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(Editors' Note: This article covers a stock trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.)

Introduction

In this article, I'll discuss Franco Nevada's (FNV) gold stream deal with Teranga Gold (OTC:TGCDF) in depth. I will briefly explain the situation and the concept of the deal, where after I will make some calculations to determine the added value of the agreement for Franco Nevada shareholders. This will result in my investment thesis at the end of this article.

The gold streaming deal with Teranga Gold

Franco Nevada entered into an agreement with Teranga Gold whereby Franco Nevada secures the right to purchase a part of the gold production from Teranga's Sadobala project in Senegal, Africa. As the Sabodala asset is already in production, the execution risk is extremely low for both parties.

As per the terms of the agreement, Franco Nevada pays $135M to secure a gold stream deal which will result in Franco Nevada buying 22,500 ounces of gold per year from Teranga at just 1/5th of the spot price during the first six years of the agreement. For the remaining 34 years of the agreement, Franco Nevada is entitled to purchase 6% of the annual production at the same price conditions (20% of the spot price).

I recently wrote an article on Teranga Gold wherein I made some calculations on the expected output and extended mine life, as the company is acquiring the three partners of the neighboring project. This will extend Teranga's mine life to at least 24 years and this doesn't even include any upside exploration potential. I personally wouldn't be surprised if the Sabodala mine would still be producing gold at the end of the streaming agreement, in 40 years from now.

Some calculations

In this subtitle I'll do my best to calculate the potential returns of this deal for Franco Nevada. I will use a fixed gold price of $1250/oz (which results in a purchase price of $250/oz for Franco Nevada). As the project is already producing, I think a discount rate of 5% is sufficient, as the Teranga operating team has already proven it has sufficient technical and operational expertise to keep a mine running.

I will also use a base case scenario with a mine life of 24 years and a production of 310,000 ounces of gold from year 7 on, which results in an annual delivery of 18,600 ounces of gold to Franco Nevada. I think this assumption is quite realistic, as Teranga has said several times it was aiming to produce in excess of 350-400,000 ounces of gold per year at the project. I'm using a corporate tax rate of 27%, which was the average tax rate the company paid in the third quarter of this year.

Cash Flow per year

Corporate tax at 27%

after tax

Discount rate (5% per annum)

NPV5%

-135000000

0%

-135000000

-135000000

22500000

0%

22500000

1,00

22500000

22500000

0%

22500000

1,05

21428571

22500000

0%

22500000

1,10

20408163

22500000

0%

22500000

1,16

19436346

22500000

0%

22500000

1,22

18510806

22500000

0%

22500000

1,28

17629339

18600000

27%

13578000

1,34

10132113

18600000

27%

13578000

1,41

9649631

18600000

27%

13578000

1,48

9190125

18600000

27%

13578000

1,55

8752500

18600000

27%

13578000

1,63

8335714

18600000

27%

13578000

1,71

7938775

18600000

27%

13578000

1,80

7560738

18600000

27%

13578000

1,89

7200703

18600000

27%

13578000

1,98

6857813

18600000

27%

13578000

2,08

6531250

18600000

27%

13578000

2,18

6220238

18600000

27%

13578000

2,29

5924036

18600000

27%

13578000

2,41

5641939

18600000

27%

13578000

2,53

5373276

18600000

27%

13578000

2,65

5117405

18600000

27%

13578000

2,79

4873719

18600000

27%

13578000

2,93

4641638

18600000

27%

13578000

3,07

4420607

109,275,447

Based on the aforementioned assumptions, this streaming deal has an after-tax NPV of almost $110M to Franco Nevada, so shareholders should be happy. I will now calculate the NPV of the streaming agreement using a bearish scenario and bullish scenario.

First up is the bearish scenario, wherein I will use a gold price of just $1000/oz. This obviously assumes the mine will remain open at this gold price.

Cash Flow per year

Corporate tax at 27%

after tax

Discount rate (5% per annum)

NPV5%

-135000000

0%

-135000000

-135000000

18000000

0%

18000000

1,00

18000000

18000000

0%

18000000

1,05

17142857

18000000

0%

18000000

1,10

16326531

18000000

0%

18000000

1,16

15549077

18000000

0%

18000000

1,22

14808645

18000000

0%

18000000

1,28

14103471

14880000

0%

14880000

1,34

11103685

14880000

0%

14880000

1,41

10574938

14880000

27%

10862400

1,48

7352100

14880000

27%

10862400

1,55

7002000

14880000

27%

10862400

1,63

6668571

14880000

27%

10862400

1,71

6351020

14880000

27%

10862400

1,80

6048591

14880000

27%

10862400

1,89

5760563

14880000

27%

10862400

1,98

5486250

14880000

27%

10862400

2,08

5225000

14880000

27%

10862400

2,18

4976191

14880000

27%

10862400

2,29

4739229

14880000

27%

10862400

2,41

4513552

14880000

27%

10862400

2,53

4298621

14880000

27%

10862400

2,65

4093924

14880000

27%

10862400

2,79

3898976

14880000

27%

10862400

2,93

3713310

14880000

27%

10862400

3,07

3536486

66,273,586

So even when you use a gold price of just $1000/oz, the after-tax NPV5% of the streaming deal is still positive to the tune of $66M.

In the bullish scenario, I will use a gold price of $1500/oz.

Cash Flow per year

Corporate tax at 27%

after tax

Discount rate (5% per annum)

NPV5%

-135000000

0%

-135000000

-135000000

27000000

0%

27000000

1,00

27000000

27000000

0%

27000000

1,05

25714286

27000000

0%

27000000

1,10

24489796

27000000

0%

27000000

1,16

23323615

27000000

0%

27000000

1,22

22212967

27000000

27%

19710000

1,28

15443301

22300000

27%

16279000

1,34

12147640

22300000

27%

16279000

1,41

11569181

22300000

27%

16279000

1,48

11018268

22300000

27%

16279000

1,55

10493589

22300000

27%

16279000

1,63

9993894

22300000

27%

16279000

1,71

9517994

22300000

27%

16279000

1,80

9064756

22300000

27%

16279000

1,89

8633101

22300000

27%

16279000

1,98

8222001

22300000

27%

16279000

2,08

7830477

22300000

27%

16279000

2,18

7457597

22300000

27%

16279000

2,29

7102474

22300000

27%

16279000

2,41

6764261

22300000

27%

16279000

2,53

6442153

22300000

27%

16279000

2,65

6135384

22300000

27%

16279000

2,79

5843223

22300000

27%

16279000

2,93

5564974

22300000

27%

16279000

3,07

5299975

152,284,908

When the gold price averages $1500/oz during the 24 year mine life, the after-tax NPV increases to in excess of $150M.

The results of these calculations mean that Franco Nevada did a great job by securing the gold stream deal, as even at a gold price of just $1000/oz the after-tax net present value is still positive.

Investment Thesis

Based on the previous calculations, the shareholders of Franco Nevada can be happy with the Teranga deal, as even in the bearish scenario the streaming agreement has a positive NPV using a 5% discount rate. This shows again Franco Nevada has an excellent management team with a special sixth sense for good deals.

As Franco Nevada had almost $1B in working capital at the end of Q3, the cash to pay for the streaming agreement was immediately available, and the streaming agreement will already have an effect of $22.5M in additional operational cash flow from 2014 on.

Source: Is Franco Nevada's Newest Streaming Deal Adding Value?