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Due Diligence

All Investors — private or institutional — need to balance their exposure to risk against their expected returns. That requires an understanding of the source and relative magnitude of the risks attaching to a specific industry, company or project. However, many investors do not have sufficient in-house expertise to assess the full range of technical risks and opportunities associated with mining projects. The mining consultant, or Independent Engineer (‘IE’) can provide that expertise by assigning a team with the required skills and experience to conduct a technical due diligence investigation of the investment target on behalf of the potential investor.

The nature of the assignment will be tailored to the size of the investment, the scope of the project, and the specific needs of the investor — the aim is to complement, rather than replace, the in-house team. Therefore, due diligence work does not lend itself to a cookie-cutter or one-size-fits-all approach. In addition to the need to manage technical and commercial risk, institutional rules (and good governance) may also require verification of compliance to the World Bank’s Equator Principles and the IFC’s Performance Standards on Environmental and Social Sustainability.

Who does it?

On a large multi-disciplinary assignment, the team might compromise a geologist, a geological database specialist or resource modeler, mining engineer, geotechnical engineer, metallurgist/process engineer, environmental engineer, social impact specialist, mineral marketing specialist and/or mining economist. Where the project requires specific infrastructure (e.g., pipelines, ports, or railways) appropriate specialist expertise is added to the team.

What does it cover?

The market price of the product is typically the most sensitive value driver for the project, but this is generally seen as a financial rather than technical risk, and hence outside the scope of the IE’s review. Although the technical risks in each project are different, some common themes emerge. For example:

— is the geological model of the deposit consistent with and supported by the data and field observations?
— has an adequate quality assurance/quality control program been implemented for sampling and data collection?
— is the sampling/analytical database free of material errors, and the resource estimate consistent with that data?
— is the block model upon which the resource is based optimized for, and consistent with, the geological model.
— does the geological model and the block model for the resource support the mining method chosen.
— if a concentrate is to be produced, does the database contain enough information regarding deleterious elements to model them, if necessary
— do mine development and production plans appear achievable given the proposed heavy equipment fleet and workforce?
— are process recoveries and throughput supported by the testwork and plant design?
— are the metallurgical testwork samples representative of the typical mill feed?
— was variability of the ‘ore’ taken into account?
— have appropriate geotechnical studies been made for the design of tailings and waste rock storage facilities
— what provision has been made for wastewater treatment and discharge?
— have adequate transport and communications been provided for?
— what plans have been made for recruitment, training and housing and/or transport of the planned workforce?
— if additional licenses or permits are required, how likely is it they will be forthcoming, and what are their time frames?
— what is the social licence for the project, what opposition or support to the project is there in the surrounding communities.
— does the economic analysis make adequate provision for construction delays and potential cost over-runs.
— where applicable, are product specifications and off-take terms reasonable and achievable?

The Approach

Typically, the job commences with a desktop review of available information from the public domain and/or supplied in terms of a non-disclosure or confidentiality agreement. That review may then be followed by a site visit and a meeting with the technical team representing the project proponent (‘sponsor’). The visit gives the IE a first-hand appreciation not only of the project site itself, but also the regional and social setting, workforce availability, the state of relevant infrastructure (power, water, transport and communications, etc.) and other issues. That meeting allows the due diligence team to assess not only the purely technical aspects of the project but also the degree to which alternative scenarios have been considered and, crucially, the capacity of the sponsor’s team to execute the project successfully.

The Sponsor

While the emphasis of any due diligence assignment is on the assessment of down-side risk, it is also important that the IE identify opportunities to enhance project value. This requires that all other participants, and especially the sponsor’s team, contribute positively to this process.

Probing for gaps or flaws in the sponsor’s technical studies is crucial to the due diligence, and when the sponsor’s team shows that it has dealt consistently with all the issues raised, confidence in other areas of the project also naturally grows higher. Conversely, a reluctance to discuss details of the work or explain the choice of technical options inevitably prolongs the investigation and can reduce perceived confidence in other areas of the project.

The Client

The client’s expectation will be that the IE should identify all material technical risks and be able to advise on their potential impact on financial returns. That advice, presented in a formal due diligence report, gives the background to those findings and provides recommendations comprising any modifications required to the mineral resource or reserve model, assumptions for the forecast capital cost, time schedule for mine development, construction and ramp-up, steady state rates of production and sales, operating costs, sustaining capital, working capital, contingencies, cost and over-run provisions.

The due diligence report will also list ‘areas of concern’ that must be addressed before financing can proceed. Thus, the IE’s due diligence report becomes a key document in the client’s management of the project as it moves forward.

The usefulness of the opinions expressed will be judged by the client according to how well those opinions are supported, and how material they are to the assessed value of the investment opportunity. The exit strategy, and hence the duration of the investment, will be different for equity and debt investors. The IE’s report must take that into account.

The IE

While the IE must act solely in its client’s interest, the IE’s team is most effective when members are able to develop a professional relationship with their counterparts on the sponsor’s team. At the same time, though, having identified an area of concern, the IE must be able to offer an objective opinion on its significance, potential impact, and mitigation. Depending on whether those opinions coincide with or differ from the sponsor’s view of the project may result in the IE either being seen by its client as too supportive of the project, or being seen by the sponsor as over-critical or unreasonable, to the detriment of the deal process. Collectively, therefore, the IE’s opinions must be carefully weighed and balanced.

Another area in which the IE can find itself ‘caught in the middle’ is when due diligence assignments are structured in such a way that the IE’s services, provided strictly on behalf of the client, are nonetheless paid for by the sponsor. This apparent conflict of interest is best dealt with at the outset, by having all three parties sign an agreement that spells out the responsibilities of each.

In summary, to successfully complete its assignment an IE must play the parts of auditor, critic, detective and diplomat while providing an objective, dispassionate and independent overview of all aspects of the project.