EXPLORATION ’93 — Royalties can be a gold mine in

Royalties — a cold chill to the producer but gravy to the royalty-holder. It all started in the days when the king owned the land and all that therein lay. And while royal personages have all but vanished, there is little prospect of royalties going the same route. Nevertheless the nature of these payments has gradually changed, at least as regards mining, alleviating the chill by several degrees.

In the early days, a miner finding gold or silver on the land would have to petition the Crown for mining rights. If he received the royal grant, he would be obligated to pay a portion of the produce to the Crown. The portion was called the “royal tithe.” It might be a third or possibly more of the metals produced.

The traditional royalty is embodied in today’s “net smelter return” (NSR). It is a common system of payment and the most favored by the royalty-holder. A relatively new wrinkle is the “net profits interest” (NPI) and this is the system preferred by those who have to pay rather than receive. Both systems have a range of variations.

The NSR is sought after by the holder because royalty payments have first call on revenue. Regardless of whether the company made or lost money, payments come off the top.

At the same time, no royalty-holder wants to risk killing the goose that lays the golden eggs and the holder will often phase in payments gradually so that the struggling producer is not strangled at birth.

Sometimes the owner will employ the opposite strategy and require payments right from the beginning and before production begins. This early payment tactic usually comes with the provision that prepayments will be deducted from future revenues. This seemingly predatory approach reflects the relative ease (compared with a century ago) with which companies are able to raise money on the market.

Very much in the NSR’s favor is the simplicity with which it can be calculated. There is also little delay between a mine reaching production and the owner’s receipt of the first royalty payment. In addition, future payments can be estimated with confidence and the book-keeping required is easily verifiable.

Last, but not least, an NSR contract is cut-and-dried in the legal sense. All the royalty-holder needs to do is check the mine’s revenue receipts and apply his percentage. Other than smelting and refining charges, his take is net of the cost of production. It is “free.”

Producers and those who invest time, money and effort in a mining project must wait a number of years before seeing a return on their money. They see things in a different light. They prefer the NPI.

Under an NPI contract, the producer (miner) sees the return of some or all of his investment, plus or minus a stipulated rate of interest on his investment before the royalty kicks in. In this way, the producer is relieved of an extra expense when the project is least capable of carrying it. On the other side of the coin, NPI contracts are complex legal instruments. Specialist legal help is needed to compile them, and their month-to-month performance should be monitored by accountants. There are many cases on record in which the royalty-holder lost income to which he believed himself legitimately entitled because his understanding of the contract differed from that of the miner.

The first Canadian company to single-mindedly capitalize on royalty revenue was Franco-Nevada (TSE), incorporated in 1982. This company aggressively acquired royalties and equity-financed the necessary vehicle. Asked how the company first became involved, President and Chief Operating Officer Pierre Lassonde pointed out that royalty companies are commonplace in the U.S. oil and gas industry.

“There are close to 20 (such) royalty companies in the States. That started us looking at what was happening in that line here in Canada,” he said. “To our surprise, we couldn’t identify a single company in the business capitalizing on hard-rock royalties. That was our cue. That was the real start of Franco-Nevada.”

Franco-Nevada spun off Euro-Nevada (TSE) in 1987 and acquired Redstone Resources (TSE) two years later. Redstone is a far older company than either of the others and had been long-established in mineral exploration before it was brought into the fold. That happened in late 1988.

Each company has a different appeal to investors, but central to all is the objective of royalty income or the “creation” of royalty-making situations. Franco-Nevada started out in 1983 as a conventional exploration company active in California, Nevada, and later in Utah. It acquired its first royalty rights in 1985 in the form of a 3,416-acre tract in the Carlin Trend of Nevada. The property carried a 4% NSR and a 5% NPI royalty. Working on the property was a joint venture consisting of Pancana Industries of Calgary and Denver, Colo.-based Western States Minerals. An open pit had operated for a number of years and was producing 44,000 oz. gold per year through heap leaching. These two companies sold out to American Barrick (TSE) later that same year.

Immediately after acquiring the property, Barrick embarked on an intensive drilling program and ultimately delineated what has become one of North America’s largest gold deposits. The Goldstrike mine is now mined at the rate of 140 million tons of ore and waste per annum and in 1992 produced 1.1 million oz. gold.

Franco-Nevada’s royalty share is 4% of the annual gold production (gold metal, not revenue) and the company expects its first 5% NPI revenue in 1994-95.

The company’s first royalty income was $505,304 in 1987. In 1992 it was $10.3 million.

Today Franco-Nevada has more than 33,000 acres of royalty lands in the Carlin Trend.

It also holds a 100% interest in 620 acres at Hemlo, Ont. Franco-Nevada purchased the property outright from International Interlake (VSE). (Here, diamond drilling has identified the down-dip extension of the main Hemlo gold zone at depths from 3,500 ft. to more than 6,000 ft. below surface. Consultant Watts, Griffis & McOuat estimates an inventory of 1.8 million oz. gold for the partly explored extension. Mining is not expected to be active at these depths until about 10 years from now.)

Franco-Nevada’s focus is on the Carlin Trend (plus a far smaller, long-term interest in the Hemlo gold camp).

Euro-Nevada is more broadly based and its objective is to be the most diversified gold-royalty company in North America. It, too, holds royalties on 41,000 acres on the Carlin Trend, plus another 131,000 acres elsewhere in the U.S. and in Canada. Included in the royalties are the Meikle mine (adjacent to Goldstrike), Eskay Creek of British Columbia and Holt-McDermott in Ontario. Royalty revenues increased to $5.5 million in 1992 from an initial $218,000 in 1989.

Redstone’s objective is to specialize in the royalties of non-gold mineral deposits. The company has a 4% NPI in Falconbridge Dominicana, a ferro-nickel producer in the Caribbean. Approaching production are the Midwest uranium deposit in Saskatchewan, operated by Denison (TSE), et al., and the MacArthur copper deposit in Nevada, now being jointly developed by Arimetco (TSE) and Holcorp (CDN). Both properties will generate a 2% NSR with Midwest responsible for $700,000-per-year advance payments beginning in 1993. Redstone also holds properties in the exploration stage, including the Coates deposit in the Northwest Territories, estimated to contain 68 million tons grading 2.13% copper over a 6-ft. width. Redstone’s aim is to parlay its property interest in Coates into a royalty interest, leaving the expense and risk of development to others. This is the business plan of Redstone and sister companies Franco- and Euro-Nevada. Royalties are their niche.