Technical Due Diligence what do we look out for?

Technical Due Diligence –

what do we look out for?

AusIMM M&A Masterclass May 2014

Mark Noppe

General Manager and Principal Consultant

Disclaimer

This presentation is a summary of a full presentation delivered to the South Queensland Branch of the AusIMM on Tuesday 20 May 2014 by Mark Noppe of Xstract Mining Consultants.

This presentation may contain some market information which has been calculated for the purposes of this presentation, and not for any valuation exercise. Any results shown in this presentation are purely for illustrative purposes only.

The due diligence investigation of mineral assets and companies typically requires specialist sector knowledge. This presentation deliberately simplifies key concepts for the purposes of explaining in a simplistic manner. Users of this presentation should not rely on this presentation for accuracy in undertaking a due diligence of a minerals asset or a mining industry related company.

For further information regarding this presentation, please contact Xstract Mining Consultants.

Content: Resource project reality check

•

Background

– What can go wrong?

•

Reporting context

– Exploration Results and Exploration Targets

– Mineral Resources and Ore Reserves

– Mining value chain

•

Technical-economic studies

– What does the term “feasibility study” mean?

– Confidence (accuracy and risk) in study types

– Real world example

•

Due diligence

– Mining context

– Study types and levels of detail

Background: What can go wrong

Background: Risks in resource projects

Dilution Geotechnical

Mineral Deposit (Tonnes/Grade) Processing Recoveries Environmental

Interest Rate Commodity Price Financing Foreign Exchange Foreign Exchange Documentation Joint Venture Ownership Tenure Group Structure Mining Equipment Debt Gearing Labour Unrest Climate Expropriation Sovereign Debt Fiscal/Dividend Policy Weather Impact Reputational Reporting Corruption Technological Opex/Capex Cultural Management Commodity Substitution Infrastructure Insurance Accounting Rules

Mining Method Skills & Labour Availability

Context: Importance of Resources/Reserves

NPV

pricing

Resource / Reserve estimates

Ore

Context: Mineral asset development stages

(VALMIN, 2005)

Project

development stage Criterion

Exploration areas Mineralisation may or may not be defined, but where a Mineral Resource has not been identified.

Advanced

exploration areas Considerable exploration has been undertaken and specific targets identified. Sufficient work has been completed on at least one prospect to provide a good geological understanding and encouragement that further work is likely to result in the determination of a Mineral Resource.

Pre-development /

resource Mineral Resources and/or Ore Reserves were identified and estimated. A positive development decision has not been made. This includes properties where a development decision has been negative and

properties are either on care and maintenance or held on retention titles.

Development Committed to production but not yet commissioned or not initially operating at design levels.

Operating Mineral properties, in particular mines and processing plants, which were fully commissioned and are in production.

TECHNICAL-ECONOMIC STUDIES

AND ASSURANCE/CONFIDENCE

Types of study

• Scoping Study or Preliminary Assessment

– Broad brush, back of the envelope

– Do not use term “Feasibility”, generally no Reserve • Pre-feasibility Study

– Firming up on the numbers, evaluating options, identify preferred option • Feasibility Study

– Decision to develop and/or fund

– Do not use term “bankable” – assumes the study will be automatically accepted (the bank will decide!)

Types of study

Technical-economic studies in context

(what industry generally accepts, but the Codes don’t say)

Measure / Item Scoping Study Pre-feasibility

Study Final Feasibility Study

Cost accuracy ±25%-50% ±15-25% ±10-15% Cost contingency 30-50% 15-30% <15% Proportion of Engineering complete <5% <20% <50%

Resource categories Mostly Inferred Mostly Indicated Measured and

Indicated

Reserve categories None Mostly Probable Proved and Probable

Mining method Assumed General Optimised

Mine design None or high-level

conceptual plan and schedule Preliminary mine Detailed mine plan and schedule

Scheduling Annual

approximation 3-monthly to annual Monthly for much of payback period

Due diligence studies

“caveat emptor”

What, Who, When, Where, How?

• An investigation in the material facts of a proposed transaction which may lead to an investment • Undertaken by the investing

transaction counterparty

– Often involves advisors and consultants • Usually prior to the investment

transaction occurring

• In the offices and the site of the recipient counterparty

• Typically involves the checking of legal, commercial and technical data

Due diligence success

Legal

(Lawyers)

Commercial

(Accountants with technical experts)

Technical

(Geologists and Engineers)

The correct decision!

Legal

• Does the tenement exist?

• Does the owner have rights to it?

• Are these assignable (i.e. in the proposed transaction)? • Encumbrances?

• Future permits?

• Social license to operate (including local people)? • Any government issues?

Commercial

• Can the development of the tenement possibly make money? (if, then)

• Taxes, rents, rates, royalties, minimum expenditure, validity dates?

• Expected outcome and potential future NPV? • Any financial encumbrances of the

company/tenement owner?

• Do any committed contracts, formal and informal, exist?

Technical

• What are the Resources and Reserves (if any)?

• If not, what do you hope or expect to eventually be present at this project?

• What the processes (mining, extraction) to get the concentrates to a saleable form?

• Infrastructure, current and required? • Are the physical characteristics

modelled correctly in any

Examples of M&A due diligence

• Exploration project

– Single discipline review (geological team) generally

– Short time frame with positive and negative aspects to be identified • Producing property

– Large and multidisciplinary team

– Geology, mining, geotechnical, metallurgical and environmental

– Requires significant input from legal team

– Time frame will be dependant on level of detail • Public company

– Significant input from legal and accounting teams

– Large and multidisciplinary team – Can have a significant time-frame

Full due diligence

• Country risk • Political risk

• Security of tenure • Approval process

• Land compensation claims

• Nature of deposit

• Basis of resource estimate • Mining scenario

• Geotechnical model

• Metallurgy and processing

• Business model • Tax regime • Social aspects • Health and safety • Human resources • Reputation

• Corporate governance

• Compliance with legislation • Heritage, fauna and flora areas • Closure provisions

• Hydrology

Due Diligence

Types and level of due diligence

Data

Process

Time (cost)

Process review Full due diligence (detailed technical audit)

Insights

• Due diligence is an important multi disciplinary activity which takes place prior to any investment

• It varies depending on the scope and scale of the proposed transaction; it can take weeks and thousands, or months and millions

• Important to advance various aspects of due diligence in harmony to optimise timing

• The due diligence exercise should provide the investing company an appreciation of the risks and issues with the proposed

transaction

• All jurisdictions, commodities, project types have risks

• Purpose of due diligence remains to make the right decision given the events and timing

AND THEN THERE IS THE MINERAL

ASSET VALUATION

Valuation approaches

Approach Appropriate Method

Exploration Development Production Dormant Defunct

Income

Not generally

used Widely used Widely used Used Not generally used

Market

Widely used Less widely used Widely used Widely used Widely used

Cost

Used Not generally _used Not generally _used Less widely _used Used

Industry practice

• Use at least two different approaches

• Justification of primary and secondary valuation methods

• While DCF remains the most widely accepted approach, sector

specific methods are also appropriate, especially for pre-development assets

Conclusion

“Even small errors (10%) can make a big impact on profits, nearly

everything is potentially material. Assume nothing, check everything, trust no one!”

~Harry Parker, 2004

P.S. Don’t forget to assess the UPSIDE!