An Overview of Valuation Practices and the Development of a Canadian Code for the Valuation of Mineral Properties

Transcription

1 An Overview of Valuation Practices and the Development of a Canadian Code for the Valuation of Mineral Properties Keith Spence, Hons. B.Sc., MBA Export Development Corporation Co-Chair, CIM Valuation Committee (CIMVal) ABSTRACT The notion of value has always been a subjective and contentious issue. Indeed, Value is in the eye of the beholder. There are varied methods and practices for valuing property, as there are industries in which they are applied. For example, there are replacement value, insurance value, salvage value, appraised value, book value and fair market value, to name a few, although in the mining industry, valuations usually refer to fair market value. In the Canadian mining industry, at present, there are no comprehensive regulations or guidelines that specify which approaches or methods are appropriate for use in the valuation of mineral projects. In January 1999, The Mining Standards Task Force of the Toronto Stock Exchange and the Ontario Securities Commission recommended that the Canadian Institute of Mining, Metallurgy and Petroleum establish a committee to review and advise on approaches and methodologies for the valuation of mineral properties. Among the approaches to be considered, are included the following: the Discounted Cash Flow Approach, the Cost Approach, the Option Pricing Approach and Market Comparables Approach. In addition, methodologies differ depending on whether the project is at the exploration stage or the producing stage. The CIMVal committee expects that its final report will form the basis for a standard Canadian Code for the valuation of mineral properties. RÉSUMÉ A graduate of University of The University of Western Ontario, with both an Honours B.Sc. in Geology with Geophysics and an MBA., Mr. Spence spent over a decade as a corporate banker specializing in large corporate financings, complex transactions and mining project finance at Royal Bank of Canada and Bank of Montreal respectively. Subsequently, Mr. Spence spent two years as the President of Alliance Pacific Resources Inc., a junior exploration company with activities in the Peoples Republic of China. Valuation of the company s properties and its proposed acquisitions formed an integral part of his role at the company. While in banking, valuation of the underlying loan security on corporate transactions were also vital aspects of his banking practice. Mr. Spence is currently responsible for mine financing business development and mining relationship management at the Export Development Corporation. He is Past Chairman of the Mineral Economics Society of the Canadian Institute of Mining, Metallurgy and Petroleum (CIM) and a member of the CIM National Council. Mr. Spence has also organized and chaired numerous CIM symposia and technical sessions. He is a member of the Board of Directors of The Prospector s and Developers Association of Canada.

2 INTRODUCTION A valuation of a mineral property may be required for merger and acquisitions transactions, stock market transactions, fairness opinions, taxation purposes, litigation, assessment of bank security, insurance claims, expropriation, accounting purposes, initial public offerings (IPO s) and asset disposals. In the Canadian mining industry, at present, there are no comprehensive regulations or guidelines that specify which approaches or methods are appropriate for use in the valuation of mineral properties. Following the BreX fiasco the Toronto Stock Exchange and the Ontario Securities Commission (TSE/OSC) established a Mining Standards Task Force (MSTF) which examined the conduct, standards and practices within the mining industry. Among its recommendations in January 1999, was that the Canadian Institute of Mining, Metallurgy and Petroleum (CIM) establish a committee to review and advise on approaches and methodologies for the valuation of mineral properties (the CIMVal Committee). Simultaneously, other committees have been focussing on other key areas of regulation such as standardized definitions for ore reserves/resources, qualifications of a Qualified Person to conduct certain activities in the mining profession and Best Practices guidelines for exploration practitioners. Unlike Australia where the Valmin Code and Guidelines for the assessment and valuation of mineral assets was introduced in 1995 and revised in 1997, the Canadian regulatory scene has relied on the more dated National Policy No.2-A, Guide for Engineers, Geologists and Prospectors submitting reports on mining properties to Canadian Provincial Securities Administrators. While a worthwhile document, National Policy No.2-A, is somewhat limited in its applications to valuation practice. Further, while Australia is fortunate to have a National Securities Commission, Canada s regulatory framework is under the purview of provincial authorities. It is noted, however, that provincial regulators have worked together through a loose structure called the Canadian Securities Administrators (CSA) which has attempted to give a national scope to certain regulations. National Policy No. 2-A is currently being revised and will be replaced by a new National Instrument The U.S. regulatory framework with respect to valuation of mineral properties is more disjointed than Canada. Trevor Ellis, an experienced U.S. mineral property valuator, describes the U.S. as a patchwork of regulations. In the U.S., mineral property valuations are limited somewhat by the Securities Exchange Commission s (SEC) stipulation that publicly listed companies are only allowed to report proven and probable reserves. Resources as we know it, are not to be reported. The Uniform Standards of Professional Appraisal Practice (USPAP), while not specifically designed for the valuation of mineral properties, is required by various U.S. regulatory bodies and financial institutions. However in using the USPAP to value a mineral property, one has to decide whether the standard for appraising personal property or the standard for appraising a business should apply. Thus while Australia is ahead of the curve in terms of mineral property valuation standards and Canada is in the process of getting there, the U.S. could best be described as trying to cope with the existing structure, until it is changed. THE NOTION OF VALUE Value is in the eye of the beholder. A seller typically ascribes more value to his object for sale than the buyer would ascribe to it. Hence value is a relative notion. However, there is a school of thought that value can be absolute regardless of what the buyer or the seller thinks the object is worth. Thus the art and science of valuation has seen a constant debate between what something is worth versus what the market thinks it s worth and versus what a strategic or motivated buyer thinks it s worth. Accordingly, the lexicon of valuation includes variants on the word value such as: book value, insurance value, replacement value, salvage value, appraised value, investment value, fundamental value, true value, intrinsic value, liquidation value, strategic value and fair market value. Fair Market Value is the generally accepted standard for valuation by most authorities (appraisal societies, tax authorities 2

3 and regulatory bodies) and will be the standard used in this paper. Fair Market Value is defined by the American Society of Appraisers as: the amount at which property would change hands between a willing seller and a willing buyer when neither is acting under compulsion and when both have reasonable knowledge of the relevant facts. In Canada, Fair Market Value based on precedent by Canadian Courts is defined: as the highest price available in an open and unrestricted market between informed and prudent parties acting at arm s length and under no compulsion to act, expressed in terms of cash (Minister of Finance vs Mann Estate 1972). Another working definition in Canada which is widely used by valuation practitioners is as follows: The price agreed upon between a willing buyer and a willing seller dealing at arm s length, both fully informed and under no compulsion to act in an open unrestricted market, at a given point in time." Despite the variations in definitions it is clear that for Fair Market Value to exist the following tests must be met: (1) Both seller and buyer must be willing and not under compulsion (2) The transaction must be at arm s length (3) Both seller and buyer should be informed or have reasonable knowledge of the associated facts A fourth test, which although not explicitly mentioned in all of the three definitions above is at a given point in time. In other words value has to be assessed within the context of the date at which the valuation is effective. VALUATION APPROACHES Whether someone is valuing a house, a boat, a business, jewelry or a mineral property, these properties fall within one or more of three basic approaches to valuation. These can be classified as the Cost Approach, the Income Approach or the Market Approach. The Cost Approach as the name implies focuses on what was spent on the object plus or minus a discount or premium as the case may be. The Income Approach focuses on the cash flow generated from the object of valuation while the Market Approach places emphasis on what someone is willing to pay for such an item. Since a mineral property represents various stages of development from say moose pasture to producing mine to mine closure, one can easily see that some approaches will be more appropriate and applicable than others with respect to specific stages of property development. This will be discussed with more detail later. In addition to the three basic approaches mentioned above, another approach which has gained more prominence in recent years is the use of option pricing techniques in valuation. Black and Scholes (1973) in their seminal Nobel Prize dissertation argued that one could look at value within the context of a series of options. Additionally, Brennan and Schwartz (1985) investigated options within the context of valuing mineral properties. Further, when one examines the rudiments of option pricing theory, it becomes evident that almost anything can be valued using options. In fact there are situations in valuation of a mineral property where there are so many unknowns that an Option Pricing methodology is the best mechanism to assess value. Option Pricing also provides considerable flexibility in the valuation process. 3

4 VALUATION METHODS USED IN MINERAL PROPERTY VALUATION Within the broad approaches or categories to valuation of mineral properties, there are several methods which are utilized in the valuation process. Like the broad approaches themselves, the methods are generally associated with various stages in the mineral property life cycle, from early exploration to production, latterly closure. Table 2 classifies valuation approaches and their constituent methods. TABLE 1. Valuation Approaches and Methods Approach Methods Brief Description of Method COST Appraised value method Meaningful past exploration costs plus warranted future costs Historical cost method Cost less any outstanding obligations and/or depletion INCOME Discounted cash flow The NPV of a stream of cash flows analysis MARKET Comparable transactions Similar properties should have similar value Market capitalization per Total capitalization dollars divided by reserve or resource ounce total reserve or resource Market capitalization per Similar to above but based on ounce of annual production production Option agreement/jv terms The incoming participant agrees to make certain payments and/or expenditures on the property OPTION PRICING Call option value Allows flexibility, good for significant unknowns Put option value Allows flexibility, good for significant unknowns OTHER Gross contained metal value Tonnage x grade x price Statistical/probabilistic Geoscience factor method Decision tree analysis Probability factor applied to NPV of a theoretical deposit A methodology published by Kilburn using location, grade, geology and applying a factor to each category Utilizing traditional yes-no analysis and also applying a probability factor Rules of thumb Back of the envelope analysis, e.g. $15 per ounce in the ground 4

5 APPLICATION OF MINERAL PROPERTY VALUATION METHODS IN CANADA - A BRIEF SURVEY The writer conducted an informal survey among valuation practitioners in Canada to ascertain what were the dominant valuation methods used in the valuation of mineral properties and also to determine whether there was a significant variation in the methods used, based on the stage of development of the property. The survey also attempted to determine whether acting for a Buyer or Seller influenced the ultimate value of the property being assessed and also whether it influenced the method utilized. Valuation practitioners surveyed included geological consultants, investment bankers, mining engineers and project evaluators. The highlights of the survey are in Table 2. TABLE 2. Results of Informal Survey of Valuation Practitioners Property Stage Characteristic 1)Very early stage Exploration (just above the level of moose pasture with a few holes drilled with encouraging results) Dominant Methods Appraised value/cost approach, market comparables 2) Early stage Exploration (with a several holes Appraised value/cost approach, market drilled with encouraging results) comparables 3) Late stage Exploration (decision made to do a Discounted cash flow, market comparables full bankable feasability study, pre-feasability study already completed with positive results) 4) Early development (a full bankable feasability Discounted cash flow, market comparables study completed and the bank financing lined up. construction to begin in the next 6 months) 5) Late development (full completion to be Discounted cash flow, market comparables reached in the next 6 months) 6) Producing mine Discounted cash flow, market comparables 7) Late stage producing mine (reserves to be Discounted cash flow, market comparables depleted in 2 years; limited further exploration potential ) 8) Mine closed (equipment still on site, limited further Salvage value exploration potential) With respect to the question, whether acting for a Buyer or a Seller affected the ultimate assessed value of the property, the answer was overwhelming NO (70%) in both instances. Some of the respondents did, however, indicate that they would emphasize the strengths or weaknesses of the property, when their judgement was required with respect to adding a premium or discount to the ultimate value. See Chart 1 for breakdown. The important finding of the survey was that most respondents used at least two methods to evaluate a mineral property, and in fact the norm was to use three methods of valuation. This emphasizes an important principle in the process of valuation. One must use multiple methods, obtain a range of values and then apply judgement to choose an appropriate value, if required to specify a value. See Chart 2 which compares single methods vs multiple methods. 5

6 The survey also showed the dominant use of Market Comparables, regardless of the stage of development of the property. The Market Comparables method was complimented by the Cost/Appraised value method for earlier life cycle projects while the Discounted Cash Flow Approach was utilized as soon as cash flows could be estimated. KEY PRINCIPLES OF AN APPROPRIATE VALUATION Although as discussed earlier in this paper, value is in the eye of the beholder, a body of knowledge has developed over the years which has attempted to give some measure of objectivity to the art and science of valuation. The following are generally accepted hallmarks of a good valuation: (1) The valuator must be qualified, capable and competent in the valuation of the particular object he or she is valuing; in this case the particular type and stage of the mineral property. (2) The valuation method should be transparent. (3) The valuator should be independent and be at arms length from the transaction, if the valuation result is for third party use. (4) More than one method should be used in the valuation process. In fact it is preferable to obtain a range of values (or cluster of values) in the valuation process. (5) The valuator s assessment of value should not be influenced by the fact that he or she is acting for the buyer or the seller. (6) Since information and knowledge are key ingredients of an objective valuation, all material information about the object of valuation, should be disclosed. CONCLUSION The paper has described elements of value, it has examined the state of valuation of mineral properties in the key mining jurisdictions of Australia, Canada and the U.S.A. and the various approaches and methods were categorized. The mandate of the CIMVal committee was highlighted and an informal survey of valuation practitioners was evaluated. Three dominant themes are therefore evident: (1) The valuator must follow good valuation practices in the process of valuation. (2) A range or cluster of values derived from more than one method is highly recommended. (3) Different methods of valuation may be more applicable depending on the stage of development of the mineral property. It is, however, important to note that mineral properties represent a continium from early stage to late stage and therefore the transition from one method to another will demand some level of judgement. The CIMVal committee intent is that its recommendations will be adopted by Canadian securities regulatory boddies, with the ultimate goal of having uniform valuation standards for mineral properties in Canada. 6

7 CHART 1. Frequency of Usage Of Various Methods NB: Numbers on left hand scale for illustrative purposes only, not actuals Cost Market Cashflow Option Other Closure Late Producing Producing Late Development Early Development Late Exploration Early Exploration Very Early Exploration 7

8 CHART 2. Single Method Usage Vs Multiple Method Usage NB: Numbers on the left hand scale for illustrative purposes only, not actuals Single Multiple Closure Late Producing Producing Late Development Early Development Late Exploration Early Exploration Very Early Exploration REFERENCES AMERICAN SOCIETY OF APPRAISERS. Opinions. Volume BRENNAN, MICHAEL J. and SCHWARTZ, EDUARDO S Evaluating Natural Resource Investments, Journal of Business, Vol. 58, No. 2, pp BLACK, F. and SCHOLES, M The Pricing of Options and Corporate Liabilities. Journal of Political Economy, Vol. 8, pp CAMPBELL, IAN R.; LOW, ROBERT B., MURRANT,MORA. The Valuation and Pricing of Privately-Held Business Interests. 8

9 ELLIS, T.R., ABBOTT D.M., SANDRI H.J Trends in the Regulation of Mineral Deposit Valuation. Reprint March KILBURN, LIONEL C Valuation of Mineral Properties which do not contain exploitable reserves. CIM Bulletin, August LAWRENCE, M.J. and DEWAR, G.J.A Mineral Property Valuation or What Number did you have in mind? October LAWRENCE, ROSS D The role of the Economic Geologist in Financing Exploration and Mining Projects. November PRATT, SHANNON P., REILLY, ROBERT F., and SCHWEIHS R. Valuing a Business The analysis and appraisal of closely-held companies. Third Edition. ROSCOE, WILLIAM E The Value of Mineral Exploration Properties as a Raw Material for New Mines. Presentation to the CIM Mineral Economics Society Discussion Group, Toronto. October ROSCOE, WILLIAM E Valuation of Mineral Properties for Compensation. Presentation to the British Columbia Expropriation Society, Fall Seminar, Vancouver. October SMITH, L.D Valuation Methods for Mineral Properties. THE AUSTRALIAN INSTITUTE OF MINING AND METALLURGY Code and Guidelines for Technical Assessment and/or Valuation of Mineral and Petroleum Assets, and Mineral and Petroleum Securities for Independent Expert Reports. (The Valmin Code) November