The Valuation of Mining Companies - Newsletter #4 of 6
Today's Newsletter is authored by Ian R. Campbell FCA FCBV.
Ian R. Campbell is a graduate of the University of Western Ontario School of Business
Administration, a Fellow of the Canadian Institute of Chartered Accountants, and
a Fellow and founding member of the Canadian Association of Canadian Business Valuators.
He is the author of the widely used business valuation texts The Principles and Practice
of Business Valuation (1975), The Valuation and Pricing of Privately Held Business
Interests (1990), and The Valuation of Business Interests (2001);
he also is an Editor of Canada Valuation Service. He worked actively
in the founding of The Canadian Institute of Chartered Business Valuators, and was
a director of the Institute from its inception to 1976. In 1976 he founded
Campbell Valuation Partners Limited, where he continues to play an active role.
He has given evidence in Business Valuation matters before most Canadian and Provincial
Courts in many of the leading Canadian business valuation related cases. The Canadian
Institute of Chartered Business Valuators annually awards the Ian R. Campbell Research
Grant in the amount of $10,000 to one or more applicants who provide Business Valuation
research topics for consideration. This Grant was established in 2007 and
first awarded in 2008.
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Background
I concluded in mid-2005 the U.S.$ was going to fall against other world currencies,
and focused on the mining and oil & gas industries. Much to my surprise,
I found little written on 'How to Value Mining Company Shares'. Having written
Business Valuation tests used by many Canadian professionals, I decided to write
an 'Electronic Book' dealing with what I think ought to be considered when valuing
Mining Companies - which I initially converted into a 4 Part Newsletter Series.
Newsletters #1, #2 and #3 of the Series were e-mailed on June 3, June 16 and July
2. They can be found filed under 'SRP Newsletter Archive' Button on the Home
Page of http://StockResearchPortal.com.
Due to length, I have elected to split what was going to be Newsletters #3 and #4
each into two Newsletters to be e-mailed in accord with the following schedule.
Hence the entire series will be comprised of 6 Newsletters, all eventually filed
under the aforementioned 'SRP Newsletter Archive' Button.
Newsletter Index and Release Dates
#
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Topic
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Release Date
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1
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Introduction/Investment
Overview/Exploration & Mine Development/Resources & Reserves/Steps in Mine
Development
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June
3
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2
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Mining
Company Risk Assessment - Part #1
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June
16
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3
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Mining
Company Risk Assessment - Part #2
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July
2
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4
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Mining
Company Risk Assessment - Part #3
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July
14
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5
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Valuation
Methodologies
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July
28
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6
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Required
Rates of Return
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August
11
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Mining Company Risk Assessment - Part #3 - Topics Discussed in this Newsletter
Mining Company Risk Assessment - Overview
Development Stage of Project
Feasibility Studies
Mineralization & Mining Technique(s)
Mining & Process Infrastructure
Mining & Processing Costs
Mine Life
Environmental Issues
Other Matters of Interest
Mining Company Risk Assessment - Overview
The following assumes a 'single project' company. If a company has more than
one project the considerations discussed that are 'project specific' need to be
considered separately with respect to each project. From an investor perspective
important timing issues, risk assessment, company information, and an appropriate
'risk related rate of return' ought to be include a large number of common factors.
Newsletters #2 - #4 of this 6 Part Newsletter Series discuss many of these factors
- in some cases followed by discussion shown in smaller print. On a cautionary
note, 'Risk Factors' are fact and circumstance specific, and no list or broad discussion
of 'Risk Factors' should or can be considered all-encompassing.
Development Stage of Project
It is important to know what exploration or mine development stage the Company's
project currently is at. Project 'stages' can be summarized as:
1. The 'seed money' stage, where one or more exploration properties have either
been identified as acquisition targets, or have been either recently acquired or
targeted. Investment at this stage obviously is highly risky, as any investment
made at this point is to a very large degree a 'bet on the Board and Management'
both being able to find and negotiate acquisition on commercially sensible terms
if they have not already accomplished that.
It is important for anyone investing in a private placement at this stage in the
company's evolution to be satisfied with the terms of the private placement offering
(including the number of warrants offered in conjunction with shares, the escrow
period, the promote (if any), including options (if any) granted to the Board and
Management concurrent with the financing. It also is important to reflect
on whether the size of the private placement will be sufficient to ensure completion
of the initial project exploration and resource and reserve determination without
the likelihood of the company having to dilute shareholders pursuant to subsequent
financings. Investors who purchase the company's shares in the open market
should assess these same things in a risk context. While highly subjective,
in order to invest in a mining exploration company at this stage an investor ought
not to invest unless he/she believes the near-term return on investment potential
has a real potential of being very significantly higher than returns expected:
- by corporate acquirers when they acquire conventional
businesses with established products, customer bases, and after-tax free cash flow
- this is discussed in the last Post in this Post Series; and,
- from investments in normal sized trading lots
of 'Mid and Large Cap' public companies.
2. Partway through its exploration program without proven success.
This is arguably the riskiest investment stage where an exploration program has
been partially completed and has yet to find what it expects to be find. Any
investment made at this point continues largely to be a 'bet on the Board and Management',
in circumstances where the Board and Management to date has not realized success.
Again, investors ought not to invest unless they believe the near-term return on
investment potential has a real potential of being significant higher than returns
expected by corporate acquirers when they acquire conventional businesses, and from
investments in normal sized trading lots of 'Mid and Large Cap' public companies.
3. Partway through its exploration program with some demonstrated success.
4. At the stage of having NI 43-101 measured, indicated and inferred resources.
5. At the stage of having NI 43-101 proven and probable reserves.
6. At the pre-feasibility study stage.
7. At the feasibility study stage.
8. At the permitting stage.
9. At the mine and processing facilities funding stage.
10. Successfully completed the mine and processing facilities funding stage.
11. Partially completed the mine and processing facilities construction.
It is particularly important at this stage to monitor both cost overruns against
forecasted costs and the actual time of construction measured against the planned
construction timelines.
12. Completed mine and processing facilities construction and in production.
Arguably risk diminishes as the project proceeds through each stage in its evolution
from demonstrated exploration success to production. Once in production risk
can be assessed on a day-to-day basis based on conventional rate of return expectations.
Importantly, during the mine and mill construction phase the risks of cost overruns,
equipment shortages, timing delays, unanticipated problems with infrastructure tie-in,
and so on are always present, and need to be carefully monitored.
Feasibility Studies
1. Pre-feasibility and Feasibility Studies are comprehensive study of the viability
of a mineral project that has advanced to a stage where the mining method in the
case of underground mining, or the pit configuration in the case of an open pit,
has been established and an effective method of mineral processing has been determined.
These studies include financial analysis based on reasonable assumptions of technical,
engineering, legal, operating, economic, social, and environmental factors that
enable:
- a Qualified Person (as defined in Canadian
NI 43-101 to determine if all or part of the Mineral Resource may be classified
as a Mineral Reserve;
- the Board and Management to determine if in
their respective views a project is commercially viable; and,
- ultimately for lenders, investors, and perhaps
in the end corporate acquirers to determine if in their respective views a project
is commercially viable.
Things that must be considered when determining whether a project is commercially
viability include:
1. The existing resource and reserve base at any given point in time in the contexts
of geographic location, average grade, existing proven and probable NI 43-101 resources
and reserves, and the perceived potential to expand the mineable deposit and timing
of such expansion.
2. The project's physical location and comparative geo-political risk.
3. The geology of the deposit in the contexts of extraction method (open pit
versus underground), quantity, grade and metallurgy.
4. Whether company determined mineral cut-off grades are commercially viable over
commodity pricing cycles expected over the life of the project.
5. What infrastructure (roads, rail lines, water access, utilities access, ore processing
facilities), trained labour, weather conditions (enabling year-round exploration
and drilling), and access to assaying laboratories is available to the property.
6. The economics of the project in the context of forecasted metal prices, mining,
milling and processing costs, recovery of secondary metals, and project financing.
7. Specifically with respect to financing, it is important to understand the company's
(read Board of Director's and Management's) philosophy and strategy of financing
through debt, equity or a combination of the two. The company's resultant debt:equity
ratio is an important measure of project and company risk - and speaks directly
to investor-specific risk tolerance.
Where a company has completed a pre-feasibility study or a feasibility study it
is important to review it or them in detail to gain an understanding of the assumptions
that have been made with respect to both revenues and costs, and the resultant internal
rate(s) of return imputed in those studies.
Mineralization & Mining Technique(s)
1. It is important to understand the targeted mineralization and expected mining
technique, including consideration of historic mine workings and proximity to existing
commercial deposits.
Generally, but in particular with respect to an early stage exploration company,
the anticipated grades and potential quantities of targeted mineralization need
to be carefully considered both in and of themselves and in the context of the physical
characteristics of the prospective ore body. Essentially there are two distinctly
different mining techniques, being 'open pit' mining, and 'underground mining'.
The former typically enjoys lower operating costs per unit of production, and faces
less risk on many fronts than the latter. Accordingly, one typically would
expect low grade ore bodies to be commercial only if they were found in reasonably
consistent quality and large quantity near the surface such that they can be 'quarried'
pursuant to an 'open pit' mining process.
Mine & Processing Infrastructure
1. It is important to understand the project's mine and processing infrastructure
in at least the following contexts:
- If the mine and processing infrastructure is
of a 'greenfield' nature, what is the likelihood of it being permitted on a timely
basis, and of it being built on time and within budget?
- If the mine and processing infrastructure is
completed and mineralization is being mined and processed, how well maintained is
that infrastructure in the contexts of annual repairs and maintenance expenses being
incurred?
- If the mine and processing infrastructure is
completed and mineralization is being mined and processed, how well maintained is
that infrastructure in the context of annual sustaining capital expenditures being
incurred?
Mining & Processing Costs
1. With respect to 'producer' operations, it is important to understand and assess
the company's historic and (more importantly) prospective processing and refining
costs per unit of output, cash operating costs per ounce produced and metal credits,
and its annual EBITDA (earnings before interest, taxes and depreciation), EBIT (earnings
before interest and taxes), after-tax income, annual sustaining capital reinvestment,
prospective free cash flows, and what might be ultimate mine closure and environmental
remediation costs?
2. With respect to the company's labour force, what Labour Laws exist in the country
where the company conducts its operations with respect to severance and safety,
is trained labour readily available, are there labour productivity enhancement opportunities,
and is the labour force unionized and what are the contract terms?
Mine Life
For a producer at least the following questions need to be addressed with respect
to resources, reserves, capital assets, production capacity and efficiency:
1. What is the company's estimated mine life at any given point in time having regard
to where in the commodity cycle metal prices then are?
2. What is company's 'capitalization v. expense policy' with respect to capital
equipment and spare parts?
3. What is their technological state and state of repair and what is the dollar
amount of forecasted capital expenditures over next three fiscal years?
4. Are required new equipment and spare parts readily available?
5. Importantly, what % of Capex is of a 'sustaining' versus a 'growth' nature, where
'sustaining capital reinvestment means 'the capital outlay required each year to
maintain operations at existing levels'?
6. What is mine output capacity, mine efficiency, processing plant capacity, processing
plant efficiency, and so on?
7. Does the mine experience, or is it at risk of experiencing, water flood issues?
8. Are power, water, and other utilities readily available to the company's exploration
and mining sites?
9. Does the company have long-term supply contracts for power, water, and other
utilities and if so on what terms?
10. Does the company prospectively face possible significant escalated utilities
and water costs?
Environmental Issues
For both explorers and producers at least the following questions need to be addressed
with respect to environmental issues:
1. Is there both a Board approved environmental policy and system of internal ongoing
environmental surveys, prevention policies, and environmental liability audit procedures
in place?
2. Are there known environmental liabilities, or have there been third-party environmental
complaints, inspections, or examinations? If so, how have these liabilities
been quantified and accounted for?
3. Has the company commissioned Phase I or Phase II environmental studies with respect
to its properties?
4. Is there adequate environmental liability insurance to cover any existing or
possible liabilities?
5. What were the prior uses of the company's properties, and have appropriate steps
been taken to ensure the company has not assumed environmental liabilities created
by prior owners or lessees - including ensuring that prior owners and lessees are
contractually committed with respect to environmental liabilities that existed when
the company took the properties over?
6. Does the company have environmental liabilities related to properties it previously
owned?
Other Matters of interest
For both explorers and producers at least the following additional questions need
to be addressed:
1. What liability insurance, operations insurance, and property insurance does the
Company have in place?
2. Are, or in the past have, the company or any of its Directors and Officers been
subject to penalties or sanctions related to bankruptcy, income tax, breach of securities
law, or been found guilty of criminal or fraudulent activities?
3. Is the company or its operations subject to unusual Government Approvals or Regulations?
4. Does the company have any outstanding disputes with tax authorities, including
unresolved income tax assessments or reassessments?
5. Does the company have any known unresolved regulatory compliance issues?
6. Is the company a litigant or potential litigant in threatened or ongoing litigation?
7. Does the company have any contractual obligations outside it normal course of
business, or any material contingent liabilities?
For a comprehensive discussion of Share and Business Valuation see 'The Valuation
of Business Interests', Ian R. Campbell and Howard E. Johnson, The Canadian Institute
of Chartered Accountants, 2001, available through the websites of either Campbell
Valuation Partners Limited www.cvpl.com, or The Canadian
Institute of Chartered Accountants www.cica.ca.
The views expressed in this Newsletter are those of the author. The value of shares
of a given company is time and fact specific. The valuation theories, principles,
methodologies, observations, comments and data inputs discussed in this Newsletter
are of a general nature, and are provided for information and general guidance only.
They should not be taken to include all 'value or price relevant factors'.
Nothing in this Newsletter is intended to, nor should be taken to, constitute economic
or investment advice.
The author(s) of this Newsletter or the owners of Stock Research DD Inc. (the owner
of StockResearchPortal.com and StockResearchPortalBlog.com)
or their families, entities in which they have ownership interests, and officers,
directors, employees, agents, partners, affiliates and partners of Stock Research
DD Inc. may beneficially own securities and participate in Private Placements of
companies references in this Newsletter. The fact that a company is referenced
or discussed in this Newsletter should not be construed as an investment recommendation
with respect to that company or its securities.
Copyright 2009, Stock Research DD Inc. All rights reserved. This Newsletter
is protected by copyright and other intellectual property laws and may not be reproduced,
rewritten, distributed, re-disseminated, transmitted, displayed, published or broadcast,
directly or indirectly in any medium without the prior written permission of Stock
Research DD Inc.
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