Mineral Industry Acquisition Analysis

ACQUISITION JUSTIFICATION There are many reasons why companies consider acquisitions as a means to expand their operations. Some wish to reduce the impact of business cycles on their businesses. Others seek firms within the same industry for expansion and increased market share. Still others diversify in order to avoid takeovers. Whatever the reasons or justification, an evaluation of an acquisition candidate should be systematic and thorough. To many financial managers the concept of a systematic acquisition evaluation indicates the need for a regular set of evaluation criteria. While these are available from numerous sources, one basic parameter frequently overlooked is the application of these criteria to an industry which is different from the acquirer. This becomes particularly important when evaluating firms within the mineral industry. The mineral industry is significantly different from other industries to require different valuing techniques. • This paper will present a number of reasons why an acquisition candidate in the mineral industry should be evaluated differently from other acquisitions, including by other mineral firms. Additionally, this paper will review the most appropriate means of valuing a mineral firm. • Firms considering the acquisition of a mineral firm should understand the nature of the industry before ever making a tender offer. Some of the general considerations include the following: • Level of Capital Intensity: In the mid-1980's the start up cost for a gold mine has been between 20-200 million dollars and 500-1,500 million dollars for a bauxite operation. • Global Nature of Competition: Except for certain industrial minerals, most minerals and metals are traded worldwide and many on national exchanges, such as COMEX. • Start-Up Time: Many mining operations in developed and developing countries have long lead times, 7 to 10 years in some cases, prior to the start-up of production. • Long Term Nature of Investment: For most mineral operations payback usually occurs at least 7 years after production has started. Additionally, many mining operations will continue producing for 80-100 years. • High Level of Risk: The number of factors that a mining firm cannot control such as grade, volume, world supply and demand, plus the long payback periods tend to classify mineral firms at a higher than average risk compared to other investments. • Cyclical Nature: The mineral industry is cyclical in nature, experiencing long troughs and explosive peaks, thus making timing a critical issue. • Labor Intensive: Even with the large capital requirements needed to operate a mine, most mines are labor intensive in proportion to their capital equipment. • Location: Obviously, the nature of this industry requires operators to work in difficult locations, frequently far from civilized localities, in poor weather conditions and without proper supply and distribution infrastructure. One of the most important considerations is an understanding of asset replacement and asset value. Unlike manufacturing concerns, firms in the mineral industry are working toward the elimination, through depletion, of their asset base. Product flexibility is not available to a mining operation. A mineral firm basically has two options as its resource base is depleted: 1) replace the asset with new production, or 2) deplete the asset and close down operation, as in the South African gold mining model referred to later in this paper. An understanding of the