THERE was a sign of things to come in London this week and Australia's resources sector should take note.
BlackRock Inc, the world's biggest investor in resources with an estimated $36 billion sunk into the sector, announced it was investing $110 million into an iron ore company.
Nothing unusual there, except that BlackRock was not buying shares in the company - London Mining - but rather securing a 2 per cent royalty on all future iron ore sales from the company's Marampa mine in Sierra Leone.
The mine is already producing more than one million tonnes a year, and BlackRock's funding will help expand that ninefold.
BlackRock's top fund manager, Evy Hambro, revealed the company had been reviewing the way it invests, and royalty arrangements had become more attractive as sources of funding had dried up for mining companies.
"It's an attractive deal to BlackRock because [we] can borrow at well below the cost of debt that is available to mid-tier to junior miners and earn a return on investment that's well above that level," he said.
"In today's environment, the banks' ability to lend has been vastly reduced ... bank capital is scarce and, when available, more expensive."
He said the model gave BlackRock exposure to iron ore without direct exposure to the sort of rampant cost inflation that has become the norm in the mining sector, as the royalty is set on sales revenue not overall profits.
Nor will BlackRock's return be beholden to the whims of executive judgments on dividends, and Mr Hambro indicated that this investment would not be the last of its type.
"We continue to evaluate a number of other opportunities that are similar in nature to this royalty," he said.
BlackRock has made no secret of its frustrations with the big diversified miners, who always seem to have another growth project to fund rather than returning a bigger slice of profits to shareholders.
Last year, it resorted to publicly questioning the likes of BHP Billiton over its growth strategy and approach to shareholder returns. It has since put its money where its mouth is, reducing its stake in BHP and Australia's biggest gold producer, Newcrest.
Mr Hambro's suggestion that more royalty-based deals are imminent should give hope to mid-tier Australian miners caught between the scarcity of finance and the market's sudden reluctance to invest in resources stocks.
Such deals have proved successful in the past: in 2006, Manhattan-based investor Leucadia National bought a royalty note on production at iron ore mines being developed by Fortescue Metals.
Fortescue famously went on to become one of the world's biggest iron ore producers, and while the terms of that royalty note are now subject to a legal dispute, the deal has still been wildly successful for both parties.
Royalty and off-take focused companies in North America have indicated they believe the conditions are primed for royalty-type deals to take centre-stage, and Tim Schroeders, fund manager of Pengana Capital, said there was merit in the concept.
"It's pleasing there is this sort of innovation occurring from one of the biggest global investors in mining," he said.
"I've no doubt we will see more of it."
Frequently Asked Questions about this Article…
What exactly did BlackRock do at the Marampa mine and how much did it invest?
BlackRock invested US$110 million to secure a 2% royalty on all future iron ore sales from London Mining's Marampa mine in Sierra Leone. It did not buy shares in the company — the deal gives BlackRock a cut of sales revenue as the mine expands (the mine was producing more than one million tonnes a year and the funding is intended to help expand output up to about nine times that level).
What is a royalty investment in mining and how does a sales-based royalty work?
A royalty investment gives an investor a fixed percentage of future sales revenue from a mine rather than equity or control. In this case BlackRock will receive 2% of Marampa's iron ore sales revenue over time. Because the payment is tied to sales (not company profits or dividends), royalties provide a predictable cash stream without taking direct ownership or depending on management's dividend decisions.
Why has BlackRock shifted toward royalty deals instead of buying shares or providing traditional loans?
BlackRock’s fund manager Evy Hambro said royalty arrangements have become more attractive as traditional sources of mining finance have dried up. Banks' ability to lend has been reduced and debt is more expensive, so royalty deals let large investors gain exposure to commodities while avoiding the higher cost and operational risks associated with lending or owning miners' equity.
How do royalty investments protect investors from mining cost inflation?
Because royalties are calculated on sales revenue rather than net profits, the investor’s return is less sensitive to cost inflation that squeezes a miner’s profits. That means a royalty holder like BlackRock can earn from rising sales without being directly exposed to escalating operating costs or capital overruns that affect profit margins.
Could more royalty-style funding help mid-tier Australian miners find finance?
Yes. The article says BlackRock’s move should give hope to mid-tier Australian miners stuck between scarce bank financing and weak investor appetite for resources stocks. Fund managers and royalty-focused firms in North America see the conditions as favourable for more royalty deals, and local managers like Tim Schroeders have welcomed the innovation.
Has BlackRock indicated this royalty investment is a one-off or part of a wider strategy?
BlackRock’s Evy Hambro indicated the firm is evaluating a number of other opportunities similar in nature to the Marampa royalty, suggesting this type of deal is likely to feature more prominently in their resource investments going forward.
Are there past examples of successful royalty or off-take deals in the iron ore sector?
Yes. The article cites a 2006 deal where Leucadia National bought a royalty note on production at iron ore projects developed by Fortescue Metals. Fortescue later became one of the world’s biggest iron ore producers, and while aspects of that royalty note have been legally disputed, the transaction has been described as highly successful for both parties.
How has BlackRock behaved toward large diversified miners like BHP Billiton and Newcrest?
BlackRock has publicly questioned the growth strategies and shareholder-return approaches of big diversified miners such as BHP Billiton. The article notes BlackRock reduced its stakes in BHP and in Australia’s largest gold producer, Newcrest, signalling frustration with companies that prioritise new growth projects over returning more cash to shareholders.
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