Commodities

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

It’s been a good week for Glencore, a phrase rarer these days than some of those weird metals at the bottom of the periodic table.

It isn’t just that the stock is up 10 percent over the past five sessions, even after Thursday’s decline, beating Glencore’s London-listed peers handily. It’s that the company just did something that it ought to be known for, but which has gotten lost beneath all that debt: a good trade.

Glencore on Wednesday announced a so-called streaming deal with Canada’s Silver Wheaton. Silver Wheaton pays Glencore $900 million up front, and in return gets a big cut of future silver production from the Antamina mine in Peru, paying just 20 percent of the prevailing price.

Peaks and Valleys
SOURCE: Bloomberg

With Antamina, Silver Wheaton gets its hands on a stream of supply from a low-cost mine expected to keep producing for decades. Yet, like any good deal, it isn’t the only side walking away with something. Glencore got a good price, at least when extrapolating from the production numbers and other details released on the deal.

Assuming a long-term silver price of $15.50 an ounce -- in line with the current futures curve -- and a discount rate of 5 percent, Silver Wheaton wouldn’t break even in terms of net present value until 2044. That doesn’t factor in financing costs for the debt used to pay Glencore up front or taxes, which aren’t usually payable on foreign streaming income for Silver Wheaton (although it is currently in a dispute with Canadian authorities about this).

The chart below shows the build-up for discounted cash flow for the deal at three different price levels for silver -- and yes, only in models does cash flow in that smoothly. At the highest price, Silver Wheaton hits the magic $900 million figure in 2031, a mere 16 years away.

Point Breakeven
Implied cumulative discounted cash flow for Silver Wheaton's streaming deal at different long-term price levels
Sources: Company presentation, Bloomberg
Key assumptions: silver at $15.50 an ounce in the current quarter in all cases; 5 percent discount rate; 5.1 million ounces a year in 2016 and 2017; 4.66 million ounces thereafter until 140 million reached; 22.5 percent of constant output thereafter.

You can shift the various numbers up and down any which way you want, of course. Plug in the average price for the past 20 years, about $12.70 an ounce, and I’ll likely be dead before the deal breaks even, for instance.

The bigger point is that Silver Wheaton is banking on the mine’s lifespan extending for many, many years, silver prices rising, or a combination of the two. For example, at $15.50 an ounce and just 30 years of output, the internal rate of return on the deal comes in at around 5 percent -- not exactly breathtaking. Bump the price to $21.50 and the lifespan to 40 years, and the return rate is almost 9 percent.

So Glencore, despite the pressure it is under, didn’t exactly give away the family silver with this one. Is it ideal? Of course not: The very fact that the company has had to resort to such financing to assuage concerns about its balance sheet testifies to the hole it dug itself into with the Xstrata takeover a few years ago. It remains vulnerable to swings in copper prices and sentiment around China.

Nevertheless, the streaming deal brings in needed cash without being a fire sale and shows Glencore using its trading chops to address its chief problem. That alone is worth something more to the stock price than just the money raised.

Disclosure: Peter Grauer, the chairman of Bloomberg LP, the parent of Bloomberg News, is a senior independent non-executive director at Glencore.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Liam Denning in San Francisco at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net