Interview with Silver Wheaton’s Randy Smallwood

Silver Wheaton (SLW-T, SLW-N) has come a long way in a short period. Formed in 2004 out of Wheaton River Mineral’s silver assets the company is now the biggest silver streaming company in the world.

It’s built such growth on a straightforward business model: target near-term or in production miners in need of cash and offer upfront payments in exchange for all or a portion of their silver production at a low fixed cost.

The strategy has yielded agreements on 17 operating mines and four development stage projects including such world-class assets as Barrick Gold’s (ABX-T, ABX-N) Pascua-Lama project and more recently Hudbay Mineral’s (HBM-T, HBM-N) flagship 777 mine and Constancia project.

Silver Wheaton’s president and chief executive, Randy Smallwood took some time to speak with The Northern Miner about the corporate philosophy behind Silver Wheaton’s success and the general lay of the land.

How does the current environment of low equity valuations and relatively high precious metal prices affect Silver Wheaton? Does it present opportunities?

Right now companies are hesitant to use their own equity in a deal because every one feels they are more undervalued than everyone else. We have cashflow though, so we’re doing deals from our current cashflow, which gives us some capacity.

I’d say that the current environment is very good for us. When miners have significant capex traditionally they turn to bank debt but with a tight debt mark and undervalued equity we can provide an alternative funding source.

And because copper and base metal companies are not so focused on precious metals we give them a method for crystallizing value on their non-core assets, which is the silver.

This current market is reminiscent of 2008 when we did quite a few transactions. It’s similar to that, but precious metals hadn’t climbed up to where they are now. We’re as busy as we’ve ever been in terms of looking at opportunities, and think it will remain strong for the next 6-12 months.

What happens in 6-12 months that changes that?

Well the only solution when a country runs into debt issues is to devalue its currency.

The situation in Greece is what you have when you can’t devalue. If Greece wasn’t part of Europe it would have devalued the drachma and we wouldn’t even be hearing about it.

With the U.S. I fully expect quantitative easing, which is just another word for devaluing the dollar. After that happens precious metals should outperform.

We didn’t do anything when silver was up to US$50 per oz., but now it’s time to put our war chest back to work and you saw some of that with the Hudbay deal.

Do you believe that silver prices have found support in the US$27 range?

We are comfortable with where we are. We see an increase in demand for silver on both the industrial and investment side so we’re comfortable with this being good base level. We’re seeing more stability in last few months than we’ve seen in a while.

Given current low equity valuations would Silver Wheaton ever consider buying equity in a company?

Our primary focus, I’d say 99% of it, is on streaming. We do take on the occasional early stage equity investment if we see promise there and then we’ll be supportive all the way through to production. We did it with Bear Creek Mining (BCM-V) a little while back.

In that scenario we hope to convert our equity position into a stream as the project comes to production. For us the equity investment side is like our exploration department: it offers high risk and high return.

At the last PDAC luncheon panel you mentioned that you saw an arbitrage opportunity with base metal mines. Can you expand on what you meant by this?

Most silver is produced in base metal mines and when base metal companies calculate a net present value (NPV), they tend to use a higher discount rates than precious metal companies because they often have higher capex and operating costs. So there’s an arbitrage opportunity there when you calculate the NPV within a precious metal company because the discount rate tends to be lower.

The other main arbitrage, which is not as effective now, is that precious metal companies tend to have a higher net asset value (NAV) multiple than base metal companies. So by taking silver out of a base metal company and putting it into our company that instantly creates value and by sharing that arbitrage with our partners, we create value and both sides win.

You’ve also spoken on the tax advantages that Silver streams have when compared to a silver royalty.

Royalties are registered on the land and are liable for taxes in the country but royalty companies don’t have any costs in the country where the mine may be, so there’s no offset, its just pure taxes.

When we looked at it, the operating company in the country are more efficient at taxes because they have operating costs that can be used as an offset to their tax bill so it’s way more efficient.

How much does exploration upside factor into the projects you look to finance?

The most important thing we look at is the operating margin. We want projects in the lowest half of the operating cost curve. The lowest quartile is our target, but we’re happy with the lower half, and 80% of our current streams come from mines in the lower half of the cost curve.

Once you find quality like that generally, as they say, the best place to make a discovery is in the shadow of the head-frame. It’s a phrase that is well used and it has good substance. A good quality mine generally has good quality deposit to be found around it.

We like certain styles of mineralization and we do like underground investments because they are so expansive. Lundin Mining’s (LUN-T) Zinkgruven mine (a Swedish mine which Silver Wheaton holds a silver stream on) never had more than 10 years or reserve rung but it has been running continuously for 160 years.

Glencore International’s (GLEN-L) Yauliyacu mine in Peru (which Silver Wheaton also has a silver stream on) has never had more than 6 to 7 years of reserves but it’s been in operation for 180 years. So we want to be where the additional potential is obvious.

You’ve said before that you should only invest in countries where an increase in royalties won’t hurt the investment. Can you discuss Peru in this context?

I think President Humala has done a very good job. He took the royalty scheme from a gross royalty to one that is profit based. Mining companies don’t have a problem with profit sharing or paying taxes, the burden is when a mine isn’t making money and you have to still have to pay.

One of Humala’s first changes was to change the royalties, and there was a bit of an increase, but the focus was to shift to a profit based royalty and I think he has done a good job.

Listen, social license is not easy to get anywhere. You have to have community support. When we looked at Constancia (Hudbay’s Peruvian project which Silver Wheaton recently completed a silver stream on) and met with the community and we understood the strength in the relations there.

 So Peru is still a very attractive place to invest and we believe there is good value there right now because there is this conception of it being a challenging space to operate in.

How reluctant are you to tap into your $400 million revolving line of credit? Can it make sense to finance a stream with debt?

The first thing we use is cashflow and we still have over $600 million in cash. The objective is to get rid of our own cash first as our business model is to have zero cash.

We buy ounces in the ground, and that $400 million gives us extra. We could easily lever up and bring more debt into the equation but our production profile over the next five years is over 48 million oz. of silver. That means that cashflow will grow over the next four to five years at a rapid pace.

Now after we pay out 20% of our cash as a dividend the rest goes into the ground. Of the 80% of cashflow that will be left we only need about 20% of that to be sustainable and replace our reserves. That leaves 60% to fund growth or re-distributed.

How much do you feel you are in competition with exchange traded funds (ETFs)?

We provide so much more than an ETF ever can. They don’t have their costs fixed. We have our costs fixed by contract in the US$4 per oz. range.

So we offer operating costs that are fixed and we also offer leverage, yield, organic growth, and the possibility of acquisitions, and on top of that ETFs charge twice what we charge on a per oz. basis.

I’m not sure anyone would invest in an ETF.