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Franco-Nevada knows how to price potential

Fabrice Taylor is a chartered financial analyst

You know you're doing something right when you can sell fresh shares for more than investors can buy your stock in the marketplace.

Franco-Nevada Corp. just closed a financing that raised more than $300-million. The company didn't seem to need cash - it had $200-million of working capital and no debt before the financing - but when you can raise money you should, and that's especially true of commodity-related companies. It never hurts to have a war chest of "cheap" money.

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So raise money Franco did, in what I think is spectacular fashion. When the deal was announced on May 27, Franco's shares were changing hands at $30.51.

The deal, a bought one, offered units at $32.50. True, said units came with a half warrant to buy another share (i.e. for every 100 shares you got 50 warrants to buy shares).

But the strike price of the warrant - the price at which investors can buy it - is $75, for a period of eight years. You have to be bullish: Franco's stock will have to compound at around 15 per cent to give the warrants value.

So it looks like Franco got money on good terms. It looks like the royalty collector is valued on excellent terms, too. According, for example, to National Bank Financial, the company's net asset value is $13.70 a share. The stock is quoted at twice that. How is it possible that you have to pay twice what the company's stock is worth to get your hands on some?

Management and reputation are probably part of the equation. Franco's a name; it made a lot of money before being swallowed up in the Newmont empire, from which it was carved out and refloated on the public markets. The business model probably has special appeal today too: Franco is, as mentioned, a royalty company.

It earns money mainly right off the top line, that is before everyone else, from a portfolio of senior energy and precious metals producers. In other words, it's not exposed to the operational risk that can bedevil these companies. By the same token, it can earn less too because it doesn't get the kick from the leverage a well-run company can engineer.

But is that enough to explain why this company is so richly valued? Probably not. Investors might pay for the growth potential embedded in royalties. The Franco story is legendary in that regard. One of its earliest royalty investments cost about $2-million and covered about 3,400 acres of ground in the middle of a gold trend in Nevada. The property was a small producer but the land was cheap and Franco management's theory was that a deposit to the south owned by Newmont would extend northward. That ended up being wrong.

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But in any case, Barrick Gold bought the land covered by the royalties for $62-million then cranked up production, which rose from 44,000 ounces to 75,000 at once. Within three months, Barrick "hit a hole," as they say - made a major discovery of ore that would become Goldstike, the biggest new discovery outside South Africa.

Production, over which Franco earned a roughly 13-per-cent interest, grew to more than two million ounces annually, and Franco never had to put up a dime of the huge amount it took to build the mines. (This account is from Get Smarter, by Franco founder Seymour Schulich - well worth reading.) To date, Franco's investment in that royalty has produced about a billion bucks - breathtaking.

Of course, such finds are exceptionally rare. There's a lot of luck involved. So how much is "potential" worth?

That's a tough one to answer, but I would make a simplistic argument that potential is reflected in the warrants, which are changing hands for $4.30. Investors, in other words, are willing to pay that much to bet that Franco's share price will be north of the strike price - call it north of $80, because you have to add in the value of the warrant.

Hard to say if that's a fair price or not, but it's a lot easier to say that Franco has a conservative culture; it avoids debt and sells equity when it deems it dear. This is a stock worth owning, particularly if you can get it for less.

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About the Author
Investment Columnist

Fabrice Taylor, CFA, publishes the President’s Club investment letter, for which he and The Globe and Mail have a distribution agreement. More

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