In the last few years, while mining companies have been hit with
hard times, large-cap royalty companies are thriving and smaller
cap royalty companies have emerged, hoping to profit from the
A royalty company acquires and earns revenues from royalties. In
theory, investment in a royalty company
offers greater diversification to investors. While a typical mining
company only holds a few principal properties, a royalty company
generally holds many royalties, so bets are hedged.
A royalty is a right to receive a payment from the proceeds from
the sale of minerals produced from a property. Royalties are
typically paid in cash, but may be taken in kind and paid in
minerals. A royalty should not be confused with a streaming deal,
although many royalty companies are also in the business of
streaming deals. In a streaming deal, the royalty company pays cash
to a preproduction resource company in exchange for the right to
purchase minerals produced from the property later below market
price. Streaming deals typically operate as an alternative form of
financing to resource companies.
A royalty may also be sold as a source of financing, but can
also be generated in several other ways. For example, a property
owner may retain a royalty when it sells a property or a joint
venture partner's interest may be converted into a royalty once
that interest is diluted down below a certain threshold.
There are several types of royalties. Two that are common are
the net smelter returns royalty (NSR) and the net profit interest
royalty (NPI). An NSR is a percentage of revenue from the sale of
minerals less permitted deductions, such as refining,
transportation and marketing costs, and taxes. An NPI is a
percentage of profits realized from mining operations after all
exploration and developments costs have been recuperated by the
When investing in royalties or royalty companies, one must be
careful. A royalty may not be as valuable as it appears at first
glance. The royalty may have title defects or competing claims to
title. The royalty may not cover the claims overlaying the deposit
or cover the main mineral being extracted. There may be too many
royalties burdening a property, making commercial extraction
uneconomical to the property owner. The royalty may be subject to a
buy-back clause whereby the property owner can repurchase all or
part of the royalty at a discounted price. The royalty holder also
needs to understand what costs may be deducted. The more costs that
may be deducted, the less valuable the royalty becomes.
This is especially important for NPI holders. While payment on
an NSR begins at commercial production, an NPI only begins to
generate cash flow after all mining exploration and developments
costs are deducted—which may be significant. It is not
uncommon for NPIs to never generate a profit. Accounting disputes
are common between the NPI holder and the operator of the property.
One also needs to understand how long the royalty will generate
cash flow. Does the royalty cover the life of the mine or will it
expire after a certain amount of minerals are produced?
Finally, many royalties are acquired at the exploration stage.
To truly understand the value of a royalty, one
needs to understand the likelihood of the property ever
reaching commercial production.
Most mineral properties do not.
Companies considering an investment in a royalty should conduct
careful due diligence and consider retaining
specialized legal counsel.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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