ParibasSofreminesPrivatisation of Balkhashmed: Transaction price

Paribas/SofreminesBalkhash, 2 October 2018
to GKI
attention Mr Madiev

Note to file

Reference: Balkhashmed. Tender for privatisation: Note on the strategy of sale of Balkhashmed complex.

The purpose of this note is to estimate a minimum transaction price and to provide GKI with a reference value for evaluating offers from prospective investors.

Prospective investors are to be found, by Paribas, and motivated to propose a best price and acquisition share, for the following package:

  1. Balkhashmed metallurgical complex: smelting and electrolytic refining of copper, with an annual capacity of blister copper of 120000140000tCu and of cathodes of 135000150000tCu.
  2. Two operating copper mines (Kounrad and Sayak with a combined copper reserve of approx. 1MtCu).
  3. An ore concentration plant with capacity to treat various ore types in separate lines (total capacity of processing is 15Mt/year.
  4. Several explored but undeveloped copper orebodies, (Boshikul, Koktau, Kusmuraun, Actogay, and Aidarlay), with a total copper reserve of approx. 15MtCu, byproduct gold of 110t, silver and other associated precious metals.
  5. Several explored, but undeveloped gold and silver orebodies (Zharkulak, Muzbel, Kenzhem), with a total gold reserve of approx. 70MtCu, plus silver and other precious metals.
  6. A transformation plant which produces rolled bars and strips of copper and copper alloys with a capacity of 32000tpa (which is being stepped up to 75000tpa), wire bars (40000tpa) and magnet wire (70008000tpa).
  7. A plant to treat electrolytic slimes for the concentration of precious metals (Au, Ag, Se, Te and platinoids), and a precious metals refining plant (under construction by Boliden Contech).

In addition to this, the package for sale may comprise of the following:

Industrial units of the metallurgical complex, plus a minimum set of non industrial units, i.e. units that provide essential services and support to the industrial units.

NB: optionally, the investor may be allowed to bid only for core industrial units of the metallurgical complex (smelting, converting, acid plant, electrolytic refinery), plus the minimum lot of non industrial units (see previous note on non industrial units).

Two operating mines (Kounrad and Sayak) which presently provide copper ore to Balkhashmed concentration plant, adjacent to the metallurgical complex, located at Balkhash (remaining reserve approx. 1Mt Cu).

Boshikul, a new copper orebody (2MtCu), to be developed (mine and concentrator); this development would enable to optimise the production of refined copper and the supply of copper raw material by own sources.

Additional copper resources in orebodies, Actogay, Aidarlay, and seven small orebodies situated near Balkhash, plus possibly Chatyrkol, Karatas, Temirtau, which could be developed for further decreasing dependence of the complex on foreign sources of supply (reserve approx. 13MtCu).

Alternatively, prospective investors could be requested to indicate what the effect on their proposed acquisition price and share, if Balkhashmed complex had to bear the annual running costs of all the non industrial units, during a transition period of say five years. The cost would then be reduced by 20% each year, and transferred to a local Authority or independent enterprise (see previous note on non industrial units).

2.Capacity of production of the metallurgical complex:

The optimum capacity of smelting and refining is between 135000180000t/annum of refined copper and is determined by the capacity of production of blister copper. The total capacity of the refining section (thermal and electrolytic units) is 300000t/an[1]. The smelting unit is supplied by copper concentrates (disregarding internal recycling and scrap), the converter section is supplied by matte produced by the smelting section plus some matte purchased from outside (Ust Kamenogorsk metallurgical complex of Kazakhstan). The refining section (anode furnaces and electrolysis units) is supplied by blister copper from the smelting and converting units plus some blister purchased from outside (Itych and Ust Kamenogorsk metallurgical complexes of Kazakhstan). The graph overleaf depicts a simplified flow sheet of copper supply.

The following table shows refined copper production and distribution of copper supplies in 1993 and 1994:

The next table shows refined copper production and copper supplies in the two options of 135000tpa and 180000t of refined copper, with a projection of copper supply in the future after development of new mining capacity at Boshikul orebody.

The development project of Boshikul effectively permits an annual production of about 39000t/annum of Cu in concentrates at 20% Cu[2] If new mining and concentrating capacity is not developed at short and medium term, Balkhashmed will have to rely increasingly on custom smelting of foreign concentrates (Chile, Mongolia and other sources) .

In projecting the sources of copper supply for the future, the following method has been adopted:

1.set smelting and converting at levels of 120000 and 1400000t/a Cu;

2.production of concentrates by Kounrad and Sayak mines at level of the past 5years (20000tCu Kounrad, 10000tCu Sayak)

3.concentrates from Mongolia also at level of the past 5 years (45000t/a)

4.concentrates from Chile nil

5.Kazakhstan concentrates at the level of prerecession, which is assumed to be two times more than in 1993

6.Boshikul concentrates at a level of 39000tpa as per the feasibility study of development of this orebody;

7.Mattes from other metallurgical complexes in Kazakhstan, at the level of prerecession, which is assumed to be two times more than in 1993

8.Blister from other metallurgical complexes in Kazakhstan, at the level of 15000 and 40000t Cu as before recession.

The following graphs show the distribution of copper supplies, corresponding to refined copper production achieved, for the two options: minimum and maximum.

3.Estimated transaction price

To establish an estimate of the minimum transaction price that GKI should expect from a prospective investor, the following method is applied:

1.sales proceeds on the basis of refined copper production, average long term copper price (US$/lbCu), and addon value of precious metals content (Au, Ag plus Se, Te and Pts),

2.direct costs of production, mainly copper supply, plus transformation costs (inputs, personnel, general and administration cost)

Sales proceeds less direct costs of production are the operating profit.

3.capital cost required to revamp the complex's industrial buildings and its main plant and equipment, and for undertaking additional investment to increase production and productivity of factors overall

Operating profit less capital cost is an operating cash flow.

One can then calculate the value of a transaction price for a 100% acquisition share, which equates the discounted value of the operating cashflow, at set discounting rates, say of 15%, 20% or 25% (from which a curve can be drawn showing transaction price as a function of the rate of discount). The rate of discount, among other criteria of evaluation, reflects the risk factor that the prospective investor considers for the transaction.

Other criteria of evaluation include quantity and quality of geological reserves, technical aspects of mines, concentrator(s), metallurgical complex, the transformation plant, the slimes treatment plant and the precious metals refinery, non industrial activities, and the social, political and economic context of Kazakhstan, the CIS and Russia.

1.sales proceeds

Average long term price of copper on the international market is assumed to be 1.00US$/lb Cu. This is lower than the current price, and lower than the average price of the past 4 years. But copper prices exhibit a trend for cycles. The 1.00$/lb figure reflects copper prices in constantUS$ over the past 50years. Moreover, it is in line with projections made by the WorldBank (see Commodity Prices November 1994 issue). The trend of an increased share of copper production by low cost leaching and SX/EW technology, should contribute to maintain the long term average price around 1.00US$/lb.

The average price of copper in US$/lb of Balkhashmed's production would be lower than the international price, for several reasons:

part of the production is sold in Kazakhstan, at prices which are not yet fully free and even if they were free, Balkhashmed would have to sell at a price compatible with the economic situation of the country;

part of the production is sold in CIS countries, where a similar situation is likely to apply for some years; moreover, the economic situation in these countries may continue to impose barter trade therefore reducing the selling price on this account.

part of the production of refined copper is obtained by custom treatment of concentrates (e.g. Mongolian concentrates) in this case, Balkhashmed treats copper concentrates delivered to them by the miner and ships refined copper (cathodes, etc.) back to the miner. Because of the pressure of market forces, and of its need to purchase high grade concentrates for its reverbatory furnaces, Balkhashmed is in weak bargaining position vis à vis its suppliers and therefore has to accept a low level of profit on its smelting and refining charges. Also it has to accept to give some credit on gold and silver content, even if grades are too low, in the form of reduction on the smelting and refining charges or in the form of copper.

part of the production of refined copper is reserved for transformation into rolled products for the Kazakh market, at the copper price prevailing on the internal market in Kazakhstan and the CIS. The copper transformation plant of Balkhashmed is a source of additional value added. For the purpose of better understanding its economics it has been separated from the smelting and refining activity of copper and byproduct precious metals. It is clear that metal transformation yields a higher value added and a higher profit margin than smelting and refining, therefore contributing positively to the overall profit margin of the Complex

on the international market, quality of cathodes (MOK, below gradeA ), impose an 810% reduced copper price.

The following diagram shows our method of estimating the average long term selling price of Balkhashmed refined copper. This works out to be 0.83US$/lbCu.

Production of refined copper, as explained above, is considered to be 135000t/aCu, of which approx. 45000t comes from external matte and blister.

Addon value for precious metals content is assumed to be 35% of the total sales proceeds; this 35% figure is conservatively based on the consideration that is supplied by Balkhashmed own and purchased sources as today and in future (Kounrad, Sayak and Boshikul). The bonification for precious metals content was approx. 40% during the period 19891994 (on the basis of Au, Ag production in kg compared to Cu production in tonnes, and with prices of 350$/oz Au and 4$/oz Ag).

NB: The copper transformation plant's value added is not accounted for.

2.costs of production, mainly copper supply, plus transformation costs (inputs, personnel), plus general and administration cost)

The costs of copper supply by sources have been estimated as shown in the following table in US$ values:

There results an average cost of total copper supply, of 0.57US$/lb.

The costs shown in the table below are those considered for Balkhashmed own sources, i.e. direct costs (for inputs, personnel and transport).

There results an average cost of copper supply for Balkhashmed own sources of 0.51US$/lb.

Transformation costs, which are variable costs or costs proportionate to production, are estimated on the basis of Balkhashmed's data which show cost of inputs to be 0.047US$/lbCu (1993). We believe that this figure should be multiplied by a factor (43.29/24.8) corresponding to the differential exchange rates, so 0.082US$/lbCu should be considered.

Cost of personnel, which is a fixed cost, is estimated on the basis of personnel number in 1993 (10458 without personnel of mines Kounrad and Sayak) and an average cost/month of 5600Te (first half 1994, at average exchange rate 24.8Te/$ (not 43.29)), hence a cost of 28.4M$/annum.

Cost of administration, which is a fixed cost, is estimated to be 6.6M$/annum.

3.capital cost required

Capital cost required comprise of:

investments to revamp industrial buildings as well as plant and equipment of the complex

additional investments to increase production and productivity of all factors overall; these include:

copper transformation plant already started but to be completed

Au, Ag and precious metals refining plant

Revamping of the Vanjukov smelter

a new acid plant

investments to expand and deepen the present operating mines of Kounrad and Sayak

investments to develop and exploit the Boshikul mine

The revamping investments are estimated as follows:

We believe that it is not possible to use western methods of accounting and balancesheet evaluation, as suggested by Balkhashmed, because of the problems converting historical asset purchase values from USSRroubles into US$, the recent strong depreciation of the Russian rouble and, more recently, the introduction of the Kazakh Tenge which entailed a division of rouble values by 500 and by 4.7Te/US$ and finally the strong depreciation of the Te which fell from 4.7Te/$ to more than 50Te/$ from 1/94 toend 1994.

Temporarily[3], we assume that the capital cost of a plant of this nominal capacity (235000t/annum refined Cu, or 520Mlb), is 900MUS$ (1.73$/lbyear), of which 25% are buildings and 75% are plant and equipment. Nine hundred million US$ is therefore the replacement value of this complex if it had to be built today.

As of mid 1994, we consider that the buildings are affected by a wear factor of 30% and plant and equipment by a wear factor of 20%. Hence the cost of revamping comes to 70M$ for buildings and 130M$ for plant and equipment i.e. approx. 200M$ in total i.e.22.2% of the replacement value of all plant and equipment.

Awaiting for more actual data, Balkhashmed considered that, in 1994, they would spend 32MTe for rehabilitating their buildings and that for this amount, they would restore 3.54% of the value their buildings. They assume that their buildings are depreciated by approx. 40%, so to restore the full value of their buildings they estimate that they would have to spend 360MTe.

Likewise, for the industrial plant and equipment, they say they plan to spend 300MTe in 1994 and that for this amount they would restore 5% of the value of their plant and equipment. They assume that their plant and equipment is depreciated by approx. 30% (according to depreciation history), so to restore the full value they estimate that they would spend 1800MTe.

The total revamping cost, according to Balkhashmed, is therefore 2160MTe.

The question now is what rate of exchange is to be used to convert this amount into US$? If we use the rate of exchange prevailing as of 1/7/1994 (43.29Te/$), as Balkhashmed did, we would be using a depreciated value of the Te which may not be in line with the time when those cost estimates were made. The Te/$ rate was 6.31 as of 1/12/93 and it was 43.29 on 1/8/94, and it was 11.56 on 1/3/94. It is this exchange that we propose to use, which converts Balkhashmed's figure to 190M$.

This figure tallies with the 200MUS$ estimated before.

We therefore consider that revamping will cost approx. 200M$.

As for the other items of the investment program, they are given by Balkhashmed mostly on the basis of preliminary consultations of plant and equipment suppliers.

The following table gives a summary of the costs of investment considered for establishing the cash flow projections and the minimum transaction price.

Hence it is possible to establish a cashflow statement with the following data:

·sales

·less costs

·less investment program

·equals cashflow

4: Cash flow projection

With these assumptions, the following cash flow projection has been established for 20 years. The transaction price has been calculated to equate the discounted value of this cash flow at 20% rate of discount. With the above assumptions, the minimum transaction price comes to 240MUS$.

The minimum transaction price is therefore the internal rate of return that the prospective investor may expect on the transaction price paid, considered as an initial investment. The investment program for revamping and modernisation of the complex is considered to be financed by the profits of the project.

Assuming that the foreign investor would be offered 30% acquisistion, the minimum price paid would be 80MUS$ which is dependent on the rate of discount considered, i.e. the rate of return expected on this payment. If one considers a 25% rate of discount, the transaction price falls to 150MUS$ and the investor’s price to 50MUS$.

NB: The foreign investor may convince Balkhashmed to consider another program of investments or additional investments with a view to increasing the overall productivity of the complex. A different set of series for costs, investment program and surplus cash would therefore result.

However, the result should be more favourable for the investor, and the price offered by him may then be higher than the minimum price.

It is necessary that Paribas/Sofremines propose a true minimum price, and for that that they consider a correct figure for the rate of discount i.e. the rate of return.

The diagram hereafter, shows the evolution of the transaction price with the rate of discount as explained above, and for two values of the copper long term average price: 0.90 and 0.83US$/lbCu.

It can be seen that the central estimate, around 20% rate of discount, is 350M$: 240M$ at 0.83$/lbCu, 450M$ at 0.90$/lbCu. At 25% rate of discount, i.e. a higher risk assessment, it is around 220M$, 150M$ at 0.83$/lbCu, 300M$ at 0.90$/lbCu.

It is most interesting to point out that by investing say 120M$ to increase production of refined copper to 300000t/annum as it was mentioned in above, the rate of return on the transaction price, would increase to approx. 24% instead of 20% in the base case (220M$ at 0.83$/lbCu). This result is obtained after running a capital cost and copper production sensitivity calculation on the model.

APPENDIX

Exchange rates

1

[1] Historic statistical data on production and operating parameters of the smelters, the converters, the anode furnace and the electrolytic refining unit, are available in the data room.

[2] Data on Boshikul mine and concentrator project is available in the data room

[3]Temporarily, because we believe that actual figures should be made available by Balkhashmed.