Mining conference workshop 11092012 assef

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Conference Workshop Book

Mining Investment & Finance

Optimising mining investment structures & returns

DATE ISSUED:

10th September 2012


What are the core competencies of the Firm ?

How are Shareholder Returns generated ?

Competencies in the Resources Space

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Lincoln Crowne & Company | Strictly Confidential

Understanding Core Competencies

Resource companies are either ‘discoverers’ or ‘manufacturers’

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

Recognise the entrepreneurial spirit of the young mining company and keep doing deals

2. Newly discovered ore bodies can be sold or licensed early

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

Flexibility in timing and a clinical understanding of opportunity value (time) can pay dividends

3. Mining is no different from manufacturing or technology

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

Align the junior company with delivering projects that are able to be leveraged into costadvantage by larger / regional players

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 mindsetSee : Acacia Coal (16m MC) and Bandanna (190m MC)

Look at what deals would make sense to accelerate the potential of a resource

5. Deal making skills can enhance shareholder value

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

Invest in people and skills which enhance value. No to lifestyle company

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Resource Project Lifecycle

Does not factor in ‘wildcat hits’ which can occur across the Resource space

LO

WH

IGH

BR

OA

DE

R IN

TE

RE

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EXPLORERS DEVELOPERS PRODUCERS

SINGLE

ASSETS &

SMALL

PORTFOLIOS

FEEDSTOCKS

FOR LARGER

PLAYERS &

INVESTMENTS MERGERS,

CROSS

BORDER

ACQUISITIONS

Develop an

asset(s)?

Accelerate

Portfolio

NO MANS LAND

© LCC 2012 Deal Drivers Framework


Examining:

Tactics in positive markets, capital structures, ‘constraints’

Sector Cyclicality

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Shareholder Value & Commodity Attraction

Trade in the ‘bubble’, understand that bubbles do not last, balance sheets critical

★ Examine Coal Sector 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

★ Bulk Commodity Constraints Ignored

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 Availability Capital markets commence to dry up. Reality of the requirement of capital becomes a focus. M & A activity becomes patchy

★ Balance Sheet Companies take the profile of ‘traditional’ commodity companies – balance sheets in focus

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Coal Sector Constituents Under Pressure

High cash costs associated with ‘bulk commodity’ starts to bite – balance sheet focus


Traditional and non traditional approaches to value

Valuation in the Resources Space

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Valuation Approach to be Determined ?

No perfect model, need to present a ‘multi point’ approach

� Comparable Analysis Look at trading companies that have a similar resource Not all resources are the same. Can be mixing oranges and apples

� Single Transactions Look at in geography transactions and compare technical data Close as one can get, but items such as size, quality, infrastructure must be filtered

� Joint Venture Expenditure

Link value to potential payoffs from JV expenditure obligations Can be limited in ‘payoffs’

� Factoring Formula Formula such as the Kilburn Geoscience Rating Method. This starts with a base acquisition cost and then introducers ‘multipliers’ and weightings

Risk weights the opportunity, but based on objective and subjective elements

� Earn In Calculations What the willing buyer acquires an interest in the permit Bad deals can limit equity value

� Control transactions Working backwards from control premia Comparables challenge

� DCF / FCF Pure speculation in early stage projects, assumptions difficult to ‘defend’

Can be highly in accurate

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Resource Project Lifecycle

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

LO

WH

IGH

BR

OA

DE

R IN

TE

RE

ST

EXPLORERS DEVELOPERS PRODUCERS

SINGLE

ASSETS &

SMALL

PORTFOLIOS

FEEDSTOCKS

FOR LARGER

PLAYERS &

INVESTMENTS MERGERS,

CROSS

BORDER

ACQUISITIONS

Develop an

asset(s)?

Accelerate

Portfolio

NO MANS LAND

© LCC 2012 Deal Drivers Framework

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Opportunity cost – Bandanna Energy

Intrinsic value removed, ‘bankruptcy’ valuation steps forward, capital raising difficult at best

� Sector out of favour Once the sector is out of favour capital quickly dries up. Any asset based valuation pushed to one side

� Balance Sheet exposure 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

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Discussion points on Valuations

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

� Risk Mining is a risk game, but what is the typical return that an institutional shareholder / cornerstone investor will be looking to receive ?

� Portfolio theory Given that many junior resource companies have multiple assets within their portfolio do they enjoy a strategic advantage or a hindrance ?

� Core Competency 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 ?

� Cost of Capital 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)

� Competition 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) ?

� Deal Structure What does potential deal structure do to the potential valuation of the project ?

� ‘Tiffany Box’ 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) ?

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Cornerstone Investor Requirements

Review of Domestic –v- International Requirements

� Valuation Venture capital approach to early stage Resources projects creeping into the market – problems abound

Staggered Deals : Copperchem

� Payback Large cornerstones looking for swift payback 12 – 18 months High competition for such projects

� Directorships Cornerstones often want these Can mean a ‘conflict’ at Board

� Marketing Agreements

Many are after these at commercial rates Can effect takeover premia in the stock

� Non Dilution Certain shareholders are looking for non-dilution provisions in the Resources space – or top up options, etc.

Private equity focus

� Offshores Absolute focus on ability to get project into production Watch out for ‘researchers’

� Grades & Cash Costs

Cornerstones undertaking extensive independent work to verify potential

Timetables can be up to 12 months

� Cookie Cutter If it is not a simple deal won’t engage Research alternate projects to ascertain fit

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Cost of Capital In Current Market Conditions

The larger the capital requirement, the larger the ‘cost of capital’

� 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

� Pre IPO Capital 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

� Mezzanine / Private Equity Capital

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

� Debt Availability 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)

� Cornerstone 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 ?

� Hedging 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 ?

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Backdoor Listing and Recapitalisations

Promoters seek to make the ‘economic rents’

� Shell Valuation Always contentious. Promoters attempt to extract ‘premium’ due to convenience – but backdoor loophole all but removed

Should be same costing as for front door

� Capital Structures Typically complicated. Options, warrants, performance payments all make it difficult to create true value for the Company

Institutional investors tend not to engage where complication exists

� Directorships Often a compromise between parties – and not typically the best talent that can be sourced

Smaller Boards for smaller companies – keep costs low

� Trading Tend to be favoured companies for day traders given there is typically significant issued capital

Cornerstone shareholderstypically also consider looking at the Project level

� Capital Raisings 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

Low market caps mean rights issues of prospectus styled issues still required

� Balance Sheet Typically tend to be weak following any deal Little incentive to invest

� ASX complication Change of Direction or Change of Size issues mean that shareholder approval is required – potential for expert reports

Process ensures transparency


Observations from the ‘buy side’

Deal Filters – Choosing the Correct Project ?

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Understanding Project Position / Selection

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

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Elements for Consideration in Resources

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

� Infrastructure & Port Access

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

� Depth & Quantity Open Cut the preference, given underground operations CAPEX and timetable complications

� Environmental & Community

Community engagement critical if near any population (see CSG), environmental issues can complicate and delay – including cash for environmental bonds when in production

� People 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)

� CAPEX to ROI Investors seek quick paybacks given illiquidity and choice for investment

� Competition for Resource Gold and Precious metals easy to ‘trade’, bulks and exotics not as easy to create markets for

� Royalties and Government Policy

Mining Rent Resources Tax effect. Mine closures & project shelving (BHP at Olympic Dam, BMA at Gregory). International choice of investment venues

� Timetable Current market not ‘patient’ – capital being directed to projects that can move to cash flow positive within 12 to 18 months


Observations from the ‘buy side’

Observation on Feasibility Errors

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Errors in Resource Project Feasibility

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

� 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

� Commodity pricing 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 Contractor cost over life of mine are typically underpriced. Example : Oil & gas explorer

with Drilling requirement but no contractor – quote to contract difference

� Contingency 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

� Timetable 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

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How Aggressive Are Project Assumptions ?

3 Month Price Action

3 Year Price Action

Would you invest ? Assumption of gold at US $1550

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Errors in Resource Project Feasibility (con)

Lack of flexibility in financial modeling a common observation

� Cut Off Grades Unrealistically low cut off grades which are not globally competitive. These question the economic viability of the projects when cost base is considered

� Mine Life 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

� Change in Process 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)

� Scale Lack of scale makes an operation exposed to additional losses – fragile business models

� Weather Never factored in

� FIFO costs 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

� Environmental Reports, maintenance, bonding and reclamation are often low. Government Bonds are only estimates and do not result in 100% cover (if an acquisition)

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Building a Market Presence – Chasing Capital

Wide ranging roadshows often yield little value for early stage Resource companies

� 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 achieving a capital raising. There is a ‘loop’ which is brokers expect some form of corporate activity to justify the investment in aresearch commitment

Understand the importance of independent research

� Individual Senior Brokers

Small companies often have evangelists. These are senior brokers in a Firm that takes the time to understand the potential of the business model

Company needs to invest in cultivating senior broker contacts – including site visits

� Seeking out experts

There is some skepticism about reports, competent person statements and project potential. Objective calibration to leaders in a sector required

Research and objective focus on skills of professionals recommended


Examining:

Formation, Structures, Valuations, Dissolution, Exits

Joint Venture RelationshipsReadings :

Joint Venture Laws in Australia

When do Joint Ventures Create Value ?

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Discussion points on Joint Ventures

Smaller players need to take care in ensuring a JV covers a wide range of scenarios

� Ownership What difference does the ownership structure make ? Should one be a passenger in any deal ?

� Signalling How can a Joint Venture be used effectively from a shareholder value perspective ? Are such signals permanent ?

� Valuation How does valuation interact with ownership ? Do small differences in structure make any difference to potential value of a minority shareholder ?

� Capital Calls & ‘Loans’ 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

� Dissolution 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)

� Duties & Reporting Importance of duties. Why is ongoing reporting a requirement ?

� Contract v Fiduciary How do fiduciary duties interact with Joint Ventures ? How are these mitigated ? What does that mitigation in fact mean ?

� Disputes on JVs What happens if a JVA is incomplete in terms of time ? Glide path clauses.

� Heads of Agreement Breaking a few myths

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

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Valuation & Joint Ventures – Inputs

Poorly addressed clauses can have a negative bias on value

� Ownership What difference does the ownership structure make ? Should one be a passenger in any deal ?

� Typical Factors Considered

Size, Public / Private, Size Holding, Operational relevance (passenger –v- operator) , Dissolution Mechanisms, Rights in Shareholder Agreement (decisions), Liquidity, Marketability, Dividends

Size Larger the project the higher the level of interest and the leverage for shareholder returns

Public / Private Typically there is a discount associated with a private company as opposed to a public

Holding Closer to the 50% mark the minority arguably the lower the discount to be applied. Tactically can use structured deals to protect

Operational

Relevance

Significant issue. If operationally involved (even in part) then can move away from minority shareholder argument

Dissolution

Mechanisms

Open mechanisms lead to lower discounts as able to be marketed. Structured or majority controlled processes may result in ‘land locked’ assets

Decision Making Is the minority involved ? Decision making can lead to argument for lower discount (see example)

Liquidity What market is there for the asset ? Size and quality of both asset and holding critical

Marketability Links to Dissolution Mechanisms

Dividends How will these be able to be valued ? Is there value in a preferred dividend ?

Payments More payments the higher the ‘option value’ associated with the shareholding

Marketing

Agreements

Care needs to be taken in tying up marketing agreements early. Marketing agreement can ‘cap’ both value and liquidity

Progress Has the JV been advanced or is it a scenario of a larger player ‘shelving’ the asset once the JV agreement is in place ?

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Positive ‘Signaling’ Potential from JVs

But how relevant is the JV for the Target’s shareholders following announcement ?

Why no follow on in share price ?

Examine announcements


Potential payoffs of early stage projects

Use of Real Options in the Resources Space

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Introduction to Potential Application of Option Theory

• Discounted cash flow (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 flexibility 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 firm 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

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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)

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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)

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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

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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)


Examining structures that have been applied

Discussion on Benefits and Restrictions

Structured Deals

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Creating Shareholder Value By M & A ?

Value creation is driven by advancing projects – not the acquisition of something ‘cheap’

Acquisition Premium

Market Value

Price PaidBidder Value ReceivedValue Created For

Bidder

Value Of Performance

Improvement

Stand Alone Value

Acquisition Base Case framework★ Bidder’s 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 Bidderfollowing acquisition, the approach to boosting performance via advancing operations & potential for advanced balance sheet management

★ Bidder’s 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. Index weighting2. Operational efficiencies3. Simpler path to production


Examining:

Relevance, Potential, Tactical Application, Takeout Valuations

Royalty ArrangementsReadings :

Iluka Mining Area C – Macquarie Report

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Discussion Points on Royalty Arrangements

Tactical advantage of royalty arrangements should be considered in any deal

� Relevance Why have them ? Relevance for companies that are ‘in a hurry’ ?

� Bounties and other Milestones

Advantages. Risk / reward, alignment of parties, extracting maximum value

� Application Early stage ? Development stage ? Mining stage ? What is the volatility of the arrangement ?

� Protecting the Royalty Requirements to pay. Disputes. ‘Definitions’ in shareholder agreements

� Dissolution How to position for a take out ?

� Duties & Reporting Importance of reporting & audit obligation. Calculation in case of disputes

� Contract v Fiduciary No fiduciary – contractual. Effect on dispute mechanisms.

� Example : Poorly worded definition resulted in claim that royalty calculations in error.

Index


Appendix

Section 3: Target Companies

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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 taxpayer’s particular circumstances from an

independent tax advisor.

Important Information

LCC’s approach to all engagements is based on both technical and economic fundamentals – and how these fundamentals translate into positive shareholder value.

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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 Children’s 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

LCC’s Community Focus

LCC Strives to make a positive difference…

PHILANTHROPY

The Lincoln Crowne Foundation is an extension of the Firm’s corporate social responsibility arm that director, Nicholas Assef initiated.

The foundation’s 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

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 andanti-corruption.

ung loba lcompact .o rg


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Australia

Correspondence

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T: +612 9262 2121

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PROJECT TEAM

Nicholas Assef

[email protected]

T: +612 8288 8688

Contact

Mining conference workshop 11092012 assef

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