Prospect Generators Part 2: Royalty/Exploration Companies

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Includes: AAU, EMXX, VGMNF
by: Ben Kramer-Miller

In Part 1 I introduced the reader to prospect generators. Prospect generators are similar to mining companies, although they focus on the exploration part of the business in order to:

  1. Mitigate the high risks of exploration
  2. Pass on the high costs of exploration to other companies
  3. Devote capital and intellectual resources to exploration

In so doing they sell a portion of the upside enjoyed by taking a mine from exploration to production.

In this article I will introduce the reader to a few companies that incorporate the royalty model into their businesses. Investors who are not familiar with this model should see my article on royalty companies. These companies make deals with mining companies whereby they give mining companies an up-front payment in cash or stock in exchange for a royalty or a stream on an agreed upon mine. A royalty agreement entitles the royalty company to a predetermined portion of the resources produced by the mine in question, while the mining company operates the mine. A stream entitles the streaming company to the right to purchase a predetermined portion of the resources produced by the mining company at an agreed upon price. In general royalty and streaming companies offer investors exposure to the mining industry with lower risk than if they were to purchase mining shares. Prospect Generators that are also royalty companies will sell exploration properties, on which they have had success, to companies in exchange for a royalty or a stream on those properties. In this way these prospect generators do not have to find the capital necessary in order to develop these properties, while at the same time they are in a position to profit from production from these properties. Furthermore, some companies will also purchase royalties or streams as a way to fund their future exploration operations. Investors who like the royalty business model, and who are capable of analyzing an exploration team and its property portfolio should consider the companies I discuss in this article. They include: Eurasian Minerals (NYSEMKT:EMXX), Virginia Mines (OTCPK:VGMNF) and Almaden Minerals (NYSEMKT:AAU).

Before I discuss these companies I must emphasize that with a few notable exceptions, the companies I discuss here predominantly have royalty agreements on properties that are a long way from becoming producing mines, and as a result it is impossible to accurately value these agreements as a function of their future cash flows. Potential investors are urged to evaluate the competency of individual management teams and the capital situations of the companies involved. Briefly, Eurasian Minerals has several royalty agreements and joint ventures with larger companies, Virginia Mines has a huge royalty agreement with a large company [Goldcorp (NYSE:GG)], and Almaden Minerals tends to have royalty agreements with smaller companies. While each of these companies is small and unprofitable, the latter of the three should be viewed as far more speculative than the first two.

Eurasian Minerals

Eurasian Minerals is one of the best prospect generators for investors who are interested in this business model. Management has created a company that is leveraged to exploration success while at the same time mitigating the risks that are typically associated with exploration. The company holds several exploration properties all over the world giving investors exposure to base and precious metals, although it focuses on copper and gold. The company also incorporates the royalty business model as well as a way to sell properties to development companies. As a result the company has an extensive pipeline of properties that will potentially provide a lot of future cash flow should these early stage properties eventually become producing mines. The following table lists these properties.

Project Operator Location Mineral Agreement Type
Leeville Newmont Mining (NYSE:NEM) U.S.A. (NV) Gold 1% GSR
Maggie Creek Newmont Mining U.S.A. (NV) Gold 3% GSR
North Pipeline Nevada Rae Gold U.S.A. (NV) Gold (alluvial) > of $0.50/yd or 4% NPI
Golden Ibex Golden Ibex, Inc. U.S.A. (NV) Gold 1% NSR
Red Hills GeoNovus (OTC:GMINF) & Inmet (OTC:IEMMF) U.S.A. (AZ) Copper 2.5% NSR
Middle Mountain GeoNovus & Inmet U.S.A. (AZ) Copper 2.5% NSR
Silver Bell West GeoNovus U.S.A. (AZ) Copper 2.5% NSR
Balya Dederman Madencilik Turkey Lead, Zinc, Silver 4% NSR
Aktutan Dederman Madencilik Turkey Precious & Base metals 4% NSR
Golcuk Pasinex Resources Turkey Copper 2.9% NSR
Viscaria Avalon Minerals Ltd. Sweden Copper, iron 0.5% NSR
Deli Jovan Reservoir Capital (OTCPK:RSERF)/ Orogen Serbia Gold 2% NSR on gold, 1% on base metals
Stara Planina Reservoir Minerals (OTCPK:RVRLF) Serbia Gold, copper, molybdenum 2% NSR on gold, 1% on base metals
Plavkovo Reservoir Minerals Serbia Gold 2% NSR on gold, 1% on base metals
Brestovac Reservoir Minerals, Freeport McMoRan (NYSE:FCX) Serbia gold, copper, molybdenum 2% NSR on gold, 1% on base metals
Neavesville Glass Earth New Zealand Gold, silver 2% effective NSR
Gezart Young Hyun Chemical Company Kyrgyzstan Gold 2.5% NSR
Uchkol Young Hyun Chemical Company Kyrgyzstan Gold 2.5% NSR
Click to enlarge

*Investors are encouraged to view the following glossary of explanations of Net Smelter Royalties (NSR) and Gross Smelter Royalties (GSR) created by Franco-Nevada Corporation.

Unfortunately none of these properties is near production, and so Eurasian Minerals' royalty cash flow is a long way away. However the company recently purchased Bullion Monarch, which is a royalty company with roughly $5 million of annual cash flow. Given the company's exploration budget of $15 million and $20 million in cash this royalty cash flow will be essential in limiting share dilution. Furthermore, given that the company's fully diluted market capitalization is just $105 million it trades at just 21X its annual cash flow. Given that royalty companies such as Franco-Nevada (NYSE:FNV) and Royal Gold (NASDAQ:RGLD) trade at approximately 15X cash flow without such an extensive pipeline (relative to their market capitalizations) of exploration properties, Eurasian Minerals seems to be relatively inexpensive as a high risk/reward royalty company.

In addition to having current cash flow and a deep pipeline of potential future royalty streams, the company has an extensive portfolio of exploration properties, which can provide it with enormous upside if just a couple of them end up being large mines. Being a project generator, Eurasian Minerals has joint venture partners with interests in many of these properties, and so its exploration costs remain low while it retains meaningful exposure to the upside that positive exploration results can yield. Some of these properties include the Akarca gold/silver project in Turkey and the Vert de Gris Porphyry property in Haiti.

Virginia Mines

Virginia Mines is a prospect generator that has several exploration properties, all of which are located in Canada (which is one of the best places in the world to mine given the lack of political activity and the fact that mining permits are easy to obtain). The company's business model isn't spelled out as clearly as Eurasian Minerals', although it seems to be set on selling properties that they have explored successfully to larger companies for development in exchange for royalties. The company's focus is geographic: it only explores in Canada. As for the company's metal exposure, it has a gold focus, although it has exposure to base metals and uranium.

Virginia Mines is currently valued at roughly $300 million, making it the second largest prospect generator by market capitalization [behind only Seabridge Gold (NYSEMKT:SA)]. It has a substantial royalty agreement on Goldcorp's (GG) Eleonore mine in Quebec: the mine is expected to begin production in 2014 and yield 600,000 ounces of gold per year, of which Virginia Mines has a Net Smelter Royalty of 2.2%, meaning that Virginia Mines will receive 13,200 ounces per year. This can go up to 3.5% later on in the mine's life. Given that the major royalty companies are valued at around 15X cash flow, conservatively at 10X cash flow this royalty is worth $185 million at $1,400 gold.

Going out several years the company has several other royalty agreements, some of which should provide cash flow, although presently none of these projects is nearly as large as Eleonore. The following chart lists these agreements.

Project Operator Mineral Agreement Type
Eastmain CBay Gold 2% NSR
Apple Strateco Uranium 2% NSR
Duncan Augyva Iron Ore Virgina Pays $0.40 per ton
Stabell Alexandria Minerals Gold 2% NSR
Dubuisson Northern Star Gold 2% NSR
Malartic Northern Star Gold 2% NSR
Lac Dufault Nyrstar Base Metals 2% NSR
Sagar Energizer Resources Gold/Uranium 1.5% NSR
Northbelt TerraX Minerals Base Metals 2% NSR
Lac Clark Chibougamau Independent Mines Copper, Gold, Silver, Zinc, Iron 1% NSR
Click to enlarge

These agreements are all on early stage properties that are owned by very small companies. Nevertheless it owns several properties that are subject to limited geo-political risk. All of these properties have enormous upside potential, but the same can be said for Eurasian Minerals' early stage royalty properties that are owned by much larger companies that do not face bankruptcy should their properties not be valuable enough to become mines. For this reason, at current valuations, I prefer Eurasian Minerals to Virginia Mines except for the additional political risk taken by investors in the former company.

Almaden Minerals

Almaden Minerals is the riskiest of the companies discussed here, although there is enormous upside potential. Currently it is valued at $105 million, the same as Eurasian Minerals, although it has only $13 million in cash compared to Eurasian's $20 million. Its properties are all located in low risk jurisdictions: the United States, Canada, and Mexico. All of its properties (and there are 40 or so) are early stage exploration properties, so it is difficult to value them. It is additionally difficult to value the company as a whole given the fact that unlike its peers Almaden has no foreseeable cash flow. Nevertheless for a company as small as Almaden it only takes a couple of properties yielding impressive exploration results to greatly reward shareholders, and the company's Ixtaka property in Mexico is one such property, as early drill results have shown that the property may contain high grade gold and silver deposits.

Other than that the company has several early stage royalty agreements on gold, silver, and base metal exploration properties. The following table lists these properties.

Project Operator Location Mineral Agreement Type
Cabin Lake Tarsis Resources Ltd. Yukon Territory Zinc, silver 2% NSR
Caribou Creek Tarsis Resources Ltd. Yukon Territories Copper, zinc, lead 2% NSR
Elk Gold Project Gold Mountain Mining British Columbia Gold 2% NSR
Meister Property Tarsis Resources Yukon Territory Zinc, silver 2% NSR
Mor Tarsis Resources Yukon Territory Zinc, silver 2% NSR
The Ram Ross River Minerals Yukon Territory Gold 2% NSR
La Bufa Lincoln Gold Corp. Chihuahua State Gold 2% NSR
Caballo Blanco Gold Group Mining Vera Cruz Gold 1.5% NSR
Erika Project Tarsis Resources Guerrero State Gold, silver, lead 2% NSR
El Poulpo Ross River Minerals Sinaloa Copper, gold, molybdenum 2% NSR
Mezquites Tarsis Resources Nayarit Gold, silver 2% NSR
San Pedro Tarsis Resources Nayarit Gold, silver 2% NSR
Yago Tarsis Resources Nayarit Gold, silver 2% NSR
Click to enlarge

As I mentioned above it is difficult to value these royalty agreements. Given that investors can purchase Eurasian Minerals for the same price as Almaden it is difficult to make a case for investing in the latter company at current valuations. Nevertheless I like the locations of Almaden's mines, and the company's Ixtaca property is the only property owned by the three companies mentioned here that can potentially become a major mine. If Ixtaca yields a mine similar to other early stage high grade mines such as Pretium Resources' Brucejack, Almaden can be worth several times its current valuation. Thus, given the exploration potential here this might be a good speculation stock at lower valuations, or if there are additional positive drilling results.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in EMXX over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.