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An Economic and Financial Deconstruction of the Commodity

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An Economic and Financial Deconstruction of the Commodity AN ECONOMIC AND FINANCIAL DECONSTRUCTION OF THE COMMODITY STREAMING BUSINESS MODEL by Daniel Victor DiFilippo A thesis submitted to the Robert M. Buchan Department of Mining In conformity with the requirements for the degree of Master of Applied Science Queen’s University Kingston, Ontario, Canada January 2015 Copyright © Daniel Victor DiFilippo, 2015 Abstract The objective of this thesis is to evaluate the viability of the commodity streaming business model, both as a standalone enterprise and as a financing service for exploration and mining companies. A silver streaming company, Silver Wheaton, was chosen as the subject of a case study to accomplish this and nine silver streams that it acquired in its first eight years from 2004-2012 were analysed and evaluated. Using publicly available technical data, cash flow models were developed for all of the mines and development projects with which Silver Wheaton made agreements during this time period. Subsets of these cash flows were isolated to represent the positions of both Silver Wheaton and its operating partners in each transaction. The Capital Asset Pricing Model and its associated economic metrics were employed and calculated for all of the isolated stream cash flow models to evaluate the expected financial gain or loss to each party for every deal. Cash flow models were developed using two silver price series; one conservative and one bullish price series. These were compiled through the aggregation of price forecasting data from mining equity research reports published in the months leading up to each transaction. It was found that the business model resulted in poor financial outcomes for Silver Wheaton and excellent financial outcomes for its operating partners in over 50% of the transactions it concluded, when evaluated at conservative silver prices. Conversely, when evaluated at bullish silver prices it resulted in excellent financial outcomes for Silver Wheaton and extremely poor financial outcomes for its operating partners in every instance. ii Given that today silver is produced primarily as a by-product to gold and base metals, the business model has a uniquely large target market when focusing on silver and has been replicated to varying degrees of success by other companies, both with silver and other commodities. It provides a viable alternative to traditional financing avenues for exploration and mining companies during all periods of the mining business cycle and is positioned to grow in significance as a form of mine and project financing. iii Acknowledgements The success of this thesis and associated studies has been achieved with the help and guidance of many individuals. Firstly, I would like to thank my two supervisors, Professors Jim Martin and Jeffrey Davidson, for their invaluable advice, guidance, criticism, and encouragement throughout the development of this thesis’ concept and writing. Special thanks is due to Prof. Davidson for his patience throughout the writing and re-writing process; without his sound understanding of academic writing I surely would not have improved this document to a satisfactory calibre. I would like to thank Dundee Capital Markets and those with whom I worked in Fall 2011: Bob Sangha, Sandeep Singh, Brad Ralph, and particularly Stanley Iu, Michael Spencer, Alexandra Cowie, and Olga Ivleva. The experience and guidance I received during my time as a mining investment banking intern were integral to my understanding of how financial and economic concepts are practically employed during transactional and enterprise analysis and evaluation in the mining capital markets. Thank you to my parents, David and Mary Jo, for their constant support and guidance throughout my schooling and life. Special thanks is due to my father for his interest in Silver Wheaton and its operating model when I was a young undergraduate student; his fascination with the metal streaming concept became mine, as well. Finally, thank you to my fiancée, Catherine. Her love, support, and belief in me and my abilities have been deeply motivating throughout this academic journey and beyond. iv Table of Contents Abstract ......................................................................................................................................................... ii Acknowledgements ...................................................................................................................................... iv Table of Contents .......................................................................................................................................... v List of Figures ............................................................................................................................................ xiv List of Tables .............................................................................................................................................. xv List of Abbreviations .............................................................................................................................. xxvii Chapter 1 ....................................................................................................................................................... 1 Introduction ................................................................................................................................................... 1 Chapter 2 ....................................................................................................................................................... 6 The Silver Streaming Model as exemplified by Silver Wheaton .................................................................. 6 2.1 Problem statement ......................................................................................................................... 9 2.2 Scope ........................................................................................................................................... 10 2.3 Thesis organization ..................................................................................................................... 11 Chapter 3 ..................................................................................................................................................... 14 Basic Concepts in Project Evaluation: A Review of Relevant Concepts and Literature ............................ 14 3.1 Basic concepts in project evaluation ........................................................................................... 14 3.1.1 The cash flow concept ......................................................................................................... 14 3.1.2 Discounted cash flows ........................................................................................................ 15 3.1.3 Capital Asset Pricing Model and beta factors ..................................................................... 17 3.1.4 Economic evaluation metrics .............................................................................................. 19 v 3.1.5 Minimum acceptable rate of return and discount date selection ......................................... 20 3.1.6 Inflation ............................................................................................................................... 22 3.1.7 Consensus price estimate methodology in mining finance ................................................. 23 Chapter 4 ..................................................................................................................................................... 26 Application of Concepts to the Evaluation of the Silver Streaming Business Model ................................. 26 4.1 Methodology and research plan .................................................................................................. 26 4.1.1 Data sources ........................................................................................................................ 26 4.1.2 Case study: Silver Wheaton Corp. and its operating partners ............................................. 27 4.1.3 Selection of streams to be evaluated ................................................................................... 28 4.1.4 Explanation of enterprise analysis and silver price stress test ............................................ 30 4.1.5 Analysis of value addition or reduction to development project economics ...................... 31 4.2 Calculation of WACC ................................................................................................................. 31 4.3 Calculation of estimated silver stream cash flows ...................................................................... 33 4.3.1 Calculation of cash flows for mines utilizing silver streams .............................................. 33 4.3.2 Calculation of silver stream cash flows for operating partners ........................................... 36 4.3.3 Calculation of silver stream cash flows for Silver Wheaton ............................................... 36 4.3.4 Treatment of outdated capital and operating cost estimates ............................................... 36 4.3.5 Silver price series used in silver stream cash flow models ................................................. 37 4.4 Limitations and assumptions ....................................................................................................... 39 4.4.1 Sample size ........................................................................................................................
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