Key areas overlooked in a due diligence review of a mining business

Successful acquirers are not looking to buy a P&L, a balance sheet and a cash flow, they want to understand a target’s potential and identify areas of vulnerability. In our experience, the key areas that can be overlooked as part of a due diligence review of a mining business include:

1. Cashflow. It is vital to review the sustainability of cashflow as it is one of the single largest value drivers for most businesses in the mining sector at this time. Earnings before interest, taxes, depreciation and amortization (EBITDA) can be used as a high level indicator of cashflow but, due to the current volatility with commodity prices, it is by no means a thorough tool when making an important investment decision. For instance, EBITDA does not take into account any capital expenditures, working capital requirements, hedging activities, debt payments or taxes. It is essential to fully understand the movement of cash balances and working capital requirements between periods.  It is also very important to review and analyse the impact of historical and future cash flow from key contracts, including the target’s obligations to pay to mining contractors, holder of the underlying mining licence and local/central government levies, etc.

2. Supply and demand. In addition to focusing on the production side of a target, a company’s future growth also depends on its relationships with its customers and suppliers, but all too often these relationships are neglected in the due diligence process. It is important to determine why customers do business with the target, and whether there are factors which may impact their revenue streams. A thorough review of the seller’s supply chain is also required to identify any dependencies, unidentified related party relationships or areas for potential savings.  In certain jurisdictions, relationship with local and central government bodies is vital.  It is particularly important in the mining sector due to the relatively early stage of development of the countries that the targets are likely to be operating in, whereby governmental intervention and political stability could cause concerns to the acquirer.

3. Barriers to entry.  Any unique infrastructure requirements or distribution systems in situ at the target company which limit competitors taking a market share need to be scrutinised in detail.

4. Management. It’s tough to place a high value on a business which is reliant on a sole decision maker. The management team, including key technical personnel in place at a target needs to be scrutinised to ensure they have the depth to run the business, and that procedures are put in place to retain talented management teams post acquisition.

5. IT systems. Information is the lifeblood of most organisations and integrating two companies’ information technology systems can be costly and time consuming. Due diligence should determine whether the seller’s IT systems are compatible with the buyer’s system, or what interim measures need to be introduced in the short term.

6. Hidden liabilities. Hidden liabilities can quickly erase the value of an otherwise promising transaction. It is not only important to review potential tax liabilities but also thoroughly analyse and evaluate, in conjunction with the legal due diligence, potential exposure to other liabilities such as environmental risks, rehabilitation requirements or employee legal claims and, if necessary, adjust the purchase price mechanism accordingly.

Effective due diligence is about balancing opportunity with informed scepticism. It is about testing every assumption and questioning every belief. At Moore Stephens, we look beyond the numbers and focus on areas that will actually add real value to an acquisition process so that informed decisions can be made. Our team is able to respond quickly to client needs, offer the full range of assurance and advisory services, and all at a sensible cost. And as one of the few ‘mid–tier’ accountants specialising in the mining sector, Moore Stephens provides a real alternative to the larger firms.

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Michael Simms

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