 Silver Wheaton - The New Kid on the
Block
Sean Rakhimov
December 14, 2004
Editor: Silver Strategies
"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 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 website
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.
Sean Rakhimov
email: sean@silverstrategies.com
Editor: Silver Strategies
Disclaimer: The author does not
own shares of Silver Wheaton, nor has he received compensation
from the company for this report. Information contained herein
is obtained from sources believed to be reliable, but its accuracy
cannot be guaranteed. It is not intended to constitute individual
investment advice and is not designed to meet your personal financial
situation. The opinions expressed herein are those of the author
and are subject to change without notice. The information herein
may become outdated and there is no obligation to update any
such information. The author, entities in which he has an interest,
family and associates may from time to time have positions in
the securities or commodities discussed. No part of this publication
can be reproduced without the written consent of the author.
© Copyright 2004 by Sean Rakhimov.
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