Introduction
This is my fourth installment of a monthly article which covers a variety of mining industry and mineral economic topics. Again, I invite any criticism and much appreciated feedback which I can use to evolve the writing style and topics to be more inline with your needs and interests. If you chose to read on, you need to be warned that I don’t provide financial or legal advice.
Technical
This is the technical portion of the article in which I explore the importance of economic analysis of mineral deposits. In my experience, the economic analysis of mineral deposits is required for the following three primary purposes;
Purpose #1 Giving Context to Exploration Programs
Purpose #2 Identifying Acquisition Targets
Purpose #3 Due Diligence Evaluations for Mergers and Acquisitions
Purpose #3 – Due Diligence Evaluations for Mergers and Acquisitions
We’ve covered Purpose #1 and #2 in previous articles which naturally leads up to the most important aspect of mineral analysis which is Purpose #3 – Due Diligence Evaluations for Mergers and Acquisitions. Purpose #3 occurs when you have finally found an asset or company which appears to fit the objects of your organization and also just as importantly, your company appears to fit with the objectives of the other party. The realization that the two parties might be right for each other could have first been initiated from the bottom up (through casual discussions between the two corporate or business development officers) or from the top down (though discussions between the corresponding CEO’s or among Board members). In either case, it is unlikely that any due diligence effort will commence without the two CEO’s reaching a gentleman understands as to the structure of the senior management team envisioned in the new entity. This gentlemen’s agreement between CEOs can however change down the road once the real details of a transaction are negotiated between the Board of Directors and also with the influence of major shareholders. Solving the initial “social issue” or who will be the future No. 1 executive is key and unfortunately one of the biggest barriers to consolidation of the Canadian mining industry, particularly with weak junior companies. There are many juniors with poor balance sheets (funding limitations) and inflated expectations of their fragmented ownership of dormant mineral assets. These companies also tend to be controlled by very senior executives who would serve themselves and investors much more effectively if merged with other companies facing similar circumstances thus achieving improved economies of scale. It is however very difficult for these old mining men to relinquish control of a dream they have held to for many years and hand the reigns over to the next generation of explorers and developers. This reluctance is unfortunately more about ego than geological merit and value investing.
It is highly recommended that before beginning the Due Diligence (DD) process that the CEO get the blessing of the Board or at least from the designated member(s) of the Board which give guidance with respect to corporate development matters. After engaging in the DD process there is nothing more embarrassing than having to inform the other party of your withdraw because the Board is not in favor of a future arrangement. When this happens, your credibility as a corporate development officer and company spokesperson is badly damaged, thus making it even harder to find organizations willing to discuss transactions.
Confidential Information
Given the go ahead to begin the Due Diligence (DD) process, the first step must be to sign a mutually acceptable Confidentiality Agreement (CA). This sounds easy but can take weeks to finalize, thus delaying the DD process and also increasing the risk of rumors reaching the street of what might be cooking. Problems finalizing a CA can arise from a number of issues including the duration of the CA, wording of a standstill provision (conditions preventing friendly discussions turning hostile) and the extent of the area of interest (defined area surrounding the outer perimeter of the disclosing party’s mineral rights). A good CA is critical and must effectively mesh the technical and legal aspects of the arrangement (i.e. don’t let the lawyers for both parties craft the document in isolation) thus minimizing the potential for complications to arise down the road.
Once the CA is signed, the two parties can begin exchanging information. One of the best ways to get things started quickly and effectively is through private access to an electronic dataroom. In this way, various DD specialists can access information in their area of expertise from the privacy of their work place or home, and at any time of the day. The DD team members can thus quickly form an opinion of the assets, and potential opportunities for mutual value creation and also prepare a list of questions which can be passed on to the other side in preparation for the DD site visit(s).
DD Team
There are two approaches to selecting a DD technical team. The first approach is to sole source the technical scope of work to a “Name” consulting firms such as Micon International, Scott Wilson RPA, SRK Consulting or possibly Hatch or SNC Lavalin to list a few. This approach tends to be the most politically correct option since the report and opinions made will be by an independent third party and publically recognized organization. The second approach is to “hand pick” a specialized team of professionals from within the organization and/or from a pool of the best available external contractors. I personnel prefer the “hand pick” option because you can build a very trustworthy and technically strong team of people who you have either work with in the past or have been referred to from those which you have worked with and trust. The drawback with the “hand picked” option is that management may have greater difficulty justifying their decisions with shareholders etc. and it is also more difficult to deflect blame if the technical aspects of the decision prove incorrect or if timing of the acquisition turns out to be poor. During times when corporate activity in the mining business is booming it is often difficult to get technical help on short notice from an established consulting firm and when you do, it may come from inexperienced or junior personnel. On the other hand, there are many semi-retired geologists and engineers with 30 and 40 years experience in mining operations that are self-employed and operate from their own homes (free of overhead costs) and can thus offer competitive consulting rates.
An area where you will certainly have to draw on the help of a large consulting firm will be with respect to estimating or auditing feasibility estimates for capital and operating costs for new or expanding mining operations. A major consulting firm is in the best condition to know what the current cost of a comparable project will be. Your decision as to which firm maybe best in estimating these costs should likely be based on the group that has constructed in recent times a similar project in a similar environment and or part of the world.
I personnel prefer to hire a “top notch” individual to join my DD team rather than a “top-notch” engineering consulting firm but it really comes down to your own needs and preferances. If your organization has an operating mine or mines, you are at a great advantage when performing DD since you can draw from a group of people which are familiar with very specific day to day aspects of mining and milling better than what a consulting firm can likely offer. The choice of who you assign to your technical DD team is critical to the success of the merger or acquisition, and unfortunately it can also be a very difficult decision. As a DD manager I will not begin the assignment without confidence in the capability of the team and unless our chance of success appears high.
The first phase or gate in a DD exercise is performed with respect to the disciplines of geology, mining and metallurgical engineering. This task may be performed by as few as three individuals with specific expertise in these fields and also specific to the assets of interest. My main point hears is to say that you can’t assign an open pit engineer to perform a DD review of an underground mine. You may not even be able to assign an underground engineer with a background in a particular mining method to an underground mine with an unfamiliar mining method or drastically different production rate or cost structure. The same applies to geology. It would be unfair to ask a geologist with a life time of experience in the coal industry to give opinion on a massive copper porphyry deposit.
From first finalizing the CA, it generally will take about two to four weeks for the technical team to review data from the electronic data room, visit the project site(s) and provide an assessment report to management. Assuming that the DD assessment proves positive then the exercise takes on an expanded role in covering other very important issues such as legal (property title, existing agreements and contacts etc.), social economic and environmental conditions. If your organization does not have the human resources to tackle this specialized scope of work you will have to look again at engaging outside “name” consulting forms or alternatively independent consultants.
Building a Model (the Business Case)
An important aspect of the DD process is building a technical and economic model of the asset of interest and also the impacts and benefits it will have on your organizations financial and human resources. Today, most mining companies with publicly disclosed mineral resources have based them on computer databases and geological block models. With a copy of the geological database and resource modeling criteria and assumptions you can quickly run your own mineral resource estimate to compare and confirm the stated results of the target. In the case of surface deposits it is very easy to use the power of computers and perform a pit optimization using the geological block model and based on the economic criteria of the target company and also compared to your DD teams assessment of mining costs, metallurgical recovery and with respect to your Board’s view of metal prices. This same exercise is not as simple when evaluation underground deposits. Computer programs are available and are a great tool in mine design but the optimization of the deposit economics in terms of selecting the best mining method and production rate etc. must still heavily rely on the human experience and decision making. This means that more time is required for the DD of new underground deposits and mines and must rely on the judgment of experienced operators and engineers.
Many engineers and geologist use a very detailed check-list of items which they feel must be covered before the DD site visit. This may not be possible in situations where the target company has not organized their technical and financial data in an electronic format (typical of foreign owners). This however doesn’t give a good first impression of the credibility of the other party but sometimes you have to take a chance and travel to the site with little more than a high level corporate PowerPoint presentation. I was recently burned on a gold project opportunity in Brazil which looked too good to be true and it was. After several weeks of negotiation of a letter of intent, I traveled to site with a team consisting of a senior geologist and metallurgist as well as accompanied by a local Brazilian who covered the local aspects of the project. I should have listened to my spider senses on this project especially since the Canadian agent living in Toronto had a poor reputation. I felt that maybe the reason that such an attractive project was still available was because the agent had such a poor reputation and thus few buyers would pay attention to his pitch. We uncovered many problems with the project which at the time was producing about 1,500oz of gold a month and at a small profit. I could have probably tuned a blind eye to the host of operating thorns present if only the deposit they were mining and property had interesting exploration potential, unfortunately it did not. This is an example of when even the most skeptic of engineers didn’t listen to his own gut instinct which resulted in a waste of clients’ money (cost of the DD). My team was thankfully paid in full and I hopefully I will get an opportunity to make it up soon to the client.
I think that this is where we will leave the discussion regarding Purpose #3 today. I have an interesting example of major DD assignment of a major copper project I was involved with several years ago, and will describe next time.
Feature Commodity – Rare Earth Elements (REEs)
So much is being said about Rare Earth Elements in recent weeks and the apparent panic of buys wanting to secure supply outside of China. My experience in REEs is very limited and but extends way back to the 1980 when I worked as a summer student at Bernic Lake, Manitoba for Tantalum Mining Corp which was a subsidiary of Hudson Bay Mining at the time. The mine was quite unusual, with the pegmatite located about 60m below Bernic Lake and hosting more than 80 different minerals, with tantalum, spodumene, cesium and rubidium being of economic interest at the time. The mining method was room and pillar with breasting and bench cuts. The extreme hardness and strength of the pegmatite allowed rooms to be mine out with dimensions of 22m square and roof heights in places reaching 30m. Ground support (rock bolting etc.) was rarely required. With the mine located just about 100km from Winnipeg and in the countries friendliest province, it proved to be one of the best summer’s I can remember.
What you need to be very aware with respect to companies exploring and developing REEs projects is that while the market is rapidly growing it is relatively small, illiquid and dominated by powerful end users. Assuming that you can overcome technical issues such as the lack of infrastructure and remote site access to locations hosting large and high grade REE deposits, the most important aspect and name of the game is really the marketing of intermediate commercial concentrates and finished products. These mining companies must have a clear strategy with regard to maximizing their margins which tend to be weighted on the finished product end of the value chain. Again, my knowledge of REE industry is very limited and therefore I suggest you do your own research. An article (see link below) which I think gives a very balanced, and independent perspective on the past history, present and future of REEs is entitled “Abandoned Canadian mine a lesson for rare earth investors” by Julie Gordon, Reuters. I suggest you read it.
http://www.montrealgazette.com/business/Abandoned+Canadian+mine+lesson+rare+earth+investors/3799498/story.html
Wes Roberts
December 2010
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