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Saturday, March 21, 2009
If you sat down to dream up the perfect mining investment, it would look like what Pierre Lassonde did with a tiny company called Franco-Nevada...
Lassonde and his partner Seymour Schulich formed Franco-Nevada in the early 1980s. Its sole purpose was to acquire more natural resources royalties than any other company on Earth.
Most people hear "royalty" every now and then in relation to the Beatles or Michael Jackson owning royalties on catalogs of hit pop songs. All royalties share a similar attribute. All royalties get you a share of the revenue without having to own a piece of the business. As a business, holding royalties is a lazy man's dream come true.
A natural resource royalty is acquired by investing money in a potential mining project. In return for putting up cash early in the game, the royalty investor earns a slice of a mine's cash flow when it starts producing. Acquiring royalty interests is one of the all-time great businesses. You don't have to deal with operating expenses or employees. You don't have to finance and maintain huge, expensive pieces of equipment. You just sit back and watch the money flow into your bank account. It's the real insider's way to invest in mining.
Pierre Lassonde got his momentum rolling when a single royalty – on the Goldstrike Mine in Nevada – started gushing cash early in the company's history. Lassonde put the fresh capital into more royalties. And in 2002, Lassonde sold Franco-Nevada to Newmont Mining for $2.9 billion.
You could have bought Franco-Nevada early on for a few dollars and sold it for over $180 per share – a huge home run, a 50-bagger!
I once told readers of Extreme Value that my favorite businesses were asset management, insurance, and banking. With little of your own capital, you can establish a highly profitable business by handling other people's money with care. I think all three of those industries are going to have a rough ride over the next few years... which makes royalty holding the absolute best business in the world right now.
Like my other three favorites, royalties allow you to benefit from the use of other people's money. In this case, the other people are mostly the mining companies that build, operate, and maintain the producing mines. The royalty holder invests only a small amount of capital.
Otherwise, you rely on the mine operator to buy all the big, expensive machines and to take care of all the armies of people who operate the machines and get the rocks out of the ground. The beauty of royalties is notowning the business, but owning the right to a piece of the business' sales. You relieve yourself of all the hassles of running a business and just pay to get your share.
It sounds too good to be true, but that's an accurate description of what it means to be a royalty holder. You buy the royalty, then never spend another penny as you collect money from the mine operator throughout the productive life of the mine. You get all the good stuff, and little of the bad stuff that comes with being in the mining business. That's how Peter Lassonde multiplied his shareholders' money 50 times over.
The investment advisory industry has spilled a lot of ink about royalty companies in the past few years. Most investors who bought in were crushed in last year's commodity selloff. This selloff has created a smorgasbord of incredible values in the sector. I'm in near disbelief that you can buy companies with steady cash flows and open-ended future potential for close to their book values. This gives you a margin of safety and triple-digit potential when mining stocks recover.
Getting familiar with publicly traded natural resource royalty companies is easy. There aren't many of them. You can type "mining stock royalties" into Google and get acquainted with the sector. But do it soon. Opportunities tosafely make triple-digit profits rarely come around. And they don't last long. This is one of them.
P.S. You can also read my last two issues of Extreme Value. Read together, they're a rough how-to guide for making the best royalty investments in the world.
If you're buying regular mining stocks right now, you're on the outside of the game. These companies will get you inside. They'll let you get a share of companies with great sources of cash flow... and dozens and dozens of properties, each with plenty of upside potential. You can click here for more on this kind of opportunity.
WHAT A SHOPPING DISASTER LOOKS LIKE
Our chart of the week is the market saying, "Shopping malls are in big trouble right now."
It's the past year's trading in Macerich, one of America's largest mall operators. Like a lot of real estate players, Macerich has a ton of debt... its cash flow is drying up... and creditors are knocking on the door. Back in December, our colleague Porter Stansberry told his Put Strategy Reportreaders:
"Like residential condo flippers, many of the bigger players in the commercial property market went crazy in 2005-2007. These companies – firms like General Growth, Macerich, and SL Green – were built to fail. They cobbled together assets and took on so much debt that any decrease in property values would be fatal. And now, commercial property is looking at the largest declines in asset prices since the Great Depression. It's a complete disaster in the making"
Macerich hit a new low yesterday... and the predicted disaster is in play.
– Brian Hunt