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Executive summary:

  • Royal Gold puts its $705M working capital at work by acquiring a gold stream on Rubicon Minerals' Phoenix project.
  • Acquisition price is $75M for a 6.3% royalty on the first 135,000 delivered ounces, decreasing to 3.15% for the subsequent ounces.
  • After-tax NPV5% is positive for Royal Gold, indicating this is an excellent deal.
  • Additional exploration potential might increase the mine life and the value of the gold stream.

_________________________________

Introduction

After writing about Royal Gold's (NASDAQ:RGLD) quarterly results in January it's time to revisit the company and analyze the gold streaming deal it just closed with Rubicon Minerals (NYSEMKT:RBY) which is aiming to develop its Phoenix Gold project in Canada's Red Lake district. In this article I'll discuss the rationale of the deal and I will make some calculations to determine the eventual value for Royal Gold shareholders. This will result in my investment thesis at the end of this article.

The rationale behind the deal and the terms.

In my previous article, I stated that Royal Gold's current ratio was an astonishing 30. Whilst a high current ratio is usually good because it means the company has sufficient current assets to cover its current liabilities, a current ratio which is too high could mean the company isn't allocating its capital efficiently.

I am glad Royal Gold decided to put a part of its working capital of $705M to work as the company announced today it entered into an agreement with Rubicon Minerals to acquire a gold stream on its Phoenix Gold project which is located in Canada's Red Lake district. I think this is a good move as the Phoenix project is fully permitted and construction has started.

As per the terms of the agreement, Royal Gold will pay a total of $75M in exchange for a gold stream whereby Rubicon Minerals will deliver 6.3% of the annual gold production to Royal Gold at 1/4th of the market price. After an initial 135,000 ounces will have been delivered, the streaming deal halves to 3.15% per year. As the feasibility study outlined a production rate of 165,000 ounces per year, Royal Gold will receive approximately 10,000 ounces per year in the first 13 years of the mine life.

Is this deal accretive to Royal Gold shareholders?

Let's now see if this deal adds value to the shareholders of Royal Gold. In my first assumption I will use a gold price of $1300/oz which is approximately the current gold price. I think a discount rate of 5% is sufficient as the project is located in a safe region and construction works are going smoothly.

Year

Production (koz)

Cumulative share to RGLD based on 6.3% (in koz)

1

140

8.8

2

154

18.5

3

163

29

4

156

38.6

5

142

47.5

6

159

57.5

7

224

71.7

8

242

87

9

196

99.2

10

185

111

11

193

123.1

12

131

131.4

13

70

135.8

Using the abovementioned annual production rate (see the technical report at SEDAR), the following calculation summarizes the expected NPV of this transaction.

Cash Flow per year

Corporate tax rate (30%)

after tax

Discount rate (5% per annum)

NPV5%

-75000000

   

-75000000

1800000

0%

1800000

1,00

1800000

8580000

0%

8580000

1,05

8171429

9700000

0%

9700000

1,10

8798186

9750000

0%

9750000

1,16

8422417

9250000

0%

9250000

1,22

7609998

8900000

0%

8900000

1,28

6973383

9750000

0%

9750000

1,34

7275600

13850000

0%

13850000

1,41

9842936

14500000

20%

11600000

1,48

7851337

11900000

30%

8330000

1,55

5369592

11500000

30%

8050000

1,63

4942002

11700000

30%

8190000

1,71

4788523

7800000

30%

5460000

1,80

3040332

3800000

30%

2660000

1,89

1410655

     
    

11,296,389

So by using a tax rate of 30% and a discount rate of 5%, the NPV of the streaming deal is positive for Royal Gold shareholders. Let's now see what would happen if Rubicon is able to extend the mine life by another 5 years at an average output of 150,000 ounces per year (keep in mind the streaming agreement covers just 3.15% of the produced ounces from here on).

Cash Flow per year

Corporate tax rate (30%)

after tax

Discount rate (5% per annum)

NPV5%

-75000000

   

-75000000

1800000

0%

1800000

1,00

1800000

8580000

0%

8580000

1,05

8171429

9700000

0%

9700000

1,10

8798186

9750000

0%

9750000

1,16

8422417

9250000

0%

9250000

1,22

7609998

8900000

0%

8900000

1,28

6973383

9750000

0%

9750000

1,34

7275600

13850000

0%

13850000

1,41

9842936

14500000

20%

11600000

1,48

7851337

11900000

30%

8330000

1,55

5369592

11500000

30%

8050000

1,63

4942002

11700000

30%

8190000

1,71

4788523

7800000

30%

5460000

1,80

3040332

6100000

30%

4270000

1,89

2264472

4600000

30%

3220000

1,98

1626319

4600000

30%

3220000

2,08

1548875

4600000

30%

3220000

2,18

1475119

4600000

30%

3220000

2,29

1404875

4600000

30%

3220000

2,41

1337977

    

19,543,372

So by extending the mine life by five years, the NPV increases by 75% despite a 50% cut in the stream rate to 3.15%.

Just for fun; this is the calculation of the undiscounted NPV of the project.

Cash Flow per year

Corporate tax rate (30%)

after tax

Discount rate (0% per annum)

NPV0%

-75000000

   

-75000000

1800000

0%

1800000

1,00

1800000

8580000

0%

8580000

1,00

8580000

9700000

0%

9700000

1,00

9700000

9750000

0%

9750000

1,00

9750000

9250000

0%

9250000

1,00

9250000

8900000

0%

8900000

1,00

8900000

9750000

0%

9750000

1,00

9750000

13850000

0%

13850000

1,00

13850000

14500000

20%

11600000

1,00

11600000

11900000

30%

8330000

1,00

8330000

11500000

30%

8050000

1,00

8050000

11700000

30%

8190000

1,00

8190000

7800000

30%

5460000

1,00

5460000

6100000

30%

4270000

1,00

4270000

4600000

30%

3220000

1,00

3220000

4600000

30%

3220000

1,00

3220000

4600000

30%

3220000

1,00

3220000

4600000

30%

3220000

1,00

3220000

4600000

30%

3220000

1,00

3220000

    

58,580,000

Conclusion

Based on my calculations, this deal is quite good for the Royal Gold shareholders. Even after deducting the applicable maximum taxes and using a 5% discount rate, the NPV of the streaming deal is still positive and the undiscounted NPV of a scenario with an 18 year mine life is close to $60M.

In my previous article I recommended to write a P40 July 2014 at $0.80. As the share price increased by almost 20%, this put option can now be bought back at a profit at $0.30-0.35.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within 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.

Additional disclosure: I have no position in Royal GOld but I wrote a put option which I might cover at any time.