Royal Gold, Inc.'s Absolute Best Move in 2016

By Reuben Gregg Brewer Markets Fool.com

Royal Gold, Inc. (NASDAQ: RGLD) makes money a little differently than most other gold and silver companies. In a way, 2016 was a relatively inactive year for this precious metals streaming name. But investors shouldn't take that to mean Royal Gold wasn't working hard. In fact, the company's top move last year materially improved the outlook for one of its most important mine investments. Here's what happened and why investors should be pleased.

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Centerra Gold employee stamping a gold bar. Image source: Centerra Gold.

This mine matters -- a lot

Mount Milligan mine reached full capacity in 2015. In fiscal 2016, the mine contributed roughly a third of Royal Gold's revenue. With a 20-year mine life, and potential opportunities for increasing production, this is an important asset for Royal Gold.

But Royal Gold doesn't actually do the mining, because it's a streaming company. That means it gave mine owner Thompson Creek cash up front to build the mine in exchange for the right to buy gold at reduced rates once the mine was up and running. Royal Gold invested roughly $780 million in Mount Milligan between 2010 and 2013 in exchange for 52.25% of the mine's gold at a cost of $435 an ounce. This is the kind of streaming deal you want to see Royal Gold make.

Royal Gold's streaming portfolio. Mount Milligan is a key asset. Image source: Royal Gold, Inc.

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A troubled owner

The problem was that by the time Thompson Creek had completed Mount Milligan, it had also accumulated around $900 million worth of debt. That's a big number for a company with a market cap hovering around $100 million. With roughly a third of that debt set to come due over the next couple of years, Thompson Creek was in a financially precarious position -- and so was Royal Gold's investment in the Mount Milligan mine.

Faced with the options of working through a potential bankruptcy or pitching in to help find a better solution, Royal Gold chose to help. It worked with Thompson Creek to find a buyer. When that buyer, Centerra Gold (NASDAQOTH: CAGDF), was found, Royal Gold was also willing to adjust its royalty agreement to ensure a deal would get done.

The most important change was the reduction of Royal Gold's gold streaming interest from 52.25% to 35%. That's a big adjustment, but in exchange Royal Gold got an 18.75% copper stream. Royal Gold will continue to pay $435 per ounce of gold and will pay 15% of the spot price per metric ton of copper. Royal Gold believes the net impact will be revenue-neutral.

Royal Gold's Mount Milligan stream, before and after the Centerra acquisition. Image source: Royahl Gold, Inc.

But the end result will be huge. The $1.1 billion acquisition included the payoff of Thompson Creek's debt. Better yet, heading into the acquisition, Centerra had no long-term debt and its cash balance stood at $450 million. With its owner having little debt and plenty of cash, Mount Milligan is clearly in more financially stable hands now that the acquisition has been completed.

The best option

It certainly wasn't ideal that Thompson Creek was struggling with debt. However, given the situation, Royal Gold's decision to back Centerra's acquisition of Thompson Creek was indeed the right move. It put a key asset into stronger financial hands. Although there were changes made to the royalty agreement, Royal Gold expects its stake to remain, financially speaking, unchanged. And the changes made to the agreement broadened Royal Gold's streaming portfolio a bit by modestly increasing its exposure to copper.

It would be wonderful if every investment Royal Gold made worked out perfectly. But that's just not possible. Which is why backing the Centerra acquisition was, by far, the company's best move in 2016. Making the hard calls to improve Royal Gold's long-term outlook is exactly what you want to see management do.

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Reuben Brewer has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.