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"There is nothing new under the sun" goes
the old adage, and investment buffs complement it by saying "There is
certainly nothing new in the stock market".
This premise is being put to test by developments
surrounding the new kid on the block - Silver Wheaton (TSX: SLW),
formerly Chap Mercantile, Inc.
Silver Wheaton,
as many investors know, is an offshoot of Wheaton River Minerals
(AMEX: WHT), a growing metals producer of mainly gold and, to a lesser
extent, silver.
The spin-off came about in a hurry after hostile takeover bidding process was
initiated by Coeur D'Alene Mines (NYSE: CDE), a major silver producer.
Though the deal is labeled "a
transaction" in Wheaton's
press releases it is in effect a spin-off coupled with simultaneous reverse
takeover of an exchange-listed company.
Incidentally, Wheaton River Minerals since
announced a merger with Canada's
Goldcorp (NYSE: GG), but that should not have material effect on
Silver Wheaton.
Curiously, the new company neither owns nor operates
any properties, but is a holder/owner of "silver produced" which
makes Silver Wheaton a de-facto royalty company. My compliments go to Wheaton's management
for creativity. If I didn't already own shares of Wheaton River
this particular solution would convince me to buy some. I don't mind
investing in a company whose management demonstrates such extraordinary
business acumen.
Let us look closely at the terms of the deal. The
following can be deduced from a press release by Wheaton River Minerals dated
October 15, 2004.
From Wheaton
River Minerals'
perspective:
1. The whole transaction is worth C$70 MM.
2. Of that amount C$46 MM is paid to Wheaton
River in cash and 75% stake in
Silver Wheaton is attributable to Wheaton
River based on the
share ownership.
3. Wheaton River will receive US$3.90/ounce of
silver produced from Luismin operation,
"subject to adjustment".
From Silver Wheaton's
perspective:
1. Silver Wheaton gets a right (and obligation) to purchase all silver
produced from Luismin operation of Wheaton River
Minerals. Currently estimated at a little over 6.5 million ounces.
2. Cost of production is fixed at US$3.90/ounce, "subject to
adjustment".
The Math
What it all means is that Wheaton River Minerals
through this transaction sold forward 25% or presently about 1.6 million
ounces of its annual silver production from Luismin
operation for C$70 million at a cost of US$3.90. In my opinion a fantastic
move by any measure.
What about the remaining 75% you ask? Well, Wheaton River
keeps the upside on 3/4 of its Luismin silver
production via its stake in Silver Wheaton. In effect for Wheaton River
shareholders it's like taking money out of your left pocket to put in your
right pocket.
Then there is the "subject to adjustment"
clause that refers to US$3.90 per ounce payable to Wheaton River.
Press releases do not go into the details of terms though the same terms are
more defined in the Zinkgruvan deal below. For
convenience we will assume that Wheaton
River will extend the
same courtesy and cost adjustment terms that was shown by Lundin
Mining below, particularly given the close timing of these two transactions. Not
bad for Wheaton River, which negotiates for both sides (Wheaton River and Silver Wheaton).
The Lundin Deal
While we were mulling over the intricacies of the above
transaction, on November 14, 2004 Silver Wheaton lost no time and struck
another deal, this time with the Lundin Mining
Corporation (TSX: LUN). Any resource investor should know the Lundin name. If you don't, look them up, you'll find that
it is one of the most respected names in the business. The Lundins are and have been over the years very successful
mineral resource investors.
Upon close examination this deal looks awfully
similar to the one above. Bottom line here is that Silver Wheaton is paying
US$75 for (at present) 1.85 million ounces of annual production of silver
over at least the next 19 years at a cost of the lesser of US$3.90/ounce and
quote - the then prevailing market price per ounce of silver - end quote. Fixed
US$3.90 price is subject to an inflationary adjustment after three years.
One has to believe the deal is good for Lundin Mining. It must be, considering that they acquired
the entire Zinkgruvan operation only in June 2004
for approximately US$106 and it is primarily a zinc/lead mine. Was it good
for Silver Wheaton? - is a question to answer.
What the market had to say
The market is always the best gauge. At the time of
this writing Silver Wheaton is trading at C$0.68 (close 12/10/2004) while NY
spot silver stands at US$6.68.
According to the web site company's share structure,
after the proposed 5-1 stock split (not yet in effect as of this writing)
will be as follows:
Symbol: TSX: SLW
Shares outstanding: 166.9
M
Warrants: SLW.WT - 23.5 M,
Exercise price C$4.00, expire Aug 5 2009)
Warrants: SLW.WT.A - 8.1 M,
Hold period until March 31, 2005,
Exercise price C$5.50, Expire Nov 30, 2009)
That puts its market capitalization at about C$492.3
MM or roughly US$402.2 MM (based on CAD/USD at 0.817). We can read that as
"moderately optimistic" valuation of the company.
Based on a few assumptions:
Silver: US $7.00
2005 Production: 9,500,000
ounces (projected by the company)
Stock Price: US 0.56 (before reverse stock split)
Cost per ounce: US $3.90
Based on these numbers Silver Wheaton is trading at
approximately 13 times of 2005 sales. Operating expenses could be low since
this is a royalty company, but at this point it's hard to put a number on
them. The $3.90/ounce is cost for first three years. It will rise thereafter,
but likely no more than corresponding appreciation in silver price.
Starting 2006 this the company is expected to
produce 10 MM
ounces of silver. It's easy to see that each $1 increase in silver price
should result in additional $10 MM in cash. That is if the company does not
hedge its future production. Wheaton Silver's web site states zero hedging at
present time.
A pure silver play
Silver Wheaton Corporation is a Canadian based
"pure" silver mining company with 100% of its cash flow from silver
production - says the Corporate Overview section of Silver Wheaton's website.
Indeed, this company owns nothing but "silver ounces in the ground"
- a term that has become so dear to many a silver (and gold) investor. No
properties, no mines, no equipment, does not need a large staff to operate
and has no overhead related to that.
To be sure, we have seen similar deals on the part of Silver Standard
(NASDAQ: SSRI) and Vista Gold (AMEX: VGZ), companies that are well
regarded in the industry and among investors large and small. The difference
is that Silver Wheaton already has its silver being mined. No need to build
mines and mills and roads and power lines - none of that. To me that is a
huge advantage.
The other thing is that 100% of Silver Wheaton's
revenue comes from silver. To my knowledge there is no other company with
such concentration of assets in silver (or any other metal for that matter). Expect
the company's stock to become somewhat of a proxy to the silver price as well
as high volatility in price as is often the case for the metal itself. Of
course, there are risks as well.
Risk Factors
If one accepts that silver price will stay the same
or increase, the risk factor in Silver Wheaton seem to be as follows:
a) The parent company selling Silver Wheaton shares on the market to simply
raise cash thus depressing the Silver Wheaton share price or
b) Wheaton decides to reacquire Silver Wheaton on terms not too favorable for Silver Wheaton shareholders who made long
term investments in the company;
c) The company's ability to effectively address any potential production
issues is limited by the nature of its property rights;
d) The same risks related to an investment in any mining company hold true
for Silver Wheaton shareholders.
However, these factors do not negate the benefit of
owning Silver Wheaton shares as part of a balanced portfolio of silver
stocks. In terms of risk this is as close to "no-brainer silver
play" as you'll ever get. Barring any major problems with the company,
and I don't know of any such problems at this time, it's all about the price.
Among the advantages of investing in silver mining
sector is the fact that there are so few primary silver stocks. The choices
are limited and therefore relatively easy. Of course, one has to exercise
judgment and do his/her own homework. My favorite
analyst for silver investments is David Morgan.
The list of other major silver companies is short: Pan
American Silver, Silver Standard, Coeur d'Alene
Mines, Sterling Mining, Hecla Mining (more
gold than silver), Apex Silver (more
zinc/lead than silver), Mines Management (more copper than silver). Then
there are a number of smaller companies with exposure to silver and companies
with blue-sky potential of exploration success. Among explorers Mag Silver or Esperanza Silver come
to mind. However, Silver Wheaton is fairly unique, and I would hazard to say,
in a balanced portfolio of silver stocks this one is a must have.
By : Sean
Rakhimov
Editor, www.silverstrategies.com/
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