Astute acquisitions - due diligence
A lack of consistency in terms and processes can mislead mining companies when purchasing resources. Michael Forrest talks to Mark Noppe, Managing Director of Xstract Mining Consultants, Brisbane, Australia, about defining due diligence and its potential pitfalls.
Mining is a risky and expensive business, especially in exploration, where millions of dollars can be spent with little end result. Today’s mining market is buoyant, fuelled by high commodity prices that are set to continue, and as a result, there is considerable pressure on mining companies to expand production at existing mines and look for acquisitions to provide for the future. Acquisitions are an instant way to gain resources, but have risk factors that require careful study to avoid buying misrepresented firms.
Those studies have been referred to under a variety of names, from ‘due diligence’ to ‘definitive feasibility’, and are supposed to highlight the risks involved in the purchase. There are a number of resource and reserve reporting codes around the world that define the level of risk in terms of grade, tonnage and metal quantities, such as the Australian JORC Code and Canadian NI 43-101. However, they do not define the steps that need to be taken for due diligence, or adequately define the inherent confidence levels that are present in feasibility studies. Instead, the variety of terms that are designed to advise the potential investor about the inherent risks and accuracy of the reviewed data are often misleading, even to the informed reader.
‘The JORC Code, for example,’ states Mark Noppe of Australian mining consultancy, Xstract Group, ‘does not define what the type or level of technical studies mean. It refers to “appropriate studies”, “final feasibility studies” and “type and level of study”, while the Australian mineral asset valuation Valmin Code refers to the “technical and economic feasibility of the operation” and “feasibility and associated studies to establish capital costs”.
‘The Canadian NI 43-101 code, on the other hand, provides definitions of “preliminary assessments”, “preliminary feasibility studies”, “feasibility studies” and “economic evaluations”. However, none of the codes define the level of accuracy or associated uncertainty/risk expected to be conveyed by the various study levels and types, even though there is a fair degree of consensus among professionals on the relative accuracy of a number of the key inputs and outputs in these studies.’
This relationship between resource and reserve definition and the ‘definitive feasibility study’ is complex, but it is crucial that these assessments are suitably matched, not only to the accuracy of the cost estimates, but also to the level of confidence in the underlying resource and reserve asset. For example, it is misleading to report a mining project at a ‘final feasibility study’ level if there are insufficiently measured and indicated mineral resources, and proven and probable ore reserves to support the minimum economic mine life. This is regardless of what level of detail is reportedly available on other inputs, such as equipment costs. Each level of the technical study needs to convey the appropriate risk/ opportunity profile of the project to the stakeholders.
The first stage in any acquisition or merger is due diligence. Noppe explains, ‘The term is believed to have originated after the 1929 stock market crash in the USA. It was followed by new Congressional laws in 1933, called the Securities Act, that required companies to provide an accurate disclosure of material information to investors and placed an obligation on those offering securities to “conduct a reasonable investigation to detect material misstatements or omissions in the disclosure”. It also provided a defence if the deal was later proved to have fatal flaws.
‘The 1933 Act states that due diligence should follow “the standard of reasonableness that is required of a prudent man in the management of his own property”. Others have described due diligence as common sense coupled with a reasonable degree of scepticism.’
Due diligence requires a considerable amount of seasoned good judgement and appropriate investigation of the material elements of the transaction. In a mining context, the term can refer to a wide variety of assessment, such as exploration potential, resources and reserves, safety processes, manning levels and process technology.
Terminology is also complex with terms, such as audit, desktop review, technical audit, technical due diligence review and full due diligence. None of these terms are defined by the resources codes.
Back to basics
A full due diligence can involve multidiscipline teams, site visits, check sampling, interviews, legal/ financials, and social and environmental aspects that can often take three months or so to complete. For project financing and accounting, Equator Principles may be required.
The Equator Principles are voluntary guidelines for social and environmental risk management, based on policies and guidelines from the World Bank and the International Finance Corporation, first adopted by 10 banks in 2003. To date, over 60 financial institutions are signatories to The Equator Principles, and they Extract team in Mongolia represent over 85% of the global project finance market. ‘Be wary of any study, however defined, that does not address these basic principles,’ states Noppe.
He notes that all these guidelines and rules help investors understand the risks and rewards in mining projects, but ‘because of the lack of a common definition of terms used by companies to express due diligence and feasibility, they can often have different meanings.’
‘This sounds as if mining companies were purposely trying to hoodwink investors. This is simply not the case.’ The strict guidelines for reporting resources and reserves under the JORC Code, NI 43-101 and other codes, are well known. These codes define resources in economic terms, but the conversion of indicated and measured resources to probable and proved reserves requires a more detailed consideration of processing, metallurgical and other factors.
The codes also rely on the input of the ‘competent person’, that is a qualified practitioner who has at least five years’ experience in the project under review and is a member of a recognised professional body. Because each mineral deposit is different in geology, mineralogy, location and economic environment, hard and fast rules cannot be applied. In response, stock exchanges around the world rely on those professionals to give accurate and honest reports and opinions on projects that come to market for capital. A common set of definitions for the meaning and accuracy of due diligence and feasibility studies would go a long way to improve this reporting.
Mark Noppe, Managing Director of Xstract Mining Consultants Pty Ltd, 20/333 Ann Street, Brisbane, QLD 4000, Australia. Tel: +61 7 3221 2366. Website: www.xstractgroup.com