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Osisko’s Canadian Malartic mine.

daniel rompre

The royalty stream born out of Osisko Mining Corp.'s drawn out takeover battle is being talked about as a rare, promising investment in a sector decimated by cost overruns and billion-dollar writedowns.

Osisko Gold Royalties Ltd., which was created during Yamana Gold Corp. and Agnico Eagle Mines Ltd.'s joint acquisition of Osisko Mining, is being showered with praise, largely because of its connection to Quebec's Canadian Malartic gold mine.

Although the mine now belongs to Yamana and Agnico Eagle, Osisko Gold Royalties has a 5 per cent royalty stream on it, which could generate $35-million in annual free cash flow. Typically when royalty companies are set up they lack a critical mass, RBC Dominion Securities analyst Dan Rollins wrote in a note to clients, but Osisko's already has a "cornerstone royalty" stream.

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Along the same lines, CIBC World Markets' Cosmos Chiu dubbed Malartic one of North America's "most substantial royalty assets."

RBC's Mr. Rollins also notes that royalty startups tend to be under-capitalized, so they struggle to buy new streams. Osisko Royalties was set up in a way intended to prevent this problem, starting out with $157-million in cash and no debt.

Right from the start, Osisko Royalties has options on two other royalty streams that could add future growth without their having to acquire anything. The company already owns a 2 per cent royalty on development properties in the Kirkland Lake district, as well as 2 per cent royalties on the Hammond Reef and Pandora development projects.

Mr. Rollins argues these projects are likely to see some action. "Given Agnico Eagle/Yamana paid full market value for Osisko Mining, both parties have an incentive to maximize value through Canadian Malartic and through the potential development of Odyssey, Upper Beaver and possibly Pandora, providing Osisko a natural option on higher probability royalties," he wrote.

The royalty sector is also a hot one – at least relative to traditional miners. The S&P/TSX global gold index is down roughly 35 per cent since the start of 2013, when the market really fell off a cliff. But streaming companies Franco-Nevada and Royal Gold have gained back all their losses. In the silver sector, the metal itself is up 7.5 per cent this year, while Silver Wheaton has gained 25 per cent.

One of the core reasons for this is that royalty companies don't have to worry about development costs; they more or less collect cheques, provided the underlying metal price doesn't plummet. This line of reasoning factors into Mr. Chiu's belief that royalty companies should be viewed in a positive light.

"Using conventional operating cash flow multiples, royalty companies are often criticized as being 'expensive,' " he wrote. "We disagree. Rather, we highlight the need to use free cash flow to measure the multiples of the royalty companies versus the mining companies. With this as a measure.. we calculate that royalty companies actually trade at a ~30 per cent discount to the multiples of the mining companies."

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So Osisko Royalites is well-positioned to start, and the case has been made that it should be worth even more from the get go. But how should investors measure its success?

"The near-term litmus test for Osisko will be how effectively management allocates capital towards growth and/or dividends," RBC's Mr. Rollins noted. "Should accretive transactions be inked, we expect the company's share price would re-rate higher as confidence in the business increases, diversification improves and value is surfaced.

"However, should Osisko be seen to be pursuing growth for the sake of growth, the company's share price is likely to suffer."

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