Mineral & coal valuations, from a Cat-in-a-bag to VALMIN.

Mineral & coal valuations, from a Cat-in-a-bag to VALMIN.                    (Vol 90)

Introduction.

The valuation of Freeport shares has become a hot topic. There are a number of recent Initial Public Offerings (IPO’s) on the Jakarta Stock Exchange (IDX) for mineral and coal companies, along with various acquisitions that each have a different path to valuations. Recently the Indonesian Stock Exchange (IDX) and the Financial Authority (OJK) are considering allowing exploration companies to float IPO’s on the IDX. The organizational structure behind developing a code, and associated body, to manage mineral & coal company valuations under the Indonesian Financial Authority (OJK) is being developed. It is common practice to look around at other countries system of codes, learn from their experiences, and see what best suits Indonesia.

This article provides a quick look at Australia’s VALMIN code, and then reviews some current mining company valuation practices in Indonesia.

Some public attitudes towards valuation.

During the IUP boom period it was common practice for people from all walks of life to “secure” a IUP of about 2,000 Ha through connections to the local Regent. Then, without any real exploration, immediately try to sell it for a contrived market standard price of $5 million. This “kutching dalam karong” (cat in a bag) approach to valuation put all the risk of exploration and of finding something onto the potential buyer. Hotel lobbies and coffee shops were full of people huddled over scant documents trying to close a deal. Most of these deals were for coal, but others included bauxite, nickel, gold, manganese or whatever was thought to be in the area.

During the boom period, a number of banks were eager to loan into the mining industry. It seems most banks had little understanding of the project risks, and the temptation of fantastic high quick profits caused some banks to brush over, or lacked, adequate protocols. The reputation of the JORC code quickly became a finance industry standard for seeking a reliable economic feasibility study based on sound data. Having a JORC code compliant report became the new standard for the “hot” properties, leading to some poor professional JORC reporting. More measured banks typically sought a second or third opinion of the JORC studies from reputable independent resource consultants. The Indonesian KCMI code of resource and reserve reporting grew out of this era, with a significant difference to the JORC code being that the Indonesian KCMI Competent Persons became more closely scrutinized by the professional body.

A Select number of companies with modest production are seeking to raise funds for expansion through listing on the IDX or other exchanges (Singapore / Hong Kong). This process is more orderly, and typically takes about 6 months and $0.5 million to comply with for the Indonesian listing requirements. Documents required for listing include reliable reserve, financial and legal review reports that can take much longer to compile and are costlier to develop to the required standard. The prospectus documents carry mandatory disclaimers that any investment carries a certain amount of risk. There is a recent MOU between the IDX and the professional KCMI body in that the resources and reserve reports should be KCMI compliant and reviewed by the KCMI Competent Persons body prior to being accepted by the IDX for listing. It is expected that company valuations should then take into consideration the KCMI report on resources and reserves.

Do we need a code?

When a company or a government represents a large number of stakeholders, then determining the value of a mining company should be undertaken in a manner that is seen to be fair and professional.

There are many aspects of a fair manner. For the Indonesian geologists and miners, the VALMIN Code may help develop reporting from an “I did it my way” to let’s-do-it-together.

• Geologists often debate on various technical parameters, such as acceptable drill spacing, or acceptable recovery where the author defends their position with an emotive statement that it is their opinion that is to be applied. Under a VALMIN code the debate would need to be satisfied on the grounds of “reasonableness”.
• Geologists spend years and millions of dollars to get a justifiable resource and reserve estimate. Mining engineers spend months and good money to develop optimization designs and get quotes for construction and operation costs. The common Indonesian practice of presenting a historic graph of coal/mineral price, then guessing a number to be the sales price bases for the economic assessment would need to consider “forward looking statements” under VALMIN.
• Miners are often concerned that companies present only simplistic summaries of resources and reserves on public reports, wherein supporting data may be excluded on the grounds that it is not material. The decision of what is material can be varied and vague, and so enables to company to have a one-way communication. Under the VALMIN code the Materiality concerns are defined as “all the relevant information that investors and their professional advisors would reasonably require, etc”, to enable the reader to determine for themselves what is material.

What’s in the VALMIN Code.

The following is a quick view of the VALMIN Code. The actual 42-page VALMIN Code is written with carefully chosen words and phrases, wherein each sentence could provide the bases of a lengthy detailed professional or legal discussion. Readers are encouraged to download the actual VALMIN code at; http://www.valmin.org

 

1. Introduction: – The purpose of the Australasian Code for the Public Reporting of Technical Assessments and Valuations of Mineral Assets (VALMIN Code) is to provide a set of fundamental principles, minimum requirements and supporting recommendations to assist in the preparation of relevant Public Reports on Mineral Assets. The VALMIN Code is based on international good practice. The VALMIN Code is designed to fit within the Australian regulatory framework, including the JORC code.
2. VALMIN Practitioners: – a) Specialists and Securities Experts are defined, and are to prepare and accept responsibility for a Public Report.
3. Code of Principles: – The Fundamental Principles of the VALMIN Code are Competence, Materiality and Transparency. All assumptions must be set out clearly in the Public Report.
4. Additional Requirements: – Reasonableness and Independence are defined and noted as vital principals.
5. Public Report: – The intent of a Public Report is to gather, summarise and interpret the Material information related to the Mineral Assets under consideration along with the opinions of the Practitioner, which are to be presented clearly, concisely and accurately. There are three main types of public reports; – 1) Technical Assessment Report, 2) Valuation Report 3) Independent Expert Report.
6. Commissioning a Public Report; – The written agreement with the Commissioning Entity must cover the scope and purpose of the Public Report. The cost of providing the Public Report must be disclosed.
7. Technical Assessment: – A Technical Assessment is an evaluation prepared by a Specialist of the technical aspects of a Mineral Asset.

A Public Report that deals with current or proposed mining and processing must include a description of the overall mining practices. Production Targets involve forward-looking statements, for which these must meet the Reasonable Grounds Requirement.

8. Valuation: – A Public Report must disclose the basis of value. Technical Value is an assessment of a Mineral Asset’s future net economic benefit at the Valuation Date under a set of assumptions deemed most appropriate by a Practitioner, excluding any premium or discount to account for market considerations. Market Value is the estimated amount for which the Mineral Asset should exchange on the date of Valuation between a willing buyer and a willing seller in an arm’s length transaction after appropriate marketing where the parties had each acted knowledgeably, prudently and without compulsion.

The selection of the Valuation Approach and underlying Valuation Method used is the responsibility of a Practitioner and must not be influenced by the Commissioning Entity or other parties. Three widely accepted Valuation Approaches are: 1) Market-based, which is based primarily on the notion of substitution. In this Valuation Approach the Mineral Asset being valued is compared with the transaction value of similar Mineral Assets under similar time and circumstance on an open market. 2) Income-based, which is based on the notion of cashflow generation. In this Valuation Approach the anticipated benefits of the potential income or cash flow of a Mineral Asset are analysed. 3) Cost-based, which is based on the notion of cost contribution to Value. In this Valuation Approach the costs incurred on the Mineral Asset are the basis of analysis. Guidance on Valuation Approach is given though Table 1.

 

Table 1.

Valuation Approaches	Exploration Projects	Pre-development Projects	Development Projects	Production Projects
Market	Yes	Yes	Yes	Yes
Income	No	In some cases	Yes	Yes
Cost	Yes	In some cases	Yes	No

 

A Valuation Report should make use of at least two Valuation Approaches. A range of values (high/most likely/low) must be determined.

9 Financial Modelling: – The basis for using a wide range of financial inputs, along with forecast future economic conditions and financial modelling for Valuation purposes must be stated.

10 Risks & Opportunities: – A Public Report should include an evaluation of the risks likely to apply to the Mineral Assets under consideration. A risk evaluation includes an analysis of the uncertainties inherent in the assumptions made and the effects they may have on the outcome.

11 Other: – A draft copy of a Public Report should be given to the Commissioning Entity so that it can advise the Practitioner of any Material omissions, comment on the factual accuracy, and assumptions made and advise on any included information that is confidential.

12 Declarations: – A Practitioner must declare in a Public Report that the report has been prepared in accordance with the VALMIN Code or indicate those areas where the report is not and explain why this is so. The Practitioner must sign off on the Public Report.

VALMIN and Indonesia.

We can see that the underlying principals from the KCMI and JORC Code on mineral & coal reporting (Competence, Materiality and Transparency) are continued, along with Reasonableness and Independence. The JORC 2012 edition’s new concept of “if not why not” is brought into VALMIN, though using different terminology. This VALMIN code overlaps with other professional fields, including legal, financial, tax, accounting standards and was written with the anticipation that this code would be tested in the law courts.

Finding a suitable independent person with 5 years technical and a further 5 years valuation experience for Indonesian exploration and mining projects will be a challenge.

For Indonesia to develop a similar code would need the close cooperation with the Financial Authority (OJK) and other institutions. At present the IDX outlook is a somewhat “buy at your own risk”, whereas in the Australia Stock Exchange (ASX) outlook is to ensure a certain level of “fair play”. The development of a code for technical reporting and valuations in Indonesia has commenced with the first phase to introduce the topic to various Government technocrats, politicians and geology / mining professionals. Going down this responsible reporting path is important, as Indonesia’s financing competitors in Singapore and Hong Kong are strengthening and revising their stock exchanges to attract mining business into their markets.

The IMVAL TEMPLATE – International Standards for Valuation of Mineral properties

IMVAL (International Mineral Valuation Committee) was formed in 2012 by representatives of VALMIN, SAMVAL, CIMVal, SME, AIMA, and RICS representing mining valuation standards from Australia, South Africa, Canada, US and UK respectively. IMVAL was formed with the goal of harmonizing international standards for valuation of mineral properties.

Concepts, principles and definitions were taken from three existing mineral valuation codes or standards (VALMIN for Australasia, SAMVAL for South Africa, and CIMVal for Canada) and aligned with those of the International Valuation Standards (IVS) to form the IMVAL Template. It is designed as a principles-based, high level document to guide and underpin national codes or standards. It is intended for it to have similar usage and stature as the CRIRSCO TEMPLATE for reserves and resources. It is important to note that the CIMVal Standards and Guidelines will continue to be the principal document for the valuation of mineral properties in Canada.

IMVAL can be found at;  //www.cim.org/en/News-and-Events/News/2016/IMVAL%20template

Valuation of Exploration & Mining Projects.

Mining investments are characterized by high capital intensity with long payback, large average operating margins but with strong cyclicality in earnings and significant sector risks. The exploration industry is dominated by Juniors and some Major mining houses, whereas State Owned Enterprises and a variety of investors prefer to enter post exploration.

Standard valuation approaches as set out in VALMIN above are 1) Income based Nett Present Value (NPV) analysis, 2) Market value for developing projects based on comparative transactions, and 3) Cost based mainly for exploration projects. For some exploration projects, cost methods for valuation can be further divided into A) Appraisal value (past and future costs to achieve production), B) Exploration expenditure multiple, C) Geoscience value for an area with suitable geological setting, D) Replacement value and E) Book value based on value of assets with multiplier applied. Each of these approaches has numerous components – for example, the cost approach may first look at defining which costs are directly related to the addition of value to the projects, and which costs are not.

Multiples reflect the probability of success or failure of the project. For example, a project that is along strike of an operating coal mine may have a higher multiplier than other coal exploration projects.

Discount factors often applied to mining investments include systematic and market risk, finance risk, project risk, along with country risk. Country risk is defined as uncertain conditions which have non-technical causes, are external to the project, and which can materially impact the viability of a project. These conditions include political, social, macroeconomic and regulatory uncertainty. A Bloomberg graph indicates Indonesia’s Political Risk Insurance is about 1%, Credit default risk is 2% and local market equity risk is about 3%. By comparison Australia’s similar risk factors are each below 1%. Other risk factors may also be considered, including currency and financial market stability, schedule and capital cost, ability to operate, company reputation, labour and process issues.

 

The discount and multiplier factors may apply various recognized rating systems. Professionals with considerable experience in valuations may show greater awareness of multiples and discount factors. Valuation experts can be highly specialized. There are separate valuation experts for 1) assets [resources & reserves], 2) company [company reputation & debt/ earnings] and 3) securities [market depth and liquidity]. Within each valuation group of experts are specialized valuation experts, for example, when using a comparative project approach – one expert may be for porphyry gold in Indonesia, and different expert for porphyry gold in Nevada. The more experienced valuation experts tend to build up a personal library and connections in their specialized areas, and so can more readily undertake a related valuation.

 

IDX listing rules for Mining board.

The IDX listing rules I-A.a for mining companies defines a Competent Person “ as an independent party which is registered with the professional organizations in the field of mining and or geology, which exercise its expertise based on standards established by the relevant authorities, or published by professional organizations either domestic or overseas”. In providing professional services as regulated in this Rule, the Competent Person shall maintain independence.

The listing requirements include Article III.1.6 “Having proven reserves and probable reserves based on the Report of the Competent Person”. For companies that have not yet reached to coal sales stage (Article II.1.8), various requirements are listed, including having a Feasibility Study (FS) and statement that the terms of the FS shall remain valid for a year prior to listing, as signed by a competent person. The Mining company also shall comply with general IDX listing rules, including:  Attachment I-A-1 Appraisal report by the Appraisal registered at the Financial Services Authority (if any).

The present IDX building carries a number of slogans to suggest the protocols and transparency demanded by the IDX on listed companies can further quantify investor risk. Such slogans are “Successful investing is about managing risk, not avoiding it,” and “It’s the investor who is risky, not the investment.” Many of the past prospectus were promptly posted on the IDX web site, included an extensive appendix of the JORC report, and included comments on “geological risk”. It is noticeable that some recent IPO’s prospectus is; A) very slow to be posted on the IDX web site, and B) are devoid of the full JORC / KCMI report, and C) typically do not specifically emphasize geological risk.

The listing rules can be downloaded (English) from the IDX web site. http://www.idx.co.id/en-us/home/regulation/listingregulations.aspx

Some recent Indonesian valuation cases.

1. PLN coal mine acquisition.

The Jakarta Post (28 Feb 2018) article “Coal mine acquisition to ease PLN’s burden” set out a PLN strategy to acquire coal mines and thus secure a cheap supply of coal, with less impact from global coal price fluctuations. The focus will be on mine mouth power plants. “The value of taking over such mines would factor in the amount of their coal reserves and production and land compensation costs disbursed by current operators. PLN must pay around $1 per ton of coal reserves”. Later discussion with PLN strategic procurement director Supangkat Iwan Santoso considered the earlier proposal to assign $1/ton of reserves in the valuation process was no longer valid, as such in-the-ground coal belongs to the State. Indeed, PLN would approach the valuation through an appropriate certified appraiser, in conjunction with advice from an appropriate government recognized coal advisor. This advisor could be from an institution such as ITB, or an independent party. PLN may rely upon the ESDM for some assistance. The process would include a preliminary due diligence phase including a site visit, document and legal review etc.  It is possible the valuation process may look at the projected discount cash flow.

PLN is keen to look at the cost structure of supplying coal to the Java power plants, wherein each stage of the transportation and materials handling will seek out the lowest operational cost, rather than cheapest construction cost option.

2. BRM

On the 2 March 2018, PT. Aneka Tambang (ANTAM) issued a press release wherein ANTAM sold its 20% share in the Dairi project to PT. Bumi Resources Minerals Tbk. (BMR) for US$ 57.309 million. It would seem the nature of this valuation and sale was on the bases of a “willing seller and willing buyer”, with no independent valuation process. The ownership history of this project is that ANTAM was a 20% free carried party till production. BMR is known to be successfully restructuring its debt, wherein the recent sale of 51% of Dairi to Chinese firm was a win-win opportunity to reduce debt, and to have the incoming party contribute further to the capital construction of the Dairi mine. It seems ANTAM took this opportunity to also exchange equity for cash, and so sought to sell its 20% interest in Dairi. The original sale of Dairi from Herald Resources to BMR was undertaken some years back, when the commodity prices were booming, and so set a relatively high share sale price. Later, the sale of 51% to the China company incorporated some aspects of this earlier high price. Apparently, the negotiation price for ANTAM started with this concept of a historical high price, wherein a discount factor was introduced to reflect ANTAM’s non-contributing nature, and possibly the recent changes to the regulations changing the economics of the project – from exporting concentrate to the much more capital-intensive need for a smelter.

Deriving the value of a project is one aspect of a deal. Another is the terms of closing the deal. This may include the terms of payment, with so much paid upon signing, and so much upon key milestones, or key dates.

In February 2018, PT. Borneo Olah Sarana Sukses Tbk (BOSS) undertook an IPO on the Jakarta stock exchange for a nominal Rp 100 share with an offering price of Rp 400 per share. The issuance was for 400 million shares for a target value of Rp 160,000 million and represents 28.57% of the total shares. The public report indicates a MAPPI valuation of the fixed assets of Rp. 116,835 million, so the assigned share value must represent more than just the fixed assets. The prospectus states the approach to the share valuation was “The offering price of the share is determined based on an agreement result and negotiations of the Company and the Underwriters by considering the outcome of Initial Bid (Book-building)”. We may see this as a variant of the “willing seller and willing buyer” approach, though it is the Underwriter that is taking the initial risk that there will be adequate buyers at this price. The Prospectus goes on to give a number of considerations (10) when determining this share offering price. These factors included; – “Financial performance of the company”, that might have some similarities to a NPV approach? Also “the above factors in relation to the determination of market value and various assessment methods for several companies engaged in similar fields with the company”. Perhaps this may be similar to a comparative evaluation approach? The Prospectus does not go on to provide many details behind the derivation of the share price.

4. – coal trader.

In December 2017, PT. Dwi Guna Laksana Tbk. Undertook an IPO on the IDX under the “Development” board. They issued 3,100 million shares (being 35.89% of total shares) with a nominal value of Rp 100/share for an issue price of Rp 150/share for a value of Rp 465,000 million. DWGL have three small coal IUP concessions in South Kalimantan that apparently have no exploration, resources nor reserves. DWGL’s business is trading coal, mainly sourced from PT. Borneo Indobara (BIB), wherein an overly simplified table states that BIB has 555.3 million ton of coal reserves and 1,740 million to of coal reserves at 3,900-4,200 Kcal/Kg (as at October 2017). DWGL has a number of long term contracts and letters of intent to sell coal into many Indonesian power plants and others.

The prospectus sets out the process for determining the share offering price (page 113).  “This bid price is determined based on the price of the agreement and the negotiations of the Company and the Guarantor Implementing Securities Emissions”. The prospectus then lists 9 book building factors related to the companies past performance, anticipated share demands, current market conditions etc. This includes the comment “The above factors in relation to the determination of market value and various assessment methods for some companies operating in the same field as the Company”. This would seem to suggest an element of valuation through comparable transactions may have contributed to setting the share price.

Freeport.

The ESDM started out by passing regulations that the Freeport compulsory divestment should adopt the “Cost” approach to valuation. This approach was widely rejected by Freeport and the professional valuation industry, as reflected in the VALMIN table above, wherein operating mines should not use the cost bases for valuation. Note that the Government has recently appointed Morgan Stanley to make a valuation of Rio Tinto’s interests in the Grasberg mine. This would suggest the Government is now adopting an international approach to the valuation process.

Freeport may be using an international / USA equivalent to VALMIN as required by their stock exchange compliance regulations and associated laws. These professional codes typically require strict protocols about independence, including that Freeport nor the Government cannot talk to the people conducting the valuation. This would explain the resounding silence on this hot topic. We can imagine a further complication is; 1) the Governments often changing the regulations, and 2) that different sites are proposed for the new smelter, and 3) the Governments changing approach to the Rio Tinto factor. Each change probably means the valuation process has to be amended, leading to a prolonged valuation process.

Once the valuation process is complete, then we may look forward to the direct negotiations between Freeport and the Government over acceptance of the valuation and the sale mechanics. The March media report that President Jokowi wants this Freeport deal done by April 2018 may compromise the government taking a strong negotiating position.

Conclusion.

We may get beyond some local ethical issue associated with viewing exploration as a “gambling” industry. By incorporating the core values of Competence, Materiality and Transparency, along with Reasonableness and Independence, we may demonstrate that investing in exploration is a credible risk and reward businesses venture. The OJK intends to be the oversight body, to a new organization for mineral & coal valuations, that may be developed in parallel to the KCMI and MAPPI professional organizations.

The formal valuation process is a highly specialized, where entry is largely limited to the restrictive apprenticeship approach. Introducing a formal high level public reporting and valuation code for the exploration and mining industry will strengthen Indonesia’s mining future.