Market Cap, NAV and finite resources

Question

Gave a read through this question and I believe I understand the following:

1. NAV is the sum of a companies assets; represents the value if the company was liquidated
2. Market Cap is (shares outstanding x share price) and represents the market's perceived value (today + future value)

The former straightforward, it's the latter that confuses me, but mainly when it comes to commodities (e.g. copper).

If we look at a company like Amazon, it makes sense that the share price, representing how much an investor is willing to pay for 1 piece of Amazon, would be higher than Amazon's NAVPS. Amazon may build a server system and have proprietary software that has a fixed worth of $200M (fake number). Assuming Amazon had 100M shares outstanding, it's reasonable to assume that Amazon shares would trade higher than $2/share because Amazon generates revenue from server compute time, server space and licensing their software. This is the "future value" baked into Amazon's market cap and share price.

But how does this apply to a copper miner? They have a mineral resource that has a valuation (a feasibility study) at a certain price and it's applied to, giving their resource a Net Present Value with a Discount Rate (generally 8%). For simplicity, let's assume their statements say the NPV8 of their copper deposit is $300M. When they contract out their supply of copper, the value for which they are going to get is known and the resource is finite, so unlike Amazon they don't have the potential to generate revenue year over year without depleting the deposit.

So why would a mining company have a market cap beyond the value of their finite resource?

Answer 1

The futures market will determine the value of their copper, which may still be in the ground or has been mined and stockpiled. It isn't uncommon in the mining industry for companies to hold a reserve of what they've mined back in order to be able to take advantage of sudden short-term price spikes, in which case there is a future yet-to-be-determined valuation that can be placed on it. One must also consider that while they know how much of a resource they have still in the ground, it may not be feasibly minable (is that a word?) at current prices, or they're waiting for some technology that will help them recover enough from the ore to make it worth mining. There's still a valuation attached to it (usually based on something approaching current market prices), but until it's produced and deliverable, that value will always be in doubt. The copper mining industry went through that back in the 1990's, when copper prices plunged and the cost of production didn't merit trying to extract anything but the most high-grade and readily accessible ore. Some companies went bankrupt after borrowing against the value of their reserves and then prices fell off the cliff. Oil companies face this all the time. There's technically a "today value" to all of the oil in the ground that they have rights to produce, but until it is produced and sold (or a futures contract based on it is sold), the value will fluctuate all over the place.

A mining company could have a market cap beyond the value of its resource holdings because it perhaps is viewed as a strong player in its particular field with a better chance of surviving the peaks and valleys of the commodities markets and would thus be in a position to acquire assets of less-fortunate rivals at prices below market when they fail. The company may hold a near-monopoly in its field. Another reason could be that it, unlike some or any of its competitors, already has long-term delivery contracts in place with major buyers that guarantees its revenue stream well into the future, enabling it to better forecast its cash flows, borrow at better rates, and be more successful at efficiently planning and executing its operational plans.

To answer your question with another question, why would Apple's market cap be several multiples of the value of all the products it sells in any particular year? And for that matter (and as a rhetorical question), why would ANY company have a market cap that exceeds the value of the goods and services it produces, if the sum value of those goods and services should serve as the basis for that valuation?

Many times, the additional market cap reflects investor faith in the long term prospects of the company relative to other players in its sector, thus making it worth more to them than anyone else with less certain prospects.

Answer 2

Your assumptions in the NAV are different from what the market is using to value the mine. There are 3 assumption differences that come to mind when you or the company calculated NAV. I'm sure there's others, but these are the first that come to mind. At the end of the day, there's no reason investors have to believe the company's NAV of $300mm when valuing the asset.

• Market price of the commodity: You must have assumed a $/ton price by which the mine will sell its commodity for the next 20 years for the NAV. The market could have a better or worse view than you on the price. This gets more complicated in determining how much the mine has contracted at long-term fixed prices versus how much they are selling at market prices versus how much they are hedging commodity prices with financial instruments, and ultimately how this will evolve over time. Even a simple case where forecasting a single spot market price through time is total guesswork past 5 years.
• Discount Rate: The discount rate you used for the NAV is 8%... but is that the WACC of the mine? Maybe 8% is close if the mine is fully equity financed, but I think I'd slap a good chunk of debt on the mine (especially if there are long term contracts) and drop the WACC down significantly. If the WACC investors are using for the market cap is higher, they may be using a lower discount rate. (Maybe going so far as to assume someone will buy the mine and change the capital structure)
• Production speed: The NAV assumes the mine is depleted at a certain rate per year, but maybe the market thinks the mine will be depleted faster with technological advances. That would increase the NPV beyond your NAV. Or maybe they think the commodity will be outlawed past year 15, which would decrease the NPV lower than the NAV.

At the end of the day, yes, your inclination is correct that NAV and Market Cap do need to equal with the same assumptions. It's much easier to equalize the two with a mine (hence why people use NAV as a reference for commodity producing firms), but there's still seriously difficult assumptions to make around valuation however you slice it.

And a big caveat, I'm just assuming this is a company that owns one asset and distributes all cash flow to investors. If you are thinking of an operating company that is continually reinvesting, only distributing a portion of the proceeds, and continually raising capital in debt/equity/project finance... that's just an entirely different proposition and there's no reason to think NAV on operating companies is tied to market cap except for providing a theoretical floor by which market cap shouldn't go below (again the problem of matching assumptions here is difficult even to provide a floor for the market cap).