Background to this Series of Posts

This is the 15th 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.

Comparables Based Valuation Methodologies

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The Comparable Transactions Methodology

This commonly adopted methodology can result in the development of either enterprise value or equity value. Pursuant to this methodology, in the context of:

1. Developing prospective stock market prices Securities Analysts commonly adopt this methodology by comparing prevailing stock market price metrics for the company they are analyzing to stock market prices prevailing for companies they believe to be ‘peer group’ companies. Assuming proper selection of the ‘peer group companies’ and appropriate analysis and application of financial and stock price metrics this arguably is a sensible methodology for them to use in their analysis. However, it is a highly subjective methodology and hence each application of it should be reviewed carefully to ensure its application seems sensible.

2. Acquisitions by Corporate Acquirers. ‘Valuation ratios’ are developed from analysis of open market transactions involving the arm’s length sale of companies that are considered sufficiently similar to the company being valued that reliance can be placed on the results of that analysis. Applied in this way, in my experience this methodology is at best a ‘test methodology’ unless persons adopting it have detailed knowledge of the ‘comparable transactions’ including the comparative negotiating strengths of vendor and purchaser and the post-acquisition synergies the purchaser expected at the time of the acquisition. Absent that specific knowledge on the part of the analyst, in my view this methodology at best is a value ‘litmus test’.

The Market Capitalization per Ounce of Annual Production Methodology

This methodology is a ‘company comparator’ methodology that develops en bloc enterprise value for mining and mining project related assets. Pursuant to this methodology the ounces of current production are multiplied by the current market price of the metal(s) being mined for the company being analyzed and companies taken to comprise that company’s ‘peer group’. The results are adjusted by adding all debt and future capital requirements related to each company’s respective mining assets, and deducting all cash on hand and all non-mining assets. This methodology is simplistic, does not take into account operating costs or income tax rates, and is ‘time dependant’ on the prevailing metal price. Neither Securities Analysts nor Corporate Acquirers typically adopt this methodology. It is noted only for completeness. It is sometimes used by company’s themselves in company presentations. Where adopted as a comparator test in my view it should not be considered meaningful, and should be given little if any weight.

The Dollars per Ounce of Reserves Methodology

This methodology is a ‘company comparator’ methodology that develops en bloc enterprise value for mining and mining project related assets. Pursuant to this methodology the ounces of proven and probable reserves (see NI 43-101 for definitions) are multiplied by the current market price of the metal(s) being mined for the company being analyzed and companies taken to comprise that company’s ‘peer group’. The results are adjusted by adding all debt and future capital requirements related to each company’s respective mining assets, and deducting all cash on hand and all non-mining assets. This methodology is simplistic, does not take into account operating costs or income tax rates, and is ‘time dependant’ on the prevailing metal price. Neither Securities Analysts nor Corporate Acquirers typically adopt this methodology. It is noted only for completeness. Where adopted as a comparator test in my view it should not be considered meaningful, and should be given little if any weight.

The Capitalization per Ounce of Reserves Methodology

This methodology is a ‘company comparator’ methodology that develops en bloc enterprise value for mining and mining project related assets. Pursuant to this methodology the market capitalizations of companies that are being compared are adjusted by adding all debt and future capital requirements related to each company’s respective mining assets, adding all future capital requirements expected to be incurred in relation to those mining assets, and deducting all cash on hand and all non-mining assets. Results then are divided by the number of ounces of reserves, and the results derived for each company are compared. This methodology is dependent on detailed knowledge of information that typically would not be publicly available (detailed future capital requirements, for example), does not take into account operating costs or income tax rates, and is ‘time dependent’ on the prevailing metal price. Neither Securities Analysts nor Corporate Acquirers typically adopt this methodology. It is noted only for completeness. Where adopted as a comparator test in my view it should not be considered meaningful, and should be given little if any weight.

The Imputed Bullion Price Methodology

This methodology is a ‘company comparator’ methodology that develops en bloc enterprise value for mining and mining project related assets. Pursuant to this methodology ‘life of mine costs’ are added to the results derived from the ‘Adjusted Market Capitalization per Ounce of Reserves’ Methodology. Given that the latter methodology in my view has no theoretical or practical merit, neither does the ‘Imputed Bullion Price Methodology’. Neither Securities Analysts nor Corporate Acquirers typically adopt this methodology. It is noted only for completeness. Where adopted as a comparator test in my view it should not be considered meaningful, and should be given little weight.

The Zero Discount Net Present Value Methodology

This methodology is a ‘company comparator’ methodology that develops an equity value. Pursuant to this methodology recoverable ounces of reserves are multiplied by the point in time cash margin generated from metals production for the company being analyzed and companies taken to comprise that company’s ‘peer group’. Cash margin is defined as the difference between the assumed average forward metals price and the company’s long-term average cash cost per ounce of production based on ‘life of mine’ averages for costs and recoveries assuming no post-valuation date inflation. Future capital requirements are deducted from the result, and the balance is tax-effected at each company’s long-term average income tax rate. Working capital and the value of any non-mining assets are added, and long-term debt is deducted. This methodology is simplistic, and in my view from an acquisition perspective has little or no merit. It is adopted from time to time by Securities Analysts when developing prospective stock market prices, but in my view is unlikely to be adopted by Corporate Acquirers in acquisition analysis.

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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