The Silver Wheaton Valuation Method, Part 1: Valuing Impact Silver

Includes: ISVLF, SLW
by: Douglas Dillon

Silver Wheaton's (NYSE:SLW) recent silver stream deal with Aurcana Corporation [AUN.V] provides a significant data point for valuing junior silver producers or near producers. This article describes how to apply this data point in evaluating these juniors. It's written at a level understandable even by "newbie" investors.

The "Value Investing" method of investing in stocks is to invest in companies that are "really" worth significantly more than the value assigned by the stock market. The idea is that eventually (hopefully soon) the market will come to its senses and raise its valuation to something closer to the company's real worth via a stock price rise.

My favorite introduction to this style of investing is Pabrai's "The Dhando Investor". The value assigned by the stock market is the company's market capitalization. Market capitalization (market cap) is easily calculated by multiplying the company's current stock price times the fully diluted number of shares. The fully diluted number of shares can usually be found in the Investor's section of the company's web site.

While it is easy to calculate the market cap, it is not so straight-forward to calculate what the company is "really" worth. The parlance for this is, "valuing the company". There are many ways of valuing companies and these ways vary significantly in their complexity and ease of calculation. When a company is dramatically undervalued, the method of valuing the company need not be extremely accurate. It need only be accurate enough that its error is significantly less than the amount it indicates that the company is undervalued.

This article provides a quick and dirty way of valuing junior silver mining companies. This valuation can be used to identify companies that are dramatically undervalued. It can also be used as an initial filter to determine which companies are worth the effort of a full, detailed examination.

Silver Wheaton is one of the most successful companies in the silver mining industry (see chart below). It doesn't actually mine silver. Instead it buys the silver byproduct from base metal (or sometimes gold) mines. It can do this with win-win deals because the market values silver mine production more highly than base metal mine production. Typically the deal is structured as an up-front payment for the right to buy a fraction of the silver output of a mine at a low cost, for example, $3.90 /oz. Silver Wheaton wins when it sells the silver at market price (currently around 17$/oz giving resulting roughly 13$/oz profit for Silver Wheaton). The actual mining company wins by getting an up front payment plus the $3.90 / oz when the silver byproduct is actually mined. The $3.90 / oz helps lower the cash cost for the mine's primary metal.

The market likes what Silver Wheaton has done and is doing (click to enlarge image):

Silver Wheaton's recent deal with Aurcana Corporation provides a way for valuing producing or near producing silver mining juniors. The deal, in simple terms, is: Silver Wheaton gets 50% of the silver production from Aurcana's La Negra Silver-Copper-Zinc mine. Silver Wheaton pays 25 million$ up front and $3.90 for each such oz delivered. From Aurcana's web site we see that La Negra is expected to produce 820,000 oz/year with a nice long mine life.

So, here's the key data point: Silver Wheaton, who is about the best in the industry, thinks it is quite profitable over the long term to buy a silver mine's production at $61 / annual oz produced. We can use this data point to value junior silver miners and it is very relevant as long as the junior has a cash cost near $3.90 / oz.

Let's use this valuation method to value Silver Wheaton itself. Since Silver Wheaton thought it was a good deal, one would expect that Silver Wheaton is valued more highly than this.

From Silver Wheaton's June 2008 presentation we see:

  • Silver Wheaton expect to receive (produce) via its silver stream deals 27 million oz.
  • Silver Wheaton has fully diluted 266 million shares for a market cap of 3.862 billion $.

Thus Silver Wheaton is valued at 143$ / annual oz produced. Silver Wheaton (as a major with diversified risk and a low cash cost of $3.90 / oz) is valued quite highly compared to what it just paid for its recent incremental increase in production from the Aurcana deal.

Impact Silver (OTCPK:ISVLF) is an nice little silver mining company with four little producing mines near a company owned mill on a large property in a historic silver mining district in Mexico. The company management seems to have the desirable properties of looking out for the stockholder's interest by avoiding dilution and meeting its commitment (although it doesn't give a lot of future guidance). Having management that looks out for the stock holder is what I find really attractive at first glance.

Impact Silver has 49.8 million fully diluted shares for a market cap of roughly 51 million $. It produced roughly 350 thousand oz of silver in 2007 and seems to have a good plan for doubling that. So, applying the Silver Wheaton Valuation Method, what Impact Silver is "really worth" is 700,000 oz * 61 $/oz or roughly 43 million dollars.


The Silver Wheaton Valuation Method indicates that Impact Silver is fairly valued. This means it's valued for about what Silver Wheaton has shown it would be willing to pay for its expected silver production. As such, it appears to not be a good value investing target.