Mining valuation issues. Wayne Lonergan Lonergan Edwards & Associates Limited November 2016
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1 Mining valuation issues Wayne Lonergan Lonergan Edwards & Associates Limited November 2016
2 Valuation concepts Market value The price that would be negotiated in an open and unrestricted market between a knowledgeable, willing but not anxious buyer and a knowledgeable willing but not anxious seller acting at arm s length
3 Key valuation issues
4 Key valuation principle All value is the present value of future cash flows
5 Present value Present value allows for both:» Time value of money» Risk PV - i.e. all future cash flows expressed as if received today
6 Key valuation methodologies Discounted cash flows (DCF) Surrogates for DCF:» Capitalisation of earnings: PE EBIT» Asset based
7 Special value MV special value» Special value = additional amount a particular purchaser is willing to pay to extract particular benefits» Additional value to one owner is not market value» Is it property of the target?» Is SV available to several purchasers, then reflected in MV
8 DCF Discrete cash flows for the forecast period Where C/Fs can be reliably measured (with a reasonable level of confidence) Capacity to address growth / losses / capital expenditure requirements Best suited to finite life assets (mines)
9 Valuation methodologies DCF concept Year 1 Year 2 Year 3 Year 4... [Terminal value] $ $ $ $ $ $$ Net present value Discounted for time value of money and risk (Compound interest in reverse)
10 WACC WACC considers:» Cost of equity (K e )» Cost of debt (K d )» Weighting (, E/D + E) WACC is not actual Portfolio based, marginal cost of capital
11 CAPM Typically derived using the capital asset pricing model (CAPM) Basic theory:» Investors are always willing to invest in risk-free assets (R f )» Require a premium for taking on greater risk (R m - R f )» Aren t compensated for diversifiable risk (portfolio basis), only nondiversifiable risk (β) (systematic risk)» K e = R f + β (R m R f )
12 Key valuation issues Goodwill DCF / inputs Acquisition accounting Tax Deferred tax assets / liabilities Other Reasonableness tests Plant and equipment
13 Goodwill
14 Goodwill Goodwill calculated as a residual*» E.g. (price paid per share x no. Of shares) NTA = goodwill Inherent problems with residuals Problems can arise in:» Valuation of the total» Valuation of the other components All errors flow to the residual *Not always
15 Goodwill Goodwill:» Attractive force that brings in custom» Recurrence» Cash flows not attributable to other assets (Purported)mining goodwill examples:» Potential for more» Potential for there to be more than estimated» Potential for price increases» None of these related to the ore body???
16 Goodwill Goodwill:» Goodwill is still an asset» There must be cash flows attributable (Placer) If there are no cash flows, the asset may still exist, but have no material value
17 Goodwill Goodwill in commodity producers:» Homogenous product (commodity)» No product differentiation (especially gold)» No attractive force (legal sense of goodwill)» Most industry processes are common knowledge
18 Goodwill Accounting goodwill market value of goodwill:» Therefore accounting goodwill not a reliable measure for valuation purposes
19 Forecast prices
20 Forecast prices Forward market values Gold is a financial asset Contango Backwardation
21 Reference to analyst forecasts Consensus isn t consensus, it s an average (at best):» Why is an average more reliable Range can be very wide Should be market based where possible:» Objective» Verifiable» Market based» Accessible to all Addition of gold premium / NAV multiple to gold companies by analysts Compensates for too-low forecast assumptions
22 Other commodity price indicators
23 Other commodity price indicators Detailed industry studies (expensive) Broker / Analysts forecasts Recent Federal Court Practice Note on surveys
24 Metal prices Active forward markets exist for gold, currencies (shorter for other metals)» Forward market and pricing issues» Forecasts lower than spot (gold is a store of wealth. Do the central banks believe them)» Implications of forecasts that differ to forward markets» = risk-free profits by selling now and buying at forecast prices!!
25 Production Contemporaneous views preferable to post val date views Levels of confidence (base, optimistic?) Technical specialist opinions may be influenced by conservative professional or regulatory requirements Is the price / cut off grade used for resource estimates still current?
26 Value normally exceeds LOM planned production Only prove up sufficient reserves to justify funding Resource to reserve conversion is normal
27 Gold mining asymmetry of risks / returns There is an element of optionality with gold mining companies At higher gold prices, gold producers benefit in three ways:» From achieving higher revenues for (fundamentally) same costs» Higher gold prices convert previously uneconomic to economically recoverable» Prospective areas become more valuable
28 Mining risks
29 Mining risks is asymmetrical Operating leverage (refer paper) Resource to reserve conversion Price cycle effects Uneconomic becomes economic (and vice versa) Mean reversion
30 TAB uplift Tax cost base uplift For tax depreciable assets Circular calculation
31 Acquisition accounting Required by accounting standards Measurement of consideration:» Cost focussed» Cash more reliable than scrip» Acquisitions of 100% more reliable indicators of market value than of minority interests» Goodwill calculated as a residual, but: Accounting liabilities and valuations measures may differ materially, e.g. Provisions, contingencies, deferred tax liabilities Accounting goodwill market value
32 Acquisition accounting Relevance because it is market evidence of transaction» But of what?» Equity or assets?» MI or control?» Pre-existing ownership interest?
33 Acquisition accounting Date Date of acquisition» Accounting rules require measurement at acquisition date (AASB 3-8) date the acquirer gains control» Different for duty purposes (90%)» Bids can be launched and priced months in advance» Mitigated somewhat by material adverse change clauses, repricing mechanisms» Are bids launched at prices that allow for these contingencies (i.e. Forward priced)?» Goodwill (calculated as a residual) will reflect price movements Is that an asset?
34 Deferred tax assets / liabilities Required by accounting standards tax effect of difference between carrying values and tax values Value = PV of after tax cash flows» Therefore tax is allowed for in the valuation of the underlying investment DTLs unlikely to be realised (excluding inventories) Whole of DTLs should not be added to liabilities in calculating goodwill DTLs should be present value adjusted
35 Restoration / recreation method Rejected twice (same judge, SAT level) Assumes the other assets don t exist / aren t available for sale But:» Management team is available» Other items of plant are available and on site» Chattels, containing information, were also acquired Inconsistent with reality of Duties Act ( land and chattels) Calculates the price at which the buyer would be indifferent this is not MV Ignores the position of the vendor» Crystallises costs, doesn t consider standard assets Worst case scenario isn t MV
36 Recommended reading Available from leading book stores or Allen & Unwin Available from leading book stores or Sydney University Press Alternatively visit Lonergan Edwards & Associates website at
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