Perilya Broken Hill Ltd v Valuer-General

[2012] NSWLEC 235

Land and Environment Court

New South Wales

Medium Neutral Citation:

Perilya Broken Hill Limited v Valuer-General [2012] NSWLEC 235

Hearing dates:

10 - 12 October 2012

Decision date:

19 October 2012

Jurisdiction:

Class 3

Before:

Lloyd AJ

Decision:

The Court makes the following orders:

1. The appeal is allowed.

2. The determination of the Valuer-General is revoked.

3. The value of the property described as ID3448162 as at 1 July 2007 is determined as $4,900,000.

4. The exhibits may be returned.

Catchwords:

VALUATION OF LAND - unimproved value - mines - valuation based on business model - discounted cash flow - depreciation - royalty based on after tax calculation

Legislation Cited:

Valuation of Land Act 1916 s 4, s 6A

Category:

Principal judgment

Parties:

Perilya Broken Hill Llimited (applicant)
Valuer-General (respondent)

Representation:

R P L Lancaster SC (applicant)
T S Hale SC with J B Maston (respondent)
Sparke Helmore (applicant)
I V Knight, Crown Solicitor (respondent)

File Number(s):

30076 of 2011

Judgment

1. The property described as ID 3498162 comprises a number of parcels of land with mining leases known as North, South and Potosi Mines and other land at Broken Hill, covering an area of 3,033 ha. The property is used for the production of lead, zinc and silver.

1. On 13 September 2007 the Valuer-General determined the land value as at 1 July 2007 as $20.9 million. The owner of the land, Perilya Broken Hill Limited, lodged an objection to the valuation, which the Valuer-General disallowed. Perilya now appeals to the Court against the disallowance of the objection, contending for a value of $5.25 million, although during the hearing it contended for a lower sum.

1. The question for determination is: what is the value of the land for the purpose of the Valuation of Land Act 1916?

1. A valuation under the Act is an artificial value. It is the unimproved land value but must include "land improvements". The artificial nature of the exercise is shown by the following provisions of the Act.

1. Section 6A(1) states:

The land value of land is the capital sum which the fee-simple of the land might be expected to realise if offered for sale on such reasonable terms and conditions as a bona-fide seller would require, assuming that the improvements, if any, thereon or appertaining thereto, other than land improvements, and made or acquired by the owner or the owner's predecessor in title had not been made.

1. The reference to "land improvements" requires recourse to the definition of that term in s 4:

Land improvements means:

(a) the clearing of land by the removal or thinning out of timber, scrub or other vegetable growths,

(b) the picking up and removal of stone,

(c) the improvement of soil fertility or the structure of soil,

(d) the restoration or improvement of land surface by excavation, filling, grading or levelling, not being works of irrigation or conservation,

(d1) without limiting paragraph (d), any excavation, filling, grading or levelling of land (otherwise than for the purpose of irrigation or conservation) that is associated with:

(i) the erection of any building or structure, or

(ii) the carrying out of any work, or

(iii) the operations of any mine or extractive industry,

(e) the reclamation of land by draining or filling together with any retaining walls or other works appurtenant to the reclamation, and

(f) underground drains.

1. The parties agree that the highest and best use of the land is mining. Because the mines already exist, the reference to land improvements means that the unimproved value must include all excavations, filling, levelling or grading, roads, mine shafts, ventilation and service shafts and associated retaining structures. All mining and processing equipment associated with the existing mining operations and other structures are assumed to be not present.

1. The parties and their respective expert witnesses agree that the price which the fee simple of the land might be expected to realise in the hypothetical sale referred to in s 6A of the Act is the present value of the royalties to be paid to the owner of the fee simple by the operator of the mine and for the life of the mine. The parties also agree upon a royalty rate of four per cent of the profit to be derived from the mining operations. There is a dispute as to what that profit is and how it is to be calculated. There are no comparable sales. The value must thus be based on the business model of the mine to determine the amount of profit from which the royalty is to be paid.

1. Evidence was given on behalf of Perilya by Mr D Herdman, a mineral valuer, and on behalf of the Valuer-General by Mr M Hopcraft, a property valuer. As the mining operator lessee would have to spend close to $200 million to re-establish the mining operations, which will have annual sales of about $164 million and a mine life of five to seven years (including start up time), the theoretical lessee would utilise a discounted cash flow computation to calculate the royalty. A discounted cash flow requires the input of many variables, and both valuers used discounted cash flow computations of varying complexities.

1. The parties agree that the reserves in the ground as at 1 July 2007 were 11,198,000 tonnes, rounded to (say) 11.2 million tonnes, the payable recovery from various minerals being:

zinc 83 percent

lead 95 per cent

silver 95 per cent

1. The parties also agree that the estimated life of the mine as at 1 July 2007 was 5.5 years against the annual rate of extraction of 2.1 million tonnes. The parties also agree that the cost of purchasing and installing the improvements, plant and machinery necessary to operate the mine as at 1 July 2007 would be $195 million.

1. The parties do not agree on the following:

(i)   the cost of pre-production development, including the setting-up and commissioning of the plant, equipment and buildings;

(ii)   the set-up period to be allowed for pre-production development;

(iii)   the estimates of anticipated mineral prices for the end products;

(iv)   mining costs, as a proportion of earnings;

(v)   the accounting for the security to be lodged for remediation;

(vi)   the depreciation of the plant and equipment

(vii)   whether the royalty to be paid to the landowner is to be based on before or after-tax profit.

The cost of pre-production development

1. There was no evidence of the cost of re-establishing the mine. Mr Herdman allowed $60,000,000 for this item. Mr Hopcraft did not make any allowance for this item. Counsel for both parties, however, accepted that there would be some cost, which would be in addition to the agreed capital cost of $195 million for plant and equipment. It is self-evident that costs would be incurred in employing staff to plan and design the required plant, machinery and buildings; to call and assess tenders for the provision of plant, machinery and buildings; to supervise the installing and commissioning plant, machinery and buildings; and to engage and employ about 350 staff required to operate the mine. In the Court's experience approximately $10 million would be incurred under this item.

1. There would be no cost in extending shafts and drives as they are assumed to already exist at the valuation date, so that the mining machinery would immediately have direct access to the ore body.

1. As noted at [13] above, in the Court's experience, the cost which would be necessarily incurred is about $10 million, of which $3 million would be incurred over the first year and $7 million over the second year.

Pre set-up period

1. It follows from [13] - [15] above that a start-up period of two years would be required before any production could commence. This is consistent with the expert evidence. Mr Herdman, who has had considerable experience in the field, said that it would take a minimum of two years for a mine operator to design, call tenders, order and install the necessary plant, machinery and buildings before the mine could commence operating. Mr Hopcraft initially made no allowance for a start-up period but conceded in his evidence that there should be an allowance for a start-up period of between one and two years and that a two-year period would be reasonable. I am prepared to accept the specialised expertise of Mr Herdman and adopt a two-year deferral period before the commencement of production.

The capital cost of equipment

1. I have noted that the parties agree that the cost of purchasing, installing and commissioning the necessary plant and equipment for mining is $195 million. Mr Herdman accounted for the entire cost in the first year. I have noted at [16] above that Mr Hopcraft conceded that it would be reasonable to allow a period of two years to return the mine to an operational condition if all the plant and equipment had been previously removed. In the Court's experience this expenditure would not be totally incurred in the first year, and a more realistic approach is adopted by allocating $95 million in the first year and $100 million in the second year.

The anticipated prices for the extracted minerals

1. Mr Herdman contends that the anticipated prices should be based on the average price of the minerals from 2003 to 2012 to allow for the cyclical nature of the commodity markets. Mr Hopcraft contends that the prices should be based on the spot prices on 1 July 2007, being the relevant date of valuation. Both parties agree that the prices spiked in 2007 and the market was then generally optimistic.

1. I am not persuaded by either approach. Mr Hopcraft's one day spot price approach is to take a view which is far too short. It is highly unlikely that an operator of the mine who had to commit some hundreds of millions of dollars to the project would rely on a sudden spike in mineral prices. It is more likely that a range would be taken proximate to the valuation date. From the Court's experience, in the bullish economy existing in July 2007 a prudent hypothetical mine operator would base its calculation on the average annual prices for 2005, 2006 and 2007 with a double weighting being applied to the 2007 figures. The anticipated mineral prices thus adopted are:

zinc $3,547.74 per tonne

lead $2,406.81 per tonne

silver $ 434.92 per kg

Expenses as proportion of earnings

1. Neither valuer provided detailed evidence of the ratio of costs to expenses. Mr Herdman reviewed the financial statements of Perilya for the years 2004, 2005, 2006 and 2007 and determined that the average for fixed and variable operating costs were 71.31 per cent of gross revenue. Mr Hopcraft's review of the financial statements showed that fixed and variable operating costs were 65 per cent of gross revenue. This is, coincidentally, the Perilya figure, rounded to the nearest whole number, on the 2007 accounts and is the mid-point for mines in New South Wales generally.

1. Having regard to the cyclical nature of mining profits, the optimism in the market for minerals in July 2007 - confirmed by statements in Perilya's 2007 annual report - it can be concluded that a prudent hypothetical purchaser would approach the question of the expense ratio in a similar manner to the price of minerals - that is, by considering the 2005, 2006 and 2007 figures actually achieved in this mining operation, with double loading being applied to the 2007 figure. This results in an expense ratio of 61.74 per cent, resulting in a profit margin of 38.26 per cent, which I adopt.

Discount rate

1. Both valuers agreed to adopt a discount rate for profit and risk of 25 per cent. There are a number of variables which bear upon the discount rate, including ore prices, the cost ratio, currency risks, and start-up costs. The agreed discount rate should be applied for the life of the mine.

Rehabilitation security cost

1. Each of the mining leases in the present case require, individually and collectively, the provision by the leaseholder of a security in the sum of $23,893,742 to be given and maintained with the Minister, to secure the fulfilment by the leaseholder of its obligations under the lease. The leases state that the security must be in cash or a security certificate in a form approved by the Minister and issued by an authorised deposit-taking institution.

1. Mr Herdman's uncontradicted evidence is that it is uniform practice in the mining industry to bring the security into account as a cost at the commencement of the mining project. Accordingly, I find that the security must be included as an establishment cost of the mining operation. Mr Herdman, however, made no balancing entry to reflect the return of the security at the end of mining operations.

1. If the security is included as an establishment cost of the mining operation, then clearly it should also be included as a non-taxable sum available to the mine operator when the mine is closed. It cannot be assumed that the mine operator would not fulfil its obligations under the lease.

Depreciation

1. The Valuer-General submits that allowing for depreciation amounts to double counting the cost of the plant and machinery.

1. However, an examination of the calculations adopted by Mr Herdman in his spreadsheets tendered in evidence show that the only function of including depreciation as a cost is to calculate tax. That is, the cumulative cash flow which he adopted is a pre-depreciation cash flow and the amount of depreciation is not reflected in the discounting process other than to calculate tax. There is no double counting of the $195 million cost of the plant and equipment. I thus do not accept the Valuer-General's submissions.

Rate of payment to landowner

1. As noted at [8] above, the parties agree that the rate of payment to a notional lessor would be four per cent of the profit to be derived from the mining operations. The parties do not agree as to whether this should be applied to the cash flow before or after tax.

1. Mr Herdman's evidence is that in his experience a percentage royalty is always calculated on an after-tax basis, this being the actual cash which is available for payment.

1. Mr Hopcraft's evidence, based mainly on his expertise in valuing quarries, is that royalties are frequently based on a rate per tonne.

1. I prefer the evidence of Mr Herdman, who has had extensive experience as a mineral valuer in the operation of underground mines and of the practice generally adopted in such enterprises. I thus accept that the royalty should be based on an after-tax calculation.

1. In passing I note that the parties accepted that in this case it is not appropriate, when deducting the cash flow upon which the royalty is based, to deduct the Crown royalty. For the purpose of the present exercise it is ignored.

Conclusion

1. In the light of the foregoing, the resultant net cash flow to the mining operator, from which the 4 per cent royalty is to be paid, is calculated in accordance with the spreadsheet which is annexed to this judgment. Three matters should be noted. Firstly, the royalty would only be payable once the mine achieved a positive cash flow. Secondly, the royalty would be payable on the annual cash flow and not on the cumulative cash flow as shown on Mr Herdman's spreadsheet which was tendered. Thirdly, the calculation in the annexed spreadsheet is based upon the actual figures set out in the evidence, rather than some of the rounded figures. As demonstrated by the annexure the net present value of the royalty stream, as at 1 July 2007, is $4,904,435.66 (after tax), which may be rounded to $4,900,000, this being the capital sum which the fee simple of the land might be expected to realise if offered for sale on such reasonable terms and conditions as a bona fide seller would require (assuming that the improvements, other than land improvements, had not been made).

1. I acknowledge the assistance of Acting Commissioner Cowell, who heard the case with me.

Orders

1. The Court makes the following orders:

(1)   The appeal is allowed.

(2)   The determination of the Valuer-General is revoked.

(3)   The value of the property described as ID3448162 as at 1 July 2007 is determined as $4,900,000.

(4)   The exhibits may be returned.

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Annexure

Decision last updated: 19 October 2012