Why doesn’t the market value of a mining project match NPV?

A common scenario we encounter as mineral project valuers, is explaining to company stakeholders why we have valued their mineral project with a current pre-feasibility study (PFS) or feasibility study (FS), or even a scoping study with a cash flow analysis, at a market value significantly less than the net present value (NPV) in their mining study. For example, the PFS for a project might have an NPV of $200 million, and yet it has a preferred market value of $40 million.

An NPV derived from a discounted cash flow (DCF) model is not market value.

An NPV is the present value of the cash flows at a required rate of return of your mining project to your initial investment. It is a tool to estimate your return on investment (ROI) for a project. Why would anyone pay the NPV to acquire a project, where excluding any synergies or advantages to the purchaser, the investment would have zero return? Therefore, logically the market value will be less than the NPV – but by how much depends on many factors.

Ramelius and Explaurum takeover bid.

A recent example is where Ramelius Resources Limited (Ramelius) announced a hostile takeover bid for Explaurum Limited (Explaurum). Ramelius offered approximately A$60 million in an all scrip bid for Explaurum. Explaurum’s key asset was the Tampia Gold Project in Western Australia, which had a recently completed FS (May 2018) on mining the Tampia deposit. The FS returned a (pre-tax) NPV of A$125 million. The Independent Expert’s Report returned a valuation range of A$51.7 million to A$67.3 million specifically for the Tampia deposit as part of its overall valuation of Explaurum.

A key aspect of the difference between NPV and market value is largely attributed to timing.

Under the VALMIN Code (2015 Edition) we must undertake our valuation at a specific reference date, based on the current status of the project at that date, and the market valuation should only be considered as the likely valuation range at that date. The valuation practitioner provides an opinion on the estimated value of the project, within a range, would be by taking it to market at that specific date.

Factors affecting project development

In valuing the project, many important factors affecting the potential development of the project may need to be considered.

These include:

• Has the company gotten all the social, environmental and government approvals, permits and agreements in place?
• Has the company got funding or access to capital to fund the development and working capital needs of the project?
• Are you relying on new or novel, experimental, or untested mining approaches or processing technology, which may increase the technical risks associated with your project?
• Different commodities attract different risks, does your commodity need to fit into a specific product specification for it to be marketable?
• Is the market for the project commodity subject to volatility (e.g. iron ore) or are you relying on new markets such as with battery commodities like lithium or cobalt?
• Gaining approvals to mine can also mean proving that you have a “social licence” to operate, especially if your project is potentially contentious, i.e. in an environmentally sensitive area or have an impact in areas of significant heritage value.
• The ability to attract funding for the capital expenditure and initial working capital requirements of a mining project is also crucial. Projects with a funding solution in place are inherently worth more than ones without.
• Access to transport infrastructure is critical for getting bulk commodities to market and hence comes with inherent risk.

Gap in time a material risk

A PFS as defined in Clause 39 of the JORC Code includes financial analysis which has assumed that the funding and necessary approvals are in place. It is undertaken to determine the technical and economic viability of the project to support reporting of Ore Reserves, identifying the preferred mining, processing, and infrastructure requirements and capacities. It will also highlight areas that require further refinement within the final study stage. A FS as defined in the JORC Code is a comprehensive technical and economic study of the selected development option identified in the PFS. It will demonstrate that, at the time of reporting, the project is economically minable.

From reporting a PFS, it can take two or more years to get all the necessary approvals (mining licences, environmental consent, etc.) and will most likely require a FS before the project can be funded. This time value of the money gap is not built into the discounted cash flow models of a PFS or FS as it is an unknown. Though for the more advanced FS it can be considered a lesser unknown compared to a PFS. However, this gap is even longer for projects still at the conceptual or scoping study stage.

This gap in time is a material risk, the more significant the potential time gap between the PFS and getting into production, the larger the potential risk. Within this time gap commodity prices, modifying factors, ability to raise funding and other inputs may change significantly, either improving or destroying the economic viability of the project. In the worst-case, these inputs no longer support the reporting of Ore Reserves.

Discount rate

A PFS generally uses a benchmark-based discount rate, many large companies use a constant discount rate across projects and risk rank outside of this. Many PFS rates adopted are “industry norms” having been taken from other announcements without adjusting for risk. Therefore, when a market value NPV is calculated using a risk-based discount rate considering the above-mentioned risks the project NPV will be lower than the PFS/FS NPV.

Quantifying transactional risks

This collection of difficult-to-quantify risks are inherently built into M&A transactions, best seen when comparing the value range of a selection of related transactions of projects of the same commodity and at a similar developmental stage to the PFS or FS values for those projects. A proxy for market value is the enterprise value (EV) of the company (market capitalisation plus debt less cash). Comparing the EV of the company to the study value of the project the company owns, indicates how the market is pricing in these risks. Variations in EV without the reporting of material news are primarily driven by commodity price fluctuations and sentiment towards that commodity.

Some examples include:

• Clean Teq Holdings announced a Definitive Feasibility Study in June 2018 for the Sunrise Nickel and Cobalt Project. The post-tax NPV at an 8% discount rate was US$1,392 million with an internal rate of return (IRR) of 19.1%. The EV of Clean Teq Holdings as of 1 July 2018 and 1 November 2019 was ~US$320 million and ~$US70 million respectively, over that time frame the cobalt price more than halved.
• Australian Mines announced an updated bankable feasibility study for the Sconi Nickel and Cobalt Project in June 2019. The post-tax NPV at an 8% discount rate was US$817 million with an IRR of 15.0%. The EV of Australian Mines as at the 1 November 2019 was ~43 million.
• Kin Mining announced a Pre-feasibility Study for the Cardinia Gold Project in August 2019. The post-tax NPV at an 8% discount rate was A$66.8 million and A$118.0 million at A$2,000/oz and A$2,200/oz gold price, respectively. The EV of Kin Mining as of 1 December 2019 was ~A$20 million.

All the above risks, and others such as sovereign risk (the specific risks of operating in a certain jurisdiction) can have a substantial effect on the current market value of a mining project, leading to quite different numbers to the NPV in the study DCF.