Silver Wheaton Deploys Cash Chest For First Acquisition In Three Years

Silver Wheaton (NYSE:SLW) said last week that it has agreed to buy all of HudBay Minerals Inc.’s silver production from two of its mines along with some gold production from one of them for about $750 million plus additional ongoing payments. ^[1] This is in-line with Silver Wheaton’s business model of providing funds for capital expenditure upfront when a project is being developed and, in return, obtaining the right to buy the precious metals produced at low, fixed prices.

Silver Wheaton’s main competitors are Silver Standard Resources (NASDAQ:SSRI), Pan American Silver (NASDAQ:PAAS), Bear Creek Mining Corporation (CVE:BCM) and Endeavor Silver (NYSE:EXK).

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Terms of the deal

Under the deal, Silver Wheaton is entitled to 100% of the life-of-mine silver production from Hudbay’s currently producing 777 Mine in Manitoba, and 100% of the life-of-mine silver production from its Constancia Copper-Molybdenum-Silver Project in south Peru. It is also entitled to 100% of the gold produced from the 777 Mine until Constancia satisfies a completion test, or the end of 2016, whichever is later. Thereafter, Silver Wheaton’s share of gold production from 777 will be reduced to 50% for the remainder of the mine’s life. Silver Wheaton will pay a price of $5.9 per ounce of silver and $400 per ounce of gold for the duration of the contract. These prices will be subject to an inflationary adjustment of 1%, beginning in the fourth year.

In return, Silver Wheaton will pay Hudbay $750 million, of which $500 million is payable upon closing, with two further payments of $125 million each to be made upon the satisfaction of minimum capital expenditures having been incurred at Constancia. ((The Hudbay Stream Continuing the Growth, Silver Wheaton, August 8 2012))

The deal specifies 90% of expected throughput and recovery by the end of 2020, failing which, it will be entitled to a proportionate return of the upfront cash consideration relating to Constancia.

As is the case with its previous deals, Silver Wheaton will not pay for any ongoing capital or exploration costs at the mines.

What it means for the company’s business

As we had reported in our pre-earnings article, Silver Wheaton has a cash chest of $1 billion. It was only a matter of time before it would go scouting for new assets, particularly given that its contracts with Barrick Gold for Lagunas Norte, Pierina and Veladero mines end in 2013. This deal will add 4.9 million ounces to  its long-term average annual silver equivalent production figures.

In our opinion, the deal fixes the price of silver at a relatively lower figure, considering the quantum jump in the cost of production over the last few years. Going forward, we believe it will rise further owing to higher costs associated with labor, energy, and regulatory compliance. This, in turn, will result in deals with streaming companies at higher than prevailing prices. Also, with industrial demand expected to pick up, the market price of silver is likely to rise. This will allow streaming companies to make good profits. Hence we think that Silver Wheaton has got itself a good deal. The clause that specifies return of cash consideration to Silver Wheaton in the event that production targets are not met ensures shareholders have adequate downside protection.

We are in the process of revising our current price estimate of $37.50 in light of the latest earnings numbers.

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1. Silver Wheaton buys silver production at 2 mines, Bloomberg, August 8 2012 [↩]