Alternative Financing for Natural Resource Companies: Bringing Future Cashflows on-stream 1

Briefing note February 2013

Alternative Financing for Natural

Resource Companies: Bringing Future
Cashflows on-stream
Mining and oil and gas companies are increasingly turning to alternative
financing structures to fund their development. Of these, royalty and streaming
agreements are two alternative means by which a company can raise capital to
fund its development plans or to refinance existing obligations whilst providing
the investor with exposure to the potential upside in production and commodity
prices over the life of an asset or license.
So how do they work? agreements often relate to "by- realise value on its future production,
products" e.g. silver for gold allowing it to capitalise on proven
Royalty agreements producers or gold for copper reserves before the operation
Royalty agreements provide for an producers which may not be fully becomes productive. This means that,
up-front payment by the investor in valued by investors when valuing the unlike equity financing there is no
return for a percentage royalty which "main" product. dilution, and unlike debt financing the
would be payable at regular intervals investor is taking both production and
Both royalty and streaming
and which would be calculated on the commodity price risk.
agreements enable a company to
basis of the net revenue generated
over the life of an asset or license.
Often royalty payments only begin
after the company has recovered its
What are the benefits for a company of these forms
capital costs. of financing?
Streaming agreements There are potentially significant benefits to a company of entering into royalty
and/or streaming agreements over traditional forms of equity and debt
As with a royalty agreement an up-
financing:
front payment is made by the investor
but instead of receiving a royalty the „ No dilution of existing shareholders
investor is entitled to a percentage of „ Access to non-bank sources of finance
the production over the life of the
„ Preservation of management control (no "operational interference" of the
asset or license. In addition to the up-
kind encountered in a farm-out or joint venture)
front payment, there would often be
„ No financial covenants
an ongoing per ounce/per tonne/per
barrel payment made by the investor „ Investor takes production risk
at the time of sale. Streaming „ Company may have the opportunity to repurchase the royalty or stream
„ Speed of financing
„ Usually no government/regulatory approvals required.
2 Alternative Financing for Natural Resource Companies: Bringing Future Cashflows on-stream
Things to watch out for
when negotiating royalty
and streaming
agreements
Scope of agreement
The first point which needs to be
clearly provided for in the contract is
the exact scope of what the investor
is getting in return for their investment.
Is the royalty/streaming limited in time
or limited to a specific mine or license
area? The investor may expect to
benefit from any new discoveries
during the course of the agreement
which gives them upside where there
are reserves upgrades within the
license area. The agreement may
therefore contain a cap whereby the
investor is entitled to a percentage of
future revenues or production from
the asset or license up to "X" US$,
ounces, tonnes or barrels. On the flip-
side, the investor will take the risk of
any reserve downgrades. The
agreement could also be made
across assets or license areas so
although there is a reserve
downgrade risk, this can be mitigated
(made the company's problem) if
spread over a portfolio of assets.
Careful consideration should be given
to exactly which minerals or
hydrocarbons fall within the scope of
the agreement. For instance, the
contract should make it clear whether
the investor is entitled to an interest in
by-products of the mine or license or
any revenue not directly related to the
sale of the principally-mined resource.
Pricing
The investor will need to discount the
expected future cashflows in order to
calculate the net present value of the
royalty or stream which is attributable
to the asset or license. The investor
may also seek to structure incentives
Some recent examples of royalty and streaming
deals
February 2013
Vale announced that it had signed a US$1.9 billion deal with Silver Wheaton
Corp. to sell the gold produced as a by-product of Vale's copper and nickel
mines. The agreement gives Silver Wheaton Corp. the right to acquire 25% of
all the gold to be produced at Vale's copper units in Salobo, Pará, Brazil
throughout the mines’ lifespan, calculated to be 50 years, and 70% of the gold
extracted over a 20-year period from seven nickel mines in Sudbury, Canada.
Vale is due to receive an initial cash payment worth US$1.9 billion plus US$10
million in warrants.
December 2012
Sandstorm Gold announced that it had entered into a gold stream agreement
with Mutiny Gold to purchase an amount equal to 15% of the gold produced
from the Deflector Project in Western Australia for an initial up-front cash
payment of US$9 million in addition to a future cash remittance of US$29
million, subject to Mutiny receiving final mine permits and completing certain
funding conditions, plus an on-going per ounce payment.
November 2012
Franco-Nevada Corporation announced it had entered into a sale and
purchase agreement with Penn West Petroleum to acquire an approximate
11.7% net royalty interest in the Weyburn Oil Unit for C$400 million in cash,
prior to normal closing adjustments.
August 2012
London Mining announced a US$110 million royalty transaction with Blackrock
World Mining Trust for a 2% revenue-related royalty calculated on iron ore
sales from the company's Marampa license located in Sierra Leone. The
royalty is payable quarterly in arrears calculated on the amount receivable at
the relevant point of sale.
August 2011
London Mining announced a US$30 million royalty transaction with Anglo
Pacific Group for a 1% revenue-related royalty calculated on future iron ore
production at the company's Isua Project located in Greenland.
January 2010
Talvivaara Mining Company announced a long-term zinc in concentrate
streaming agreement with Nyrstar. Pursuant to the terms of the contract
Talvivaara was required to deliver all of its zinc concentrate production to
Nyrstar until a total of 1,250,000 metric tonnes had been delivered. Nyrstar
agreed to pay an up-front payment of US$335 million for the zinc stream plus
an extraction and processing fee per tonne of zinc in concentrate delivered.
 Alternative Financing for Natural Resource Companies: Bringing Future Cashflows on-stream
which regularise its income stream
over the life of the asset or license
whilst encouraging the company to
ramp up production.
Intercreditor issues
When the royalty or streaming
agreement is entered into prior to the
company obtaining bank financing, it
is likely that financing banks may
have concerns about whether the
royalty/streaming will make
enforcement of their security package
more difficult in a distress scenario.
Lenders (especially if lending on a
project finance basis) may want to
enter into an inter-creditor agreement
with the royalty-holder to address the
royalty/stream-holder's claim on the
relevant secured assets, adding
complexity to the financing package.
Protections for the investor
„ Warranties
The investor is likely to seek a
warranty package similar to that
which would be provided on an M&A
transaction. Specific protections
which the investor are likely to focus
on are warranties that the licenses
are in full force and effect, warranties
that there are no existing charges
over the revenue or production which
is the subject of the royalty and/or
streaming agreement and warranties
as to the accuracy of any reserve
reports and/or production reports or
forecasts used in the valuation.
„ Assurances
The investor is also likely to want to
contract in relatively "safe" legal
jurisdictions and ones in which the
rights created by the royalty or
streaming agreement are recognised
and can be adequately enforced,
meaning this may not be suitable for
implementation in certain emerging
economies.
„ Undertakings
The investor is likely to require on-
going undertakings that require the
company to carry on its business in
the ordinary course and which require
the company to mine, extract and/or
process the mineral or hydrocarbon
products in accordance with good
industry practice and applicable law.
The investor is also likely to require
that certain milestones are achieved
(by way of example, in the case of an
oil and gas company these may be
the completion of seismic studies or
achieving first oil). If the company fails
to achieve these milestones within the
specified time period then the investor
may seek to negotiate a right to
repayment in full of its investment. In
order to protect its cash position, the
company may seek to include a
provision whereby in the event that
such milestones have not been
achieved and the investor is seeking
repayment of its investment, the
company has the option to satisfy its
obligation to the investor in shares (as
well as cash).
Change of control
Both royalty and streaming
agreements are by their nature likely
to be long-term investments which in
many cases are likely to extend for
the life of the asset or license in
question. Where an investor has
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provided equity finance it would
realise value on a change of control of
the company and where an investor
had provided debt finance it is likely
that the finance documents would
require prepayment on a change of
control. With royalty and streaming
agreements, consideration needs to
be given as to whether to include a
mechanism for "taking the investor
out" on a change of control or
whether the royalty or streaming
agreement should continue
irrespective of who owns the
company.
Assignment of rights
Given the likely long-term nature of
such agreements and in order to
make the investment more liquid it is
likely that the investor will require that
its rights under the royalty and/or
streaming agreement can be
assigned to a third party without the
consent of the company. However,
the company may negotiate a
matching right whereby should the
investor wish to assign its rights under
the relevant agreement the company
shall have the right to require that the
investor transfers the rights to the
revenue/production to it for the same
price that it would otherwise have
transferred such rights to a third party
for (i.e. the company undertakes a
buyback of the rights to its
revenues/production).
4 Alternative Financing for Natural Resource Companies: Bringing Future Cashflows on-stream

Authors

David Lewis Ashvin Seetulsingh Alex Drysdale Philip Sealey

Partner, Corporate (London)
Co-head Mining & Metals
Group
T: +44 20 7006 1903
E: david.lewis
@cliffordchance.com
Foreign Legal Consultant,
Finance (Hong Kong)
T: +852 2826 3553
E: ashvin.seetulsingh
@cliffordchance.com
Lawyer, Corporate (London) Counsel, Banking & Finance
(Perth)
T: +44 20 7006 4936
E: alexander.drysdale T: +61 892625 542
@cliffordchance.com E: philip.sealey
@cliffordchance.com

Other contacts

Tracey Renshaw James Pay

Partner, Corporate (Perth) Partner, Finance (London)
Co-head Mining & Metals
T: +61 892625 505 Group
E: tracey.renshaw
T: +44 20 7006 2625
@cliffordchance.com
E: james.pay
@cliffordchance.com

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