My recent post on “Battery Wars” was a broad overview of the ongoing global struggle to develop one or more cost-effective batteries to power a commercially viable electric or hybrid vehicle. Follow-on commentaries to that post have added more substance and I invite readers with knowledge to add their views on the viability of lithium-ion vs. current NiMH batteries - or any other alternatives.
Because lanthanum, a rare earth element, is essential to the NiMH battery, the business of mining of rare earth elements and related investments has become a sub-text of the battery investment question, as has the mining of lithium in the case of SQM, of course. In regard to REEs, I mentioned two Australian companies that are gearing up to mine REE’s, one of which, Lynas Corp., experienced a financial blowup last week that cut its stock price in half. Some readers have asked if Lynas is an attractive investment here.
To answer it, let’s first look at the industry. An excellent basic primer on REE’s was posted on Seeking Alpha recently. REEs are used in a wide variety of growth products and therefore should enjoy relatively robust demand going forward. From that piece, here is a table showing the industrial uses of REEs:
As the author notes, “REM [rare earth metals] are now especially important, and used extensively, in the defense industry. Some of their specific defense applications include: anti-missile defense, aircraft parts, communications systems, electronic countermeasures, jet engines, rockets, underwater mine detection, missile guidance systems and space-based satellite power.
USGS figures for 2006 indicate that the three main uses of REM in the U.S. were: automotive catalytic converters (25%), petroleum refining catalysts (22%) and metallurgical additives and alloys (20%).
Domestic demand in the U.S., as well as the demand for REM globally, remained strong in 2007, and have continued so in 2008. This has been true both for mixed rare earth compounds and the metals and their alloys. According to the USGS: “The trend is for a continued increase in the use of rare earths in many applications, especially automotive catalytic converters, permanent magnets, and rechargeable batteries.”"
Other indicators of the positive outlook for REEs include the fact that China, the dominant global supplier (90%) of REEs, is cutting back its export quotas in order to boost its domestic consumption.
Also, prices for REEs were strong in 2008, particularly for lanthanum, which rose from $6 to $13 per Kg. More pricing information is included in the post referenced above. I do not have recent months’ pricing, so I can’t comment on how the global slowdown has impacted REE pricing in the short term, although Lynas’ 2/10/09 press release said, “Both Rare Earths demand and prices remain robust and the project economics remain solid.” Over the intermediate to longer term, the supply and demand dynamics for REEs seem quite favorable.
So, if the longer term supply/demand dynamics seem positive and the company is close to production, do we buy Lynas Corp. (OTCQX:LYSCF) here? The question boils down to how serious their financing problems are.
As their press release indicates, bondholders are claiming that Lynas has failed to meet the preconditions required for releasing $95 million of that financing. The company says, “bolox.” An insightful discussion of their problem on the UK Fools web site details the matter and suggests the bondholders are offering phony objections aimed at getting better terms. Reading between the line of the press release you can see the same argument from the company.
The bondholders’ claim is likely based on technical, legal readings of the documents, not substantive realities. The financiers’ objective is to pressure Lynas to amend the price at which the bonds are convertible. The original price of U.S. $1.359 per share was negotiated before markets collapsed and is thus a long way out of the money from the roughly $0.20 price at which Lynas stock was trading before the announcement of a financing problem or the $0.10 current price. The press release suggests that a solution to this impasse is not close.
A number of alternative outcomes can easily be visualized. One would be the jettisoning of Lynas’ relationship with the bondholding firms and substituting new financial backer(s), probably one or more users of REEs. In that scenario Toyota (NYSE:TM) or some other automotive or industrial user of REEs that wants to take a substantial equity position in Lynas would provide some amount of financing, after which Lynas would be free to pursue legal claims for damages against the bondholders without much further delay in the start up of its mining operations.
On the other hand Lynas is a small, start-up company operating in very choppy financial waters and the bondholders are some of the most renowned players in the global financial markets. It is likely Lynas wants to avoid a Sampson vs. Goliath fight that could poison the financial well for them for many years to come. So perhaps a more likely outcome is that Lynas will cave in to the bondholders and negotiate a lower convertible price and everyone will walk away with a smile on their face and a very bad ongoing relationship that could perhaps be improved with time. No doubt public shareholders would see substantial dilution and management would be issued new shares at lower prices to retain their original stake.
A third alternative is that the impasse could hobble the company for an extended time, possibly even requiring a huge refinancing at some point down the line that would virtually wipe out current stockholders.
My sense is that Lynas management is practical and canny. They will find a way to resolve the conflict in the near term at a cost that may be substantial but will not be totally destructive. I think they want to maintain the good will of the investing public and will work to that end.
But that’s simply a hunch. I have no direct information. What to do? I have, believe it or not, bought more shares recently at $0.10, but there is no guarantee that it won’t be “good money after bad.” It really is my most extreme form of gambling. If the situation works out, Lynas shares could be worth many multiples of the current price by year end. If not, they could well be worth nothing.
What makes me think the odds are decently in my favor is the long term outlook for REEs and the prominent position that Lynas’ Mt. Weld mineral deposits occupy in the global outlook for sufficient REE supplies over the next few years. Given that, my guess is that Lynas management will have some options for solving their problem in a manner that satisfies all parties - or at least allows the project to move forward.