Tim Treadgold: Briefcase on the art of asset valuation

Big bets have been placed on the assumption that a new bidder will emerge in the battle for control of Portman, the iron ore miner with a split board and widely differing valuations.

When Briefcase last looked Portman was trading at $3.86, a nose ahead of the $3.85 offered by the only publicly-declared bidder, Cleveland Cliffs – and down significantly on the $3.94 paid by some lucky punter on March 1.

In the background, acting as chief cheer-leader for a higher bid, is Credit Suisse First Boston, an investment bank of impeccable reputation and connections - but one that may have trouble in justifying its extreme optimism in suggesting that Portman is worth somewhere north of $4 a share.

Time will tell whether CSFB is on a winner, and makes handsome profits for its many clients who have acquired Portman shares above the Cleveland price.

But, the very public split in the Portman board, and a little slice of history could be pointers to a sort of “back to the future” experience.

The issue in question also relates to another investment bank arriving at what it thought was a fair valuation of a mining asset. The time was 1987, a boom-time just like now, and the asset was the Lady Bountiful goldmine being sold by WMC to Consolidated Exploration for the sky-high price of $201 million.

Supporting that value was a seven-page document from the venerable old investment house of Ord Minnett (no relation to firm which currently trades under the same name) which said the price was fair and reasonable.

At the time of the deal, WMC (the vendor) had 201 million reasons to be happy, and so was Consex which had acquired an operating goldmine which, unfortunately did what goldmines sometimes do – it ran out of gold ahead of time, and Consex collapsed in a shower of creditor claims.

The revival of Consex, or to be more accurate the launch of a legal claim on its behalf, was led by canny Perth accountant Ivan Hoffman, better known as the man behind the Fortron car security and electronics business. He argued that the original deal was over-priced and some people involved should have known the gold was going to run out.

Hoffman launched a claim for $175 million against Ord Minnett (with WMC as a co-defendant) over the valuation. The upshot was a settlement on the courthouse steps for $16.1 million – and a truly bizarre piece of WA history which saw Western Power (then trading as the State Energy Commission) paid $2 for every $1 owed ($140,000 on a $70,000 debt), part of Hoffman’s promise to creditors of a two-for-one deal if they backed him in his claim.

The really interesting piece of this lesson in history is how it relates to people valuing mining assets from afar, because as far as Briefcase can remember no-one from Ord Minnett actually visited Lady Bountiful when performing that 1987 valuation, and it wonders how many chaps from CSFB have crawled over Portman’s Koolyanobbing operations in arriving at their conclusion that the stock is worth $4, or more.

Members of the Portman board who say that the $3.85 from Cleveland is fair and reasonable disagree strongly with CSFB’s assessment of their company – which some people might find odd because it would appear to be in their favour, that is to say why would anybody object to someone lifting the value of your company.

The answer, of course, is when you’ve agreed to a price – but also because you wonder whether the chaps saying the asset is more valuable have taken into account extra costs associated with future mining operations; such as hauling ore over longer distances, rising labour costs, and equipment shortages - the sort of thing you see when on the ground.

This appears to all come back to that question of who knows that asset best, who regularly kicks the tyres etc etc. On that score we might be watching history repeat itself with a Sydney-based investment bank not having sufficient firepower on the ground, at least not in Koolyanobbing anyway.

Which leaves that $4 (and more) valuation up in the air, and Briefcase wondering (yet again) why is it that we place so much faith in this curious art of valuation.

Speaking of valuations, there was a wonderful example in Perth last week of what Briefcase calls the theory of The Never Ending Boom.

Seasoned readers will instantly spot the point because it is only three years ago that we were in the middle of The Never Ending Slump.

Without delving too deeply into how quickly sentiment can change it is worth hunting down a copy of a paper delivered by Alan Heap, a well-respected commodities analyst with Citicorp Smith Barney.

Heap told the 250 delegates who attended the 8th annual global iron ore and steel forecasting conference that the so-called “super-cycle” of ever-rising commodity prices was alive and well, and he could see no reason why prices for iron ore, copper, nickel and other raw materials should not stay higher, for longer.

The core of his argument is that we are in a time similar to the great industrial boom of the late 19th century, and the boom which followed world war two when Europe and then Japan re-industrialised. This time, of course, it is China leading the way.

Over time, Heap may be proven right, though as has been demonstrated somewhat painfully it is fine to have a prices boom, but in order to cash in you have to be able to get your product to market.

In effect,  Australia has hit the ceiling in terms of what it can ship out. The choke point, as always is at the ports where coal ships are queuing to load cargo, and it may not be long before similar lines of ships at anchor are seen off WA’s iron ore ports.

The boom in demand is undoubtedly with us, but Australia’s inability to supply might yet see the best years of the boom slide by.

“The dubious privilege of a freelance writer is he’s given the freedom to starve anywhere.” S.J. Perelman.