Seymour Schulich says “a free option is a terrible thing to give up, and a wonderful thing to own” in his book Get Smarter: Life and Business Lessons. His success as the co-founder to the predecessor to Franco-Nevada Corp. FNV-T can be credited to optionality, a concept often misunderstood and undervalued.
Two primary types of optionality come into play with a minerals royalty business model like Franco-Nevada’s – price optionality and land optionality. However, there is now a third option associated with Franco-Nevada – the potential reopening of the shuttered Cobre Panama mine option – and investors are currently getting this option for free.
The most remarkable form of optionality lies in land optionality. This involves holding a royalty over an extensive land package, even if the mining operator initially targets only a small portion of that land for development. If successful, the operator will eventually proceed to develop other sections of the land. The royalty company incurs no costs or obligations for additional exploration and development expenses. However, should minerals be discovered in these areas, the royalty company benefits.
The founding story of Canada’s Franco-Nevada is a great example of land optionality. In 1986, Pierre Lassonde and Mr. Schulich bought their first precious metals royalty for US$2-million, covering 3,416 acres of land in Nevada. Shortly thereafter, Toronto’s Barrick Gold Corp. ABX-T launched an exploration program in the area that unveiled one of the largest gold deposits in North America. This royalty arrangement has since paid more than US$1-billion in cash to Franco-Nevada, and the benefits are continuing.
Price optionality is straightforward. Royalties are secured based on existing commodity prices, and any increase in gold and silver prices contributes to additional revenue for the royalty company without requiring any extra effort. The abundance of monetary, fiscal and geopolitical risks has driven gold prices close to historic highs. Gold frequently serves as a portfolio diversifier, and the added benefit of price optionality is that it tends to manifest itself particularly in periods of heightened volatility.
In 2002, Toronto-based miner Newmont acquired Franco-Nevada for US$3-billion. Franco-Nevada’s management team had displayed remarkable astuteness in acquiring high-quality royalty properties and expanding the business. In 2007, Newmont initiated an initial public offering for Franco-Nevada. Since the IPO at $15.20 a share, the stock has exhibited remarkable growth, reaching a recent closing price near $145 a share. Although a bear market in gold commenced in 2011, Franco-Nevada shares have continued to make gains, demonstrating its ability to grow without necessarily needing a continual rise in gold prices.
The trials and tribulations of Vancouver’s First Quantum Minerals Ltd. FM-T and its Cobre Panama project have been well covered in this newspaper. To briefly reiterate, Cobre Panama is a copper mine in Panama that was built at a cost of approximately US$6.8-billion, of which Franco-Nevada contributed US$1.36-billion. The mine created 40,000 direct and indirect jobs. In 2023, despite First Quantum offering significant concessions in its agreement with the country, popular protests forced the Panamanian government to order the mine to close.
Arbitration proceedings under the terms of the Canada-Panama Free Trade Agreement have been initiated by both First Quantum and Franco-Nevada against the Panamanian government. Similar cases in the past have resulted in significant penalties for the governments involved. To mitigate this potential outcome, there is a possibility that the Panamanian government may engage in renegotiations. Predicting the ultimate outcome is challenging, but given the asset’s significance (1.5 per cent of the global copper supply), the probability of the mine being permanently closed is relatively low.
For Franco-Nevada, Cobre Panama was its largest royalty asset at about US$2-billion in net asset value and 22 per cent of revenue. However, the value subtracted from Franco-Nevada’s market capitalization owing to the shutdown of Cobre Panama has been more than US$6-billion.
If Cobre Panama ever goes back into production, it might add $45 to $50 a share to Franco-Nevada’s stock price. (It had reached a record high of $218 a share in 2023 before the announcement the mine would be closed.) That scope for upside makes it essentially a free option. In the meantime, investors can enjoy a 1.3-per-cent dividend yield, a strong balance sheet, best-in-class management team and, importantly, a portfolio of 432 high-quality royalties that should compound with time because of their price and land optionality.
Disclosure: The author and the accounts he manages at White Falcon own shares in Franco-Nevada.
Balkar Sivia is the founder and portfolio manager of White Falcon Capital Management Ltd. (www.whitefalconcap.com)
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