Mining Conference Workshop 11092012 - Assef

Mining Investment & Finance
Optimising mining investment structures & returns Conference Workshop Book

DATE ISSUED: 10th September 2012
CONFIDENTIAL DOCUMENT
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Competencies in the Resources Space
What are the core competencies of the Firm ? How are Shareholder Returns generated ?
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Lincoln Crowne & Company | Strictly Confidential
Understanding Core Competencies

1. Unique characteristics lose value over time Rich ore bodies on the whole suffer declining grades and increasing costs as time moves forward. The management team need to be continually looking for new discoveries and opportunities which have complimentary and overlapping timetables There is a trade off between advancement and optionality in value of a newly discovered ore body. Understanding the position of the discovery against the backdrop of the market, and having an ability to move quickly can pay dividends Technology revolves around discovery and manufacturing around being the lowest cost producer. Mining is no different, and larger companies focus on cost base and not resource Recognise the entrepreneurial spirit of the young mining company and keep doing deals Flexibility in timing and a clinical understanding of opportunity value (time) can pay dividends Align the junior company with delivering projects that are able to be leveraged into cost advantage by larger / regional players Look at what deals would make sense to accelerate the potential of a resource Invest in people and skills which enhance value. No to lifestyle company
2.
Newly discovered ore bodies can be sold or licensed early Mining is no different from manufacturing or technology
3.
4.
Alliances can make significant cost sense
Resource companies on the whole cannot afford to build infrastructure. Alliance agreements can assist in the development of a lowest cost producer mindset See : Acacia Coal (16m MC) and Bandanna (190m MC) For the smaller player it is essential that the deal making skills of the Company are advanced. In the process of advancing projects there is a real ability in furthering shareholder value by such a pro active approach
5.
Deal making skills can enhance shareholder value
Page 3 | WWW.LCC.ASIA
Resource companies are either discoverers or manufacturers
Resource Project Lifecycle
HIGH
BROADER INTEREST
SINGLE ASSETS & SMALL PORTFOLIOS
FEEDSTOCKS FOR LARGER PLAYERS & INVESTMENTS
MERGERS, CROSS BORDER ACQUISITIONS
Develop an asset(s)?
Accelerate Portfolio
LO W
NO MANS LAND
EXPLORERS
DEVELOPERS
PRODUCERS
LCC 2012 Deal Drivers Framework

Does not factor in wildcat hits which can occur across the Resource space
Sector Cyclicality
Examining: Tactics in positive markets, capital structures, constraints
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Shareholder Value & Commodity Attraction

Examine Coal Sector Bulk Commodity Constraints Ignored Capital Availability Balance Sheet Sector moved through significant market attraction within the period of 2009 to 2010. Numerous small IPOs took place which all returned significant post IPO performance Anticipated high level of M & A Activity drove valuations in the sector not fundamentals. This resulted in significant paper gains - but constraints were ignored Capital markets commence to dry up. Reality of the requirement of capital becomes a focus. M & A activity becomes patchy Companies take the profile of traditional commodity companies balance sheets in focus
Trade in the bubble, understand that bubbles do not last, balance sheets critical
Coal Sector Constituents Under Pressure
High cash costs associated with bulk commodity starts to bite balance sheet focus
Valuation in the Resources Space
Traditional and non traditional approaches to value
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Valuation Approach to be Determined ?

Comparable Analysis Look at trading companies that have a similar resource Not all resources are the same. Can be mixing oranges and apples Close as one can get, but items such as size, quality, infrastructure must be filtered Can be limited in payoffs Risk weights the opportunity, but based on objective and subjective elements Bad deals can limit equity value Comparables challenge Can be highly in accurate
Single Transactions
Look at in geography transactions and compare technical data
Joint Venture Expenditure Factoring Formula
Link value to potential payoffs from JV expenditure obligations Formula such as the Kilburn Geoscience Rating Method. This starts with a base acquisition cost and then introducers multipliers and weightings What the willing buyer acquires an interest in the permit Working backwards from control premia Pure speculation in early stage projects, assumptions difficult to defend
Earn In Calculations Control transactions DCF / FCF
No perfect model, need to present a multi point approach
Resource Project Lifecycle
HIGH
BROADER INTEREST
SINGLE ASSETS & SMALL PORTFOLIOS
FEEDSTOCKS FOR LARGER PLAYERS & INVESTMENTS
MERGERS, CROSS BORDER ACQUISITIONS
Develop an asset(s)?
Accelerate Portfolio
LO W
NO MANS LAND
EXPLORERS
DEVELOPERS
PRODUCERS
LCC 2012 Deal Drivers Framework

Is there a negative co-relation of capital to development phase ?
Opportunity cost Bandanna Energy

Sector out of favour Balance Sheet exposure Once the sector is out of favour capital quickly dries up. Any asset based valuation pushed to one side The spiral effect is then that the balance sheet of the company becomes fragile and weak, and there is little prospect for any form of additional raising
Intrinsic value removed, bankruptcy valuation steps forward, capital raising difficult at best
Discussion points on Valuations

Risk Portfolio theory Core Competency Cost of Capital Competition Deal Structure Tiffany Box Mining is a risk game, but what is the typical return that an institutional shareholder / cornerstone investor will be looking to receive ? Given that many junior resource companies have multiple assets within their portfolio do they enjoy a strategic advantage or a hindrance ? What is the core competency of a junior resources company ? How can capital be used to maximum efficiency ? What is the linkage to the balance sheet of the Company ? What is the cost of capital for a small to medium explorer / developer in the resources sector ? What analogy is this to the venture capital or private capital industry ? (current gold client) What effect does competition for capital have on cost of capital, probability of success in capital raising and process for attracting capital (due diligence to project advancement) ? What does potential deal structure do to the potential valuation of the project ? How selective are larger players being in the current market ? What does this mean for due diligence ? What does this mean for timetable larger players will consider projects (spoilt for selection) ?
Is the Business Plan going to attract investors or alienate them ?
Cornerstone Investor Requirements

Valuation Payback Directorships Marketing Agreements Non Dilution Offshores Grades & Cash Costs Cookie Cutter Venture capital approach to early stage Resources projects creeping into the market problems abound Large cornerstones looking for swift payback 12 18 months Cornerstones often want these Many are after these at commercial rates Certain shareholders are looking for non-dilution provisions in the Resources space or top up options, etc. Absolute focus on ability to get project into production Cornerstones undertaking extensive independent work to verify potential If it is not a simple deal wont engage Staggered Deals : Copperchem High competition for such projects Can mean a conflict at Board Can effect takeover premia in the stock Private equity focus Watch out for researchers Timetables can be up to 12 months Research alternate projects to ascertain fit
Review of Domestic v- International Requirements
Cost of Capital In Current Market Conditions

Equity Market Capital High levels of discount associated with raisings (up to 25% - 30%). Many deals are failing particularly those that are dependent on retail shareholders. Capital is not sticky with almost immediate turnover of capital in the markets. No one wants to be caught in the lobster trap Seed money is still available, but the IRR that is being commanded for such capital is an expectation of 100% return over a 6 to 12 month period. Seed capital typically up to A$5m US Banks are pushing mezzanine capital into late stage developers and early stage producers. Rates can be extremely high up to 18% with a combination of coupon based paper and PIK Project Financing is available, in particular for short timetable producers in the precious metals space. Typically, however there is an equity leg condition precedent that is required to be satisfied prior to the capital itself being available. Debt with a mandatory equity raising is also doing the rounds ( Cortona Resources) Trading companies are looking at bulk commodity opportunities. Typical framework of up to A$30m for up to 50% of the project, with an off take agreement / marketing agreement. Care in any marketing agreement needs to be taken spot or at a discount ? This is a two edged sword is it a hedge or a high risk speculative position ? How does one cater for a hedge that moves into a negative position ?
Pre IPO Capital Mezzanine / Private Equity Capital Debt Availability
Cornerstone
Hedging
The larger the capital requirement, the larger the cost of capital
Backdoor Listing and Recapitalisations

Shell Valuation Capital Structures Always contentious. Promoters attempt to extract premium due to convenience but backdoor loophole all but removed Typically complicated. Options, warrants, performance payments all make it difficult to create true value for the Company Often a compromise between parties and not typically the best talent that can be sourced Tend to be favoured companies for day traders given there is typically significant issued capital Tend to have a more complex time of the capital raising process. Warrants (including broker warrants) tend to be the normal part of the process Typically tend to be weak following any deal Change of Direction or Change of Size issues mean that shareholder approval is required potential for expert reports
Promoters seek to make the economic rents
Should be same costing as for front door Institutional investors tend not to engage where complication exists Smaller Boards for smaller companies keep costs low Cornerstone shareholders typically also consider looking at the Project level Low market caps mean rights issues of prospectus styled issues still required Little incentive to invest Process ensures transparency
Directorships Trading
Capital Raisings
Balance Sheet ASX complication
Deal Filters Choosing the Correct Project ?

Observations from the buy side
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Understanding Project Position / Selection
An objective comparables analysis is of critical importance in assessing any opportunity
Elements for Consideration in Resources

Infrastructure & Port Access Depth & Quantity Environmental & Community People Ability to access Power, Water and Transport. For Bulks need rail / port access which means may require finance bonds well ahead of production for Port allocation Open Cut the preference, given underground operations CAPEX and timetable complications Community engagement critical if near any population (see CSG), environmental issues can complicate and delay including cash for environmental bonds when in production Excellent talent can deliver a positive bias to value, but talent comes at a cost and must be introduced at the correct time. Move to IPCC technologies to drive down OPEX (Iuka example) Investors seek quick paybacks given illiquidity and choice for investment
CAPEX to ROI
Competition for Resource Gold and Precious metals easy to trade, bulks and exotics not as easy to create markets for Royalties and Government Policy Timetable Mining Rent Resources Tax effect. Mine closures & project shelving (BHP at Olympic Dam, BMA at Gregory). International choice of investment venues Current market not patient capital being directed to projects that can move to cash flow positive within 12 to 18 months
An objective assessment of projects is required to develop a robust business plan
Observation on Feasibility Errors
Observations from the buy side
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Errors in Resource Project Feasibility

Abundance of capital Australian companies tend to calculate things on the basis that capital WILL be available. Investors are looking for privateer styled management teams who are less focused on the perfect development as opposed to getting a project established and into production Feasibility is often run at unrealistically high assumptions. For example in Gold, many projects are currently being promoted on the basis of a sustainable Gold Price at US $1,550 p oz where banks (for example) are using assumptions around US$1,100. Rapid fluctuations in commodity or FX rates are often not reflected in project briefings Contractor Cost Contingency Timetable Contractor cost over life of mine are typically underpriced. Example : Oil & gas explorer with Drilling requirement but no contractor quote to contract difference Rarely is there sufficient contingency for establishment of a project, and this in turn leads to points where certain projects can fail or run materially over budget Timetables for approvals and availability of even basics such as drill rigs can be vastly underestimated. Delays lead to high holding costs and unpredictable outcomes which disengage investors
Commodity pricing
Errors come in all shapes and sizes conservative approach v- aggressive
How Aggressive Are Project Assumptions ?
3 Year Price Action
3 Month Price Action
Would you invest ? Assumption of gold at US $1550
Errors in Resource Project Feasibility (con)

Cut Off Grades Mine Life Change in Process Unrealistically low cut off grades which are not globally competitive. These question the economic viability of the projects when cost base is considered Short mine life projects that have an expectation that the mine life will be extended. CAPEX associated with extension can outweigh the potential financial benefit Items such as Electricity and Fuel Costs are not factored in in a flexible fashion. These then result in movements with cost base that are not able to be recovered (contractor shift in price) Lack of scale makes an operation exposed to additional losses fragile business models Never factored in Cost of workforce through both mobility and accommodation are typically low. Cost of recruitment and retention of talent in smaller operations is also typically low Reports, maintenance, bonding and reclamation are often low. Government Bonds are only estimates and do not result in 100% cover (if an acquisition)
Scale Weather FIFO costs Environmental
Lack of flexibility in financial modeling a common observation
Building a Market Presence Chasing Capital

Broker Activity It is patchy at best. Most brokers are being quite activist with investee companies that are not delivering this is a developing trend amongst Australian fund managers, and dealing with activist investors can be a complicated and highly distracting activity Ideal to have multiple brokers
Research
Without independent broker research there is a lower possibility of Understand the importance achieving a capital raising. There is a loop which is brokers of independent research expect some form of corporate activity to justify the investment in a research commitment Small companies often have evangelists. These are senior brokers in a Firm that takes the time to understand the potential of the business model There is some skepticism about reports, competent person statements and project potential. Objective calibration to leaders in a sector required Company needs to invest in cultivating senior broker contacts including site visits Research and objective focus on skills of professionals recommended
Individual Senior Brokers
Seeking out experts
Wide ranging roadshows often yield little value for early stage Resource companies
Joint Venture Relationships

Readings : Joint Venture Laws in Australia When do Joint Ventures Create Value ?
Examining: Formation, Structures, Valuations, Dissolution, Exits
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Discussion points on Joint Ventures

Ownership Signalling Valuation Capital Calls & Loans Dissolution What difference does the ownership structure make ? Should one be a passenger in any deal ? How can a Joint Venture be used effectively from a shareholder value perspective ? Are such signals permanent ? How does valuation interact with ownership ? Do small differences in structure make any difference to potential value of a minority shareholder ? How should capital calls be handled ? What if a larger player fails to take up a capital call ? Effect on Project and the ability to raise capital Do pre-emptive rights clauses work ? What are the challenges that are faced in dealing with these sorts of mechanisms ? What are the alternatives that are available and what are the risks within those structures and how can they be further mitigated (examine shotguns) Importance of duties. Why is ongoing reporting a requirement ? How do fiduciary duties interact with Joint Ventures ? How are these mitigated ? What does that mitigation in fact mean ? What happens if a JVA is incomplete in terms of time ? Glide path clauses. Breaking a few myths
Duties & Reporting Contract v Fiduciary Disputes on JVs Heads of Agreement
This Agreement shall continue after the expiry of the Term for so long thereafter as shall be necessary in order to properly complete the winding up of the activities to be conducted pursuant to the JVA
Smaller players need to take care in ensuring a JV covers a wide range of scenarios
Valuation & Joint Ventures Inputs

Ownership Typical Factors Considered What difference does the ownership structure make ? Should one be a passenger in any deal ? Size, Public / Private, Size Holding, Operational relevance (passenger v- operator) , Dissolution Mechanisms, Rights in Shareholder Agreement (decisions), Liquidity, Marketability, Dividends
Size Holding
Larger the project the higher the level of interest and the leverage for shareholder returns Closer to the 50% mark the minority arguably the lower the discount to be applied. Tactically can use structured deals to protect Open mechanisms lead to lower discounts as able to be marketed. Structured or majority controlled processes may result in land locked assets What market is there for the asset ? Size and quality of both asset and holding critical How will these be able to be valued ? Is there value in a preferred dividend ? Care needs to be taken in tying up marketing agreements early. Marketing agreement can cap both value and liquidity
Public / Private Operational Relevance Decision Making
Typically there is a discount associated with a private company as opposed to a public Significant issue. If operationally involved (even in part) then can move away from minority shareholder argument Is the minority involved ? Decision making can lead to argument for lower discount (see example) Links to Dissolution Mechanisms More payments the higher the option value associated with the shareholding Has the JV been advanced or is it a scenario of a larger player shelving the asset once the JV agreement is in place ?
Dissolution Mechanisms Liquidity Dividends Marketing Agreements
Marketability Payments Progress
Poorly addressed clauses can have a negative bias on value
Positive Signaling Potential from JVs
Why no follow on in share price ? Examine announcements
But how relevant is the JV for the Targets shareholders following announcement ?
Use of Real Options in the Resources Space

Potential payoffs of early stage projects
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Introduction to Potential Application of Option Theory

Discounted cash ow (DCF) methods were, and still are, a central plank in most MBA and business education programmes. Executives, managers and analysts are taught project appraisal methods and the superiority of net present value (NPV) and internal rate of return (IRR) measures compared to return on investment and payback
However, DCF method neglects the value of the exibility of managers to react to any change such as new information as it arrives
Flexibility give management the option to change the investment / decision. This option will be exercised if it is in the interest of the rm or organization to vary decision making which can be as a result of market conditions or commodity prices
Real Option Valuation and other quantitative methods could be very useful when estimating an uncertain project such as mining or resource exploration
Alternative Valuation Methods Touching on Options
Closed form, Black-Scholes based Real Option Valuation solutions
Binomial Lattices
Monte Carlo Method
Finite difference methods for option pricing
Delay Option Abandon Option Expansion/Shrink Option Conversion Option (debt to equity)
A Practical Case by Using NPV and ROV Model

Company X has the opportunity to withdraw from a 10 years licence on Project N.
Expected to yield 50 Million barrels
Current Oil Price from field N: $11/barrel
Present Value of development cost: $ 600 Million
The commodity bull market is over and Company X is considering to quit from Project N in 5 years. (Abandon Option applies)
A Practical Case by Using NPV and ROV Model

LCC ROV Model, based on several key assumptions of uncertainty.
We exam two major sources of uncertainty affecting the value of project: the quantity and price of oil.
We also take into consideration of possible dividend pay-out.
This leads us to estimate Option Value at $ 100 Million.
Given an estimated Residual Value of $ 600 Million after 5 year, this leads us to a value of Options to Abandon (Sell) at $ 137 Million
Other Methods Used Binomial and Lattice Options

Monte Carlo. This kind of method are increasingly, and especially, applied to high dimensional problems. Useful for projecting potential IRR and returns providing an output that is a probability of the output of that project
Binomial lattices. This can be useful in more advanced projects or those moving into production (as can factor in dividend payments)
Structured Deals
Examining structures that have been applied Discussion on Benefits and Restrictions
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Creating Shareholder Value By M & A ?

Bidders future performance as MergerCo will be driven by a series of factors which result from the acquisition. Near geography resources can deliver scale (nuisance acquisitions) Critical are : The capital structure of Bidder following acquisition, the approach to boosting performance via advancing operations & potential for advanced balance sheet management Bidders strategy for any acquisition has been represented to investors as one seeking material opportunities A properly structured transaction will likely deliver 3 critical benefits : 1. 2. 3. Index weighting Operational efficiencies Simpler path to production
Bidder Value Received Price Paid Value Created For Bidder
Acquisition Base Case framework
Value Of Performance Improvement
Acquisition Premium
Stand Alone Value
Market Value
Value creation is driven by advancing projects not the acquisition of something cheap
Royalty Arrangements
Readings : Iluka Mining Area C Macquarie Report
Examining: Relevance, Potential, Tactical Application, Takeout Valuations
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Discussion Points on Royalty Arrangements

Relevance Bounties and other Milestones Application Protecting the Royalty Dissolution Duties & Reporting Contract v Fiduciary Example : Why have them ? Relevance for companies that are in a hurry ? Advantages. Risk / reward, alignment of parties, extracting maximum value Early stage ? Development stage ? Mining stage ? What is the volatility of the arrangement ? Requirements to pay. Disputes. Definitions in shareholder agreements How to position for a take out ? Importance of reporting & audit obligation. Calculation in case of disputes No fiduciary contractual. Effect on dispute mechanisms. Poorly worded definition resulted in claim that royalty calculations in error.
Tactical advantage of royalty arrangements should be considered in any deal
Index
Appendix
Section 3:
Target Companies
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Important Information
LCCs approach to all engagements is based on both technical and economic fundamentals and how these fundamentals translate into positive shareholder value.
Information that has been prepared in this Work Book has been done so by Lincoln Crowne & Company (LCC) in good faith based on information sourced from a variety of information points including public data, company published information and third party data sources such as Capital IQ, Bloomberg, IRESS, FACTSET, MDS News, Thomson Reuters and various other news and media outlets. Whilst it is believed that the information is accurate at the date of publication, no responsibility will be accepted in any way from any party seeking to rely upon this information for any business or investment decision. The information has been provided by way of background research only, and given its content is subject to continual change in fluctuating markets. In any engagement LCC acts as an independent contractor and not in any other capacity, including as an agent or a fiduciary. LCC does not provide any tax advice. Any tax statement herein regarding any US federal tax is not intended or written to be used, and cannot be used, by any taxpayer for the purpose of avoiding any penalties. Any such statement herein was written to support the marketing or promotion of the transaction(s) or matter(s) to which the statement relates. Each taxpayer should seek advice based on the taxpayers particular circumstances from an independent tax advisor.
LCCs Community Focus

PHILANTHROPY
The Lincoln Crowne Foundation is an extension of the Firms corporate social responsibility arm that director, Nicholas Assef initiated. The foundations main purpose is to support and extend partnership development to grass roots charities in the Asia Pacific region, understanding the need to invest in the future of children in neighbouring communities. lincolnecrownefoundation.org
ACADEMIA
LCC and Bond University has established a relationship around the importance of success, academic integrity and outstanding performance. To this end, LCC has sponsored various faculty awards in both the Business and Law Schools.
SPORT
LCC has sponsored 12 and 16ft skiffs in Sydney, over numerous sailing seasons and championships. In 2012, in partnership with Variety the Childrens Charity, Nicholas Assef proudly supported the Variety Port Jackson 12ft Skiff Championships. This event marked the launch of a series of projects committed to raising support for Alopecia Areata, which is a medical condition of which there is no known cure. lincolncrownesailing.com.au
GOVERNANCE
We are governed by our commitment as a signatory to the UN Global Compact. The UN Global Compact is a strategic policy initiative for businesses that are committed to aligning their operations and strategies to ten universally accepted principles in the areas of human rights, labour, environment and anti-corruption. unglobalcom pact.or g
LCC Strives to make a positive difference
Contact
AUSTRALIAN OFFICE Level 18, Aurora Place 88 Phillip Street Sydney NSW 2000 Australia Correspondence GPO Box 4154 Sydney NSW 2001 T: +612 9262 2121 F: +612 8088 1239 AFSL 278054 ACN 105 807 645
PROJECT TEAM Nicholas Assef naa@lcc.asia T: +612 8288 8688
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Mining Investment & Finance

Optimising mining investment structures & returns Conference Workshop Book

Competencies in the Resources Space

Lincoln Crowne & Company | Strictly Confidential

Understanding Core Competencies

Alliances can make significant cost sense

Deal making skills can enhance shareholder value

Resource companies are either discoverers or manufacturers

Lincoln Crowne & Company | Strictly Confidential

Resource Project Lifecycle

SINGLE ASSETS & SMALL PORTFOLIOS

FEEDSTOCKS FOR LARGER PLAYERS & INVESTMENTS

MERGERS, CROSS BORDER ACQUISITIONS

LCC 2012 Deal Drivers Framework

Examining: Tactics in positive markets, capital structures, constraints

Lincoln Crowne & Company | Strictly Confidential

Shareholder Value & Commodity Attraction

Lincoln Crowne & Company | Strictly Confidential

Coal Sector Constituents Under Pressure

Valuation in the Resources Space

Traditional and non traditional approaches to value

Lincoln Crowne & Company | Strictly Confidential

Valuation Approach to be Determined ?

Look at in geography transactions and compare technical data

Joint Venture Expenditure Factoring Formula

Earn In Calculations Control transactions DCF / FCF

No perfect model, need to present a multi point approach

Lincoln Crowne & Company | Strictly Confidential

Resource Project Lifecycle

SINGLE ASSETS & SMALL PORTFOLIOS

FEEDSTOCKS FOR LARGER PLAYERS & INVESTMENTS

MERGERS, CROSS BORDER ACQUISITIONS

LCC 2012 Deal Drivers Framework

Is there a negative co-relation of capital to development phase ?

Lincoln Crowne & Company | Strictly Confidential

Opportunity cost Bandanna Energy

Lincoln Crowne & Company | Strictly Confidential

Discussion points on Valuations

Is the Business Plan going to attract investors or alienate them ?

Lincoln Crowne & Company | Strictly Confidential

Cornerstone Investor Requirements

Review of Domestic v- International Requirements

Lincoln Crowne & Company | Strictly Confidential

Cost of Capital In Current Market Conditions

Pre IPO Capital Mezzanine / Private Equity Capital Debt Availability

Lincoln Crowne & Company | Strictly Confidential

Backdoor Listing and Recapitalisations

Balance Sheet ASX complication

Deal Filters Choosing the Correct Project ?

Lincoln Crowne & Company | Strictly Confidential

Understanding Project Position / Selection

An objective comparables analysis is of critical importance in assessing any opportunity

Lincoln Crowne & Company | Strictly Confidential

Elements for Consideration in Resources

An objective assessment of projects is required to develop a robust business plan

Observation on Feasibility Errors

Observations from the buy side

Lincoln Crowne & Company | Strictly Confidential

Errors in Resource Project Feasibility

Errors come in all shapes and sizes conservative approach v- aggressive

Lincoln Crowne & Company | Strictly Confidential

How Aggressive Are Project Assumptions ?

3 Year Price Action