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By James West
VantageWire.com
August 19, 2011

The idea of a royalty company - one that accumulates and manages the royalties applicable to producing mines in a portfolio - is not new. However, Sandstorm Metals and Energy Ltd.s (TSX.V:SND) is neither a royalty company, nor a new approach to the royalty model, as many investors mistakenly perceive. Sandstorms model is like being in a real estate deal: last money in is first money out. Its model is "risk-friendly" in that the company is willing to take on more risk than would, say, a bank. But its risk is then diversified across a portfolio of projects, thereby cancelling out the increased risk exposure of a single project investment, and further diversified through a contractual guaranteed return on investment. But for its willingness to embrace a higher degree of risk, the company receives a return on investment far superior than would a bank, plus they get to enjoy commodity price upside potential, which a bank does not. And since Sandstorm is isolated from cost increases due to inflation, the company performs well relative to pure mining companies whose overall returns will diminish in inflationary times.

Arguably, theres better profit potential and exposure, with lower risk through diversification. And for investors, that is the key perception to evaluating the suitability of Sandstorm for investment portfolios.

So what, exactly, is the Sandstorm model? Sandstorm purchases the future output of resource projects in the pre-feasibility/construction stage of its evolution for an upfront cash payment in exchange for the right to purchase a percentage of the projects life-of-mine output at a fixed unit price.

For example, in its most recent transaction, Sandstorm Metals and Energy advanced US$17.75 million in cash to Donner Metals Ltd. (TSX.V:DON), and purchased 6.4 million shares at $0.35 a share, for a total investment of US$20 million.

Besides the return on investment from future share price appreciation, Sandstorm is first in line to purchase 17.5% of the copper produced over the Bracemac-McLeod zinc-copper project at the lesser of $0.80 a pound and the then prevailing market price of copper, unless the price falls below US$2.75 per pound, at which point it becomes the lesser of $0.55 per pound, or the prevailing market price. Sandstorm makes the margin between its purchase price, and the sale price of the end commodity, which it neither has to take delivery of nor make the sale of. It comes right off the top of the partner companys production and sales stream.

The novel aspect of this approach has been perfected over time by company CEO Nolan Watson and his team, who were pioneers in the idea of the purchase of mine by-product streams during his tenure as CFO with Silver Wheaton Corp., (TSX: SLW), where he helped raise over CA$1 billion, and became the youngest-ever CFO at age 26 (in 2006) of a multi-billion company listed on the NYSE.

To put it into perspective, in August 2006, the company had roughly 203 million shares outstanding with a share price around $10, for total market capitalization of CA$2.03 billion. Today, Silver Wheaton has 353 million shares outstanding, which at Thursdays close of 36.52 makes it a $12.8 billion company; a six-fold increase in market capitalization in five years.

Does Watson have what it takes to do it all again?

The smart money in Canada, has voted a resounding "yes" with that most sincere form of flattery - cash. And lots of it. The company closed a financing in decidedly weak markets on August 3rd that consisted of a syndicate of underwriters co-led by Cormark Securities Inc. and National Bank Financial Inc., and including BMO Capital Markets, Canaccord Genuity Corp., Paradigm Capital Inc. and Casimir Capital Ltd for $CA49 million, largely the same group who gave the company $100 million in December 2010. Confidence in the companys ability to execute on its business model is evidently not in short supply.

Not surprising, really.

Watsons approach to running his own company is the same that he employs when evaluating potential investments - "Stay away from bad management".

"They might say they believe in their ability to build a mine on budget, but nobody ever does that," he said in a Globe and Mail interview in May this year.. "You need to have capital contingencies so there are buffers at every stage."

The company further limits risk by maintaining 100% of its asset investments within geographical North America. Currently, the company has commodity stream agreements in place with the following companies:

Sandstorm has agreed to purchase 25% of all oil, natural gas and natural gas liquids produced for the life of the Two Creek Jurassic A pool and for 5 years of the Two Creek Jurassic B and 15% of all oil, natural gas and natural gas liquids produced from the Strathmore property. Sandstorm has provided an upfront deposit to Terrex in the amount of $14.7 million plus ongoing per-unit payments of $15.00 per barrel of oil delivered, $1.00 per mcf of gas delivered, and $8.00 per barrel of natural gas liquids delivered. Sandstorm will also pay the direct transportation and royalty costs associated with its share of oil, natural gas and natural gas liquids.

Sandstorm has agreed to purchase 25% of the first 3,800,000 tonnes of coal produced and 16% of the life of mine coal produced thereafter from the Rosa Mine, the Rex No. 1 Mine and the Ikerd Mines for an upfront payment of US$38 million plus ongoing per ton payments of US$75 for metallurgical coal and US$55 for thermal coal.

NovaDX has provided a guarantee that Sandstorm will receive minimum cash flows of (i) US$4 million in 2011, (ii) US$6 million in 2012, (iii) US$9 million in 2013, and (iv) US$9.5 million in each of 2014 and 2015, thus providing a 100% return of capital within 5 years.

Sandstorm has agreed to purchase 18% of the first six million tons of coal produced, and 12% of the life of mine coal produced thereafter from the Big Branch Mine, the Big Branch Extension and the SID Mine for an upfront payment of US$11 million plus ongoing per ton payments of US$55, subject to certain adjustments.

Sandstorm has acquired 35% of all natural gas produced from Gordon Creek for an upfront payment of US$25 million plus ongoing per unit payments of US$1.00 per mcf of gas delivered plus 20% of the market price received that is above $4.00 per mcf delivered. Sandstorm has granted Thunderbird the right to buy back half of the future production under the Agreement, until December 31, 2013, upon Thunderbird making a payment of $16.25 million to Sandstorm, upon receipt of which, the percentage of production Sandstorm Energy is entitled to purchase shall be decreased to 17.5%.

Sandstorm has acquired 17.5% of the life of mine copper produced from the Xstrata operated Bracemac-McLeod Property for an upfront payment of US$20 million plus ongoing per pound payments equal to the lesser of US$0.80 and the then prevailing market price per pound of copper. The ongoing payments are subject to adjustment if the spot price of copper falls below US$2.75 per pound, in which case the payments will decrease and be equal to the lesser of US$0.55 and the then prevailing market price per pound of copper. The copper purchase agreement was completed with Donner Metals (TSXV:DON), who are the owners of a 35% joint venture interest in Bracemac-McLeod. In addition to the upfront payment Sandstorm is subscribing for 6,200,000 common shares of Donner at a deemed price of $0.35 per share. Donner has also agreed to issue US$1.4 million worth of common shares to Sandstorm on June 30, 2012.

Donner will have the option, for a period of 24 months, to repurchase up to 50% of the agreement by making a US$14 million payment to Sandstorm, upon receipt of which the percentage of copper that Sandstorm is entitled to purchase shall be decreased from 17.5% to 8.75%.

The Big Picture
Nolan Watson and his team definitely have the been-there, done-that street cred to a) raise the money and b) make the deals.

Looking at the market caps of other royalty "streaming" companies with which Watson is involved, its not hard to envision a scenario wherein Sandstorm Metals and Energy mimmicks the incremental value growth of much larger successes. For risk-tolerant portfolios, that could make the current market cap of the company at $CA67 million a very attractive entry point.

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