The first step in valuing a property is to assess its development state at the date of valuation. The stage of development most often will indicate the appropriate valuation approach and will have a significant impact on the final value.
Mining projects follow a broadly predictable development path, from the identification of the mine’s potential, to exploration, to evaluation (through deposit samples), to mine planning and construction, production and, finally, to then decommissioning takes place followed by remediation at the end of the mine’s life.
There are three approaches normally used to value a mining asset: its replacement cost, the amount of invested capital and its market value (based on the future income the assetis expected to generate).
In valuation theory, discretionary after-tax cash flow is of primary importance. The most commonly applied income approach is discounted cash flow (“DCF”), which assesses the value of an asset by reference to the amount, timing and risk of future cash flows. When implementing a DCF method, it is customary to follow three main steps:
Estimate future cash flows for an explicit forecast period.
Calculate the value of the asset at the end of the forecast period.
Discount the cash flows and the terminal value using a rate that takes into account the riskiness of the cash flows and the time value of money. Then sum those values to arrive at the net present value of the asset.
Extractive industries are unique in some respects: Once a mining resource is sufficiently established from a technical perspective and its economic viability is verified with a feasibility study, the processes to extract the ore and produce the commodity are well-known. Costs, therefore, can be estimated with a reasonable degree of precision. Furthermore, the product usually has a ready end market (global or regional) so revenues can be forecast using publically available forward pricing curves.
With this approach, the value is inferred from publically available information about transactions and trading prices comparable with the target mine. While each mining project may have its own singular characteristics, value data from reasonably similar mines can be used to determine a range of fair market values or to reaffirm the reasonableness of value conclusions reached by other methods, including the income-based approach.
In a cost-based approach, the value is based on the principle that a notional purchaser would not spend more on an asset than it would cost to actually construct the asset. Such costs would include the development costs of the property. The value calculated thisway may be thought of as a “floor”value, as it would not include any expected future rate of return or cash flows from the investment.
The “Standards and Guidelines for Valuation of Mineral Properties,” produced by the Special Committee of the Canadian Institute of Mining, Metallurgy and Petroleum on Valuation of Mineral Properties (“CIMVAL”), sets out the valuation approaches that normally are considered appropriate to each type of mineral property, as seen in Figure 4.
It is important to take great care in choosing a primary valuation approach for a target mine (or mines). When valuing a number of licenses or coal properties (for example, at an auction), the valuation analyses may need to be done on a block-by-block basis, as each block likely will be different in the characteristics of the resource and its stage of development. Where appropriate and feasible, it usually is best to apply more than one methodology so final conclusions can be cross checked. (The Central Mine Planning & Design Institute’s recent suggestion to ascertain total value of a block by assessing the block’s net present value based on an income approach (that is, DCF) appears to be consistent with the above standardsand guidelines.)
More to Mining than Markets and Money
The valuation approaches described above are important, but they do not contain the entirety of the valuation process. The intricacies specific to a property, as well as to its geography, need to be taken into account. And there may be other unique issues that mustbe factored in.
For example, when assessing the value and attractiveness of a particular coal block, bidders likely will take into account market power, portfolio effect (a single buyer, for instance, might ascribe a higher value to a block than if it was sold to several buyers), ownership caps promulgated by the government, and specific end-use limitations that may reduce the number of potential bidders and, thereby, affect the value ascribedto the mine.
Mining, as we’ve noted, has long been perceived as a risky business — and with good reason. Risks that are difficult to calculate precisely include regulatory hurdles (such as the time and cost of procuring approvals and producing the necessary documentation to commence exploration, development and operations of a mine) and other market and project risks that may affect cash flows (such as the realizable coal price). Before inferring the value of a property, it behooves companies and investors to assess these risks as thoroughly as possible.
The valuation of a coal project is a vast undertaking. It requires knowledge of the overall mining process, a sound recognition of the property or properties under consideration from both a technical and a financial perspective, and command of the appropriate valuation standards and guidelines. Proper valuation also demands a deep appreciation of the risks specific to the geography and project. Above all, it requires an understanding of the context of the valuation and experience with standard valuation and financial concepts and approaches.
Once all these areas have been addressed satisfactorily and due diligence applied as appropriate, then the risks of this inherently risky business may be mitigated.
Valuing a Mine – Source – FTI Journal