Silver Wheaton (NYSE:SLW) has closed its previously announced deal with HudBay Minerals, Inc. It will buy Hudbay’s silver production from two of its mines along with some gold production from one of them for about $750 million, plus additional ongoing payments.
We think this deal will benefit Silver Wheaton in multiple ways. The increased availability of silver will allow it to leverage its unique business model to take further advantage of high silver prices in the market. The company’s business model insulates it from the rising cost of silver production as well as the downside resulting from lower production. In short, the deal provides significant upside as well as downside protection.
Silver Wheaton is in the silver streaming business. It provides funds for capital expenditure upfront when a project is being developed and obtains the right to buy precious metals produced at low, fixed prices. It does not pay for any ongoing capital or exploration costs at the mines. Thus, the company’s costs are one-time and fixed. This greatly reduces its business risk. The silver obtained at a fixed price is sold at market rates which exposes it to the daily volatility of silver prices. Its gains increase when the market price of silver goes up. Prices of precious metals have been generally high for some time and are expected to be so in the near future. This makes Silver Wheaton a likely winner.
Terms Of The Deal
Under the deal, Silver Wheaton is entitled to 100% of the life-of-mine silver production from Hudbay’s currently producing 777 Mine in Manitoba, and 100% of the life-of-mine silver production from its Constancia Copper-Molybdenum-Silver Project in south Peru. It is also entitled to 100% of the gold produced from the 777 Mine until Constancia satisfies a completion test, or the end of 2016, whichever is later. Thereafter, Silver Wheaton’s share of gold production from 777 will be reduced to 50% for the remainder of the mine’s life. Silver Wheaton will pay a price of $5.90 per ounce of silver and $400 per ounce of gold for the duration of the contract. These prices will be subject to an inflationary adjustment of 1%, beginning in the fourth year.
In return, Silver Wheaton has to pay Hudbay $750 million, of which $500 million has now been paid with the closing of the deal. Two further payments of $125 million each are to be made subject to fulfillment of minimum capital expenditures criteria at Constancia. ((The Hudbay Stream Continuing the Growth, Silver Wheaton, August 8 2012))
The deal specifies 90% of expected throughput and recovery by the end of 2020. Failing this, Silver Wheaton will be entitled to a proportionate return of the upfront cash consideration relating to Constancia.
What It Means For The Company’s Business
Prior to the deal, Silver Wheaton had a cash chest of $1 billion, which it was looking to deploy. The Hudbay deal will add 4.9 million ounces to its long-term average annual silver equivalent production figures. You can check out the impact of the new silver stream on Silver Wheaton’s Trefis price estimate in the following graph. You can modify it using your own expectations and check the impact it will have on the company’s valuation.
In our opinion, the deal fixes the price of silver at a relatively lower figure, considering the huge jump in the cost of production over the last few years. Going forward, we think it will rise further owing to higher costs associated with labor, energy, and regulatory compliance. Silver Wheaton, however, will be insulated from these owing to its fixed-price contracts. Also, with industrial demand expected to pick up, the market price of silver is likely to rise. This will allow streaming companies to make good profits. Hence, we think that Silver Wheaton has got itself a good deal. The clause that specifies return of cash consideration to Silver Wheaton in the event that production targets are not met, ensures shareholders have adequate downside protection.
We recently revised our price estimate for the company to $37 after the latest earnings numbers.