Background to this Series of Posts

This is the 4th in a Series of 17 Posts that will be published on this Blog each Tuesday and Thursday from September 16 to November 11. All 17 Posts will be filed under the Blog Category ‘Valuation of Mining Companies’. For previously issued Posts in this Series click here. We hope you find this Post Series useful.

Mining Company Risk Assessment

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. This Post and Posts #5 – #10 of this Post Series discuss many of these factors – in some cases followed by discussion shown in italics. 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.

General Factors

1. The proper measurement of current business value is the present value of all future returns, where future returns are taken to be after-tax distributable or re-investable (in company growth) ‘free cash flows’. In the context of a mining project ‘free cash flow’ typically include the aggregate after-tax annual cash flow

expected to the generated over the life of the project less income tax effected annual sustaining (or ‘maintenance’, ‘no-growth’) capital investment, less the after-tax cost of any mine closure and related environmental remediation costs.

This value measure is fundamental and should be reflected upon at each stage in the life of a mining project, notwithstanding that prior to mine production there is no possibility of a project generating ‘free cash flow’. During the finding stage and mine and process facilities development stage any such value process typically would assume assessment of the project on a ‘stand-alone’ basis. In circumstances where an arm’s length purchaser (typically a ‘major producer’) bids for the project prior to production purchaser ‘synergies’ or multiple purchaser competition for the project are additional factors that ought to be considered an any value assessment.

Investment Time Frame

1. What is the investment time frame, combined with an assessment of the likelihood and timing of a likely liquidity event in the contexts of

• an exploration company selling a commercial ‘discovered’ project to a producer; or,

• a possible takeover by a producer?

In this regard, it is important to know whether it is the company’s strategy to grow organically, grow through new property acquisition, grow through company acquisition or merger, or grow through a combination of some or all of those things.

Stock markets are comprised of traders and investors with varied short term to long-term time horizons. As a result, in general:

• the shorter period of time the investor intends to hold stock in a particular company, the less that investor is likely to focus on long term macro-economic prospects, industry specific economics and long term commodity cycle prices – and the more they are likely to focus on things such as moving average share prices, share price volatility, and near term changes and volatility in commodity prices. In contrast, the longer an investor’s investment horizon the greater needs to be the investor’s ongoing and focused interest on long term macro-economic prospects, industry specific economics and long term commodity cycle prices; and,

• it is important to understand the Board’s and Management’s strategy in the context of whether they intend to develop an exploration project to the point where it can be sold to an arm’s length producer, or whether they intend to build a mine and processing infrastructure. If management plans the latter it is important to form a view as to whether management has the requisite operating experience, financial acumen and contacts, critical mass (i.e. lack of dependence on one or more individuals), and so on. It also is important to assess whether mine and plant development themselves result in a wrong risk/reward relationship resulting from permitting problems, mine and plant cost overruns, timing delays, unplanned post-production environmental costs, and so on.

Company Identified Risk Factors

1. What ‘Risk Factors’ does the company identify in its annual and quarterly corporate filings, including the company’s and market’s perception as to ‘host country’ (i.e. the country(ies) where the company conducts its exploration and production activities) political risks, foreign exchange rates, income tax rates, and so on?

The company is obligated to make full disclosure of what it believes to be the risk factors affecting its business. Accordingly, it is important to review what the company declares to be those risk factors – such disclosure typically being made in the company’s annual and quarterly Filings.

Ownership – Share Structure

1. What is the company’s share structure, and what are the terms and conditions of each class of outstanding shares, options, and warrants?

Review and analysis of these things is important this both from the point of view of understanding the rights and entitlements of each of the company’s issued share classes, and the number and exercise price of outstanding options and warrants. Analysis of the latter indicates possible future share dilution, and the price at which that dilution of existing outstanding shares will occur.

2. Is there a controlling shareholder? If there is, can the personal circumstances of the controlling shareholder be determined so as to conclude whether he/she/it is to likely to ensure or militate against good management practices and liquidity events?

Where there is a controlling shareholder this speaks to the issues of:

• the management competence of the controlling shareholder if an individual, and if he/she is active in management;

• if an individual, the controlling shareholder’s willingness to hire proven management if that is an appropriate ‘arm’s length’ thing to do;

• the controlling shareholder’s willingness to give up control if commercial sensibility dictates that should happen; and,

• if an individual, the controlling shareholder’s emotional attachment to the company and its projects, and hence his/her willingness to look to a liquidity event if commercial sensibility dictates that should occur.

There is little question that the presence of a controlling shareholder (whether or not an individual) tends to fetter corporate flexibility and liquidity. This should be reflected by investors in their assessment of investment risk and, all other things equal, should cause them in theory to demand higher returns than they ought to expect from an investment where there is no ‘control overhang’.

Project Ownership

1. It is important to know whether the company owns the project outright, or at least has control or contractual control of the project. If contractual control, it is important to understand the terms of the contract and what jurisdictional law prevails?

If the company does not own or control the project outright it is important from a risk measurement perspective to understand:

• whether the contract terms with a third party partner(s) fetters either the company’s operating control of the project or its ability to dictate both the timing and the terms of a ‘liquidity event’ (i.e. an amalgamation, joint venture, or outright sale of the project); and,

• how the laws in the jurisdiction in which the company (or if the project is owned through a subsidiary or joint venture) may influence both the company’s and shareholder (or other form of ownership) rights.

For previously issued Posts in this Series click here.

Ian R. Campbell has for over 35 years been one of Canada’s best-recognized Business Valuation Experts – see biography on this Blog.

This Series of Posts is reproduced and supplemented in E-Books titled ‘The Valuation of Mining Companies’ and ‘Valuation Methodologies’. Those E-Books can be found under the E-Learning tab in the Main Navigation Bar of www.StockResearchPortal.com. They are reviewed and amended as market conditions change and our experience dictates. Accordingly, we recommend readers of this Blog Series periodically visit www.StockResearchPortal.com and review those E-Books.

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 Post 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 Post 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 Post is intended to, nor should be taken to, constitute economic or investment advice. See Legal Disclaimer.

© 2008, Stock Research DD Inc., all rights reserved.

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