a code for the valuation of mineral properties and projects in … · 2009-08-27 · development of...

▲37The Journal of The South African Institute of Mining and Metallurgy JANUARY/FEBRUARY 2002

Introduction

The South African minerals industry hasundergone substantial changes in recenthistory, largely as a result of globalization andrestructuring. These happenings have beennecessitated by, or been the result of, globalcompetition in an industry subjected to severemargin squeezes. The restructuring andglobalization of companies has resulted on theone hand in the emergence of new companies,mergers and joint ventures, and on the otherin listings on foreign bourses. These actionshave attracted a new set of speculativeinvestors, different from the traditional institu-tional investor base. The result of these issueshas been a need for regulation and standard-ization of reporting according to good interna-tional practice, and transparency, linked toaccurate and reliable forecasting. Companies inSouth Africa have moved towards the use ofInternational Accounting Standards for

analysis and public reporting, and theSAMREC Code for Mineral Resource andMineral Reserve reporting has been developedthrough the auspices of the South AfricanInstitute of Mining and Metallurgy (SAIMM),and largely adopted by the industry.Furthermore, the listing requirements formining companies under Section 12 of the JSESecurities Exchange have recently beenmodified to deal with and incorporate theseissues.

As has been the case in Australia andCanada, where the VALMIN Code has beendeveloped, and the CIMVal Code is in theprocess of development, South Africa nowneeds to complete the process relating to thedevelopment of a code for mineral propertyvaluation, linked to the SAMREC Code and theListing requirements, which can be used bySouth African and foreign mining companiesinvesting in South Africa, and which fits intothe global standards that have been developed,while at the same time catering for local needs.

It is the purpose of this paper to describethe current situation in South Africa withregard to valuation of mineral properties, andto suggest a way forward. The paper is basedon a limited number of opinions, canvassedfrom as wide a range as possible, in terms ofinvolvement in the issue. It is a fact thatuncertainty and a degree of secrecy still existsin terms of reporting and valuation in SouthAfrica, as evidenced by the limited number,and wide variety of response. These concernsare fuelled currently by the issues of global-ization, international competitiveness,impending Capital Gains Tax and fundamentalchanges expected in the definition of mineralproperty rights. It is, therefore, not based onexhaustive research: this process, as part of awider consultative process will begin inearnest, once a base strategy has beenformulated.

A Code for the valuation of mineralproperties and projects in South Africaby A.S. Macfarlane*

Synopsis

The South African Institute of Mining and Metallurgy wasapproached by the Australian Institute of Mining and Metallurgy topresent a paper on the current practice in terms of the valuation ofmineral projects and properties, given the development of a Codefor the Valuation of Mineral Properties, developed in Australia (theVALMIN Code), and a similar Code in Canada (the CIMVal Code).

This paper is the result of research and investigation into thematter, in terms of the reporting of Mineral Resources andReserves, financial reporting practice, the Listing Rules of theJohannesburg Securities Exchange, and various practices invaluation.

The paper establishes that a strong linkage has already beenestablished between the SAMREC Code for the reporting of MineralResources and Reserves and the Listing Rules, and that, forcompleteness, a Code for Valuation needs to be developed.

This Code will be similar to its international counterparts, withthe necessary inclusions which are relevant to South Africa, andwill provide guidelines and definitions on matters such astransparency, materiality and competency in valuation.

It proposes that a multi-stakeholder steering committee beestablished under the auspices of the SAIMM, to deliberate anddesign a process for establishing such a Code.

* South African Institute of Mining and Metallurgy.© The South African Institute of Mining and

Metallurgy, 2001. SA ISSN 0038–223X/3.00 +0.00. Paper received Oct. 2001; revised paperreceived Nov. 2001.

A Code for the valuation of mineral properties and projects in South Africa

The current situation

The current situation in South Africa is one which is in aprocess of transition. Companies and organizations aregradually moving towards international standardization, as aresult of the requirements for off-shore listings, and toestablish simpler, transparent and user-friendly informationfor potential international investors. These moves comeagainst a background where the minerals industry has beena major contributor to the economy, through its contributionboth to the fiscus, and to the Gross Domestic Product of thecountry.

During times of isolation, large corporate structuresdominated the mining industry, providing critical mass tosupport the industry economically, and latterly to providecritical business mass to influence the path of the countrytowards political transition.

Furthermore, during the period 1948 to 1994, theminerals industry was of strategic importance to the countryin terms of currency exchange rates, foreign exchangeearnings, and, to an extent, a hedge against sanctions andtheir effect on the protected economy.

This was manifested through taxation policy, whichprovided incentives for investment, through the ability ofcompanies to write off capital expenditure for mineestablishment, against operating profit, in the year in whichit was incurred.

This appropriation method is still in effect, and continuesto provide such incentive for investment, but is not in linewith general international practice.

In addition to taxation, lease payment was required,which provided further income to the State. This leaseconsideration was payable regardless of mineral rightsownership. The lease consideration justified compensation tothe State for the loss of certain strategic ‘reserved’ minerals,such as gold, diamonds, uranium and oil, and must not beconfused with the international mineral royalty, which is apayment to the State for the minerals it owns. The leaseconsideration over privately owned mineral rights wasabandoned in December 1992, two years after theintroduction of Act 50 of 1990. The abolition of the old leasesystem resulted in mines no longer being required to mineaccording to their average payable grade, which opened thedoor for more business-like strategies to be introduced,focusing more on sound economic principles.

In the gold industry in particular, further incentives forinvestment, and the sustainability of the gold industry, wereprovided by a sliding tax scale, based on profit to revenueratios, and applicable to tax and lease payments.

Further capital allowances for investment in deep levelmines, were and are still available, at a rate of 12% of capitalexpenditure, to be written off against operating profit, for aperiod of up to ten years after expenditure.

Most mining projects were funded during this time on anall-equity basis, taking advantage of these variousallowances and tax breaks, although debt finance offered theopportunity to provide further tax shields through interestpayments being tax deductable. However, high interest ratesduring these times would generally make the cost of debtcapital prohibitively high, by comparison to equity under theprevailing circumstances.

During the 1990s, monetary and fiscal policy changed indriving the country towards a free market economy,gradually aligning itself with the global economy. Thisresulted in relaxation in foreign exchange regulation, freemarket influence on inflation and interest rates and a lesserreliance on the minerals industry within the economy (largelythrough development of other industries and changes inState expenditure needs).

These transitions have had a profound effect upon theminerals industry, particularly with regard to:

➤ Financing of mineral projects, in terms of increasingdebt financing

➤ The shareholder profile, changing to more speculativeinvestors seeking equity growth

➤ The structure of companies, changing to simpler, flatterorganizations

➤ Financial reporting becoming aligned with internationalrequirements

➤ Transparency of information to a more demandingaudience

➤ Listing requirements, both locally and internationally➤ Valuation methodology, becoming transparent and

aligned to best practice➤ Competitiveness, in the global arena, for funds➤ Globalization and its effect on markets and the

development of the industry in southern Africa➤ Changes in mineral rights and tax legislation ➤ Changes to environmental legislation, based on the

value of competing land concept.Despite these developments, many aspects peculiar to

South Africa remain for the time being. These need to berecognized, in terms of their effect on valuation issues, andin terms of the need to change or influence these in thefuture, to come into line with international best practice, andthe continuing globalization of the industry.

This section will explore the current situation with regardto some of these issues in more detail, in particular:

➤ Company structures➤ Financial reporting➤ Resource and Reserve classification➤ Listing requirements➤ Valuation methodologies➤ Independent reports➤ Other circumstances peculiar to South Africa.

Company structures

Two effects have been prominent in terms of companystructure in South Africa, namely the simplification of large

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38 JANUARY/FEBRUARY 2002 The Journal of The South African Institute of Mining and Metallurgy

Figure 1—Contribution of mining to GDP in South Africa, 1983–1999

corporations into operating divisions, with a clarification ofownership and accountability, and divestment of interest bylarge companies, and the emergence of new and juniorcompanies, either as public or private companies, sometimesoperating as joint venture partners, often as a means to‘empowerment’ of previously disadvantaged sectors of thepopulation.

The simplification process has also resulted in rationalization of mineral rights ownership, manifested in assetswaps and sell-offs of rights.

This activity is being given added impetus through theintended effects of the Draft Minerals Development Bill of1999 and the Minerals Policy Document of 1998, whichintend to return ownership of mineral rights to the State, aswell as promoting new entry into the sector.

This intent includes the establishment of a system ofpenalty for the under-utilization of mineral rights, andpossible expropriation in order to pass ownership toemerging or existing companies, who could turn un-utilizedrights to account.

This, coupled with desires to develop economicempowerment in previously disadvantaged sectors of thepopulation, has stimulated the need to build capacity in termsof entrepreneurship and to establish fair valuation practicesfor the transactions that result.

These activities have resulted in numerous instanceswhere valuation of mineral properties has become important,amongst them:

➤ The establishment of small, private mining companies,who have to develop feasibility studies and valuationsof exploration, potential or operating projects, in orderto raise debt finance

➤ The acquisition, sale or merger of small to mediummining or exploration companies or ventures, whichrequire fair valuation based on willing seller/willingbuyer principles

➤ An increasing number of joint venture and other ‘farm-in/farm-out’ activities, which require terms andconditions to be established based on fair valuation

➤ Asset swops and rationalization of mineral rights.Historically, the mineral right boundaries have beenbased on surface rights ownership boundaries, literallyfarm fences. Rationalization is complicated by theserestrictions, whereby third parties (surface rightsowners) require compensation or rent through royaltiesor some other form of income, always based onprojections of future earnings of the mine operator

➤ Other complications include tribute and service

agreement type arrangements, which also requirevaluation of future earnings as the basis for settingprofit ratios, income distribution and the allocation ofresidual liabilities

➤ Tribal ownership of rights, and the redistribution orrestitution of these has become particularly important,as evidenced by the Bafokeng nation case involvingImpala Platinum, in recent times. In extreme cases thiscould result in expropriation, but in either case royaltycalculation and/or compensation must be based onvaluation.

➤ Changes in ownership, asset swops, mergers, etc.,carry residual tax-related issues, created by the taxstructure. For example, the appropriation method ofaccounting for capital redemption may result inunredeemed capital shields, which have to form part ofthe valuation process, and be part of the establishmentof fair value

➤ Other taxation issues, such as ‘ring fencing’ removal,whereby tax write-offs were restricted to expenditureand income within prescribed geographical boundaries,require justification through valuation of future cash-flow streams

➤ Ownership changes, coupled with environmentalprotection requirements, necessitate the incorporationof residual liability for environmental restitution, to bebuilt into any current transaction, by way ofestablishment or transfer of trust funds established outof cash-flow for the purpose

➤ The impending (October 2001) introduction of CapitalGains Tax

➤ Environmental legislation requiring valuing ofcompeting land uses for government decision-making

➤ Good practice and due diligence in all these matters,should require that independent assessment is includedas part of the process of the transaction, not only forpublic companies, but also for private companies. Thisis increasingly the case.

Various standards exist for dealing with these activities,namely:

➤ Adherence to the International Accounting Standards(IAS)

➤ Adherence to Generally Accepted Accounting Principles(GAAP)

➤ Adherence to the SAMREC Code for Resource andReserve reporting

➤ Adherence to the JSE Securities Exchange ListingRequirements

➤ Adherence to requirements of the Companies Act➤ The Expropriation Act of 1975➤ Various Acts and Ordinances in terms of property

valuation, at National and local authority level.

Financial reporting

South African companies, since more transparent reportingbecame necessary, have generally used the GAAP principlesas a guideline for reporting.

For a company to be listed in an overseas country, it isnow preferable for the company to comply with theInternational Accounting Standards (IAS) instead.



Figure 2—Domestic control in South African mining


The International Organization of Securities Commissions(IOSCO) requested the International Accounting StandardsCommittee in 1996 to develop a set of mutually acceptableInternational Accounting Standards, which are now beingdeveloped further in terms of a project set up in 1998 to dealwith Accounting for the Extractive industries.

As mining companies have changed their focus fromprimarily domestic projects and shareholders towardsinternational investments, it has become increasinglyimportant for these companies to prepare financial reportsthat are not only accepted and understood in the country ofincorporation, but which are internationally comparable and,ideally, allow listing on a foreign stock exchange.

However, companies in South Africa are still subject totaxation regulations which provide for appropriation.

As a result, although tax is physically paid on this basis,dual reporting is the norm, based on both appropriation andamortization of capital, in IAS format.

The following summary describes current practice, interms of reporting.

Exploration, development and constructionexpenditure

Accounting practice deals with exploration and developmenton a cost basis. This requires either carry-forward of costs, orwrite-off of expenses, dependent on the perceived viability orpromise of the project. In this regard, entities involved inexploration activities tend to carry forward expenditure until:

➤ The project is abandoned, when the expenditure iswritten off

➤ The project advances to the development stage, when itis transferred to a development asset

➤ The project is sold.Asset write-downs are increasingly common in South

Africa, but were previously uncommon. It is interesting tonote that asset write-downs do not invoke the kind of equityholder displeasure that they should: perhaps herein lies ascenario for the future.

Production reporting

As with exploration and development, all expenditure up tothe point of achieving commercial levels of production mustbe capitalized and appropriated. This includes pre-productioncosts, and establishment costs, which are written off againstoperating income before tax, for tax purposes.

Where companies amortize these costs in order to complywith IAS, the determination of the changeover to commerciallevels of production is based on a range of criteria such aspercentage of design capacity achieved, continuousproduction and so on.

Once in production, expenditure is expended in the periodin which the product is sold or loses its value.

Cash cost reporting in terms of the Gold InstituteStandard has been adopted in the gold industry, andincreasingly in other mineral sectors.

Business combinations

Accounting and reporting of business combinations(acquisitions, mergers, etc.) should be done on the basis offair market value.

This requires that fair market value be assessed as theamount for which the asset could be exchanged or a liability

settled between knowledgeable, willing parties in an arms-length transaction.

IAS 22 establishes principles which are applied, but thereis a large amount of flexibility in South Africa governingaccounting of acquisitions. This may include differentmethods of accounting for issues such as goodwill, andexploration.

An issue here is the definition of an asset, and how itsvalue is ascertained: cost or future value in terms of cash-flow. This issue requires resolution, since it may result inerroneous valuations if they are based on balance sheetentries, which are derived from costs.

Limited statutory guidance is given in the Companies Act.

Joint ventures

South African companies conform to IAS 31—FinancialReporting of Interests in Joint Ventures—which defines jointventures as all contractual arrangements ‘whereby two ormore parties undertake an economic activity which is subjectto joint control’.

Depreciation and amortization

Due to the fact that most mining companies in South Africause the appropriation method of accounting, there are nocharges for amortization or depletion of reserves.

The principle applied is that mining is a wasting asset,and therefore there is no need to keep funds to finance thereplacement of the mining facility, and that shareholder’sfunds are invested in the wasting asset and the cost ofmining assets over and above the initial capital is providedout of profits earned.

This method allows early capital redemption, and servesas an incentive for investment.

The move to IAS however, as noted previously, nowmeans that companies are increasingly reporting on both anamortization and appropriation basis.

It remains to be seen whether mining taxation policy willchange in line with this.

(It is the opinion of the author that in due course, itshould).

Inventory

Due to the usage of the appropriation method of accounting,no account is taken of inventory in process.

The costs associated with the build up of inventory atstart-up are capitalized and appropriated. Once in commercialproduction, only finished products are accounted for.

Revenues

Revenue reporting in South Africa complies closely with IAS18, which requires that revenue is recognised when there hasbeen a transfer of the significant risks and rewards ofownership, and when the amount of revenue and the costsincurred, can be reliably measured, and when the flow offuture economic benefits is probable.

There is no clear statement on the valuation andreporting of hedging, other than the requirements fordisclosure.

Closure and rehabilitation

South African companies accrue for these costs, throughestablishment of trust funds.

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Resource and reserve classification

South Africa has developed and adopted the SAMREC Codefor the reporting of Resources and Reserves in recent years.The Code and its development are described below and it hasbecome a requirement that competent persons reporting interms of Section 12 comply with the SAMREC Code. Thedevelopment of the Code began in 1992 when a committee,under the auspices of the Geological Society of South Africa,and the Geo-statistical Society of South Africa, developed adraft Code for reporting of resources and reserves, followinga request to do so by the Council of Mining and MetallurgicalInstitutions (CMMI).

The draft Code was presented at the CMMI congress in1994, but failed to gain acceptance from all quarters, notablythe JSE and the Chamber of Mines of South Africa.

An ad hoc committee was formed by the CMMIsubsequently, to develop a set of definitions for the reportingof resources and reserves, comprising representatives fromthe United States, Australia, Canada, United Kingdom andSouth Africa.

Agreement was reached on a common set of definitionsat a CMMI International Definitions Group meeting in Denver,in 1997, which was subsequently endorsed by the UnitedNations Economic Commission for Europe (UN-ECE), as theirstandard for the UN Framework Classification, at a jointmeeting held in Geneva between the CMMI InternationalDefinitions Group, and the UN-ECE Task Force on Resourceand Reserve definitions.

Following the ‘Denver accord’, The South AfricanInstitute of Mining and Metallurgy (SAIMM) constituted theSouth African Mineral Resource Committee (SAMREC) inJanuary 1998, for the purpose of compiling a South AfricanCode, to be known as the South African Code for theReporting of Mineral Resources and Mineral Reserves (theSAMREC Code).

The Code incorporates the definitions agreed at theDenver accord, and is consistent with the principles andstructure of the Australasian Code for Reporting of MineralResources and Ore Reserves (JORC Code).

The development of the Code involved the participation ofa wide spectrum of stakeholders, including representativesof:

➤ The SAIMM➤ The South African Council for Natural and Scientific

Professions➤ The Geological Society of South Africa➤ The Geostatistical Association of South Africa➤ The South African Council for Professional Land

Surveyors and Technical Surveyors➤ The Association of Law Societies of South Africa➤ The General Council of the Bar of South Africa➤ The Department of Minerals and Energy➤ The JSE➤ The Council for Geoscience➤ The South African Council of Banks➤ The Chamber of Mines of South Africa.

The Code has been endorsed by the SAIMM and theSAMREC member organizations, and the Code is nowincorporated into Section 12 of the listing rules of the JSE.

During the process of development of the Code, draftswere sent regularly to equivalent committees in Australia, theUnited Kingdom, the United States, Canada and the United

Nations, in order to ensure consistency with other Codes,while at the same time ensuring that local requirements werealso addressed and incorporated in such a way as not tocompromise the intent of producing a document that wasconsistent with international practice.

Main elements, intent and concepts embodied in theSAMREC Code

The Code is intended to represent the minimum acceptablestandard for reporting of Resources and Reserves.

It is therefore in the form of standards, recommendationsand guidelines, with definitions as appropriate.

It relies on three key principles which govern theapplication of the Code, these being transparency, materialityand competence.

Transparency requires that the reader of a public report isprovided with sufficient clear and unambiguous information.Materiality refers to the requirement that the report containsthe relevant information that is required for the purpose ofthe reader, while competence relies on suitable qualificationand experience of the person compiling the report.

The main aspects of the Code are contained in theappendix, but are essentially as follows:

➤ The definitions for Resources and Reserves, respec-tively

➤ The incorporation of economic viability as thefundamental factor for classification

➤ The adoption and description of the ‘modifyingfactors’, in accordance with the Denver accord

➤ The incorporation of the concept of confidence levels inclassification

➤ Mineral Resources being inclusive or exclusive ofMineral Reserves

➤ The qualifications and duties of the competent person➤ The accreditation of foreign professionals.

Additionally, the Code contains seven major definitions,which comply fully with the definitions of the Denver accord,these being:

➤ Mineral resource➤ Inferred mineral resource➤ Indicated mineral resource➤ Measured mineral resource➤ Mineral reserve➤ Probable mineral reserve➤ Proved mineral reserve.

Definitions are also included for ‘public reports’ as wellas ‘competent person’, since these have domestic as well asinternational relevance.

In terms of valuation issues, these two definitions are ofparticular relevance.

‘A public report or public reporting is a report or reportingon exploration results, mineral resources or mineral reserves,prepared for the purpose of (a) informing investors orpotential investors and their advisers, or (b) satisfyingregulatory requirements. Companies are encouraged toprovide information which is as comprehensive as possible intheir public reports.’

‘A “competent person” is a person who is a member ofthe South African Council for Natural and ScientificProfessions (SACNASP), and/or the Engineering Council ofSouth Africa




(ECSA), and/or South African Council for Professional LandSurveyors and Technical Surveyors (PLATO) or any otherstatutory South African or international body that isrecognized or may be approved by SAMREC. A competentperson should have a minimum of five years experiencerelevant to the style of mineralization and type of depositunder consideration and to the activity which that person isundertaking. If the competent person is estimating, orsupervising the estimation of mineral resources, the relevantexperience must be in the estimation, assessment andevaluation of mineral resources. If the competent person isestimating or supervising the estimation of mineral reserves,the relevant experience must be in the estimation,assessment, evaluation and economic extraction of mineralreserves.’

These definitions, linked to the requirements fortransparency and materiality, and the conversion ofResources to Reserves through the modifying factors, placeincreasing emphasis on economic and valuation issues. Thisis particularly important for the compilation of competentpersons reports, or independent assessments that arerequired during mergers/acquisitions or other forms ofbusiness combinations, as well as for listings.

It is against this increasing requirement that the JSEreviewed its listing requirements, and established the linkagebetween these and the Code.

The new JSE Listing requirements : Section 12

As mentioned earlier, during the compilation of the Code, theJSE began drafting a new set of listing rules for mineralcompanies, which were then promulgated in September2000.

These listing rules adopted the Code in its entirety for thepublic reporting of Resources and Reserves, in order for thisreporting to be consistent with international practice.

The listing requirements further require that:➤ Competent Persons must comply with the Code and

must ensure that the information that is presented is ofsuch standard that they should be clearly satisfied intheir own minds that they could face their peers anddemonstrate competence in the commodity, type ofdeposit and situation under consideration

➤ They should also be satisfied that their reporting hasensured full disclosure by the entity commissioning itswork of all material information that might prejudicethe integrity and accuracy of the information that isbeing reported upon. No information should bedisclosed which could mislead the readers of the reportwith respect to the commercial prospects of the projectsbeing reported upon

➤ They should also be satisfied that their work has notbeen unfairly influenced by the commissioning entityas a result of unfair pressure over fees, time or futurerewards

➤ Individuals and companies that prepare and reportunder this section under the guidelines of the Codeshould be aware that, as part of the JSE approvalprocess, the JSE Listings Division will be referring allCompetent Person’s reports to an independent technicalreader’s panel constituted by SAMREC for assessmentand comment. Any material complaints concerning aCompetent Person will be referred by SAMREC to theJSE Listings Division for disciplinary action by thebody under which they are registered as professionals.

The process which is described in the last paragraph(extracted from the Listing rules), is as shown in Figure 4,and the disciplinary procedure implied by it is as shown inFigure 5.

Of significance in terms of valuation, is that the Listingrequirements, in the case of both exploration and miningcompanies, refer extensively to the inclusion of economicfactors used both in the SAMREC ‘modifying factors’ as wellas financial information used in the costing or cash-flowestimates.

In the case of exploration companies, this includes adetailed estimate/statement of:

➤ The exploration funding requirements for at least twoyears following publication of the Competent Person’sreport

➤ The exploration expenditure incurred to date and/orbudgeted for

➤ The projected adequacy of capital raised for explorationpurposes.

This is of particular significance to valuation of thesecompanies, since common practice is to value theseoperations on a cost/expenditure basis, or on a mineralcontent basis.

In the case of mining companies, the requirements aremore specific with regard to valuation, viz:

’Notwithstanding disclosures made in terms of paragraph12.14(a), the Competent Person’s report must includeannualized forecast free cash flow mining valuation numbersand all key criteria and assumptions made in arriving at suchvaluation, which shall include in tabular form, withoutlimiting the generality thereof, that portion of the life of themine, stated in years, as determined by the CompetentPerson for valuation purposes (for which there arereasonable prospects that the Mineral Resources and MineralReserves can sustain the relevant life of mine cash flows),and for each such life-of-mine year, the following:

➤ Expected run-of-mine tonnage and grade to be mined➤ A reconciliation of the grade and tonnage of the

Mineral Reserves (fully diluted to plant) back to in situMineral Reserves

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Figure 3—Intent and definitions embodied in the SAMREC Code

ProbableProved

MineralReserves

➤ Recovery factors showing final grade recoveriesreconciled back to Mineral Reserves delivered to plant

➤ Revenue receivable per final defined product unit soldand in total (for the year)

➤ Mining, beneficiating, smelting, refining, marketing,environmental and any other cost categories perdefined unit (e.g. run of mine tonne, reef tonne,recovered unit) and in total (for the year)

➤ Capital expenditure, differentiating between initial, newand ongoing capital expenditure

➤ Expected salvage value of assets less liabilitiesincluding environmental liabilities at the end of thecash flow valuation

➤ Taxation, royalties and other similar charges(providing pertinent descriptive details where relevant)

➤ Unredeemed capital expenditure balances and assessedlosses

➤ Expected interest and finance costs➤ Changes in working capital and consequent cash flow

implications➤ An estimate of all funding requirements and funding

movements, differentiating between debt, equity andinternal resources

➤ Repayment of long-term loans and debt➤ Final net free cash (for each year)➤ Range of real or nominal discount rates used to

discount the free cash flow per annum and consequentnet present values

➤ The net present value per share or unit used for finalvaluation purposes

➤ Economic assumptions such as exchange rates, interestrates, inflation rates, escalation and de-escalation ratesand any other relevant factors, and

➤ The specific terms of any forward sale or hedgingcontracts entered into.’

These provisions have thus established a linkagebetween the Resource and Reserve reporting, and thevaluation of their exploitation in terms of cash flow analysisin feasibility studies.

The intent here is again that the principles oftransparency, materiality and competence are carried throughto valuation, although these are not explicitly stipulated inthe requirements. To do so, will require the development ofan appropriate valuation Code, which will define these issuesin mineral property valuation.

Valuation methodologies

Currently, South Africa does not have a Code for valuation,such as the VALMIN Code, or the proposed CIMVal Code.

The author undertook a survey of current practices,based on responses from operating companies, analysts,bankers, academics, government agencies and otherinterested parties.

Although this survey was a very preliminary assessment,and therefore not fully comprehensive or statisticallyrepresentative, it did give some useful information on whichto estimate the status quo in mineral project valuation.

Table I shows a summary of most commonly usedmethods, for various types of assets and their valuation.

In addition to these, properties with no history ofexploration are valued on a R/ha basis, on marketcomparables with similar transactions over the same mineralpotential, or on a nominal rate approach.

This is particularly important in the light of the fact thatunder South African legislation, mineral rights and surfacerights may be separated, and end in separate ownership. Thisbecomes interesting when surface rights are expropriated orrepossessed, and the mineral rights are then separated out,but with no indication of value.

In terms of assessing a broad description of current SouthAfrican practice, Table II shows the situation by developmentstage and purpose.

The analysis shows a preference for discounted cash-flowtechniques, at any stage where sufficient information isavailable for conducting a meaningful exercise.

This analysis is in broad agreement with practicesworldwide, which are illustrated in the following Tables, IIIand IV, taken from practice reported in Canada. Thecomparison is valuable, since it shows that current practice inSouth Africa, although not formalized or regulated, alignsinternationally, and therefore will allow the development of aCode based broadly on the status quo.

The survey showed that while there is no specific Codeother than SAMREC and the Section 12 Listing requirements,there is a large degree of commonality of approach, whichcan be summarized as follows.

➤ Companies or organizations conducting valuationsgenerally use more than one methodology forvaluation, in order to mitigate against any risks orshortcomings in a particular methodology. For



Figure 4—SAMREC review procedure in terms of Section 12 of the JSE Listing requirements


example, whilst within a DCF analysis, both IRR andNPV would be calculated in order to deal with thelimitations of each, cost methods and marketcomparables would also be used. Furthermore,sensitivity analysis establishes a range of possibleoutcomes.

➤ The methodologies to be applied are dependent on theavailability of information. Thus, exploration propertyvaluation is more often based on multiples ofexpenditure or market comparable methods (based forexample on $/oz), because of the lack of confidence inthe Resource statement (based on SAMREC), or on theprojection of future cash-flows.

➤ Generally, DCF analysis is the preferred methodologyfor operations where future cash flows can beidentified. However, the accuracy of analysis is entirelyopen to the accuracy of the input information, theassumptions applied and the discount rates used.Herein lies a concern that lack of competence orstandards can very easily influence the outcome ofthese valuations, especially where two parties areentering into a negotiation for a sale or merger, wherethe motivation for the transaction is not common toboth parties.

➤ Option pricing methods are not widely used at thisstage in South Africa. They are generally reserved forvaluations where information is scarce, as in the caseof exploration properties.

➤ In the case of operating mines, real option pricing,despite the understanding that it values futuremanagement flexibility more adequately than DCF, isnot often used. This is because of two factors. Firstly,its perceived complexity makes it unattractive tooperating mine personnel. Secondly, larger companiesfeel that they will not attempt to find value in a projectwhich has not stood up to the test of DCF. In otherwords, if a project is not sufficiently robust to be

acceptable in DCF terms, then it would not providesufficient returns under an option pricing scenario.This assumes that sufficient sensitivity and riskanalysis has been conducted to define sufficientconfidence in the valuation outcome.

➤ Discount rates in South Africa may often be overstated.This is apparent while the country is in an economiccycle where inflation is declining, and where interestrates are also declining. Furthermore, risk premiumswhich are applied may result in double discountswhere diligent risk assessment and mitigation hasalready been done on key input variables.

➤ The discount rates which are applied, are generallybased on a Cost of Capital, when used for calculation ofNPV. Whilst these should be based on the Capital AssetPricing model for equity, and cost of debt, the morecommon practice is to use generic rates which areapplicable to the particular company. Furthermore,

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Figure 5—Disciplinary procedure adopted by SAMREC

Table I

Current South African valuation practice

Type of asset Most common methodology

Exploration properties Multiple of expenditure; R/ha; $/oz; market comparables

Unexploited Multiple of expenditure; R/ha; $/oz; mineral rights option pricing; tail ??-ounceResources and Reserves DCF; option pricing; tail-ounce; R/ha; $/ozProperty rights Market valueMining operations DCF; option pricing; market capitalization/ounceFixed assets Lesser of cost and net realizable valueMoveable assets Lesser of cost and net realizable valueProperty Lesser of cost and net realizable valueLand Lesser of cost and net realizable valueLiabilities Appraised valueGoodwill Difference between book and actual valueShare interests Market valueService agreements CostResidual value Salvage value; appraised value

Complaint Samrec Committee Statutory body

Complaint may be eitherirocompetent person’s reportspecifically, orinterpretation/use of reserve and/orresourcein prospectus (misuse ofCPR)or procedural non-complianceor gross negligence orothers.

Evaluates complaint todetermine if breach toSAMREC and/or JSEhasoccurred. Report typeandmagnitude of breachandrefers to JSE who referto respectivestatutory body.

SACNASP, ECSA,PLATOEvaluates complaint anddecides on proceduresandsanction according to itsownCode and regulationsInforms SAMREC ofdecision.

Minimum Acceptable Rates of Return, as hurdle rates,are often simply established as the Cost of Capital witha premium which reflects the company’s aversion torisk. It is likely that these calculations for discountrates will become more critically derived, given themove to more debt finance, international financing andtighter projects.

➤ The principle of a willing buyer and a willing seller,operating at arm’s length is, or should be, generallyapplied. If this is done, and the principles oftransparency, materiality and competence are applied,fair market value should be derived, no matter whatthe purpose or intent of the valuation exercise.

➤ Essentially, all valuations which are in the public



Table II

Common South African practice, at each stage or purpose of valuation

Development stage Preferred methodology Approach

Mineral Rights over virgin territory R/ha market comparables or nominal rate MarketEarly exploration Multiple of expenditure;R/ha or $/oz market comparables Cost/market comparablesAdvanced exploration Discounted cash-flow; option pricing Income/option pricingPre-feasibility studies Discounted cash-flow IncomeFeasibility studies Discounted cash-flow IncomeDevelopment stage Discounted cash-flow IncomeProduction stage Discounted cash-flow IncomeSalvage or closure Appraised value or historical cost Cost/market comparablesOther applicationsCapital Gains Tax Discounted cash-flow or DCF of dividend or royalty streamTransfer duty Discounted cash-flow or DCF of dividend or royalty streamEnvironmental legislation Discounted cash-flow or DCF of dividend or royalty streamMergers and acquisitions Discounted cash-flow or DCF of dividend or royalty streamExpropriation Discounted cash-flow or DCF of dividend or royalty stream

Table III

Common practice in valuation methods applied

Approach Methods Brief description of method

Cost Appraised value method Meaningful past exploration costs plus warrented future costsHistorical cost method Cost less any outstanding obligations and/or depletion

Income Discounted cash-flow analysis The NPV of a stream of cash flowsMarket Comparable transactions Similar properties should have similar value

Market capitalization per reserve or resource ounce Total capitalization dollars divided by total reserve or resourceMarket capitalization per ounce of annual production Similar to above but based on production. The incoming participant

Option agreement/JV terms agrees to make certain payments and/or expenditures on the propertyOption pricing Call option value Allows flexibility, good for significant unknowns

Put option value Allows flexibility, good for significant unknownsOther Gross contained metal value Tonnage x grade x price

Statistical/probabilistic Probability factor applied to NPV of a theoretical depositGeoscience factor method A methodology established by Kilburn using location, grade,

geology and applying a factor to each categoryDecision tree analysis Utilizing traditional yes-no analysis and also applying

a probability factorRules of thumb Back of the envelope analysis, e.g. $15 per ounce in the ground

Table IV

Valuation techniques typically applied at various stages of project life

Property stage characteristic Dominant methods

1 Very early stage exploration, (just above the level of ‘moose pasture’ Appraised value/cost approach, market comparableswith a few holes drilled with encouraging results)

2 Early stage exploration (with several holes drilled with encouraging results) Appraised value/cost approach, market comparables3 Late stage exploration (decision made to do a full bankable feasibility study, Discounted cash flow, market comparables

pre-feasibility already completed with positive results4 Early development (a full bankable feasibility study completed and the bank Discounted cash flow, market comparables

financing lined up; construction to begin in the next six months5 Late development (full completion to be reached in the next six months Discounted cash flow, market comparables6 Producing mine Discounted cash flow, market comparables7 Late stage producing mine (reserves to be depleted in 2 years; Discounted cash flow, market comparables

limited further exploration potential)8 Mine closed (equipment still on site, limited further exploration potential) Salvage value

Source: CIMVal


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domain should be subject to these principles andstandards, especially those which are regulatedactivities such as listings and mergers. In this regard,there is agreement that a Code which is in line withinternational practice, and which links the threeaspects of Resource and Reserve reporting, Listingrequirements and valuations, is necessary. This Codeshould embody principles and standards alreadydeveloped in SAMREC, IAS and Section 12, as well asthose already developed in other international Codes.The Code will also address those issues which arepeculiar to South Africa.

➤ There is agreement that the Code should not beprescriptive on valuations methodologies to be used,but, like SAMREC, should establish principles andguidelines, and establish definitions for competency.

➤ Independent technical and valuation assessmentshould be incorporated into normal practice, especiallyin circumstances of hostility, but also as a check on thequality and accuracy of input variables, assumptionsand risks.

➤ The Code will address valuations in the public domain,but, as with SAMREC, the content and intent should beextended to everyday practice, for both internal andexternal use. There should therefore, be clear audittrails for value, from Resource statements through tothe Balance sheet, and the assessment of market valuein the stock exchange.

➤ Independent valuation is also necessary for theassessment of salvage values, liability assessment, andvaluations of inventory, stock, fixed and moveableassets. Definition and agreement are required as to theaccounting methodology to be used in each or all cases(historical cost, book value, market value, etc.), andthe treatment of depreciation.

➤ The issue of goodwill in transactions is one that hasnot been defined and described in transactions. Theprinciple should be incorporated that goodwill is valuedand amortized in the valuation process. A number oftransactions have been conducted in South Africa,involving substantial components of goodwill, in theestablishment of so-called empowerment companies.

➤ Value is placed on mineral properties, mineral rights,surface rights, property and royalties by the State,through the Department of Minerals and Energy. Thisis for the purpose of establishing value and compen-sation in the case of expropriation, and for establishingthe value of State-owned rights and royalties, or for thepurpose of establishing tax, lease or other rent typepayments. Various methodologies are used for thispurpose, and covered by various statutes andprecedents. Clearly, in the interests of transparency andmateriality, these situations must be adequatelyaddressed within the Code for valuation, which wouldthen include the input of professional property valuersengaged for these purposes.

➤ Property valuers have used royalty flows to estimatevalue of mineral properties in some circumstances.Whilst this is in line with professional valuationpractice (The National Property Education Committee),this methodology is open to inaccuracy due to risk infuture cash-flow and variation in future outputs, and is

inconsistent with the approach adopted by theDepartment of Minerals and Energy, which uses eithercapital statements of in situ reserves, or sharevaluations and ratios. Clearly these inconsistenciesneed to be addressed.

➤ Various guidelines have been developed, both withinSouth Africa, and worldwide, on appropriate accuracylevels to be embodied in feasibility studies andvaluations.

These accuracy levels are dependent on the quality ofinput information as well as it’s quantity. Normal riskmanagement processes should ensure consistency in dealingwith input parameter risk, linked to feasibility study level ofdetail required. Table V shows an approximate detail scale tobe used as a guideline, but this appears to vary fromcompany to company, although it is clear that a bankablefeasibility study and valuation will require accuracy of allinput parameters to be within 5%, and to have been thesubject of substantial risk and sensitivity analysis, to theextent of having statistical confidence limits applied.

The derivation of these accuracy levels is done throughcritical assessment of the input variables, in order to reducerisk and uncertainty.

This is done through sensitivity analysis to identify keyvariables, with an increasing tendency to follow this with asimulation to assess confidence levels and the quantificationof risk.

This is becoming increasingly important in order toassess the debt coverage that the project can sustain,especially from the financier’s point of view.

Independent reports

Independent reports value mining assets using variousmethodologies, including discounted cash flow analysis andindustry valuation benchmarks such as multiples of cashflows, earnings, production, resources and reserves. Thesevaluation methodologies tend to consider historicalinformation only in so far as it provides an indication offuture performance, with the principle focus being on theprospects for the assets, in terms of the size and quality offuture earnings and cash-flows.

Valuations cover mining assets, Mineral Rights, serviceagreements, share interests and liabilities, and the valuationsare based on the technical data which is outlined in thereport of the Independent Technical Adviser, which verifiesthe accuracy of the input information.

The interests of the independent advisers must thereforebe taken into account in the development of a valuationCode.

Circumstances peculiar to South Africa

From the above analyses, it is clear that there is a need todevelop a Code for Valuation for South Africa. This Codeshould embrace as many of the aspects which have beenaddressed in the VALMIN and CIMVal Codes as are applicableto South Africa, operating in a global environment, but itshould also take cognisance of certain circumstances andissues which are peculiar to South Africa. Some of these areas follows.

➤ The Draft Minerals Development Bill is currently underpublic scrutiny. The Bill has as its main aim the returnof Mineral Rights to State ownership. The statedpurpose of this is to open Mineral Rights access to awider section of the community, and to stimulateinvestment into the small and medium scale miningsector. Implications of the Bill are that Mineral Rightsshould be utilized, and that dormant Rights should beredistributed.From an economic point of view, this requires thatRights be valued, either from the perspective of valuingtheir feasibility, or from valuing for the purpose ofexpropriation.

Furthermore, the intent of the Bill has already seen theestablishment and entrance of a number of new companies,either independently or as joint venture partners.

Under these circumstances issues relating to fairvaluation become increasingly important, for valuation,expropriation and financing purposes.

➤ The circumstances described immediately above requirethat small mining companies conduct valuations andfeasibility studies, for raising finance. The ValuationCode will need to take into account the requirement forthese organizations that methodologies which requiresignificant levels of external opinion, do not becomeprohibitively expensive, and thereby become self-defeating.

➤ Capital Gains Tax is to be introduced to South Africa inOctober 2001. In principle, any upgrading ofinformation on Resources and Reserves implies anincrease in value, which would then be liable forCapital Gains Tax upon realization of value. This aspectmay also be self-defeating in terms of encouraginginvestment, and also requires that valuation takeaccount of these issues. This will need to beinvestigated and catered for in the Code.

➤ South Africa, in terms of sustainable development ofthe minerals industry, must provide for ‘social capital’for issues such as the prevalence of HIV/AIDS,increasing standards for environmental care, trainingand development, as well as dealing with residual risksand liabilities. The valuation of these aspects needscareful consideration.

➤ The taxation policy relating to appropriation has beencovered in detail, and will result in clauses relating tocapital appropriation, capital allowances, dividendvaluation and other tax issues being incorporated. Thisalso provides the opportunity to recommend changes infiscal policy that are appropriate to internationalconsistency in reporting and valuation.

➤ Under South African legislation, gleaned from Roman-Dutch Law, mineral rights are a limited real right inthat they can be separated from the ownership of land,and transferred to a third party. However, this can onlyhappen once the minerals have been separated fromthe land. This complication has to be taken intoaccount in valuation of properties, where thisseparation can occur.

A summary of the circumstances in South Africa

The above analyses form the basis of the following summaryof the situation in South Africa, with regard to mineralproperty valuations.

➤ The South African mining industry is on a fast track toglobalization, not only in terms of corporate strategy ofmajor companies, but also in terms of the effects onnew emerging companies. Changes in economic, fiscaland regulatory policy internally are creating the needfor consistent valuation, which is in line with interna-tional practice.

➤ Changes in ownership, and the change in structure ofcompanies, requires a set of guidelines and rules thatcan be consistently applied.

➤ IAS is increasingly being adopted as the preferredmethod/benchmark for financial reporting. A numberof definitions still have to be developed andincorporated, and these need to link to a Code forValuation, such that financial reporting on mineralprojects is consistent with international practice,Listings requirements, and other public reporting.

➤ The SAMREC Code has been adopted for reporting ofResources and Reserves, through a process which hasensured that it is consistent with international practice.It has been adopted and incorporated into the JSEListing rules, which places South Africa in a leadingposition as far as valuation requirements areconcerned, for listing purposes. The final linkage willbe the development of a Code for Valuation.

➤ A review and disciplinary procedure has beendeveloped for dealing with transgressions of theSAMREC Code and Listing requirements.There is some concern that the sanctions which may beimposed are inadequate, or difficult to apply in practice.Thus, there are views that the Code should embodymore stringent regulations and sanctions, shouldmalpractice or incompetence be discovered.

➤ The compilation of the SAMREC Code has been aninclusive process, although there are concerns fromcertain quarters that the process was not inclusiveenough, and that the development of a Valuation Codewill require input from quarters not previouslyconsidered. This includes, for example, the professionalproperty valuer, the independent technical advisers, theMinistry of Finance, the auditors and so on.

➤ The Code must examine and define the competencyrequirements for a Competent Valuer. As with theCompetent Person described in SAMREC, theCompetent Valuer will be required to have requisiteexperience and qualifications, and be registered as a



Table V

Accuracy levels common in stages of projectvaluation

Type of feasi- Accuracy of capital Engineering Suitability of bility study cost estimates completed DCF methodology

Exploration review 50% nil NoOrder of magnitude 40% 2–3% Generally, yesstudyAdvanced explor- 20–40% 3–10% Yesation studiesPre-feasibility study 20% 10% YesFeasibility study 10% 30% YesJob control 5% 50–70% Yesestimates


competent mineral property valuer. The details of theserequirements need to be established.

➤ The principles of transparency, materiality andcompetence must underpin the contents and intent ofthe Code for Valuation of mineral properties.

➤ The Code must be developed as a guideline, which isprescriptive to the extent of stipulating competencies,registration, accounting methodologies, accuracylevels, and formats. It will not be prescriptive on issuessuch as methodologies of valuation to be applied orother areas where discretion and flexibility arerequired.

➤ Residual inconsistencies must be highlighted. Wherethese are statutory, then the Code should identify andhighlight these, with a view to influencing govern-mental policy, where it is in the interests of thestakeholders to do so.

➤ The Code should take account of circumstancespeculiar to South Africa, and incorporate these. Otherthan this, the Code should use VALMIN and CIMVal asthe base, recognizing the good work that has alreadybeen done in Australia and Canada, and recognizingthe value of the international consistency alreadyestablished through these documents.

➤ Accuracy levels for the stages of development offeasibility studies and analyses need to be developed,which should be embodied in the Code. This will beindicative of the degree of risk analysis that isnecessary in arriving at a bankable feasibility study.

The way forward: the birth of the SAMVal Code

This paper, based on discussion and response to the issue ofmineral property valuation in South Africa, was originallyrequested for presentation at the VALMIN Congress inBrisbane in October 2001.

Its research and compilation has identified the need forthe development of a Code for Mineral Property Valuation forSouth Africa, which is consistent with international practice,and which takes account of local circumstances.

The paper will be presented in Brisbane, and will bepublished in the Journal of the South African Institute ofMining and Metallurgy.

The SAIMM would seem to be the logical custodian of thedevelopment of the Code, given its track record of thedevelopment of the SAMREC Code, and given its professionaland independent, non-commercial status.

Publication is therefore intended to spark interest in thesubject from a wide range of stakeholders, and to enlistparticipation in the formation of an inclusive committeestructure to discuss and develop the new Code.

Such a committee will include, and not be limited to,amongst others:

➤ The SAIMM➤ The mining companies➤ The Chamber of Mines➤ The Financial Institutions➤ The JSE Securities Exchange➤ The South African Council for Valuers➤ Academia ➤ The Law Society and the Bar➤ Independent advisers

➤ The Institute of Chartered Accountants➤ The Learned Societies➤ Etc.

A steering group and appropriate working groups willthen be established to move forward on a schedule to bedeveloped, which will ensure meaningful and measurableprogress on the issue.

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Price Waterhouse Coopers. Financial reporting in the mining industry for the21st century. Price Waterhouse Coopers, Johannesburg, 1999.

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St Helena Gold Mines Ltd. Scheme of arrangement: Johannesburg. November1999.

SAMIS, M. and POULIN, R. Valuing management flexibility: a basis to comparethe standard DCF and MAP valuation frameworks. CIM Bulletin, April1998.

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SPENCE, K.N. Canadian Code for the valuation of mineral properties. MiningMillennium 2000, CIMM. Montreal, 2000.

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Various companies and individuals-Discussions, interviews and surveys. ◆

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