Lithium Americas: Re-Rating Underway On SQM Joint Venture

| About: Lithium Americas (LACDF)

Summary

Lithium Americas is re-rating and should reach $1.5-1.75 in the near-term as it moves from development into producer status with "Big 3" incumbent lithium producer SQM.

Strong new management and new board buying shares; Lithium Americas attracting institutional investor support.

Relative Arbitrage: TSX-listed Lithium Americas has substantial catch-up to do relative to its ASX and Shanghai-listed peers, some of which are up 1000%+ over the past year.

Lithium Americas (OTCQX: OTCQX:LACDF; TSX: LAC), formerly Western Lithium USA Corp, rose 50% last week on heavy volume, catapulted by its announcement on March 28 that it has formed a partnership with Chile's SQM, one of the "Big 3" in a concentrated and increasingly supply-constrained lithium market. I believe this re-rating has only just begun and LACDF has a lot more to run.

I have been following LAC for many years. I always believed that their large, high quality permitted brine, Cauchari-Olaroz, in the Lithium Triangle would be built into a high margin cash flow machine, similar to the low cost industry leader, SQM. I have observed that LAC's largest shareholder, Geologic Resource Partners, was an early investor in Talison, one of the great lithium success stories. Talison was sold first for $850M in 2013 after a bidding war in which China's Tianqi bested US specialty chemicals maker Rockwood before inviting Rockwood to buy 49% of Talison the following year at a stepped up $1B valuation. Valuation multiples for these deals were an eye-popping ~15X EBITDA.

I like to be aligned with proven investors and management. Geologic's founder and Chief Investment Officer George Ireland's continued financial support for LAC over the past several years with a long-term, activist approach, is a strong market signal in my view. Mr. Ireland became Chairman at LAC's March 30 AGM together with 3 other new independent directors who possess substantial CVs. Mr. Ireland's quote from LAC's March 30th press release:

…"I am delighted to welcome to the Board, Nicole Adshead-Bell, Gabriel Rubacha and Lenard Boggio, who are each very talented and experienced professionals. It is a new dawn for Lithium Americas. We have a 50% interest in what we believe will be a world-class, low-cost lithium mine in Jujuy province, Argentina. Our partner provides substantial technical and operating expertise and is eager to move the project forward. We, and our new partner, SQM, will each have the right to take our share of the Joint Venture product output. We have a second lithium project in Nevada, a state which is poised become a leader in lithium production. We are developing a niche industrial clay business that is starting to grow nicely. And lastly, we have a restructured board of directors with a very strong expertise in corporate governance, mining, project development, finance and government and community relations and a talented management team with the background and capabilities to make the new Lithium Americas a great success."…

Mr. Ireland puts his money where his mouth is. He and several others on the board were on the tape this week as meaningful insider buyers.

World Class Partnership

Through a confluence of developments over the past 12 months in the global battery, power and auto industries, as well as shifting politics within Latin America, Lithium Americas and Chile's SQM (NYSE: SQM, $6B market cap) have teamed up in newly optimistic and investment-friendly times in Argentina. LAC and SQM announced on March 28, following President Obama's Tango and praise for Argentina's new President Mauricio Macri, that their joint venture will immediately start work to develop Cauchari's low cost, high margin, long lived lithium resource, producing potentially 40,000 tons per year. This 40,000 tons is very meaningful - about equal in size to SQM's 2015 production of 38,700 tons.

This significant investment from an incumbent producer speaks volumes about how it sees the lithium market developing over the next decade. SQM, which has seen its market share erode from 35% to 27% over the last 3 years, is executing a strategy to extend their market leadership position, in part through substantial diversification of lithium production. I expect this news should be good for SQM, as lithium has been its only growth driver of late. 20,000 additional tons (SQM's 50% share of expected 40,000 JV tons), would represent an approximate 50% increase in SQM's current production.

I estimate that the market values SQM's current $220M-revenue, 51% gross margin, 68% EBITDA lithium business at approximately $1.5B of its total ~$6B market cap, or about 10X EBITDA. SQM's stock is currently depressed from some political uncertainty, and softness in its non-lithium businesses. Were SQM's lithium business spun off into a pure-play vehicle, I would anticipate the market might affix closer to a 15X multiple, in line with the Talison discussion above. This would value SQM's approximate $150M lithium EBITDA at $2.2B.

I anticipate that the SQM/Lithium Americas joint venture in Argentina will, in the next few years, look a great deal like SQM's current lithium business, albeit with a significantly higher realized price than the ~$5,700/ton average SQM achieved last year from its lithium products. In other words, once in production, the joint venture could be on a trajectory to generate $100-150M annual EBITDA net to LAC, which the market should value at $750M- 1.25B.

As such, the joint venture is proving to be substantial news for LAC's stock, as a high profile, pure-play, near-term lithium producer. As described by LAC's CEO Tom Hodgson on a recent conference call, which attracted substantial attention from the institutional investment community:

"What's this deal about? The deal is about a path to production and a path to cash flow and critically as important minimizing execution risk. Building a lithium mine is not a trivial undertaking and there are quite a number of examples over the last five years of parties that have tried and who either failed or have experienced significant delays and startup problems. In our discussions with various parties, we're really focused on trying to minimize that execution risk. And I don't believe we could have found a better partner anywhere in the world in that respect than SQM. They are the largest producer of lithium from brine in the world. Their project in Atacama is a couple of 100 miles away from ours, it's very physically approximate and they've got 20-some years of experience on the ground producing lithium carbonate from a resource that is somewhat similar to ours certainly we use similar processes and we think that they are truly an exceptional partner and were very, very pleased to consider them the joint venture partner. I think it's fair to say that they are familiar with most of the lithium brine source in the world and did intensive due diligence on ours before we entered into the documentation stage of our deal and came to the conclusion that this was a project that could support production of 40,000 tonnes a year. That makes it a very major project and obviously it will take some time to get to that level of production but it will be a big project and our 50% continuing ownership stake in it would be a very, very valuable asset for our shareholders".

LAC, at ~USD175M market cap at time of this post, remains significantly undervalued. I believe the stock should continue to re-rate now that it has secured a definitive, de-risked, path toward production and substantial cash flow in what I expect should be late 2018/early 2019. With SQM, the world's best lithium brine operator, LAC's stock has moved from a speculation to an institutional quality, de-risked, near-term lithium producer.

Which means it is ready for traditional mutual fund powerhouses like Fidelity, Capital Group, T Rowe Price, Royce and Oppenheimer Funds, who are current shareholders in SQM and Orocobre, and will look at LAC with a 3-4 year, $1B market cap expectation. I believe we have started to see some of this last week with immense trading volumes and large block buys.

How Much of a Re-rating?

I believe LACDF could nearly triple from today's $0.59 to $1.5-1.75, or CAD 2.00 on the TSX exchange in relatively short order. This would equate to about USD 480-560M market cap, based on 320M fully diluted shares outstanding. At that valuation, LAC will be at an approximate 50% discount to the $1 - 1.25B I expect it should rise to once in production in 3-4 years.

This 50% discount is a standard, if not conservative, market convention for natural resource developers that have definitive paths to production, but still await final financing and construction, which in LAC's case is expected to be by year-end 2016/Q1 2017. And this USD 480-560M excludes about USD35M cash from SQM and expected exercise of outstanding option and warrants, as well as LAC's Nevada Lithium Project and Hectatone businesses, which at the time of LAC's merger last year with Western Lithium were valued at USD75M.

From 2017 through production at end 2018/2019, I would expect LACDF to rise more slowly, but still double to $3 - 3.50, as they hit construction milestones and first production begins and is ramped up. Supporting these timelines are comments from CEO Tom Hodgson and President John Kanellitsas in their recent conference call.

…" over the course of the rest of this calendar year, we would expect to update that definitive feasibility study and to agree a detailed business plan with SQM…

...So as soon as the feasibility study and the work plan is complete, we have our business plan settled and let's assume the end of 2016, we could update permits and begin construction immediately…

…I think if you are focusing on late 2018, early 2019 that's probably a sensible focus for getting into production…"

Lithium Americas' Comparables

My USD 480-560M near-term market cap expectation for LAC is on par with Orocobre (Ticker: OTCQX: OTCPK:OROCF; ASX/TSX: ORE), which trades currently at AUD 626M market cap. I think this is justified as LAC's share of lithium production will be 20,000 tons, nearly twice Orocobre's 11,600 net lithium production tons. Orocobre is a very relevant comp for LAC as its lithium deposit is in the same salar brine in Argentina. However, the appropriate market valuation of Orocobre is a big question mark as it has continued to disappoint in terms of production levels and product quality. Orocobre may currently be undervalued or overvalued depending on if it finally gets things right, or if it needs to tap the equity markets yet again for working capital and debt repayment.

I believe this concern explains Orocobre's stock relative underperformance in the past few weeks, despite receiving a nearly 40% increase in target price from AUD 3.05 to AUD 4.20 from its lead analyst and banker in Australia. Orocobre no longer has scarcity value in the Australian stock market. In the last year, a number of ASX-listed, Australia-based, higher cost spodumene developers and re-starts have come on the scene responding to Chinese off-takers' open wallets desperate for supply.

Pilbara Minerals (ASX: PLS) this week just raised AUD100M in a heavily oversubscribed offering and sports a market cap of AUD 520M. Galaxy Resources (ASX: GXY; OTCQX: OTCPK:GALXF) is at AUD 404M, Neometals (ASX: NMT) is at AUD 223M, and Altura Mining (ASX: AJM) is at AUD 218M.

On the Shanghai exchange, China's Sichuan Tianqi (Shanghai: 002466, USD 6.7B market cap) is trading at a 258X P/E ratio and Jianxi Ganfeng Lithium (Shanghai: 002460, USD 3.4B) is trading at a 192X P/E ratio.

A large arbitrage has existed for many months between LAC and these ASX/Chinese peers, in particular Orocobre, Pilbara Minerals and Galaxy Resources. This gap narrowed a bit last week, but has a lot more room to go in both absolute and relative terms as LAC re-rates within a market that has continued to raise these peers' valuations. There is a mad Australia/China lithium rush going on with several companies up more than 1000% over the past year.

Company

Exchange

Market Cap ($M)

Currency

USD equiv ($M)

5d

1yr

Argentina Low Cost Brines

Orocobre

ASX/TSX

$626

AUD

$482

0%

34%

Lithium Americas

TSX

$228

CAD

$176

50%

15%

Australian Higher Cost Spodumene

Pilbara Minerals

ASX

$518

AUD

$399

41%

1450%

Galaxy

ASX

$405

AUD

$312

26%

870%

Neometals

ASX

$224

AUD

$172

18%

900%

Altura Mining

ASX

$218

AUD

$168

39%

1375%

Chinese lithium producers/converters

Sichuan Tianqi

SHE

$43,210

Yuan

$6,679

0%

192%

Jiangxi Ganfeng

SHE

$22,190

Yuan

$3,430

15%

109%

Quebec - Science Project

Nemaska

TSXV

$212

CAD

$163

50%

482%

Arbitrage with ASX Won't Last Long - LAC Has Scarcity Value

I believe this arbitrage exists in part due to a sleepier TSX market compared to the more dynamic ASX. But I don't expect LAC's undervaluation to last long - global markets just don't let that happen when there's such a strong fundamental story. I believe LAC actually may start to trade at a premium due to its scarcity value as the only advanced stage lithium project exclusively on the TSX that has a credible path to near-term production and cash flow.

On that point, I note Nemaska (OTCQX: OTCQX:NMKEF, TSX: NMX) has also been rising sharply, as they published an updated pre-feasibility study with attractive looking numbers, largely based on using higher lithium hydroxide prices in their model. I've tried to study Nemaska many times and always find it difficult to understand. It seems a bit of a science project to me. I believe most investors tend to prefer simple stories with proven technologies and partners, like LAC/SQM, to complex ones like Nemaska, that are hard to explain.

I follow Mr. Lithium Joe Lowry's regular LinkedIn posts and agree with his question "Does the world need Nemaska Lithium?". I also note the many train wrecks I have seen over the years from Quebec-based stories in niche metals with new technologies (eg, Argex, Orbite, Canada Lithium/RB Energy) and am therefore very cautious when a new one comes around.

Nemaska is a high capex project using untested technology. Its recently announced financing has come not from institutional investors, but largely from the Quebec government and local stakeholders, who subscribed recently to a placement at a huge discount to market price. Their MOU with key vendor Johnson Mathey stipulates that when/if they eventually fund, Johnson Mathey will receive fees for services to Nemaska in line with their invested dollars.

Nemaska's market cap of CAD212M is just shy of LAC's market cap. I would expect LAC to soon leap ahead of Nemaska as I believe this company is highly speculative and will struggle to find the institutional shareholder support LAC is now attracting.

The Canadian market is beginning to play catch up on the lithium scene, with Cormark and Dundee recently publishing on LAC. I've seen long-term follower David Talbot of Dundee's note last week,who upgraded LAC to CAD1.60. Cormark's new analyst Alec Miekle also rolled out new coverage on LAC, Nemaska and Orocobre, which I found well written, but in my view uses an overly conservative methodology to arrive at a CAD1.00 LAC target.

Finally, SQM brings something unique to LAC from a capital markets perspective. SQM has been a highly successful NYSE listed stock for some 20 years, with a large following among emerging market and specialty chemicals investors. LAC's partnership with SQM should enable LAC to tap into the very large US and European shareholders who own SQM stock as well as the 15+ sell-side analysts who research it. SQM analysts from the likes of Morgan Stanley and BTG Pactual asked questions on LAC's recent conference call and have started publishing supportive notes.

Disclosure: I am/we are long LACDF.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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