Background to this Series of Posts

This is the 12th 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.

Posts #11 – #16 of this Post Series discuss Valuation Methodologies adopted by stock market investors, stock market analysts, corporate acquirers, merger and acquisition intermediaries, and business valuation experts when they value shares in mining companies. In these Posts the following terms have the following meanings, where each is ‘point in time specific’:

1. Enterprise Value: The total value of a business including both its interest bearing debt and equity components.

2. Equity Value: The total value of the shareholders’ equity of a business, where shareholders’ equity is stated at its fair market value, not at its ‘book’ or ‘carrying’ value.

3. En Bloc Value: The value of all outstanding shares (or other ownership interests) of a business viewed as a whole.

4. Per Share Value: That portion of the ‘en bloc’ value appropriately attributed to each class of outstanding share capital divided by the number of shares of that share class that are outstanding at a particular point in time.

The following discussion is subject to important caveats:

1. Any conclusion as to whether a particular valuation methodology is reliable or who does or does not adopt it is fact and circumstance specific. Accordingly, the categorizations set out in the following table and commentary may be inaccurate in any given fact situation.

2. ‘Corporate Acquirer’ means a corporation that acquires all of the outstanding shares or control of another company where it is able to access all relevant information of the target company pursuant to a detailed due diligence process after executing Confidentiality and Non-Circumvention Agreements.

3. ‘Corporate Acquirer’ in the context of the following discussion does not mean a corporation who makes a takeover bid for a public company or portion of the shares thereof where the ‘bidder’ has access only to publicly available information with respect to the target company. In the latter circumstance the ‘bidder’, typically being a company who expects post-transaction synergies, will have specific knowledge of its synergy ‘expectations’ and be in a better position to assess the value of the ‘target’ to it than any analyst not directly advising on the transaction.

Asset Based Valuation Methodologies

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The Liquidation Value Methodology

This methodology develops en bloc equity value where a business is deemed not to be a going concern. Pursuant to this methodology the liquidation value of each tangible and intangible asset is determined by appraisal or otherwise estimated, and those ‘liquidation values’ are aggregated. All liabilities (whether or not recorded on the books of the business) are deducted. This methodology generally is more theoretical than practical, and is seldom if ever adopted in a going concern context by Corporate Acquirers as a risk measurement tool. In my experience it is rarely used by itself in a stock market share price context, and typically is not adopted by Securities Analysts. Having said that, where a company owns assets redundant to its operations and strategy those assets might be valued on a liquidation value (net of income tax on disposal) basis by both Securities Analysts and Corporate Acquirers, and added to what otherwise would be either an enterprise value, an en bloc share value, or a ‘proportionate’ per share price.

The Tangible Asset Backing Methodology

This methodology develops an en bloc equity value. Pursuant to this methodology the ‘value in use’ (going concern value) of each tangible and identifiable intangible asset owned by a company is determined by appraisal or otherwise estimated and aggregated. The liabilities of the business are deducted. This methodology is the theoretically correct methodology to develop ‘net asset value’ pursuant to so-called ‘peer group’ analysis. However, whereas business owners and those Corporate Acquirers who have executed confidentiality agreements have data available to them to meaningfully adjust reported asset and liability values from their book values for accounting purposes to ‘value in use’ values, Securities Analysts typically do not have the same depth of information with respect to these things available to them. In my experience, such comparisons do not tend to be particularly meaningful, and any such comparisons should be carefully assessed before placing any reliance on them. The Tangible Asset Backing methodology may be adopted by Corporate Acquirers and their advisers as a risk measurement tool where:

1. The difference between the price paid for a business and the underlying tangible asset backing is taken to be a measure of the ‘intangible value component’ inherent in the purchase price.

2. Intangible assets are thought to be at greater prospective risk than are tangible assets.

In my experience this methodology generally is adopted in part by Corporate Acquirers as a basis for post-acquisition financial and income tax reporting purposes, but is not widely adopted by Securities Analysts.

The Multiple of Net Assets Methodology

This methodology typically is used by analysts to develop stock market price estimates, being equity values. Pursuant to this methodology multiples of reported net book value (or ‘shareholders’ equity’) are imputed from what are taken to be ‘peer group companies’ and a comparator based stock market price is developed by applying the average, or some other multiple derived from that analysis, to the net book value (or ‘Shareholder Equity’) of the subject company. My experience suggests this methodology is widely adopted by Securities Analysts as a primary valuation methodology when valuing mining exploration companies and companies without cash flow and earnings, and is adopted extensively by them as a secondary valuation methodology in other valuation analysis. Broadly speaking, absent a very detailed and consistent analysis of the net assets of each ‘peer group company’ application of this methodology is likely to produce unsound results – and hence ought not as a general rule to be thought ‘reliable’. This is because:

1. Application of generally accepted accounting (GAAP) principles by different companies may result in different reported asset and liabilities values for similar assets and liabilities.

2. More particularly, at any given point in time the current values of historically acquired assets may be quite different than the carrying value of those same assets – a great deal of which current information typically is not publicly disclosed – or for that matter known at any point in time by company Boards or Managements pursuant to either appraisal or analysis.

In my experience this methodology typically is not adopted or relied on by Corporate Acquirers or their Advisers, other than perhaps as a litmus test in the context of attempting to determine whether the public markets are likely to assess an acquisition as accretive or negative to the Purchasing Company’s share price.

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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