Following on from the interest generated by his last post, Mule Stable regular Zebra (James Glover) returns to the subject of the Resources Super Profits Tax in another guest post.
In a previous post I explained how the formula for the RSPT (Resource Super Profits Tax) was derived by considering the Government to be a 40% silent investor in any mining project. I showed that the correct deduction from the return on investments is indeed GBR (Government Bond Rate), as proposed, not a higher rate that includes a “price of risk”. One important thing I missed in this analysis, however, was whether the investment amount (I) was the correct basis for valuing the Government’s new 40% “investment”. I aim to show that the correct variable should actually be the Market Value of Assets (MVA) and as such the appropriate deduction from profits is several times (maybe as much as 4 times) higher for established mines.In the example given based on the mining industry “price to earnings ratio” of 14 the RSPT would only be 9% of earnings. I should emphasise this is not about having separate formulas for new and existing mines but correctly taking into account the fair, market based, price the Govt should pay for it’s 40% share of the earnings.
For new mines MVA = I (where all “=” signs should be taken to mean “approximately equal” to head off the pedants) so the proposed tax is correct in this case.
The Government says that in return for this tax take they are taking downside risk as well as upside benefit. One of the criticisms of the RSPT is that the Government is effectively nationalising 40% of ongoing mines and the GBR deduction is irrelevant as there is no serious downside risk. In the framework I propose the Government is not currently proposing to pay a fair price for this “nationalisation”. If the fair price of the Government’s stake is taken into account then the tax from existing mines is considerably lower than proposed. It may be as low as 9% of earnings. This does not require a backdown by either the miners or the Government, although the Government’s tax take might be less than forecast
If the Government is going to nationalise 40% of a mine – at a fair price – then it needs to effectively pay 40% of the Market Value of Assets (or MVA) for the mine. For new mines the Investment = Equity + Debt is pretty much set at this value. The Government RSPT tax is then:
Tax = 40% x (Earnings – GBR x MVA)
The first term is the Government’s 40% share of the earnings (here taken as Earnings before Tax). The second term is the deduction for the interest that recognizes that the funding of the Government’s share is undertaken by the mine at the Government Bond Rate or GBR. There is no good reason for the Government to pay less than the market value of this asset or MVA. For a new mine just starting up MVA = I, the investment amount, so
Tax = 40% x (Earnings – GBR x I)
If ROI = Return on Investment = Earnings/I then we can write this as:
Tax = 40% x (ROI – GBR) x I
which is the proposed RSPT formula.
For an ongoing mining operation with established operations and contracts, the market value will exceed the book value several times over. I am going to take the very simple assumption that MVA = Price ie the market value of the assets is the market value of the equity. This ignores leverage and is probably too simplistic. Price is based on share price and the number of outstanding shares. In terms of PE-ratio (the ratio of Price to Earnings as determined by the share price) we can write
Tax = 40% x Earnings x (1 – GBR x PE-ratio)
Compared to the original formula the deduction is 40% x GBR x PE-ratio x Earnings. Alternatively we can write this as 40% x GBR x I x MBR where MBR is the Market to Book ratio = MVA/I. So the original Govt funding deduction is just multiplied by MBR. The current formula assumes implicitly that MBR = 1. For existing businesses eg. banks MVA/BVA can be as high as 4 (which is BHPs current value). This gives a very simple deduction in terms of % of earnings, rather than Investment/I, of 40% x GBR x PE-ratio. Note that this is really the same formula for new and existing mines; it just makes proper allowance for the true value of established mines.
So what is the fair deduction for existing mines? It obviously varies with share price and hence market conditions. For mines which are privately held we need a proxy based on publicly traded stocks. The PE-ratio for traded mining stocks is currently about 14. So now, using GBR=5.5%, the fair deduction for the Govt’s nationalised share for existing mines is not 5.5% (as many erroneously claim) or 22% (allowing for a 25% ROI) but 31%! Note this deduction is off the 40% so the total RSPT tax on earnings would be 9%.
So under a scheme based on a fair deduction for existing mining assets the tax should be:
RSPT = 40% x Earnings x (1 – 5.5% x 14) = 9% x Earnings.
After 30% company tax this represent a total tax of 38%. Even if we don’t know what the PE-ratio would be for mines which aren’t publicly traded we can use an industry based proxy for the mines whose stocks are publicly traded. Currently this is in the range 13-14. If I was the miners I’d be pretty happy with that. Maybe they should have taken a closer look at the RSPT before opposing it. All the miners have to do is get the Govt to accept it should pay a fair value for its stake and the framework I propose makes that transparent.