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Mike Holt is a Senior VP, Wealth Management Strategist with The MDE Group, an innovative Wealth Management Firm located in Morristown, NJ that manages over $1 billion for corporate executives and other high net worth individuals located across the US. Mike's diverse background includes auditing... More
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  • Investing in Rare Earth Mining Companies – It’s All About the People 5 comments
    Apr 7, 2011 8:49 AM | about stocks: LYSCFIQ, UURAF, AVL, NEMFF, GWMGF, ARAFF, REE
    My research into rare earth elements began as part of an ongoing effort to identify potential risks that could negatively impact my clients’ portfolios. I saw China’s stranglehold on this vital resource as a significant threat. It then occurred to me that one of the best ways to mitigate this risk is to invest in companies engaged in the development of this vital resource and the downstream products that support so many important technologies. These technologies, in turn, hold the key to the economic growth that we are so desperately seeking.
    The first step, of course, is to select worthy investment candidates from the growing list of rare earth mining companies and companies involved in the equally important downstream industries. If we were to reacquaint ourselves with the concept of investing as a means of allocating capital, and then sought to allocate our capital as effectively as the Communist Chinese government, these investments would ideally be made by companies that are dependent upon access to raw materials derived from rare earth elements. Although the market for rare earth elements is relatively small and profits have likewise been insignificant given the artificially low prices that resulted from China’s growing influence over this industry since the early 1990’s, such investments should make sense if companies developed business models that focus on the long-term sustainability of profits from their higher margin final products, rather than the short-term profitability of each intermediate process. Unfortunately, most companies outside China have not implemented such vertical integration strategies, and are now extremely vulnerable to the risk that they will not be able to access these vital raw materials without jeopardizing their intellectual property and business franchises. But, this has created investment opportunities for individual investors who can appreciate the importance of these relationships. 
    Of course, individual investors should not be expected to make such investments purely for altruistic reasons. In order for the capital allocation process to be effective, it should be based upon the long-term profitability of these investments. In other words, the activities being funded should make sense after taking into consideration their true costs and benefits. It may be helpful to conceptualize this as Chinese capital allocation with American characteristics. Within this more rational framework, this article will seek to provide investors with helpful guidance on how to invest in rare earth mining companies. In particular, I will focus upon how they should be valued, and the important but often overlooked role that a company’s board and management team are likely to play in determining a company’s failure or success.
    What’s the value in owning rare earth mining stocks?
    To begin, investors should bear in mind that their objective for investing in a rare earth mining company should be to acquire an interest in the future earnings derived from the development of these natural resources, rather than simply acquiring an interest in a rare earths deposit in a static sense. Toward this end, investors must, therefore, take it upon themselves to project what these future earnings are likely to be, and to compare their valuation estimate with the value that the market is currently assigning to the rare earth mining company. As evidenced by the bursting of previous price bubbles for many types of assets, failing to do so can have adverse consequences for investors and society at large. Conversely, overlooking attractive opportunities until it is too late can also be detrimental to investors and society.
    Toward this end, for the rare earth mining stocks that I own, I have used various discount rates to calculate a range of discounted net present values of their future earnings based upon conservative estimates of the weighted average price of the rare earth oxides that they are expected to produce over the projected life of their deposits. (Current and historical prices are posted weekly on the Lynas Corporation website, among other sources.) In some cases, ongoing operating costs are mere “guesstimates.” The resulting present values should be reduced, of course, by the projected up-front costs required to achieve a state of production. My previous post includes an example of this methodology under the heading, “Before you pay the price, ask yourself what is ‘the China price’?”
    If current rare earth prices are sustainable, the results are very attractive. Otherwise, the benefit of owning rare earth mining stocks becomes more strategic in nature, based in part upon global security concerns whose value is less tangible and therefore difficult to quantify. Under those scenarios, governments and companies whose profits are dependent upon reliable access to rare earths-based raw materials would seem to be the more natural investors. However, such strategic considerations so far have gone unnoticed. In my opinion, this means that the prices that must be paid to gain access to rare earth elements outside of China are more likely to remain at elevated levels. Consequently, those willing to commit a portion of their capital toward the development of resources outside China could possibly be rewarded with high returns commensurate with the high risks being taken.
    For a detailed description of the principal rare earth elements deposits of the United States, this 2010 Scientific Investigations Report by the USGS may be helpful. 
    But, while evaluating certain characteristics of deposits already owned by a particular company is obviously important, investors should be aware that there are other important considerations. Unfortunately, judging by the comments shared on the message boards for investors in these companies, undue emphasis is apparently being placed only upon such characteristics. In other words, too little thought is being given to each company’s business plan and the ability of their management to execute that business plan against the backdrop of a very challenging economic and market environment. Of critical importance to investors is not only whether a company’s management will be able to succeed in the execution of its business plan, but whether management will be able to do so in a manner that will be beneficial to existing investors.
    How the value in rare earth mining stocks is unearthed over time
    As indicated in my previous post, early investors in a particular company that has just gained access to a rare earths deposit may benefit if that company or certain of its assets are acquired shortly thereafter. But, absent such an acquisition, early investors who remain committed to the successful conversion of a deposit into a productive, profitable enterprise must be prepared to endure a multi-year development process in which the cycle of a mine life goes through several stages: exploration, discovery, evaluation, development, and operation (which may ultimately be followed by closure). Although they may not always think of it in these terms, such investors stand to gain from an increase in the discounted present value of the company’s future earnings, which may result from:
    • A decrease in the discount rate used to value future earnings as various development milestones are achieved. (In the example included in my previous post, using a discount rate of 15%, the discounted PV of annual earnings of $1.54 billion was calculated to equal $10.236 billion. All else being equal, if a discount rate of 30% was applied at an earlier stage of development to reflect the higher levels of uncertainty that existed before certain milestones were reached, the discounted PV of those same annual earnings would equal only $5.133 billion.);
    • An increase in the projected resource base that can be profitably developed;
    • An increase in the market price for such resources;
    • A decrease in the cost of developing such resources; and/or
    • An increase in projected future earnings stemming from synergistic horizontal and/or vertical integration strategies.
    Lynas Corporation – The “down under” company that has risen to the lead
    The pattern within which these return drivers unfold is consistent with the development process that I described in my previous post. Page 15 of a February 2011 Investor Presentation by Lynas Corporation which compares the size and progress of various global rare earths projects should also put this into better perspective. From this it can be seen that the price per tonne of ore at Lynas Corporation’s relatively large Mount Weld deposit in Western Australia is quite high relative to that of the other projects listed, and that Lynas is also expected to be the first of these non-Chinese rare earth mining companies to start production. Several years ago, the discounted present value of projected earnings from such production was less than it is today since:
    • Uncertainty whether Lynas Corporation would successfully achieve each of the milestones listed on the x axis of the illustration warranted use of a much higher discount rate than whatever discount rate an investor would deem suitable today;
    • The size of the projected resource that could be profitably developed has increased as development of the resource has progressed; and
    Despite the fact that certain projected operating costs have increased recently, from a projected $7/kilogram to $10/kilogram, these costs continue to be quite low relative to Lynas’ competitors. Furthermore, Lynas has already fully secured financing for the first stage of its two-stage construction plan, and financing that is not anticipated to be significantly dilutive to existing stockholders is expected to become available soon at terms that may be more attractive than those previously anticipated.
    I should have known it was going to get complicated
    However, a number of additional factors that investors should consider when evaluating the investment merits of various rare earth mining companies are not captured by the illustration on page 15 of the Lynas Corporation February 2011 Investor Presentation referenced above. These include:
    • The current market capitalization for the various companies;
    • The projected future costs to develop the resource and the amount of cash on hand or access to non-dilutive financing available to fund such future costs;
    • The existence of any “trap door financing,” such as warrants or convertible preferred securities, which can sometimes catch unwary investors by surprise;
    • Certain characteristics about a company’s resource(s) such as their composition (light REEs vs. heavy REEs), grade, concentration, metallurgy (which can impact processing costs), the presence of other elements that may represent additional assets or liabilities – such as radioactive elements that often accompany certain types of rare earth deposits, location (which can be further broken down into political risk and geographic risk, the latter including topographical and climatic conditions that may determine what type of mining operation is required – surface mining vs. tunnel mining – as well as whether mining activity will be possible throughout the entire year), proximity to a skilled local labor pool, and access to transportation routes and important infrastructure;
    • Certain characteristics about the company’s processing facilities, or other downstream operations. (The higher the cost of production, the greater the fluctuations in profits, and thus share price – and investors generally frown upon higher levels of volatility.);
    • The terms and conditions of any marketing agreements that the company may have in place to ensure sales of the products on attractive terms;
    • The company’s business plan; and
    • Last but not least, the background and skills of the company’s board and management team.
    The attribution of many of these factors to a number of rare earth mining companies was summarized in an October 10, 2010 Seeking Alpha article titled “Rare Earth Elements Part 2: Companies with REE Assets.” As such, a repetition of that detailed discussion is not likely to add much value here. However, in order to evaluate and compare the merits of investing in one or more rare earth mining companies, a matrix that takes all of these factors into consideration could be helpful. That may be an undertaking worth pursuing in a future article, but for now I would simply like to focus upon what I believe to be the most important of these factors, namely the quality of a company’s management. As indicated earlier, this is rarely mentioned in message board discussions among investors, nor is it often cited in the numerous reports, articles, and studies concerning the rare earths mining industry. For example, in response to a question on one of the message boards for investors in rare earth mining stocks asking whether anyone knew anything about a company’s management team, I recall one investor expressing his supposed belief that the company’s only other asset beside the rare earths deposit was “two guys and a pickup truck!”
    A skilled management team to the rescue – It’s all about the people
    Yet, management’s ability to meaningfully act upon all of the other characteristics of a rare earths mining company is likely to be far more important than the level of knowledge that an investor may be capable of accumulating regarding a company’s resource. Even if a relatively unskilled management team was successful in acquiring a substantial project, it should not be taken for granted that they will be sufficiently talented to develop that resource in a manner that will ultimately be beneficial to that company’s investors. In fact, the quality of a company’s board and management team is likely to be the most significant determinant of whether a company fails or succeeds.
    The four most important skills to be possessed by those who manage and direct a rare earths mining company are:
    1. the ability to raise capital. (Mining is a capital intensive business, so if a company can’t access capital, it can’t advance its projects much less its share price.);
    1. the ability to identify and acquire attractive projects;
    1. the ability to guide the project through the various stages identified on page 15 of the February 2011 Lynas Investor Presentation referenced above. (Rare earth mining companies are somewhat unique in that the process required to separate the ore into individual rare earth oxides after it has been beneficiated, crushed, and concentrated, is extremely complex and can be subject to extreme environmental scrutiny and regulations. Moreover, the separated oxides require further processing before they can be useful in the numerous technological applications for which they are so critical.); and
    1. the ability to make the investment community aware of management’s successful development of the company in order to boost its share price to a level that is consistent with the increased value of the company that results from their efforts.
    This is a balancing act. In their effort to acquire sufficient capital to advance their projects, management must avoid issuing too many shares at low prices, while still providing an attractive level of remaining upside potential for investors.
    So, how should investors go about evaluating whether a management team possesses these skills? The best indicator is management’s prior success – not necessarily for themselves, but for investors. And, their prior management expertise must be relevant. Individuals who have attained success in a particular field are often capable of attracting capital and exceptional staff members, and this may also enable them to gain access to an attractive project. But, without relevant expertise, they may prove to be unable to capitalize upon these competitive strengths within a new and unfamiliar environment.
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Comments (5)
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  • Poncho 462
    , contributor
    Comments (9) | Send Message
    Having just read a reasonably coherent description of one company's situation, Lynas, I cannot help but ask why your title/headline makes no sense in terms of the content of the piece. I expected at least a list of executives, and why they are able to bring a company to success, perhaps their business history, education, etc. And since Lynas is the only company discussed, perhaps a title change would be in order?


    "Investing in Lynas, my thoughts on why they are a good company".


    Your title says "..Rare Earth Companies.." Would you care to list those companies referred to in the piece?


    I realize your primary job is not to be a writer, but you are writing, and being published online, and you should make some effort to make your title match your article. I would suggest in the future that you do as the newspaper industry has always done, which is write the piece, and then have an editor or other knowledgeable person write the title or 'headline'.


    You can write anything you want, but let's not waste readers time by mislabelling your product. This is a Lynas promotion, and has no relation to the title above it. I am a former reporter and editor. If you are going to put your work before the public, learn a little about the business before you publish your next piece.
    17 Apr 2011, 03:51 PM Reply Like
  • Mike Holt
    , contributor
    Comments (1869) | Send Message
    Author’s reply » Thanks Poncho. I will try to provide more background information regarding the management teams at various rare earth mining companies in a future post.


    As for your impression that my post was intended as a Lynas promotion, I regret that you interpreted it that way. I admit that I have referenced some materials on their website to provide perspective on the entire rare earth mining industry, and I have referenced Lynas a number of times in my post. However, that is only because Lynas has progressed through more development stages than many of its competitors so it is more meaningful to reference Lynas when attempting to illustrate the various development stages of a rare earth mining company. As I have disclosed, I own several rare earth mining companies.
    18 Apr 2011, 05:11 PM Reply Like
  • Mike Holt
    , contributor
    Comments (1869) | Send Message
    Author’s reply » Lynas shares plunged last year when it was announced that they may not receive a license to commence operation of their finishing plant in Malaysia due to environmental concerns. These concerns emanated from some very unfortunate incidents associated with a previous rare earths processing facility that had been operated at a site near the Lynas Advanced Materials Processing [LAMP] facility being constructed by Lynas. The materials being processed in that other facility contained much, much higher levels of radioactivity than those being processed by Lynas, and that other facility was also not operated or closed down properly. However, these important distinctions were not fully appreciated by nearby residents, and their concerns were being stoked by a minority party politician.


    As a result of these concerns, the International Atomic Energy Agency was called in to review the safety of the LAMP facility, and the Malaysian Atomic Energy Board followed suit. Concerns regarding the LAMP facility itself seem to have significantly diminished, but some local residents remain concerned about the on-site temporary waste disposal facility.


    In five days, on January 30, 2012, the Malaysian Atomic Energy Board is scheduled to announce whether Lynas will be granted a temporary operating license. Under the terms of existing untapped lines of credit that Lynas had in place with JP Morgan and Sumitomo, Lynas would not be able to tap these lines of credit needed to complete construction of the LAMP facility if Lynas was not granted this temporary operating license. However, yesterday, Lynas announced that they have entered into a $225 million convertible bond financing deal that, regardless of whether their request for an operating license is approved, will provide Lynas with the funds needed to complete the first phase of plant construction and to cover other ongoing expenses in the event that the granting of their operating license is delayed.


    It remains unclear whether the Malaysian Atomic Energy Board will recommend the approval of Lynas Corp's request for a 2-year temporary operating license, and if so, whether granting of the license may still be delayed until Malaysian elections are completed later this year. However, the availability of this financing substantially reduces the risks that had been associated with a potential delay in the issuance of an operating license for the LAMP facility. This should also be good news for investors, in general, since the supply of rare earths from Lynas Corporation would represent the first significant source of rare earths outside of China in decades, and could therefore cause the availability of these materials so critical to so many important high technology industries to become significantly less unreliable.
    25 Jan 2012, 11:38 PM Reply Like
  • Mike Holt
    , contributor
    Comments (1869) | Send Message
    Author’s reply » The rare earths processing plant that Australian rare earths company Lynas Corp (LYSCF.PK) has built in Malaysia could potentially be the first major source of rare earths from sources outside China.


    However, operation of this plant has been held up for months because the Malaysian government has held back the issuance of an operating license that was approved in January. The date of that approval had already been delayed due to environmental concerns expressed by Malaysian protestors supported by a Malaysian politician in a minority party. After extensive reviews by a number of experts and domestic/international regulatory bodies, it has been firmly established that the plant is safe, yet the operating license has still not been issued.


    Meanwhile, shareholders of Lynas have suffered a 70% decline in the value of their shares as Lynas incurs millions of dollars of costs each month without certainty that the Malaysian finishing plant will be allowed to begin operations in time to generate revenues needed to keep the company solvent without the need for additional financing. Lynas has been here before, after the Australian government earlier rejected a bid by Chinese interests to acquire a controlling stake in the company. However, the future of Lynas is once again being jeopardized, this time, ironically, by a country, Malaysia, that hopes to spearhead its economic development by "attracting" direct foreign investments.


    The rest of the world also suffers from the Malaysian government's actions and inactions since we remain dependent on China for over 90% of the rare earths that are vital to so many high tech industries that we rely upon for the economic growth and development that we are so desperately seeking.
    31 Aug 2012, 09:55 AM Reply Like
  • Mike Holt
    , contributor
    Comments (1869) | Send Message
    Author’s reply » This morning, Lynas announced that the Malaysian Atomic Energy Licensing Board [AELB] has issued a Temporary Operating License [TOL] to Lynas, which will allow Lynas to commence operations.




    This is a significant development for Lynas (LYSCF) and for many, many others who will benefit from the availability of a new source of supply of the rare earths that have so many critical applications
    5 Sep 2012, 08:22 AM Reply Like
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