Valuations currently under scrutiny
While commodity prices have declined, costs have not retreated as quickly, and it is difficult for companies to progress new projects or brownfields developments.
By Dr Eric Lilford, Deloitte Corporate Finance Partner
The challenge is magnified by the global financial crisis and weakened global outlook.
For companies with multiple potential projects and limited capital, it is important to select the projects that offer the best potential to increase shareholder value over the medium to long term.
Whilst discounted cash flow valuation approaches are likely to continue to be the predominant valuation tool used by investors in mining projects, management may be able to better understand the economics and future potential of projects by considering alternative valuation methodologies.
In particular, management should consider methodologies that take into account potential upsides from future courses of action, or operating options. These methodologies may assist management in the mining industry in making decisions that maximise shareholder value.
Over the life of a project, management may perform many valuations to determine ‘fair market value’ and to support decision making under uncertainty.
Fair market value, the pre-eminent value determinant, is the highest price achievable between knowledgeable and prudent parties, obtained in an open and unrestricted market and expressed in terms of monetary worth. Importantly, each party acts at arm’s length and neither party is compelled to transact. For a mature project, this is generally determined using a discounted cash flow approach.
Mineral property valuations are conducted for a variety of purposes, including:
• to ascertain the viability, value and economic uncertainty of a mineral property;
• to indicate the technical, economic and operational guidelines for exploitation;
• to assist decision-making in relation to acquisitions, disposals, project financing, regulatory requirements and taxation considerations;
• to comply with legislation, such as local participation and stock exchange regulated opinions (e.g. for minority shareholder protection);
• to assist litigation proceedings;
• for expropriation considerations resulting from changing legislation or dispossession claims;
• to facilitate insurance claims;
• for accounting purposes; and
• in relation to public offerings and other capital raisings.
Three key valuation methodologies
There are a number of methodologies which may be used to determine the value of a mineral property. These valuation methodologies can be categorised under three broad groupings, being the Cost Approach, the Income Approach and the Market Approach.
The ability to correctly interpret all of the available information in order to select a preferred valuation methodology is vital. Once the valuer of a mineral property has received all of the relevant information on the property, he/she must consider the shortfalls of each of the methodologies available for use. Intuitively, new methodologies can be developed, but they are not easily motivated to acceptance by the valuation fraternity at large.
The Market Approach relies on historical transactions or current trading prices of companies with comparable properties in order to provide a best estimate for the current value of a property. The most widely accepted valuation methodologies using this approach are the Value per Unit methodologies, being the dollar per property, dollar per hectare, dollar per ounce/tonne of production or resources, Lilford TEM and Kilburn Geoscience methodologies.
The Cost Approach is one of the most simple valuation approaches available. It relies on the premise that the value of a property must be worth at least that amount expended on the property to achieve a certain level of geological understanding.
Owing to its simplicity, this approach ignores many of the critical value drivers inherent in any mineral property. The two most important methodologies using the Cost Approach are the multiple of exploration expenditure methodology and the farm-in analysis methodology.
The Income Approach is the most widely used valuation methodology for mineral properties. The basis for many of the specific methodologies under this heading is the Discounted Cash Flow (DCF) methodology.
With the appropriate discount rate, the DCF methodology assists many industry professionals in their considerations for commencing the development of a project, extending the life of a project and/or expanding the size of a project.
In addition, financiers and other stakeholders besides management also often consider DCF valuations for their specific purposes. With this as a base, sensitivity analyses and simulation analyses can be conducted to assess how robust a project is under different scenarios.
Computers have assisted in the development and use of previously impractical valuation tools, such as Monte Carlo simulation.
Valuation methodologies are not retained in black boxes that generate an answer. Experienced valuers armed with the knowledge of best practice will select the most appropriate methodologies for required purpose.
The application of each valuation methodology depends on the information available for the property under consideration, as illustrated in Figure 1. Figure 1 shows that as the geological certainty of a mineral property improves, the valuation methodologies available to perform a valuation can be broadened to include more accurate methodologies.
The valuation of a project over its lifetime is likely to require the use of a number of valuation methodologies, depending on the stage of development of the project. Essentially, the further into development of a project the more likely the methodology for valuation will be cash flow-based. While discounted cash flow valuation approaches are likely to be the predominant valuation methodology used throughout the life of a project, when management is considering early stage projects, it may often be appropriate to consider alternative valuation approaches. Such alternative valuation approaches may offer insights that assist in the selection of projects for companies with multiple potential projects and limited capital.
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To see the table containing Valuation Approaches & Methodologies click here.
To see a diagram explaining the application of valuation methodologies click here.