The Above Average Odds Investing blog published a few days ago a lengthy write-up on Sandstorm Metals & Energy, a merchant bank that provides financing to resource companies in return for a percentage of future production (the so called streaming model). The company currently owns nine resource streams, and AAOI makes a compelling case that the value of these streams is significantly more than the current market cap of the company (140M with 40M in cash) as just the gas stream could in an optimistic scenario be worth roughly that much.
There are however two major problems: the company wants to grow, and is diluting existing share holders to achieve that goal. For example: the company increased last year the share count from 222M to 318M on the following terms:
On August 3, 2011, Sandstorm completed a public offering of 88,650,000 units at a price of C$0.55 per unit, for gross proceeds of C$48.8 million ($51.4 million). Each unit was comprised of one common share of the Company and one-half of one common share purchase warrant. Each whole warrant entitles the holder to purchase one common share at a price of $0.70 until December 23, 2012. In connection with this offering, the Company paid agent fees of C$2.9 million ($3.1 million), representing 6% of the gross proceeds.
It is for me almost impossible to see how this can be a good allocation of capital for existing share holders, because if the assets of the company are indeed significantly undervalued this is a very expensive way to raise capital, especially if warrants are also given away. Some quick math to show the point:
Assume for example that the intrinsic value of the resource streams is 300M instead of the 100M that the market is currently implying. With 222M shares outstanding this would imply an intrinsic value of CA$1.35/share. Issue 88.65M shares for net proceeds of 45.7M and the value per share drops to CA$1.11/share. If we now account for the dilution that would occur if the warrants are exercised the per share intrinsic value drops further to CA$1.06/share. That’s more than a 20% drop in value per share! The best investment the company could make is in it’s own shares, while it is doing the opposite.
The second problem I see is that I don’t think that the streaming model offers a true competitive advantage above other types of financing available to resource companies. Sandstorm might be unique with the exclusive focus on the streaming model, but it’s simply a type of financing that sits somewhere between pure debt and pure equity. No reason to believe that on average this part of the capital structure offers abnormal risk/adjusted returns, and if that’s the case raising expensive capital is really inexcusable. You need to be able to redeploy the cash at very high rates if you want to make a case for dilution.
In my mind there are basically two conclusions possible: either SND.V is currently not undervalued and it prudently raising capital, or it is undervalued but it is not interested in maximizing shareholder value. Whatever the case: I’m not willing to invest.
The bookbookfund blog lists some additional concerns.
There seems to be quite the interest in these big discount to NAV.
Since AAB and SND are merchant banks investing in start-ups, would a measure of management’s competence be a measure of the NAV rise vs. an appropriate index. They may have over compensated executives, but if they are adding value it may justify it. Then you would still have to be comfortable in the index for comparison. Even the dilution could be justified today if they add a ton of value for shareholders in the future.
Interested to hear your thoughts. I have had both in the “to research” pile for several months, but have never really looked into it.
Also about URB, are you worried about it trading at a discount perpetually. I understand that a 50% discount is to much, but does it ever trade at NAV again? I also worry about another acquisition given the lack of substantial issuer bid and major NAV discount for so long.
Keep up the good work.
Benchmarking their performance is not easy. The problem is that they both have assets that aren’t straightforward shares in junior miners. AAB owns for example lots of warrants so if the underlying ‘benchmark’ would rise they have additional leverage. SND possibly also has a way different leverage characteristic than a straight equity investment since they are paying a fixed cost, which can be higher or lower than the cost of production for the company in question. It’s going to be really complicated to make a fair comparison, and if you don’t account things like leverage and you look at a period of rising commodity prices it’s easy to look good.
About URB, I don’t think it deserves to trade at NAV in its current form. With the high cost structure it’s a fundamentally unattractive product, but the attraction of the idea is imo that I’m pretty certain that the current discount is too high and unlike AAB and SND insiders cannot dilute you: you know exactly what the cost structure is. And good things can happen, the current share buy backs are pretty good way to enhance NAV/share, and maybe they will decide the wind down the fund at some point in the future. Not really something I’m betting on, but if you buy stuff cheap good things can happen.