Embedded below is the link to Bloor Street Capital’s recent interview with Pierre Lassonde, who is the co-founder of Franco-Nevada and a legendary mining investor. He discusses why investors should consider the royalty model, the history of Franco-Nevada and presents a case study of their first investment in 1986, which was a royalty on Goldstrike mine in the Carlin Trend.
Some of my notes from the conversation are included below (these are for personal reference only and not intended as a comprehensive transcript; any mistakes are my own).
Why would a mining company enter into a royalty?
For a mining company, the royalty financing is similar to an equity financing but at a lower cost than equity because you are selling part of your deposit instead of equity, so it is much less dilutive for the shareholders. It is equity in the sense that the royalty holder doesn’t run the mine – the operator does everything, yet the royalty holder takes the same risk in terms of mining risk, country risk as the operator, so they are on the same side. When you look at the multiple that the royalty companies are willing to pay for streaming royalties, it is far better than an equity deal. If your stock sells at 2-3x NAV, you are better off getting the money from the market, but in today’s market where most companies are selling at a discount to their NAV, they are much better off doing a royalty deal.
Why should investors consider royalty companies?
He always says give him free optionality and he will make you a millionaire. Optionality in their business is not well understood and therefore undervalued, because no one calculates it. But it is key to Franco Nevada’s success. There are 2 types of optionality: price and land. People understand price optionality. In the case of a pure royalty, if the gold price goes from US$1000/oz to US$2000/oz, the royalty holder gets a US$1000 increase in the revenue and the profit, because there is no cost. But the most incredible optionality is land optionality. When they buy a royalty over a land package, the mine over which they have a royalty will have resources/reserves that are fixed. But then the operator will put up US$1-2bn to put the mine into production, and then the operator has all the incentive in the world to keep exploring to be able to use that capex for as long as he can. So the operator will start putting US$10, 20, 50m a year into exploration at no cost to the royalty holder. Same if you are a streaming company, you still don’t pay any of the exploration and yet you get all the benefits of it. And as the operator reduces the cutoff grade, the operator’s costs go but for the royalty holder, it’s the same (you don’t have operating costs or they are fixed, so your margins go up with time). That is the real beauty of land optionality.
The best example of this all is the very first deal he did, which happens to be the best deal he will do in his entire life. After he and Seymour founded Franco Nevada, they raised $2m and it took them a while to figure out they wanted to do royalties. The model came from the oil & gas business because that is where Seymour came from. They were trying to find a model where they wouldn’t have to raise capital every 6 months or every year and dilute themselves all the time (or have to put up money all the time to keep the company afloat). Seymour asked him if he knew of any mining royalties and he said he knew a few but no one really talked about them and there was no real business model focused on mining royalties. Sometime later, when he was down in Nevada working, his chief geologist asked him what else they were looking for and he said to give him a call if he came across any royalties. 3 months later, the geologist was in his office reading the Reno Gazette over coffee and on page 3, there was a box ad saying royalty for sale with a phone number. When he called the number, it turned out to be someone in Texas. They started talking and the royalty happened to be in the Carlin Trend of Nevada. It turns out that 6 months before, he had done a study on where was the cheapest place to find an ounce of gold and that happened to be the Carlin Trend. In those days, they were finding gold there for US$7/oz.
So he met the royalty holder in Salt Lake City, they started talking. Prior to the meeting, Seymour and he had agreed that the fair price was US$1m. At the time, there was 500k oz of resource on the property, divided up into 6-7 little pits that they were mining at the rate of 30-35k oz a year. It was a very mom and pop operation. The seller told him he had a US$2m bank loan, the bank had called the loan and he had 90 days to repay it or they were going to put him in bankruptcy. So they agreed on a US$2m deal but he had to call Seymour. He told Seymour the good news was they had bought their first royalty, but the bad news is they had no more money. He went out for lunch with the seller while the lawyers drafted the agreement, then they signed it and he went back to Toronto. Unbeknownst to him, when the seller went back to his office, the operator was there with a cheque book ready to buy the royalty. A year later, Barrick bought the property and since then, have found 50m oz of gold. That royalty has paid Franco Nevada well over a US$1bn so far and there will be another US$500m coming. That is what he calls land optionality and it all came for free.
What gave him the confidence to increase his offer on that first royalty from US$1m to US$2m?
The question he always asks himself is would he get his money back and when. Their business is a bit like the casino where, as long as you get your money back, you can always go play again. But once you lose your money, it is really tough to go raise more capital to go play. In this particular instance, for the original US$1m deal they had calculated a 3 year payback, but they didn’t really have any reference point. So when he was thinking about paying US$2m, his assumption was it would take 6 years at a gold price of US$350/oz, but if that went up to US$400/oz the payback goes back to maybe 5 years and then there is enough reserve to last twice that, so in his mind it was a workable deal. They were perhaps aggressive with their assumptions but there was no comparison. Today, every deal there are 2-3 bidders and it is very competitive.
How long after the deal concluded did you realize you were onto something here?
The deal closed April 17, 1987. About a year later, the operator of the property wanted to sell it, so they drilled 1 hole that was like 1000ft of a third of an ounce gold. But the operator thought they had drilled down a vein and so they put up the property for sale thinking they were going to fool people. But when Bob Smith (CEO of Barrick at the time) saw that, he figured the rock package was so big that there was a lot more there, so Barrick bought the property for ~US$75m. When they started drilling, the first 3 holes they got the same thing. Finally, when they put out the result, he figured there was a lot more there given the thickness of the rock package and how uniform it was. Then they drilled the best gold hole he has ever seen in his lifetime, 1000ft of 1oz gold. He hasn’t seen anything like that in 40 years. That one asset became a company maker for both Franco and Barrick.
How does think of opportunities outside of Franco Nevada when it comes to mining?
He has found that the best place to get involved in a mining company is the second turn of the Lassonde curve, which depicts the typical mining company stock price over time, from the discovery when it shoots way up and then it comes back down. Then you do the feasibility study and then you finance to go to production and that usually kills the stock. And yet the best time to invest is when all that “bad news” is out, because the company is typically financed and ideally you have a good management team that you trust will be able to put the mine into production at the stated capital cost. At that point in time, the company is always undervalued. For example, when Lukas Lundin was buying FDN in Ecuador, he had trouble getting people involved. The resource was incredible – he remembers saying to Lukas he would buy 5% of the company with him and promote, but he wanted Louis Gignac as the guy who would build the mine because he would get it done on time and budget. The stock at that time was $4.50 and by the time it got to production it was $12. That is typical of where you can make the most money in mining with the least risk.
When you are looking at a developer, what factors are important?
Number one is management. Good people make good things happen. Number two is the asset. If you have a 1000ft of 1oz gold, it is going to turn out to be a big thing. Having a world class asset today is the most difficult thing. He looks for assets that are going to be in the 5-15m oz range. If you can get to those numbers, you are in the top 1% of gold assets in the world. Third is jurisdiction. Seymour and him used to joke they would go anywhere in the world as long as they speak English, they have an English code of law, and they can ski and play poker. At the time, that was Australia, Canada, US etc. Over time, they have diversified but there are a lot of countries they would never go. If you can’t trust the court system or the law, you have nothing. You can’t move mines, they have to be where they are.
Views on M&A in the space?
There are plenty of gold deposits to be found, but when it becomes cheaper to buy the ounces on Bay Street versus finding them, it’s normal that you go out and buy them. Over the last 3-5 years, the junior market has been on its back, the space is having incredible difficulty attracting risk money. As a result, you can buy reserve ounces for US$50/oz, but you can’t find reserve ounces for US$50/oz. That is the motivation behind what is going on today.
Is it possible to find another Gold Strike?
Yes. Canada has the second largest land mass in the world. There are huge areas of Canada’s land mass that haven’t been explored. He is convinced there are more great deposits to be found. But often there is no infrastructure that easily allows for boots and eyes on the ground (everything has to be helicopter supported, much higher cost). And so if the investors can’t get a return out of it, these deposits are not going to get the money. That is why, for example, Quebec’s Plan Nord has been so popular because the mining companies are able to drive and they are able to support exploration based on road, which is a fraction of the cost of being helicopter supported. If Ontario ever gets its act together in the Ring of Fire, you might see great discoveries over there, but for the mean time, it is too costly and you are not going to see exploration.
Thoughts on the gold equities – divergence from the gold price?
If you can’t make money with gold at US$2000/oz, you should not be in this business. If you look at the Agnico Eagles and Newmonts of the world, they are making good money. But gold equities are not priced as if gold is at US$2000/oz, they are priced as if gold is going to be at US$1500/oz. There is a disbelief out there, he doesn’t know why the gold equities are lagging the gold price so badly and it is something he has not seen in his 40 years in the business. When he looks at 2024/25 setup in terms of gold, central banks are buying gold like there is no tomorrow. Last year, a third of the gold produced went into central bank hands. This year it is the same thing. Why? Because they want to diversify out of the US dollar. At the same time, the US budget deficit numbers are such off the chart numbers, it is unbelievable. Politicians will continue to kick the can down the road until, all of a sudden, it stops. Nobody knows when, but it is like buying fire insurance for your house. You never want to be cashing in on that policy, but if your house gets burned down, you will be happy to have insurance. Having gold in your portfolio is a bit of the same thing. If there is a black swan event over the next 3 years that kicks the living daylight out of the US dollar, that is what will propel gold higher. Gold has always been the inverse of the US dollar, because the dollar is the reserve currency. When the dollar acts as a reserve currency that is solid (no inflation, low budget deficits), you don’t need gold. But when the dollar becomes suspicious, that is when you want gold.
Where does he get his passion from and what gets him going in the morning?
He would like his tombstone to say that he has made a difference in this world. To him, it is as much fun creating wealth as it is giving it away. When it comes to creating wealth, it has been very satisfying to see people benefiting from the work they have done at Franco Nevada. Back in the 1990s, every year after their annual meeting, they used to throw a party for their shareholders, bankers, analysts etc. In 1999, they rented the restaurant at the top of the old Four Seasons hotel. Before the dinner, he went to check on everything and he met an older waitress there. She told him that 12 years prior she had read something about the company in the newspaper, and decided to put all her savings into Franco Nevada. Because of that investment, she was eventually able to buy a house. That is what they work for. When you are a CEO, you are working for the shareholders, that is what creating wealth means to him. He has had quite a few other stories like that over the years and that’s what gets him going to create shareholder value.