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A look at SMG Indium Resources

|Includes:SMG Indium Resources Ltd. (SMGI)

 It must be a slow time in the IPO market for me to look at a company like SMG Indium Resources. But so it is, and this proposed IPO is one of those opportunistic and puzzling vehicles that seem to pop out of our ever-speculating financial markets.

Although the web-based roadshow presentation is a bit amateurish, the management team is plain and direct. The company is simply raising money to build a stockpile of the elemental element Indium and have a public stock that tracks the value of the commodity.

What is indium?

Screen shot 2010-08-30 at 10.36.22 AM.pngIndium is not exactly a household element like gold, lead, tin or silver, but it’s a very likable metal. It’s non-toxic, shiny and soft. Indium was first used in high-performance ball bearings during WWII. After the war it had some uses in different parts of the semiconductor industry, but really hit its stride with its inclusion (as Indium Tin Oxide or ITO) in what are now very popular flat panel displays. This development caused Indium prices to soar from $100 to $1000/kilo several years ago.

After such a large price increase, it’s not surprising that the metal attracted some attention. Up until that point there had been no real effort made in reclaiming and recycling Indium, much of which was routinely wasted during the process of LCD manufacture. (At the time only about 15% of the material actually ended up on the panel. This has been improved to 30% but still leaves plenty of waste.) Recycling and some working off of inventories has pushed prices back down to the current range of $400-500/kilo but the price volatility has been high in the last few years.

It’s worth noting that Indium is a by-product metal that comes mostly from zinc mining. It takes a lot of Zinc to yield a small amount of Indium, so it represents a tiny fraction of value to a zinc producer. The largest producer of Indium by far is China, which comprises about 50% of the total production of just under 600 tons/year of the metal. Another point on Indium has to do with refining. There is a good portion of the raw material that never gets processed due to cost and the extra equipment required. Industry estimates suggest that only about 50% of the potential Indium pulled from the ground is refined and part of annual production.

An excellent cache of information about indium can be found at the US Geological Service page on indium.

Market Dynamics

The Indium market itself is very small relative to both production of related base metals like Zinc and the end markets like flat panel displays. Because of this, the metal has and probably will continue to experience large price volatility. Demand from end users is fairly price-inelastic since the metal represents only a tiny fraction of their materials cost. At the same time, it is very difficult for primary miners to increase Indium production since it is a by-product and refiners have capacity constraints.

To add interest and a little bit of avarice to the story, the management of SMG Indium points out that there are some new markets emerging for Indium that could add significantly to demand. They include LEDs and also a type of solar cell (copper indium gallium diselenide or CIGS) that is promising. There are stockpiles of indium, but these are limited and production can’t be expanded very rapidly. So if these new sources of demand materialize it could result in much higher indium prices.

The real wildcard seems to be recycling. There’s lots of Indium out there, and improvements in terms of efficiency and reclaiming could reduce demand and improve supply. At a minimum, this could serve to limit price increases when and if they occur. This is what we call a bit of a “cloak and dagger” market when it comes to pricing because even market participants tell vague and inconsistent stories about demand and pricing. Still, if past is prologue, the price of the metal will be volatile – so if this deal gets done the shares will offer opportunity for traders.

Because Indium is recognized as a key metal some countries, notably China and Japan, have started a practice of building and maintaining stockpiles. China is said to run one in the range of 30M tons and Japan with 60M tons. These and other stockpiles, which are governed more by rumor and periodic (unverified) information releases, add to lack of transparency and volatility in the market.

With no special knowledge or expertise it’s hard to refute claims that an incremental 100M tons of demand would be very hard for the market to absorb without much higher prices. But based on current 30-50% efficiency figures, maybe there is more slack under the surface of the market than anyone can realistically know. Everyone was surprised when the silver market crashed decades ago after everyone decided they would rather sell their silver than speculate.

The Deal

I think it’s fair to say that the management team knows what they want to do and has the experience to pull it off. The IPO has been pending for years and in the interim management was able to complete a $5.8M private placement to fund their 9.2 tons of current inventory.

The deal is for 5M units consisting of one share and one five year warrant (at $5.75) each. The management team is collecting a management fee but no performance incentive. They have a major stake in the deal themselves, so in this case their interests are mostly aligned with shareholders.

Perhaps the strangest feature of this deal comes at a more philosophical level. Why should it even exist? Metal prices fluctuate and these variations are, in this case, not very disruptive to anyone. SMG doesn’t have plans to build a stockpile that they can use as a market-maker of sorts, creating an ongoing revenue stream. It’s pure stockpiling and speculation. There’s no value creation.

It’s similar to buying up 2009 Bordeaux futures or any number of bets currently available in the market. The ETF market is already awash with speculative bets for individuals and institutions. This just creates one more.

I’m a big fan of the periodic table and I can say that indium is a very likable element. One that I’d be happy to own. I’d probably be the one stranger that would prefer physical delivery of a few kilos. Anyone feeling the same way should absolutely get a copy of this book on the elements from Amazon. (Also see the iPad application, it’s great!)

Although we won’t follow this one since it’s not a growth company, we will keep an eye on it if it makes into the public markets. Especially if indium prices drop and the shares and/or warrants become cheap.

[Disclosure: None]


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Stocks: SMGI