ROYALTIES & STREAMING
Franco Injects $520m Into Oil Business as Royalties Expand Beyond Gold & Silver
Companies are playing an arbitrage between different commodities
Franco-Nevada's oil desk just passed a key milestone: for the first time it is generating more revenue per employee than the company's mining division.
Of Franco's thirty-odd staff at its offices in Toronto, only four are on oil and gas deals, but they have been quietly building a sizeable business, buying-up royalties over more than two million acres of ground in the US and Canada and doubling revenue in the last twelve months, adding-up to $23m per employee. At that rate, Walmart would generate $52 trillion and the whole of McDonalds could be run with eight workers per country.
To push the figures even further, Franco-Nevada is investing up to $520m in a new partnership with American oil investor Harold Hamm, one of the earliest proponents of the country's fracking boom. Franco and Hamm's company, Continental Resources, will inject cash and oil wells into a new fifty-fifty agreement that will go after land in basins in Oklahoma, which is “the hottest new area” for fracking, according to McKinsey, the consultant.
Oklahoma is also where Hamm was born. The 13th child of sharecroppers, he worked barefoot in cotton fields before going to work in a gas station aged sixteen. Five years later he launched his own oil company, Continental, which is now one of America's largest energy groups, pumping $3bn of oil and gas in 2017.
Whilst Hamm's parents used to pay royalties to their landlord for cotton they produced, Continental will now split profits with Franco-Nevada, which has built a C$16bn ($12bn) market cap by buying-up royalties in gold, silver and platinum since it was founded in the 1980s. “It's steps in a relationship,” said Franco's chief executive David Harquail. “There's been a very good rapport between our companies because we both have a very long-term perspective in this business, but the real test is time.”
Oil only accounts for 14 per cent of Franco's cash flow, and that figure looks likely to fall as payments kick in later this year from Cobre Panama, a huge new copper-gold mine that Franco has spent over $1bn co-financing. But as royalty and streaming groups grow, they are increasingly moving beyond gold and silver, betting that a model that began in precious metals can now be rolled-out into other commodities.
Vancouver-based Wheaton Precious, which originally focused exclusively on silver transactions, paid $390m for a cobalt deal in June, whilst royalty group Altius Minerals has spent around $430m since 2013 scooping-up royalties in potash and copper in Canada and Brazil.
Whilst gold mines tend to have short lives and high returns, says Altius chief executive Brian Dalton, mines in base
metals and bulk commodities have larger resources and greater scope for expansion. The mining industry is at least seven times bigger than the gold market, so at this early stage, he says, the runway for growth in royalties outside of precious metals looks more like “gravel surfaced.”
Trading group Glencore and private equity group Orion have also raised cash to go after royalties outside of gold. In total, mining companies have closed more than $2.5bn of royalty deals in oil, copper, potash and battery metals, with another $950m provisionally committed.
Companies can play an arbitrage between different commodities, says Canada's Scotiabank, which has structured many of the sector's largest transactions. Whilst gold royalty groups trade on multiples as high as 25 times cash flow, non-gold assets can be snapped-up for seven to eight times, opening-up a large new source of deal flow.
Potentially that brings into play another new category of assets: iron ore royalties. Ever since the 1970s, zircon miner Iluka Resources has owned a 1.2 per cent claim over “Area C” in Western Australia, one of the world's largest iron ore operations. The royalty has paid out over A$730m ($530m) to date, but that figure is about to shoot higher as the mine's owner, BHP, invests in a massive upgrade. It turned the turf on a $3.6bn expansion two months ago and has been given the green light by regulators to begin a 100-year rolling expansion of its operations across the region.
BHP will be mining its iron ore orebodies in Australia well into “the next century”, say analysts at Investec, making its price-earnings multiple of thirteen “seem silly.”
In Canada, Labrador Iron Ore Royalty owns a similar claim over Rio Tinto's IOC iron ore mine, but revenue has been hit by strikes this year and Labrador's board has asked shareholders to approve a new move into copper.
For Franco-Nevada, oil has simply been a contrarian play. “The way it's developed in the last year, oil and gas deals have been more attractive, so the market just tells us, it speaks to us, in terms of saying, this is where you should be deploying capital,” says David Harquail.
Most fracking royalties are bought “blind”, with little indication of when a discovery will turn into cash flow, Franco's head of oil Jason O'Connell told analysts last week. But its new partnership with Continental gives Franco a detailed insight into which wells are up next in production.
Franco-Nevada is the only gold company that “truly benefits from higher oil prices,” says Scotiabank. “People were questioning two years ago when we talked about doing oil and gas deals,” Harquail says. “Now they're not questioning it as much.”
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Copper & battery metals:
Wheaton Precious, Cobalt27, Altius Minerals and Orion have spent a combined $990m on royalty deals in cobalt, copper and lithium
Oil & coal:
Franco-Nevada and Anglo Pacific have spent $1.1bn on royalty deals in oil, gas, coal and uranium
Altius Minerals has led royalty deals in the potash market worth a total of $500m
Franco-Nevada, Glencore and Orion have committed another $950m to royalty deals in oil, potash and base metals