Colossus Is Weighing On Sandstorm Siblings

| About: Sandstorm Gold (SAND)

Precious metal streaming companies provide capital for mining companies in exchange for the right to purchase a certain portion of future mine output for a nominal price. Such financing may take place at a time when mines are already operating, or it may take place at a time when an exploration company is still studying a deposit in order to decide on possible future mine construction. Obviously, the risks (and the rewards) involved for the streaming company differ considerably between scenarios.

There are four larger streaming companies to choose from for precious metals investors willing to partake in this kind of business model. Among those four companies Sandstorm Gold (NYSEMKT:SAND) is a relative newcomer. This company has been quite aggressive in signing up streaming agreements over the past two years, and also arguably more risk-tolerant than its peers.

Sandstorm Gold has a sibling company led by the same CEO Nolan Watson called Sandstorm Metals and Energy (OTCPK:STTYF). The two Sandstorm companies have similar business models, except Sandstorm Metals and Energy has a more diversified focus that includes base metals and energy. Collectively we will call the two companies "Sandstorm siblings" in this article.

Some of the risks that Sandstorm Gold has taken have already returned great rewards, such as the streams from Luna Gold's (OTCQX:LGCUF) Aurizona mine or Silvercrest's (NYSEMKT:SVLC) Santa Elena mine. The jury is still out on some of the other deals, especially on the stream from Entree Gold's share of the Oyu Tolgoi project and most of the deals that Sandstorm Metals and Energy has inked.

And then, there is the deal that was supposed to establish the Serra Pelada mine currently under construction by Colossus Mining (OTC:COLUF) as a cornerstone asset within both Sandstorm siblings' portfolios. The Serra Pelada mine was supposed to start generating significant cash flow for the Sandstorm siblings in 2017. This deal has come under pressure recently with Colossus announcing a suspension of mine development activities last week and both Sandstorm companies stating that the streaming deals were under review for possible impairment charges.

Serra Pelada

For a long time the developing story of Colossus Mining has spurred the imagination of risk-tolerant investors in the precious metal mining space. This company has been developing an underground mine in Northern Brazil with the intention to exploit the awesome Serra Pelada deposit. This ore body contains exceptionally high grades of gold and Platinum Group Metals, or PGM, and has a rich history from being the site of perhaps the greatest gold rush in South America. The underground mine is being constructed in difficult soil and hydrological conditions and poses considerable engineering challenges.

Sandstorm Gold has provided $60M in upfront financing for mine construction in exchange for the rights to 1.5% of gold production and 35% of platinum production from the mine once it goes into operation. And Sandstorm Metals and Energy has chipped in a further $15M for 35% of the palladium produced at the mine.

Colossus has opted to build the mine without a formal NI 43-101 report or resource statement, and has been able to find financing regardless so far. The last bought deal at the start of August netted the company C$ 37.95M.

Technical issues with de-watering occurred just prior to the financing and led to delays in mine construction. While not appearing to be material in nature, the encountered problems were grave enough to burn enough funds for the company to go into emergency mode.

On December 6 Colossus Minerals notified the market that it will need a further $70M in funding in order to get to production. Colossus has decided to cease underground development and focus on producing a NI 43-101 report with a maiden resource for the project.

"The Company, in conjunction with its key stakeholders, is continuing its efforts to raise short-term capital to partly address its working capital deficiency and pursue other strategic alternatives."

Colossus has issued debt and needs to make interest payment at the end of the year. We presume that this payment will represent a moment of truth in the near future.

Where To From Here?

We can see three possible scenarios playing out:

  1. Colossus might go insolvent; e.g. for not being able to pay debt obligations at the end of the year.
  2. Colossus might be taken over by another company
  3. Colossus can access financing and continue with mine development.

For Colossus shareholders all three scenarios are only shades of very bad news.

  1. If Colossus goes insolvent then realistically speaking shareholders stand to lose all of their investment.
  2. In the event of a takeover shareholders should be able to get some sort of consolation prize either in the form of a cash payment or a stake in the acquiring entity.
  3. In the event of re-financing Colossus shareholders should expect to be diluted heavily, but they will continue to hold a (reduced) stake in the company.

For shareholders of either Sandstorm sibling the scenarios would present themselves as follows:

  1. If Colossus goes insolvent then Sandstorm would try to obtain as many assets as possible using their security interests. The partially finished mine and processing facility is the most obvious asset to be targeted in this case.
  2. In the event of a takeover the streaming arrangement would stand as the contract is tied to the asset. One would imagine that any acquiring company would negotiate terms with the Sandstorm siblings.
  3. In the event of re-financing nothing would change for Sandstorm, except that we would speculate Sandstorm would likely be a part of such a solution.

Our Take For Sandstorm Shareholders

Sandstorm shares have dropped for both siblings when the news became known, and deservedly so. Both Sandstorm Siblings stand to lose at least part of their initial investment and also substantial near-term growth.

We believe that scenario 3 as mentioned above is a distinct possibility. We would assume that Sandstorm will play a certain role in re-financing Colossus, either by providing additional funds in exchange for expanded streams, or by buying out the clause in the existing contract that allows Colossus to buy back half of the stream until April 2015.

However, Sandstorm will not be able to provide full funding to production and additional sources of financing will need to be found. The announced fast-tracking of the NI 43-101 report is a pretty clear indication to this regard.

We would expect the share prices for both Sandstorm siblings to show some weakness in the event of Sandstorm helping with re-financing Colossus due to skepticism among shareholders towards further exposure to the Serra Pelada mine.

In the event of a takeover we would expect Sandstorm shares to appreciate, depending on possible conditions with regards to the streaming arrangement that might be part of such a deal.

The worst case for Sandstorm shareholders would be scenario 1. Both Sandstorm siblings stand to lose a considerable percentage of the initial investment plus they lose a significant portion of their respective near-term growth perspective.

For investors interested in making an entry into either Sandstorm sibling we recommend to wait until the dust has settled. A buying opportunity might emerge when some of the present uncertainties have been resolved.

Our Take For Colossus Shareholders

Colossus shares are trading at penny-dreadful levels and anyone picking up shares is taking a considerable risk.

For existing holders the choice is between rocks and hard places. Selling out at this point in time for literally pennies on the dollar might be hard to stomach for many. The alternative is keeping the shares and hoping for scenario 2 or 3 to evolve in order to get another shot and recoup at least some lost money.

Disclosure: I am long SAND. 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.