Investing in Royalties

A new investment scheme is breaking ground in Europe. Already seen as an established asset class in various industrial sectors within North America, the concept of investing in royalties is largely unknown in Continental Europe. Bernard Tan, Founder of RE Royalties in Vancouver, Canada explains the merits.

Royalties - a short introduction

Whilst it may be considered an emerging asset class, royalties already exist linked to everything we touch on a daily basis. Whether it is a royalty payment to an inventor for the rights to a technology patent, a pharmaceutical company for the rights to a chemical formula, a musician for the rights to a song, a restaurant for the rights to a commercial trademark, a mining company for the minerals extracted from the ground, or the electricity generated by a wind farm, roylties already exist in many different industries.

Investing in royalties

Royalties provide an alternative form of investment that differs from traditional equity or debt investments. However, unlike stocks and bonds, there are no central exchanges like stock exchanges or electronic traded funds, which allow an investor to buy and sell royalties.

A royalty is a payment made to the owner of an asset for the use of that asset. The asset owner may license the asset to be used by another party, and will be paid a percentage of the revenues of the asset based on its usage. Such royalty payments are common in industries such as music, patent licensing, pharmaceuticals or media. The asset owner can also sell a royalty to a prospective investor, which allows the investor to have a percentage ownership of future production or revenues that will be paid at specified intervals like annually, quarterly or monthly. Such royalty payments are common in industries such as mining, oil and gas and even renewables.

Royalties are typically agreed upon as a percentage of gross or net revenues derived from the use of an asset or a fixed price per unit sold of an item such, but there are also other modes and metrics of compensation. A royalty interest is the right to collect a stream of future royalty payment.

Why would an asset owner want to sell a royalty?

For certain asset owners such as a mine, natural gas field or wind farm, income from the asset is generated over the life of the asset. However, because of the long life of the asset, the accumulation of cash can sometimes take a very long time. Occasionally, the asset owner may need to raise funds to buy new equipment, invest in their operations, pay down debt or develop a new project. In traditional financing, the owner can either (i) sell the asset, (ii) issue more equity which dilute his/her ownership interest or (iii) take on debt, which have to be repaid and may have restrictive covenants.

An asset owner may also consider selling a royalty interest from the project to an investor. This will allow the asset owner to maintain control of the asset, retain ownership interest, and not have restrictive covenants be imposed on them. The investor or buyer of the royalty would receive a percentage of future revenues from the asset for an agreed amount of time.

Benefits to the royalty investor

For the investor, royalties provide a stable, fairly low-risk alternative compared to stocks because investors receive a monthly payment based on the asset owner’s revenue. Investing in royalties also protects the investors from potential dilution of interests in the future. Compared to equity investments where companies may issue more shares and dilute existing shareholder interests, a royalty investment would typically be fixed. As such, no matter how many additional shares are issued, the royalty investor would receive the same percentage of revenues throughout the life of the royalty contract.

Royalty investing also protects an investor from potential future escalating costs such as increases in input costs, wages, taxes, or administration. This is driven by the royalty interests being driven by revenues (i.e. the top line) vs. the income (i.e. the bottom line), which is typically what a shareholder receives.

Unlike an equity shareholder of an asset, such as a mine, which may also have on-going sustaining capital costs to keep the asset in reasonable condition or eventual liability obligations once the reserve is full depleted, a royalty investor is not exposed to these future capital commitments. This shields the royalty investor from potential future risks that may be associated with owning an asset.

How to invest in royalties?

For investors seeking exposure in this asset class, the best way to invest would be to buy shares of companies that specialize in accumulating these royalties. Royalty companies, because they don’t operate the underlying assets, tend to have very low costs, which allows the bulk of cash flows generated from royalties to be either distributed back to shareholders or re-invested. The FT just reported on plans from Glencore to create a royalty unit, which might be floated on the market to give investors access to its royalty portfolio Telegraph - Glencore plans to spin off royalties

About the Author

Bernard Tan is the founder and CEO of RE Royalties Ltd., a company based in Vancouver, BC, Canada, focused on royalties from renewable energy projects. RE Royalties mandate is to accumulate a portfolio of royalties that provide a long-term, stable and growing income stream to its investors. For further information Bernard Tan can be reached at bernardtan@reroyalties.com or 001-778-373-6712.