in 2014-2015 to significantly increase throughput. Phase I will increase mill throughput 10% to 2,200 tpd (approximately 110,000-120,000 oz. per year) and Phase II will cause mill throughput to jump a whopping 59% to 3,500 tpd (190,000 oz. per year). Black Fox is forecast to produce 110,000 ounces annually for 12 years +/-. However, very encouraging and expansive drill results on the property indicate this will easily be a 15+ year mine. Longer-term growth for Sandstorm will be in the Black Fox Extension in addition to the underground operation at the main deposit.
Bachelor Lake (Canada) - Bachelor Lake is a greenstone hosted gold mine located outside of Val d'Or in Quebec, Canada, and is operated by Metanor Resources Inc. Following the Black Fox acquisition, Sandstorm Gold paid Metanor Resources $20m in exchange for a 20% streaming interest in Bachelor Lake for an ongoing purchase price per ounce of $500/oz. for the life of mine. Bachelor Lake was initially forecast to produce 60,000 oz. per annum, however, a study showed this high-grade deposit was achievable at just 66% capacity, leaving plenty of room for increasing annual production of this high-grade mine, not to mention a significant mine life extension that is currently just 2.5 years. Total considerations per ounce of gold receivable equate to $620/oz., however, we think this will decline over time due to new reserves and resources being identified. Bachelor Lake will serve as Sandstorm's primary growth driver in 2013 and the first part of 2014.
Summit Mine (USA) - In exchange for an upfront payment of $4m and $400 plus an ongoing purchase price per ounce, Sandstorm has the right to purchase 22% of life of mine gold production. Although Summit is a small non-core asset, the return on investment and all-in cost per ounce of gold is very attractive. Summit will produce approximately 10,000-12,000 ounces annually for an initial 12-year period, equating to annual attributable production of 2,400 ounces, although Sandstorm has the right to purchase 50% of the first 10,000 oz. Total considerations per ounce of gold are $554/oz.
Ming Mine (Canada) - In exchange for an upfront payment of $20m with no ongoing purchase price per ounce, Sandstorm receives 25%-32% (dependent on recoveries) of annual production until 175,000 ounces have been produced, dropping to 12% thereafter. Initial annual output is estimated to be 12,000-15,000 ounces; however, historical production has shown it is possible to produce 20,000-25,000 annually. Following the publishing of our first report on Sandstorm Gold, Rambler Metals announced the discovery of high-grade gold zones, which have been mined in the first two quarters of 2012 but have since reverted to the copper rich zones for the full year 2012. Gold production will drop in 2013 as Rambler focuses on the copper zones, but mining will return to the gold-rich areas sometime in late 2013/2014. Significant upside still remains at Ming in terms of exploration upside and given the much more efficient mining methods and equipment that wasn't available when it was first mined. Total considerations per ounce of gold are $367/oz.
Bracemac-McLeod (Canada) - The Bracemac-McLeod Project is a high-grade volcanogenic massive sulphide [VMS] deposit located in the historical and prolific mining district of Matagami, Quebec. Xstrata Canada Corp. has been operating in the Matagami District for almost fifty years with ten previously operating mines and one current working mine called Perseverance. As Perseverance winds down, Xstrata plans to shift operations to Bracemac-McLeod while utilizing the existing Matagami Mill to produce concentrates of zinc and copper. Sandstorm made this deal for a very attractive price and it was also the first one done concurrently with sister company Sandstorm Metals & Energy. Sandstorm was to initially receive a 17.5% stream on both gold and silver in exchange for a milestone payment of $5m to be paid in June 2012 plus an ongoing per-ounce payment of $350/oz. but has since increased its stake to 24.5% for an additional $3m.
While current mine life based on 2p reserves is only four to five years, the addition of significant mine life is apparent both in drill results and given the fact the operator will be Xstrata. A large proven copper mining conglomerate wouldn't take on a project with such a short life unless the evidence indicated anything but a substantially longer mine life. In fact, prior to Sandstorm increasing its streaming interest, Xstrata announced an increase in the planned mill feed by 33%. Average annual production will amount to approximately 2,000-3,000 oz. annually, helping augment the growth to Sandstorm provided by Bachelor Lake in 2013. Although it doesn't make financial sense at first glance for Xstrata to finance development this way, the stream was acquired via its JV partner Donner Metals.
Mt. Hamilton - The Mt. Hamilton Gold Project is located in White Pine County, Nevada, U.S.A., and is held by Mt. Hamilton LLC ("MH-LLC"), which is 80% owned by Solitario Exploration & Royalty Corp. (XPL) [TSX:SLR] and 20% owned by Ely Gold & Minerals Inc. (TSX-V:ELY). Solitario released a feasibility study in February 2012 showing favorable economics for an open-pit operation with heap-leach extraction. Once in operation, the mine is expected to produce 48,000 ounces of gold and 330,000 ounces of silver per year over an initial eight-year period, with excellent potential to add additional resources and extend the mine life. Sandstorm has a 2.4% net smelter return royalty ("NSR") on the Mt. Hamilton Gold Project. Sandstorm made an upfront payment of $10 million to MH-LLC to acquire the royalty in June 2012. We think Sandstorm entered into this agreement not for the NSR, rather for a right of first refusal. If MH-LLC enters into a gold stream agreement with Sandstorm that has an upfront deposit of no less than $30 million, MH-LLC will have the option, for a period of 30 months, to repurchase up to 100% of the NSR for $12 million. We believe there is a reasonable probability that Sandstorm converts the NSR into a stream. In fact, following the Oyu Tolgoi transaction, we believe this might be the next stream acquired in 2013. The reasons being that Solitario doesn't have a strong cash position but has significant financial obligations (exploration expenses) in 2013 and because it wants to get Mt. Hamilton cash flowing as soon as possible. Electing to pursue a stream would avoid having to severely dilute shareholders (the market realizing this has punished it, as seen through the depressed stock price). The market would likely give Solitario a re-valuation over the two months following any potential announcement of this nature and allow them to fulfill its financial obligations entirely with minimal dilution. Assuming a streaming interest is sold to Sandstorm or the proper financing for Mt. Hamilton is in place, it is probable production begins in late 2014.
Coring & Cuiú Cuiú (Brazil) - The Coringa Gold Project is owned by Magellan Minerals Ltd. and is located in Para State, Brazil, 20 kilometers east of the BR-163 Highway. Coringa is a narrow, high-grade vein system extending over an 18-kilometer strike with significant exploration upside. Magellan released a positive preliminary economic assessment on Coringa in May 2010, which is in the process of being updated, and commenced a feasibility study in the third quarter of 2012. Cuiú Cuiú is located 180 kilometers southwest of Itaituba in northern Brazil. Exploration work has identified a series of major gold soil anomalies and Magellan anticipates conducting a drilling program during the second half of 2012/early 2013 with plans to release a revised resource estimate in the first quarter of 2013.
Sandstorm has a 2.5% net smelter returns royalty ("NSR") on the Coringa Gold Project and a 1.0% NSR on the Cuiú Cuiú Gold Project. Sandstorm made an upfront payment of $7.5 million and subscribed for one million shares of Magellan at a price of $0.50 per share to acquire the royalties in May 2012. As part of the agreement, Magellan has provided Sandstorm with a right of first refusal on any future royalty or gold stream financing at Coringa and Cuiú Cuiú, and like Mt. Hamilton, was strategic more than anything else.
Serra Pelada (Brazil) - Serra Pelada is a high-grade gold-platinum-palladium deposit located in the mineral and mining prolific Carajas region in Para State, northern Brazil. The existing infrastructure and accessibility to the site are excellent, due to the close proximity of a number of major mines. This is Sandstorm's largest streaming agreement made to date (dollar-wise), giving Sandstorm Gold even more exposure in mining-friendly Brazil in this unique precious metals purchase agreement. Straying from its typical focus-gold-this agreement is primarily for platinum from Colossus Mineral's world-class gold and PGM mine, Serra Pelada. Serra Pelada boasts some of the world's highest grades and was previously host to the largest gold rush in Latin American history where a reported 2m oz. of gold was extracted in just six years. Average annual Au, Pt, and Pd production will be much clearer once an initial 12-month reserve estimate is released. Given the archaic mining methods used back in the late 1970s/early '80s, it is highly likely this proves to be a multimillion-oz. gold deposit. Serra Pelada has demonstrated the potential for several satellite deposits outside the CMZ reinforcing this stance.
Like many of its other deals, Serra Pelada is a high-grade, low-cost operation and has significant upside with regard both to production and to additional reserves/resources. The deal consisted of Sandstorm making a mere $60m upfront payment in exchange for 1.5% of the gold produced at $400/oz. and 35% of the platinum produced at $200/oz. There is, however a buyback provision, giving Sandstorm until April 1, 2015, the right to repurchase half the aforementioned stream for $48.75m. This is one of the most exciting streams, if not the most exciting that Sandstorm has acquired in terms of upside potential and will contribute materially to the short- and long-term growth attributable to Sandstorm. Serra Pelada is fully permitted and fully funded with construction ongoing and an expected 2H 2013 start.
The Deflector Mine (Australia) - Coming on the heels of the fantastic deal made with Colossus Minerals, Sandstorm Gold waited all but a few months to complete its next deal, this time acquiring a streaming interest in Mutiny Gold's Deflector Project in western Australia. It is worth noting this is the first streaming deal ever completed in the country, which is very beneficial as it further diversifies Sandstorm's asset portfolio geopolitically and introduces an alternative form of financing to Australia other than turning to the debt and/or equity markets. More importantly, Australia is extremely mining friendly and can be compared to the likes of Canada in terms of political risk. The problem with many Aussie operations is the cash cost, however, Sandstorm managed to find a good, high-grade project with significant upside potential that will also boast low relative cash costs.
The deal was as follows: Sandstorm Gold pays $9m upfront to Mutiny, making its second payment of $29m when it has received all the necessary permits. In exchange for the upfront payment, Sandstorm receives the right to purchase 15% of all the gold produced for the LOM at $500/oz. There is one caveat and that is a buy-back clause whereby for 36 months following the closing of the deal, Mutiny has the right to buy back 50% of the stream for $24.7m. Mutiny has already discussed the possibility of increasing mill throughput and therefore average annual production. There is also a provision in the contract between the two parties that dictates that if Mutiny produces 85,000 oz. or greater in any given year, Sandstorm will be required to remit a one-time $4m payment. Average annual production is currently forecast to be 55,000 oz. /yr. for 7.5 years; however, we strongly believe it will end up being well in excess of that amount. In fact, modeling shows and expansion drill programs indicate production can be increased 45%-50% to 75,000 oz. per annum, or 11,250 attributable ounces.
Premier Royalties - As Sandstorm has evolved and grown, it discussed whether to outsource a second management group, focused on the smaller deals. This turned out to be the case as Sandstorm took a significant equity position in Premier Royalties early in 2013, effectively giving Sandstorm a majority ownership position (60%). Following the announcement of the aforementioned relationship, we took a look at its core assets and realized Sandstorm found a great group of individuals to focus on this part of the business as well as adding some quality cash flowing production as well as exploration assets in the process. Immediately following this announcement, Premier acquired a bundle of cash flowing royalties primarily in South America. The newly acquired royalty portfolio added several more cash flowing NSR royalties in addition to some exploration-stage assets.
Heruga and Hugo North - These deposits lie on the Entrée Oyu Tolgoi Copper Mining Complex. This forms part of the Oyu Tolgoi Complex in Mongolia. This is a world-class complex and will have significant Au and Ag byproducts once in production. In exchange for partaking in a $10m private placement in addition to remitting $35m upfront, Sandstorm has the right but not the obligation to purchase 25.7%, or 33.8% of the gold and silver byproduct produced from these deposits. Due to the fact that this project is both in Mongolia and rather far away from production, Sandstorm was able to get an excellent deal (assuming everything plays out as planned). Once on-stream, Sandstorm will pay $220/oz. for gold and $5/oz. of silver-that is, until certain thresholds have been reached. Once 8.6m oz. Au has been produced from the JV property, the cash costs/oz. Au will increase to $500. As for the silver, once 40.3m oz. have been produced, the ongoing per-ounce price of silver will double to $10. We expect this to be a very long-lived asset, increasing production each and every year, until it can't (which shows just how vast this complex really is). Also worth noting is Sandstorm's reason for choosing this stream to augment longer-term growth. This is one of the world's up-and-coming premier copper mines and, based on the current technical report, can support over half a century of production. Sandstorm also acquired a 2.5% of the copper produced from these mines (that is, of course, 2.5% of Entrée's 20%) for $5m. Sandstorm did a back-to-back agreement, whereby it sold this 2.5% copper NSR to Sandstorm Metals & Energy. Material production from these deposits won't be apparent until late in this decade-early next decade. Although investors typically want a quick ROI when making streaming deals, Sandstorm did an excellent job negotiating this contract. Mongolia, a country that is questionable geopolitically, hosts these deposits; however, the risk taken on by Sandstorm isn't commensurate. Should delays or the like arise (due to political reasons), Sandstorm has the right to receive its original investment back immediately. Furthermore, the operator of this project will be Rio Tinto, making this streaming agreement more likely to succeed.
Ann Mason Project - Sandstorm made this deal in conjunction with Oyu Tolgoi, likely to fill the growth gap between Oyu Tolgoi (in development) and Oyu Tolgoi (commences production). Sandstorm acquired a 0.4% NSR. Ann Mason is in west central Nevada, approximately 75km southeast of Reno within the historical Yerington Mining District. Sandstorm was also given a right of first refusal on Ann Mason.
The chart below shows just how prudent Sandstorm is, regarding how much it is willing to pay per ounce of gold, getting the most bang for the buck.
Although Sandstorm's growth only really became apparent in 2012, it is literally just getting started, with its growth likely to further improve in the short-medium term through a combination of additional acquisitions, given the arsenal of available capital, potentially exercising one or more of its rights of first refusal and further upside in its existing assets.
We are a bit more optimistic than management is on Sandstorm's production outlook. By 2016-2017, Sandstorm forecasts attributable production will be at 70,000 oz. while we think it will be closer to 100,000 oz. This is primarily driven by our forecasts of Aurizona's Phase II expansion. This is, however, incredibly sensitive and we believe management has taken the base-case scenario despite all the news flow of increased forecasts or the like by the operators of several of its streams.
Sandstorm Gold has performed superbly both in what was considered a horrendous year in gold stocks and over the last two years, relative to the industry performance as measured by the XAU index. It has performed 140% better the XAU gold Index!
One could contend each one of Sandstorm's streams is nothing more than a collection of European call options, as it has all the characteristics of one (Strike Price = $350-$500, Expiration = Length of Contract and an Underlying Asset = Gold). It also meets the definition of an option, that being "A contract between two parties for a future transaction on an asset at a reference price." But aren't there risks associated with a stream? Sure, but the same goes for an option or futures contract, i.e., counterparty risk (a recent example being the MF global debacle). Assuming a stream does have more risk, instead of trying to value it using a collection of European call options (which have a time premium for every year further away from expiration), a medium ground would be to simply use the undiscounted value of all future cash flow. The chart below will illustrate a basic NAV, undiscounted value of all cash flows and the value of a stream using call options. In simpler terms, the chart is trying to replicate the business model and determine the cost of doing so.