Valuation of mineral properties mining engineering


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Valuation of mineral properties mining engineering

  1. 1. CHAPTER 4.6 Valuation of Mineral Properties Bernard J. Guarnera and Michael D. MartinINTRODUCTION raw land, where the presence of minerals is only suspected,The valuation of mineral properties or mining companies to large developed properties that have been mined for manyinvolves the integration of geology, mining, processing, min- years. The commodities can include metallic minerals, non-eral markets, society, and the environment Accordingly, it is metallic minerals, energy minerals, and gemstones.common for a multi-disciplinary team to work on valuationefforts and their findings to be incorporated into the valuation. Valuation AssumptionsIt is essential, however, that any effort be led by an experienced Before a valuation is undertaken, certain basic assumptionsvaluator who assumes responsibility for the valuation report. must be satisfied: • Mineral development is the highest and best use of theWhat Is a Valuation? property (unless the valuation is for condemnationHow does a valuation differ from an evaluation? An evalu- purposes).ation simply focuses on the technical aspects of an asset or • A fair market value is attainable.assets, whereas a valuation focuses on the worth of the asset. • All lands have an inherent value for minerals that mightTwo major factors are considered: occur on them. 1. Highest and best use: Although all mineral-containing • A market exists for the mineral or minerals that may be properties have an inherent value, which in itself does on or under the land. not indicate that a valuation of the minerals is required, • Economic realism must be employed (e.g., a granite the valuation performed must be based on the highest and deposit under an ice cap would have no value, whereas best use of a property. An example would be a mineral one adjacent to a major city could be developed for deposit suddenly discovered on an undeveloped property aggregates or dimension stone). in the middle of an area with developed residential or commercial real estate. It is possible that the value of the Existing Mineral Valuation Codes real estate would exceed the value of the minerals (the Although valuations of assets have many things in common, highest use) or, if it did not, that real estate development it is recognized that the valuation of mineral deposits, prop- was the only possible use of the property because of zon- erties, or mining companies requires expertise beyond that ing or environmental factors (the best use). Therefore, offered by the typical appraiser. In recognition of these dif- unless the valuation was for a condemnation proceeding ferences, specific codes governing the valuation of mineral specifically to value the mineral interest, the highest and deposits and properties have been developed by professional best use would be deemed to be real estate development. mining associations in countries where mineral resources sig- 2. Fair market value (FMV): The valuation should always nificantly contribute to the economy: be based on the FMV of the asset, which is the price an • VALMIN code—Australasian Institute of Mining and asset would be exchanged for with the parties being a Metallurgy. This code is statutory in Australia. willing buyer and seller, with both parties having access • CIMVAL code—Canadian Institute of Mining, to the same information about the asset, and with neither Metallurgy and Petroleum. This code is due to become party being under compulsion to buy or sell the asset. statutory in Canada. • SAMVAL code—South African mining associations.Types of Properties This code is statutory in South Africa.Valuation methods vary in type and effectiveness for bothundeveloped properties and properties already in operation. The Mining and Metallurgical Society of America is in theProperties warranting or requiring a valuation can range from process of developing recommended standards for mineral Bernard J. Guarnera, President and Chairman of the Board of Directors, Behre Dolbear Group, Inc., Denver, Colorado, USA Michael D. Martin, Senior Associate, Behre Dolbear & Company (USA), Inc., Denver, Colorado, USA 219
  2. 2. 220 SME Mining Engineering HandbookTable 4.6-1 Applicable valuation methods Types of Properties Multi-PropertyMethod Exploration Stage Feasibility Stage Development Stage Operating Stage CompanyIncome (cash-flow) approach x* x x xMarket-related transaction x x x xMarket multiples approach x x xReplacement cost approach x x x xOption/real option pricing xMonte Carlo simulation x x x x xSource: Adapted from CIMVAL 2003.*The income approach may or may not be applicable at the feasibility stage, depending on the reliability of the available information at the time that the valuation is valuation in the United States. The International for these differences will result in incorrect valuations. ThusValuation Standards Council is also developing guidelines for a property containing 1 million ounces of recoverable goldthe valuation of mineral properties. These are anticipated to with the capability of achieving full (cash plus capital) pro-focus on market factors and will potentially be in conflict with duction costs of $200 per ounce is clearly worth much morethe above three codes. than another million-ounce property whose full produc- Unless specifically requested otherwise, mineral property tion costs are forecast to be $400 per ounce. Similarly, anvaluations should be carried out in accordance with one of underground gold property with a refractory ore would bethe VALMIN, CIMVAL, or SAMVAL codes/standards. The negatively viewed when compared with an underground goldchoice of code will depend primarily on the reporting location property with an ore that would only require simple flotationof the company as well as the property, the party requesting and concentration.the valuation, and the party carrying out the valuation. The replacement cost approach can be used as a check on one of the other methods, or alone if none of the other methodsTYPES OF VALUATION METHODS is particularly applicable. This method puts a value on findingThere are three primary methods of valuations: another similar mineral property and replacing similar infra- structure that previously existed. This method is most com- 1. The income (cash-flow) approach, whereby the cash monly used for valuing early-stage exploration properties or flow resulting from a financial model is discounted at an properties that have ceased operations but still have resources appropriate rate to yield a net present value (NPV) or reserves. When using this approach, it is essential to con- 2. Market-related approaches, which develop a value based sider improvements in technology. on recent related transactions, and the market multiples The option/real option pricing valuation approach should approach for publicly traded companies or from recent be used only to value a company with multiple operations, transactions rather than an individual property. This method is described 3. The replacement cost approach, in which the cost required later in this chapter. to duplicate the asset being valued is assessed The Monte Carlo simulation approach is a method ofSecondary methods include option/real option pricing valu- analysis based on the use of random numbers and probabil-ations and Monte Carlo simulations. Table 4.6-1 lists the ity statistics to investigate problems with variable potentialsix valuation methods, together with the types of properties outcomes. In financial analysis and valuation there is a fairto which they are applicable. The methods themselves are amount of uncertainty and risk involved with estimating thedescribed later in more detail. future value of financial numbers or quantity amounts because In contrast to the other methods listed in Table 4.6-1, the of the wide variety of potential outcomes (i.e., grade ofincome approach should yield a “true or long-term value” over deposit, reserve tonnage, commodity price, operating costs,the life of the asset, provided that the inputs to the cash-flow capital costs, etc.) The use of Monte Carlo simulation is onemodel are realistic. The market-related transaction or market technique that can be applied to evaluate the uncertainty inmultiples approach, on the other hand, provides a snapshot estimating future outcomes and allows for the development ofvalue at the time of the valuation; the derived value will likely plans to mitigate or cope with higher than the income approach value in prosperous times Typically with conventional spreadsheet models, theand lower in difficult times. engineer, geologist, or analyst creates models with the best- The market multiples approach differs from the market- case, worst-case, and average-case scenarios, only to find laterrelated transaction method in that, rather than comparing the that the actual outcome was very different. With Monte Carloasset against one that was recently sold, it is based on the simulation, the analyst explores thousands of combinationsvalue ascribed by public markets to units of production of spe- of the what-if factors, analyzing the full range of possiblecific commodities. An example would be to base the valuation outcomes—an iterative process yielding much more accuratesolely on the pounds of copper or ounces of gold recoverable results with only a small amount of extra work, thanks to thefrom the property. numerous choices of Monte Carlo simulation software that When market valuation methods are used, it is essential are available. The Monte Carlo simulation cannot eliminatethat they be adjusted to reflect the realities and characteris- uncertainty and risk, but it does make them easier to under-tics of the asset or company being valued. Failure to allow stand by ascribing probabilistic characteristics to the inputs
  3. 3. Valuation of Mineral Properties 221and outputs of a model. The determination of the different • Commodity pricesrisks and factors affecting forecasted variables can lead to • Discount ratemore accurate predictions—the desire of all mining managers. The commodity prices and discount rate utilized in the cash- Reviewing Table 4.6-1, one can observe the four stages in flow valuation are two critical items that are based on the valu-the life of a mineral property and the likely applicable valua- ator’s experience and judgment. Because of the critical impacttion methods for each one. Early-stage exploration properties these two inputs have on the income approach valuation, theyare the hardest to value, whereas operating-stage properties should be developed by the valuator from first principles.are usually the easiest. In between those two stages, more Commodity price selection. While valuations arethan one method can usually be employed, with a weighted forward-looking, income approach valuations should nor-average value based on the strength of each method used or mally incorporate a constant commodity price based on long-range of values developed from which a preferred value can term historical data. Commodity prices should reflect thebe derived. It is also possible for a given property to be in up-and-down cycles, which are common to the mineral indus-more than one stage at any given time. One such example is a try. It is the authors’ experience that a 10-year period wouldproperty with undeveloped resources undergoing exploration normally incorporate both cycles. When valuing an operatingvery near an operating mine. property or one near operating status, however, it is acceptable and appropriate to include consensus pricing for the first 2 orValuation Methods for Developed or Operating 3 years of operation prior to returning to the long-term price.Properties As an example, when an examiner values an operating copperProperties that are developed (i.e., ready to operate) or are property, if the copper price for the last 10 years has averagedoperating and have a financial history, are usually valued by $1.75 per pound, but the current price is $3.50 per pound, thethe income approach. This approach employs the life-of-mine consensus view might be to use $3.50 per pound for year 1production schedule, forecast or actual operating costs, fore- of the cash flow model, $3.00 per pound for year 2, $2.25 percast sustaining and replacement capital costs, and reclamation/ pound for year 3, and then level off at the 10-year averageclosure costs. On the assumption that these have been cor- price of $1.75 per pound for the remainder of the mine life.rectly forecast and projected, the only parameters that would Discount rate determination. The discount rate essen-be subject to dispute in this method are the commodity prices tially reflects the risks present in an investment and is the rateand the discount rate used in the valuation. at which the cash flow from a mining property or of a mining Some other valuation methods used for developed or company will be discounted. It is never appropriate when con-operating properties include ducting a valuation to arbitrarily assign a discount rate; rather • Liquidation value, the discount rate should be derived from first principles. • Market-related values, Three methods are employed for deriving a suitable dis- • Replacement value, and count rate; the method selected is based on the nature of the • The value of a royalty stream if the property is being val- asset being valued. ued for a lessor. 1. Weighted average cost of capital (WACC) method 2. Capital asset pricing model (CAPM)Income (Cash-Flow) Approach 3. Risk buildup methodThe income, or cash-flow, method involves constructing afinancial model of the cash flow covering the expected life of Weighted average cost of capital discount rate deriva-the mine, generally up to the first 20 years of production. The tion. The WACC method is based on the proportional cost offinancial model should be based on constant dollars, where equity and debt for a particular corporation at a specific time.product selling prices, cash operating costs, and future capi- It should be used as a discount rate only for companies; it istal requirements are not inflated (varied). It is appropriate to not appropriate for valuing single projects. The key strengthchange future operating costs over time by reflecting changing of the WACC method is that it incorporates the global risks ofphysical conditions, such as longer haul-truck cycles, reduced all of a company’s operations and projects into a single rate,metallurgical recoveries because of a change in the character which should reflect the melded risks of the company’s assets.of the ore body, and similar measures that the mining profes- Capital asset pricing model. The CAPM was developedsional can predict. as a valuation tool for shares of publicly traded stocks. It incor- To perform an accurate valuation using this method, the porates various elements of an investment, including the risk-following inputs are required: free rate of return offered by U.S. Treasury bills and notes, the greater risks inherent in stocks versus other investments, • Ore reserves over the life of mine. Resources can be and the volatility of the shares of a company compared to the included if factored for their probability of conversion average company’s shares as measured by its beta. (Note: Beta to reserves; however, the valuator should be cognizant is a measure of a stock’s price volatility in relation to the rest of regulatory requirements, such as those of the TSX of the market. In other words, it is a guide on how a stock’s Venture Exchange (a Canadian stock exchange) that pre- price is likely to move relative to the overall market. Beta is cludes the inclusion of resources in a cash-flow model. calculated using regression analysis. The whole market, which • Production rates for this purpose is considered to be the Standard and Poor’s • Operating costs, including on-site general and admin- 500 (S&P 500), is assigned a beta of 1. Stocks that have a istrative (G&A) costs, ongoing development costs, and beta greater than 1 have greater price volatility than the over- nonincome taxes all market and are more risky. Conversely, a beta lower than 1 • Capital costs—preproduction and sustaining/replacement denotes less volatility than the market and therefore less risk. • Environmental and reclamation costs For example, if the market with a beta of 1 is expected to
  4. 4. 222 SME Mining Engineering Handbookreturn 8% annually, a stock with a beta of 1.5 should return With site-specific project risk, multiple risk factors exist12%. Young technology stocks will always carry high betas; at mining properties ranging from reserve risk through pro-many utility stocks, on the other hand, carry betas below 1.) cessing, environmental, political, and geotechnical risk.The CAPM method is appropriate only for valuing companies; Following are some of the factors that need to be considered:it is not appropriate for establishing the discount rate for indi- • Project status—This involves exploration, develop-vidual mining projects or properties. Importantly, the discount ment, or in operation. As a project advances throughrate derived is after-tax for a seller of the shares, and pretax these stages, the risk factor will normally decrease. For afor a buyer of the shares. mature operating property that is performing up to fore- Risk buildup discount rate derivation. The risk buildup casts, the risk will be lowest.method is preferred by the authors of this chapter as it reflects • Quality of analytical data—If the quality of the datathe values relevant to the specific properties. In form it is simi- derived from the drilling, sampling, and assaying oflar to the CAPM method; however, it is differentiated by its the ore body is suspect, the project risk must reflect thisinclusion of the technical and other risks associated with the uncertainty.typical mining project. Essentially it adds the components of • Processing-related risk—This risk can be high if ade-risk at the project to arrive at an overall risk rate for a given quate metallurgical test work has not been performed onspecific property or group of properties. The usual compo- samples truly representative of the whole ore body or ifnents incorporated are new, unproven technology is being employed. • The real risk-free rate of return; • Infrastructure-related factors—Risks can occur if • The risk premium expected by an investor who would there are unusual circumstances that might cause inter- invest in mining projects which can be assumed to be the ruption to the power and water supply or cause access to same as that for a publicly traded company. There would the property to be lost. be additional premium if the project being valued would • Environmental considerations—In contrast to projects have a market capitalization of a “small cap” (i.e., less 20 or more years ago, a project located in a sensitive envi- than $200 million); ronmental setting must be given a risk rating higher than • Mining industry specific risk; and one that is isolated and insulated from likely environmen- • Site-specific risk for individual properties. tal damage; government, regulatory, and permitting risks are thus assessed. The real risk-free rate of return is the difference between • Operating and capital costs, and working capital—the interest rate on U.S. Treasury notes of a maturity approxi- Poorly predicted figures for these three items introducemating that of the project life and the current inflation rate and substantial risk. The most common of these is an under-is measured by the following formula: estimation of total project capital. ^1 + Rfn h • Prices and markets—Price projections on which the Rfr = −1 ^1 + Ie h project economics are based must be realistic, and there must be a market for the product produced.where • Labor/Management issues—The availability, educa- Rfr = real risk-free rate of return tion, and trainability of the required labor force in less Rfn = nominal risk-free rate offered by U.S. Treasury developed countries is an issue. Union activism poses a notes risk to some projects. The quality and experiences of the Ie = expected inflation rate company’s management must be considered.Accordingly, assuming a 10-year mine life and 10-year U.S. • Political and social issues, and the social license toTreasury notes yielding 4% with inflation at 1.5%, the real operate—The lack of perceived support from the localrisk-free rate of return is inhabitants and government bodies is a major risk. ^1 + 0.04 h It is not always possible to secure good information on all − 1 = 0.025 or 2.5% ^1 + 0.015 h of these factors affecting site-specific project risk. If possible, a matrix should be constructed with a ranking from 1 to 10With a public company risk premium, investors clearly assigned to each factor. From this, an overall risk factor canrequire a greater return on their investment than that provided be assigned. For an exceptionally low-risk project, a factor ofby risk-free U.S. Treasury notes. They are willing to accept 1% or 2% may be chosen; for one with many uncertainties, theadditional risk for the expectation of a greater return. factor is likely to be 5% or higher. If the company involved is a large one (S&P500), the Summary of risk-buildup discount rate. Table 4.6-2 is anrisk premium for such shares can be found at the Ibbotson example of a risk-buildup discount rate, showing both pretaxAssociates’ Web site. The risk in 2007 was about 7%. and after-tax figures. Since the discount rate developed is pre- If the company has a market capitalization of less than tax, it must be converted to an after-tax basis.$200 million (i.e., small cap), an additional risk premium is Other factors to be considered in the income approachwarranted. In 2007, this was an additional 3% for a total pub- valuation method. Two other factors should be taken intolic company risk premium of 10%. account in an income approach valuation of a property or With mining industry risk, based on historic company properties.and industry returns on equity, there is an above-average risk The first, and more important of the two, comes into playpremium for certain industries. These include the aggregate, if an acquisition is involved and if the acquirer will end upmining, and petroleum industries, all of which are dependent being in control of the property, properties, or company. Givenon the vagaries of natural resources. In 2007, the industry risk that the acquirer will be in charge of his or her own destiny, hepremium for the mining industry was 2.5%. or she is not subject to the bad decisions of a senior owner. If
  5. 5. Valuation of Mineral Properties 223Table 4.6-2 Summary of risk buildup discount rate valued. For example, if both are narrow-vein, undergroundItem Rate, % gold properties and one has a grade of 0.6 ounces per ton andReal risk-free rate of return 2.5 the subject property has 0.3 ounces per ton, the value of an ounce at the subject property will obviously be lower than thePublic company risk premium 7.0 property it is being compared with. Similar adjustments needSmall cap premium 3.0 to be made for mining costs, processing costs, political fac-Industry-specific risk 2.5 tors, geography, and so on.Site-specific risk* 3.0* Market-related transactions, as applied to explorationTotal (pre-tax) 18.0 properties. Generally little information is available aboutTotal (after-tax) 12.0† exploration properties due to the early stage of the property*A low-average risk rate of 3% has been chosen for this example. in the mine development cycle. Assuming that results are†From Lerch 1990; the example assumes a tax rate of 33.3%. positive, the value of exploration properties increases with the level of work performed. Frequently a “prospectivity fac- tor” is added or deducted to the value based on known results,the acquirer is in charge, a “control premium” should be added regional settings, and the total valuation obtained from the income approach By the time that a property has either been fully explored,method. The amount of this premium cannot be standardized reached the development stage, or started production, thereand depends on the type of company and its position in the are likely to be other transactions that can be used for develop-development/operating chain. During 2007, the control pre- ing a market-related transaction valuation, provided that themium for acquisitions of large properties and companies fre- individual differences between the properties are taken intoquently exceeded 30%. account. The second factor to be considered is a terminal value Market-related transactions, as applied to develop-of the free cash flow for operations that have a life exceed- ment or operating properties. When a property is eithering that of the financial model. A terminal value is commonly in development or operating, there will be much crediblearrived at using the assumption that ongoing operations will information available for it, and, unless the commodity is anmirror the conditions that applied to the last 5 years of the unusual one, there are likely to be several fairly recent compa-cash-flow valuation, unless there is good reason to expect an rable transactions to reference for the valuation. Even so, careore-grade change or a metallurgical recovery change, and so must be taken in two areas:forth, to occur. The terminal value is measured by the follow- 1. The transaction prices for the comparables must be adjusteding formula: to present-day conditions when either or both metals prices FCFN + 1 and costs of production may have changed; and Tv = ^ D − Gh 2. The transaction prices must be adjusted to reflect the different variables that will have affected the price paidwhere for each property, including the relative size of the min- Tv = terminal value eral deposit; differences in ore grade, mining method, CFN+1 = annual free cash flow in the residual years F and processing recoveries and methods; and the amount after the final year in the financial model and cost of required infrastructure, operating and capital D = discount rate used for the terminal value costs, environmental and social issues, tax regimes, and G = annualized rate of growth of the enterprise political risk. over the life of the financial modelThe discount rate used may be higher than that used in the Market Multiples Valuationfinancial model as the inputs to the model would be less cer- The market multiples valuation method has similarities to thetain in the terminal value years. market-related transactions valuation method and has some of It is not uncommon for the terminal value to be a signifi- the same drawbacks (principally property or corporate differ-cant part of the NPV determined by the financial model. ences). It also has the “advantage” wherein other transactions (comparable existing properties) do not have to be identifiedMarket-Related Transaction and evaluated.On the surface, the market-related transactions or comparable Market capitalization, which is the quoted share pricesales approach valuation method should be the simplest to under- multiplied by the number of issued shares, can be divided bystand and the easiest not to fault. One can simply find several many factors to derive a value per ounce or pound of provenrecent transactions with their documented purchase prices and and probable ore reserves or resources, the value per poundthen compare the price paid per pound or ounce at that property or ounce of annual production, the multiplier given to earn-with the one requiring the valuation. Unfortunately, it is not that ings, and so forth. These different metrics constitute a marketsimple. No two mining properties are even remotely identical multiples valuation, and these can then be used to develop adue to differences in all the parameters that were itemized in the generic value for the company. Such figures are available forsite-specific project risk discourse previously discussed. Even many mineral companies, enabling an average valuation perparts of the same mineral deposit can be different. Nevertheless, unit of the metric to be established.because of the perceived simplicity of the method, this is a fre- A market multiples valuation can also be based onquently used valuation method and is a preferred technique by • A multiple of average annual cash flow, andthe International Valuation Standards Council. • A multiple of earnings before interest, taxes, deprecia- To achieve even relative comparability, all transactions tion, and amortization.considered must be adjusted in relation to the property being
  6. 6. 224 SME Mining Engineering Handbook Again, adjustments must be made to ensure that the value • Mining properties offer a call option on increases in met-developed is truly based on comparable factors. For example, als prices. (If the gold price is, for instance, $300 pera market capitalization value for a major mining company ounce, then a property requiring a price of $350 per ouncewith several producing mines should not be used to develop to generate a positive cash flow has a finite value.) Note:a market multiples value for a junior company with only one For readers not familiar with the concept of options, ref-producing mine. erence is made to puts and calls on 100 shares of a stock on a major stock exchange. Simply, each call gives theReplacement Cost Valuation call owner the right to purchase 100 shares of the stock inReplacement cost valuations are simply the expenditure that question at a fixed price for a fixed period of time. (Thewould be required in current dollars (or other currency units) lower the fixed price and the longer the period of time,to duplicate a prior effort. Replacement cost valuations are the higher is the price of buying the call.) For example,most commonly used for if Party A owns 100 shares of a stock currently selling at $100 per share and the calls on a price of $110 per • Exploration properties at various stages, and share expiring 2 months in the future are trading at $3 • Operations that have been shut down with remaining per share, then Party A can sell a call on his or her stock resources or reserves. and immediately pocket a check for $300. If the stock For exploration properties, the costs of land acquisition, does not reach the call price of $110 per share in the nextduplicating any geological, geochemical, or geophysical work, 2 months, Party A will have made $300 and will still haveduplicating the prior drilling and assaying performed, and so the stock. In the meantime, Party B has bought Party A’sforth, are determined as the basis of the property’s value. Any call for $300, but if the stock does not reach $110 a sharenegative results must be considered, and, using the appraiser’s within the 2-month time period, Party B will have lostjudgment, they may be subtracted entirely or included in a their $300. However, should the price of the stock risefactored manner. to, for instance, $116 per share before the 2 months are When being applied to operations that have been dor- up, Party B will have doubled their initial investment ofmant for a period of time but which still have facilities in $300. (Party B’s call gives them the right to buy the stockplace, the replacement cost valuation focuses on the current at $110 per share and they can turn around and immedi-cost required to replicate the facilities. A factor that must be ately sell it for $116 per share, thus realizing a net profitconsidered is whether new technology has made the original of $300.)equipment obsolete. If such is the case, the cost of the new When considering the use of option valuations, it is alsotechnology must be included, although it is possible that this important to recognize thatwould overvalue the property. Another factor that should beconsidered is whether there has been any change in the mar- • The longer the option period, the higher the value will be;kets for the commodity that was previously produced. • The greater the volatility of the commodity price, the If the property is being valued by the replacement cost higher the value will be;method and resources and/or reserves are still present, the • This valuation method will always produce the highestvalue could be based on the cost of replacing those ounces, (and probably unrealistic) value; andpounds, or tons present. • This method is applicable to valuations of companies, not single properties.Option/Real Option Pricing ValuationAlthough used less frequently than the methods already Monte Carlo Simulationdescribed, the option/real option pricing valuation method is The Monte Carlo simulation method can be used for any prop-one that can be used for valuing mining companies with mul- erties that are at least at the advanced exploration phase. Montetiple operating properties. The philosophy behind options is Carlo simulations allow for multiple variables to be changedbased on the formula developed in 1973 by Black and Scholes simultaneously while a specific operation is mathematicallyto be used in the valuation of equities. As currently applied to performed literally thousands of times. The probabilistic valuemineral properties, option valuations are based on the follow- results from a range of probabilities assigned to each variableing premises: in the analysis (i.e., capital and operating costs, and commod- ity prices) to arrive at a most likely value, or range of values, • The income approach valuation method may undervalue as based on iterations of cases that sample the distributions of both producing and nonproducing mining assets. This is gen- each variable. erally true in “boom” times, but incorrect in difficult times. • Mining properties offer the opportunity to be shut down Alternative Valuation Methods for Undeveloped when economics are negatively affecting cash flow and Properties reopened when economic factors are positive. Although Undeveloped properties include those with blocked-out this is true in concept, in practice, closing and reopening resources or properties with drill holes that have “ore grade” mines based on volatile economic changes is impractical intercepts. Although the lack of concrete information makes and would potentially be financially ruinous if attempted the valuation of such properties more difficult, a “probability” by mining companies. The cost of shutting down, main- approach, such as the risk-adjusted income approach, can be taining the property on a standby basis, and the time it used. The approach entails the construction of a financial model would take to reopen and ramp-up production is not con- of the property using likely production rates, ore grades, min- sidered in option theory. ing and processing methods, and capital and operating costs.
  7. 7. Valuation of Mineral Properties 225A justifiable commodity price is chosen, the real risk-free rate Table 4.6-3 Categories used in matrix valuationof return is used for the discount rate, and the discounted cash Valueflow is calculated. The valuation for an example property then Category Rank Factorbecomes the calculated NPV (say, $100 million), as adjusted A. Location with respect to off-property mineralizationfor the percentage probability that the items incorporated in Sub-ore grade in two horizontal directions 17 1.5the financial model, such as ore reserves, costs, and environ- Ore grade with two horizontal dimensions 13 2.0mental risks, have been correctly estimated. If the risks for the Sub-ore grade with three dimensions known 12 2.5stated items are, respectively, 80%, 90%, and 50%, the valu- Ore grade with three dimensions known 8 3.0ation would be $36 million ($100 million # 0.8 # 0.9 # 0.5). A past or present producing mine 5 4.0Alternative Valuation Methods for Exploration A major past or present mine 4 5.0Properties B. Location with respect to on-property mineralizationExploration properties include those where no work has been Interesting but sub-ore grade with two horizontal 13 2.0performed and those where some work has been performed. directions For properties where no work has been performed, two Ore grade with two horizontal dimensions of 8 3.0methods are commonly used: economically interesting size Interesting but sub-ore grade in three dimensions 4 5.0 1. The valuation is a percentage of the surface value of the An economically interesting ore-grade zone in three 3 6–8 property. For no work of any kind in a mineralized or dimensions unmineralized area, the percentage is 5%. For raw prop- Past producer with ore grades measured in three 2 7–8 erty, but where initial reconnaissance has indicated favor- dimensions able potential, the percentage is 10%. Major past or present producer with ore grades 1 9–10 2. The valuation is the money that has been spent in staking/ measured in three dimensions leasing and maintaining the property. C. Location with respect to off-property geochemical/For properties where some exploration work has been geophysical/geological targetsperformed, the following methods are commonly used: One target or two, based on different methods 19 1.3 Three or more targets 17 1.5 • Modified cost of work performed, with prospectivity factors included D. Location with respect to on-property geophysical/ geochemical targets • Geoscience matrix valuation One target 13 2.0In the modified cost of work valuation method, the direct costs Two or three targets 8 3.0of work performed are added to valid G&A costs to arrive at a Four or more targets 7 3.5base value. If there have been some highly favorable explora- E. Geological patterns associated with knowntion results, some enhancement of the base valuation is appro- commercial depositspriate. Similarly, if results on or at nearby similar properties One or two patterns 13 2.0have been negative, a negative prospectivity factor is applied. Three or more patterns 8 3.0 The geoscience matrix valuation method was devel-oped by Lionel Kilburn for the British Columbia Securities Source: Adapted from Kilburn 1990.Commission to assist them in validating the values beingassigned to exploration properties by junior mining compa-nies. Five major criteria are considered, which are divided into RULES-OF-THUMB VALUATIONSnineteen possibilities: In the rules-of-thumb valuation method, the valuation is based on a percentage of the commodity’s price, with the percent- 1. The location of the property with respect to off-property age dependent on the state of advancement of the particular mineralization; property. Table 4.6-4, based on more than 500 transactions 2. The presence of any on-property mineralization; analyzed by Frank Ludeman in his publication, A Decade of 3. The location of the property with respect to off-property Deals, gives the range of percentages for the different stages geochemical/geophysical/geological targets; of properties (Ludeman 2000). 4. The presence of any on-property geophysical/geochemical The rules-of-thumb values provided in Table 4.6-4 should targets; and be considered as generic, and the actual percentage a prop- 5. Geological patterns on the property associated with erty will value varies with the tenor of the mining industry. known commercial deposits. The 500 properties studied provided an average value, and The starting point, or base value, for the valuation is the the percentage of the commodity price assigned to a propertyper-acre or per-hectare cost of acquiring the right to a mineral should be based on its characteristics versus that of the “aver-property, usually the cost of staking and maintaining a claim age” property.for 1 year. The property is then rated on the basis of its scorefrom the matrix, and this rating is then used to adjust the base REQUIRED QUALIFICATIONS FOR A VALUATORvalue. The value from the matrix is arrived at by assigning The required qualifications for a valuator will depend to somepoints in the five categories, based on whether the property is extent on the complexity of the property to be valued, as wellabove or below average. Table 4.6-3 illustrates how the matrix as on the type and number of the methods to be employed.rating is derived. The greater the complexity and the number of methods to be
  8. 8. 226 SME Mining Engineering HandbookTable 4.6-4 Rules-of-thumb values accredited appraisal association or professional society. The Precious Metals Base Metals valuator and the members of the valuation team should hold (%-per-ounce (%-per-pound degrees in geology, mining engineering, or metallurgy; how-Property Stage price) price) ever, overall experience in, and a working knowledge of, theEarly exploration 1.5–2.5 1.0–2.0 minerals industry is the most important qualification.Inferred resources 2.5–5.0 2.0–3.0Measured and indicated resource 5.0–7.5 3.0–5.0 ACKNOWLEDGMENTFeasibility 10.0–15.0 5.0–7.50 The authors and SME acknowledge Behre Dolbear Group Inc. for granting permission to use their copyrighted material inProduction 20.0+ 10.0+ this chapter.Source: Data from Ludeman 2000. REFERENCES Black, F., and Scholes, M. 1973. The pricing of options andused, the greater must be the knowledge and experience of the corporate liabilities. J. Polit. Econ. 81:637–654.valuator (who may be one individual with all the necessary CIMVAL. 2003. Standards and Guidelines for Valuation of skills and experience or a small team whose combined exper- Mineral Properties. covers all the skills needed). _Final_Standards.pdf. Accessed November 2009. The principal qualifications, not necessarily in order of Kilburn, L. 1990. Valuation of mineral properties which doimportance, are not contain exploitable reserves. CIM Bull. 83:90–93. • A total lack of bias as to the outcome of the valuation, Lerch, M.A. 1990. “Pre-tax/after-tax conversion formula for • Knowledge of and previous experience in the valuation capitalization rates and cash flow discount rates. Bus. Val. method(s) to be used, and Rev. (March). • Familiarity with all relevant aspects of the minerals Ludeman, F.L. 2000. A Decade of Deals: Gold and Copper industry. Ore Reserve Acquisition Costs, 1990–1999. Castle Rock, CO: The Mining Business Digest.Sometimes in special circumstances, the valuator or the headof the valuating team may be required to be a member of an