Franco-Nevada: A clever way to get exposure to gold
While the spot price of gold has not been able to sustainably exceed the symbolic $1800 mark for several years, gold investments remain popular among diversification enthusiasts. Gold's alleged... |…
Annualized performance since Franco-Nevada's IPO (2007) The birth of a business model The story of Franco-Nevada is above all the story of a rather unusual business model. Founded in 1986 by Seymour Schulich and Pierre Lassonde, Franco-Nevada was one of the first companies in the world to offer to finance gold mines in exchange for a royalty on the extractions. Before continuing, let's take a moment to explain this type of contract.
The royalty contract means that the mining company receives money - funding - from a percentage of the revenues that it generates, or that it will generate, from a project that is more or less advanced (in development when the production phase is near or in exploration when it is still at a preliminary stage). The cash flows received by the financing company are therefore exposed both to the success of the project - quantities extracted - and to the price of the raw material extracted. To counterbalance the uncertainty in the success of the mining project, these types of royalty companies invest in many projects - much like Venture Capital funds - to maximize the chances of finding profitable projects.
Royalty companies also engage in more traditional financing through direct equity investments in mining companies, a novel business model that allows the mining companies to raise more debt through higher equity contributions. These royalty agreements have enabled Franco-Nevada to acquire stakes in some of the world's most profitable mines. One of the group's most iconic successes was its first equity investment in 1986, with a royalty agreement in the Goldstrike mine in northern Nevada.
At the time, it was a small heap leach mine operated by Western States Mining. Shortly thereafter, American Barrick - now Barrick - bought Goldstrike and conducted a deep exploration that eventually revealed a 50 million ounce deposit. This exploration was the basis of Barrick's success and therefore of Franco-Nevada.
Today, the group still operates mainly in the gold sector but has been diversifying into other metals and natural resources for some time. The composition of its portfolio is currently as follows: Gold 55% Silver 11% Natural gas 11% Oil 14% Iron 4% Other 5% A record IPO In April 2001, Franco-Nevada sold the Midas mine to Normandy Mining in exchange for 20% of Normandy Mining and a 5% royalty on the mine. In September of the same year, AngloGold Ashanti made an offer to acquire Normandy Mining at a value 60% higher than the acquisition cost of Franco-Nevada.
Seeing an opportunity to capitalize on the rivalry between Newmont Mining - the world's number two gold producer - and AngloGold Ashanti - number three - Franco-Nevada's management informed Newmont Mining of its potential intention to sell the company - and thereby facilitate the takeover of Normandy Mining. After a bidding war between the two global giants, the group was acquired by Newmont Mining and valued at $2.5 billion. A few years later, in 2007, Newmont Mining undertook a strategic restructuring and decided to spin off Franco-Nevada, which was then listed on the Toronto Stock Exchange, raising C$1.1 billion in the process.
This money was then used by management to buy back the rest of Newmont Mining's royalty portfolio as well as to make some other equity investments. This IPO is still one of the largest in Canadian history, second only to Sun Life in 2000, and the largest mining IPO in North American history. In short, this is the story behind the Franco-Nevada Corporation (FNV) of today.
Franco-Nevada, a diversified portfolio A resilient business The company has gradually expanded, placing it at the intersection between investment fund and merchant bank. However, financing, equity investments and restructuring activities are still only aimed at players operating in metals or natural resources to which FNV wishes to gain exposure . Franco-Nevada's main activities The group's business model appeals to many investors because of: Exposure to commodities Low capital intensity Minimal drawdown - more on this later.
Fundamental analysis for this type of company is extremely complex to carry out as we need to have an idea of the future prices of raw materials as well as the richness of the soil exploited by the companies in which Franco-Nevada invests. An alternative to these impossible valuations is to look at the counterparties, i.e. the companies financed.
In the case of Franco-Nevada, it is a range of "prime" partners: Glencore, Lundin Mining, Barrick, Newmont, Teck, Vale, Continental ... Franco-Nevada's dividend growth If we take a look at Franco-Nevada's accounts over ten years, the Canadian group has generated $5.2 billion in cash flow from its operating activities and paid out $1.5 billion in dividends. But this was on $6.5 billion of investments, which required several capital increases for a total amount of $2.7 billion, i.e.
a comfortable ROI in the form of dividends of around 23%. Another fundamental variable in the analysis of this type of company is the geographical risk. Franco-Nevada's portfolio is relatively well diversified, with nearly 40% of its investments in the United States and Canada, 23% in Central America, 28% in South America and 9% in the rest of the world.
The market rightly values companies with a large number of productive assets and strong diversification. A well-diversified royalty portfolio means: different sorts of underlyings, assets and geographical locations. However, this type of investment is not for everyone.
This industry is exposed to an explosion of company formation, resulting in a race to acquire streams/royalties. They are increasingly buying non-producing underlyings such as exploration companies - projects that may never go into production. Many of these listed royalty companies excel in the art of flashy communication.
Therefore, one should be very selective. Keeping in mind that a royalty company means less risk of loss, but also less leverage on the underlying commodity .