Bob Gunthorpe

Normandy Mining Limited, Exploration Division, 27 Greenhill Road, Wayville, SA, 5034


Key Words: exploration strategy, acquisition strategy, gold.



Starting around 1993, the exploration industry worldwide entered a major growth period, peaking in 1997 when total expenditure on the search for non-ferrous metals was estimated by the annual Metals Economics Group (MEG) survey to be US$5.2 billion. In 1992, total expenditure was estimated at around US$2.0 billion, and in its latest survey (for 2000) MEG estimated that total budgeted expenditure worldwide has fallen from its peak back to US$2.6 billion. The gold exploration sector mirrored this pattern in even more extreme fashion, with expenditure worldwide peaking in 1997 at US$2.96 billion, falling to an estimated US$1.09 billion in 2000. MEG has speculated that the cycle is bottoming out, as indicated by a slowing in the rate of decline in the past two years.


Major changes in the exploration business have resulted, as participants at all levels adjust their activities to cope. A recent study (Heffernan, 2000) suggested that resulting industry behaviour is trending in three directions:


(1)   A decrease in ‘greenfields’ or ‘grassroots’ exploration activity, and a greater emphasis on ‘brownfields’ exploration activity around existing operations.

(2)   An increase in mergers and acquisitions.

(3)   An upsurge in strategic alliances, particularly between majors and juniors.


Normandy has achieved its position as Australia’s largest gold producer mainly via a succession of acquisitions and mergers stretching back to 1988. Investment in exploration was also given high priority throughout this period, particularly in the near-mine arena. Together these have resulted in a near-continuous record of growth in resources and reserves, as well as production. The changes in the business environment, particularly for gold mining and exploration, provides both major challenges as well as opportunities for the company as it seeks to maintain its position.


The intent of this contribution is to review the relationship between exploration strategy and its main alternative, i.e. resource growth via merger and acquisition. As exploration strategy is the main theme of other Symposium contributors, the primary focus of this discussion will be on technical aspects of mergers and acquisitions as vehicles for resource growth. The following two questions are posed up front to guide discussion: 


(1)   What are some of the lessons of a technical nature from Normandy’s past merger/acquisition record?


(2)   What are the main technical considerations in using merger/acquisition as a vehicle for future resource growth?

What Do Investors Really Want?

 Two of the main factors driving share price performance by gold mining companies are believed to be:

-         over the short term, expectations of sustained production/cash flow growth.

-         over the longer term, delivery of organic growth in reserves and production.


In other words, exploration successes (both ‘grass roots’ and ‘brownfields’) can be critical in achieving market recognition and reward.


In the present environment, other potentially important factors are:

-         successfully executed acquisitions, particularly if closely followed by major value adding, e.g. through realisation of exploration or production upside

-         perceptions of superior management quality and expertise.


It is arguable however, whether investors discriminate between organic resource and reserve growth generated by successful exploration, versus resource and reserve growth achieved through acquisition, particularly if latent upside resource potential is quickly realised following a transaction. The fundamental share price drivers remain production and cash flow growth, plus reserve inventory expansion, by whatever means.This brings into question the value of promoting company reputations as ‘successful’ explorers, ( or alternatively ‘successful’ acquirers).   

Resource Growth Strategy and Organisational Structure

In the mining business, resource replacement and growth is one of the key technical objectives. This can be achieved by direct investment in exploration, or by relying on successful exploration by others, with the intention of subsequent resource acquisition. Together these describe an important corporate function, loosely described as ‘the management of resource inventory maintenance and growth’. This includes the functions of the typical ‘exploration division’, but is much broader in scope, including a range of other technical and corporate expertise. This creates an opportunity to redefine the roles and functions within the traditional mining and exploration organisation to recognise these wider responsibilities.


To illustrate the argument, the following alternative organisational ‘map’ has been devised.



     Resource Inventory Division


Discovery Group



     Micro       Macro

Exploration  Exploration


Mine Exploration


Acquisition Group



    Micro       Macro

    Level        Level

Disposal Group





    Probability Attributes


Low Risk

High Uncertainty


Low Risk

Moderate Uncertainty

High Risk

Low Uncertainty

Low Risk

Low Uncertainty



Explanation of terminology and usage is as follows:


(1)    Exploration at ‘micro’ level refers to the ‘traditional’ spectrum of exploration activities, covering the range from area selection/project generation through to resource estimation, (i.e. essentially the final stages of strategy implementation).

(2)   Exploration at ‘macro’ level refers to the manoeuvring and negotiating to secure strategic positional advantage, both in time and space, (i.e. strategy formulation and initial stages of strategy implementation).

(3)   Analogous meanings are applied to the activities of an acquisition group, i.e. ‘micro-level’ refers to the evaluation and ‘due diligence’ processes associated with a specific opportunity, while ‘macro-level’ refers the variety of activities involved in the identification of potential acquisition opportunities.

(4)   The terms ‘risk’ and ‘uncertainty’ are used in their classical sense. Uncertainty embodies the idea of unknown probabilities, i.e. randomness of the external environment. Risk, on the other hand, refers to a measure of the adverse economic consequences of exposure to uncertainty. The contrasting behaviour of these agents across the activity range is referred to as the ‘probability attribute’.


Pursuit of resource growth via exploration is termed low risk/high uncertainty because expenditure can be limited and controlled, typically over long periods, but the probability of success is relatively low. In this sense exploration is a ‘conservative’ way to grow, and financial risk is minimised. Mine, or ‘brownfields’ exploration, has similar low, controlled risks, matched by an inferred somewhat higher probability of success, i.e. with lower uncertainty.


 The contrasting ‘resource growth through acquisition’ alternative carries higher risk, i.e. major financial exposure is involved, but the resource assets are typically (?) reasonably well defined and carry low relative uncertainty. Asset disposal, while seemingly a straightforward low risk/low uncertainty scenario, carries substantial hidden risks if disposal is premature, i.e. prior to realisation of ultimate resource endowment of a deposit or district, and before the geology is well understood.


A highly risk-averse company would be expected to focus on exploration as its principal resource growth path. A company with greater capacity for risk, e.g. from its financial strength, analytical skills, or some other driver, would be comfortable with a greater emphasis on resource growth through acquisition.  The challenge in the prevailing industry climate is for a company to determine the appropriate balance of risk and uncertainty to be adopted if it is to achieve its resource replacement and growth objectives.

What Are A Company’s Options?

In general terms, a major gold producer (such as Normandy) has three options to replace and expand its resource/reserve inventory:


(1)   ‘Greenfields’ exploration targeted at major new deposits in either known mineralised districts, or in terrains with potential for new district-scale discoveries. This can be achieved by direct investment, or by proxy via the currently fashionable strategic alliances with surviving juniors.


(2)   ‘Brownfields’ exploration focussing on the environs of existing mining operations, with the expectation that the most likely outcome is the discovery of extensions and repetitions of known orebodies, and a lower probability of a major new discovery.


(3)    Corporate acquisitions to obtain variously defined resources and reserves, ranging from advanced exploration projects to operating mines, and also as a vehicle to access known terrains with superior prospectivity.


In choosing to follow the acquisition route, a further set of options can be defined. These consist of assets ranging from ‘grass roots’ exploration tenements, advanced exploration projects, feasibility study stage projects, ‘start up’ projects, through to established mining operations, (or possibly some combination thereof). These raise a wide range of technical evaluation issues and problems, illustrated using two cases:


(1)   Acquisition of assets at the early discovery stage through to advanced exploration project stage, prior to resource estimation.

(2)   Acquisition at the advanced development project stage, or of operating mines, where resource and reserve estimates are well established.


Following the Acquisition Route 1 – New Discoveries and Advanced Exploration Projects.


This route in general combines the two most unfavourable of probability attributes i.e. high risk combined with high uncertainty. The challenge is to assess significance of new discoveries by others, usually on sketchy information, and to arrive at a realistic valuation. The same applies to advanced exploration projects. In the case of new discoveries timing can be a critical issue. There is commonly a delay between the initial discovery (e.g. by a junior) and wider recognition of its potential significance. This delay can create a window of opportunity for a major to position itself to eventually gain control. Once the details of the discovery and its significance become more widely known, this opportunity decays, and if the asset is still ‘in play’ competitive positioning and potential bidding by other interested majors is likely, with the winning ‘bidder’ accepting a significant risk of paying too much for the asset.


If a strategy of buying-in to new discoveries and advanced exploration projects is to be successful, the following capabilities are implied:


(1)   An ability to monitor exploration activity by junior (and medium sized) companies so that worthwhile targets and projects are identified at a very early stage.


(2)   Expertise to assess the probability of these progressing to either major new discoveries or high quality development projects, in advance of competitors.


(3)   High quality communication between technical and corporate staff to ensure that any necessary transactions and ‘due diligence’ are initiated without delay.


Following this route also introduces major obstacles in the current industry climate. Constraining factors include:


(1)   The decline in ‘greenfields’ exploration activity by players of all sizes, reducing the pipeline of new discoveries available for assessment.


(2)   A decrease in the number of junior (and medium sized) companies surviving as potential partners.


(3)   The reduced ability of surviving juniors to fund advanced projects of potential interest to majors.


(4)   More intense competition among majors for the remaining pool of new discoveries and advanced projects that become available.

Following the Acquisition Route 2 – Established Resources and Reserves.


The alternative route is to confine acquisition activity to situations carrying well-defined resources and reserves. This assumes that suitable assets periodically become available, and that the parties to any potential transaction adopt realistic valuation ranges. The value of these assumptions is being tested in the current climate for reasons such as:


(1)   The decline in ‘greenfields’ exploration activity by many of the majors, and their switch to alternative strategies, such as supporting selected juniors, and growth by merger/takeover, has created a highly competitive climate, particularly for quality assets.

(2)   Opportunities arising from the pipeline of advanced projects and new discoveries generated by the junior exploration sector worldwide have diminished.


Execution of a successful acquisition strategy is fundamentally reliant on an organisation’s expertise in three critical and interdependent areas:


(1)   The valuation of mining and exploration assets.

(2)   The undertaking of technical, financial, and legal ‘due diligence’.

(3)   Bidding and negotiating tactics.


Explicit recognition of these three separate but inter-related processes is considered to be an essential pre-requisite for successful acquisition. A wide variety of corporate acquisition scenarios are feasible, e.g.:


(1)   Equity market-based acquisition/merger involving major or medium-sized companies.

(2)   Acquisition/takeover of junior, or medium sized producer, by a major company.

(3)   Outright purchase of asset.

(4)   Buy-out of joint venture partner.

(5)   Privatisation of state-owned assets or companies.

(6)   Competitive tendering for assets, e.g. of companies in liquidation.


Other more complex variants include:


(1)   The formation of a joint vehicle by two (or more) major companies to acquire the assets of a third, with the assets then distributed via a prior agreement.

(2)   A ‘friendly’ merger of two companies through a capital reconstruction using the so-called ‘scheme of arrangement’ mechanism.

(3)   The gradual assumption of control of the target company by starting with a minority interest, with the option of increasing as knowledge is built of the assets.


The valuation range assigned to the targeted mining and exploration assets is arguably the most critical part of the process, and would normally receive highest priority. Valuation issues to be considered include:


(1) Mining and exploration assets can have two kinds of value, a ‘technical’ value, and a ‘market’ value. The ‘market’ value is externally determined, essentially by investor perception or expectation. The ‘technical’ value is analytically determined, and is an estimate that takes into account the large range of factors that create value for the potential acquirer. A normal pre-condition for the process to continue would be for the ‘technical’ valuation range to exceed, or at least equal, the ‘market’ value.       


(2) The valuation adopted not only reflects the reserve base and capital base of the targeted company or producing asset, but may also factor in:

-         the potential to add to the reserve base in the short to medium term,

-         the potential to cut costs, both directly, and indirectly through expansion,

-         expected future commodity price movements,

-         a view on exploration potential upside.


(3) In the case of high quality assets (e.g. long life mines (20-30 years) with low operating costs), normal analytical methods (e.g. DCF and IRR modelling) are not regarded as adequate measures of value, and the valuation of such assets will require special treatment to account for long term strategic value. Needless to say, it is rare that high quality assets of this nature become available.


(4) In an open competitive bidding situation, with other factors being equal, the winning bid will represent the upper end of the valuation range estimated by the competing bidders. If the ‘real’ value is defined as the mean of this estimated valuation range, then the winning bidder has, almost by definition, paid too much for the asset. This outcome is more widely known as the ’winner’s curse’, and is a situation that carries high risks, and, on average, will be a ruinous strategy. It follows that open competitive bidding situations should be avoided if possible. 


(5) A fully informed and highly efficient market for mining and exploration assets also increases the risk of acquisition. In this situation, full ‘market’ values will apply, and there will be a convergence of full ‘market’ values and ‘technical’ values derived for each potential acquirer. It can be argued that in this case acquisition degenerates to serve mainly as a survival strategy, with intrinsic downside risk still attached. It follows that poorly informed and inefficient market environments are more likely to create acquisition opportunities.


(6)   The acquisition of defined resources where a large additional premium is paid for exploration potential is also a high-risk situation, and is a strategy that may be more suitable for junior companies.


To use acquisition as a vehicle to achieve its resource/reserve growth objectives, a company must evaluate and accept the range of technical risks and uncertainties involved. Pursuing ’real’ business world acquisition opportunities inevitably results in compromises on technical evaluation issues, and the company best equipped to quickly analyse the implications for a transaction will have a competitive advantage in the acquisition ‘game’.

Concluding Comment.

In the current climate, the major gold producers have developed a range of positional strategies designed to best satisfy their particular needs. The replacement of ‘greenfields’ exploration by focussed ‘brownfields’ activity, and the pursuit of mergers and acquisitions, is a recurrent theme. In the case of the latter, the resulting greater competition for available resource assets means that the major players will be unable to create opportunities without adjusting their expectations to accept significantly higher risk and uncertainty. The challenge is to define the breakeven point between the risks and uncertainties associated with flawed acquisition opportunities, and well-conceived and supported ‘greenfields’ and ‘brownfields’ exploration strategies.


This contribution is published with the approval of Normandy Mining Limited, however the views expressed are the author’s own, and do not necessarily represent a statement of the company’s position.


Heffernan, V., 2000, Growth strategies for the mining industry: acquisition or exploration?

Financial Times Energy, 131p.

Metals Economics Group, 2000, Corporate Exploration Strategies Volume 1: A Worldwide  


                    Metals Economics Group, 255p.