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Nano One Materials - Valuation

Summary

A base-case analysis of the value of NNOMF's battery cathode IP.

A clear understanding of how outcomes beyond the base-case will affect the valuation.

The most common single question I have heard to do with Nano One has been the following: valuation.

This is, perhaps, unsurprising; although Nano One's technology as applied to lithium battery cathode materials is now proven and ready for outside investment, the company's outcomes in the medium-term exist on a wide spectrum, depending on the quantity and size of deals they now strike. In contrast, a resource company at the same stage of development would find itself with a much narrower - if not altogether binary - set of outcomes: they either find financing for the mine with a known NPV of $X, or they don't.

So where to begin with valuing Nano One? The first order is to garner key metrics on the space in which they hold their IP: lithium battery cathodes. The second is to make an informed set of conservative assumptions on Nano One's possible penetration of the space. The third is to combine these data, creating a low-end "base case" valuation for Nano One's cathode-related business (i.e. a single plant for a mid-sized maufacturer), as well as an understanding of the degree to which performance above the "base case" in each of the relevant assumptions will act as multipliers.

Although lithium battery cathode powders are a specialty chemical, essentially existing as a subsector of the generally opaque and proprietary chemical industry, the space has received detailed coverage owing to their critical spot in the lithium battery supply chain between raw material and cell. Research firms like Avicenne, BMI, and Indmin give us the data we need to build a reasonable "base case".

So, let us begin with the most recent full year of data: 2016.

Global Cathode Production, 2016:
178,000 tons/yr
178,000,000 kg/yr
488 tons/day
487,671 kg/day
4,000,000,000 USD/year
22.47 USD/kg average

The next step is to extrapolate 2018 numbers:

2013:   90,000 tons/yr
2014: 105,000 tons/yr
2015: 140,000 tons/yr
2016: 178,000 tons/yr
Average Annual Growth Rate: 26%

All analysts are calling for acceleration in the growth rate, however for our "base-case" we will use the recent average.

Thus, 2018 (est.):
281,000 tons/yr
281,000,000 kg/yr
770 tons/day
769,863 tons/yr
6,300,000,000 USD/year

The average cathode price has increased minutely yet steadily year-over-year, with the balance tipping towards increasing raw material costs and cathode demand. The majority of cathode production in 2016 was LFP and NMC (a combined 64% of total), with slightly more LFP (lower cost) than NMC (higher cost) - (interestingly, the first materials made by Nano One at pilot plant scale were NMC, followed by LFP). Thus, for our "base-case", it is reasonable to proceed with the average 2016 cathode price of $22.47/kg, which captures the two most common materials and the ones that Nano One has made at pilot scale.

2016 average cathode price: 22.47 USD/kg
Cathode gross margin, industry average: 9%
Cathode gross profit, industry average: 2.02 USD/kg

Nano One indicates a ~50% cost reduction on a kWh-basis - which is corroborated by an indicated ~40% reduction in cost on a kg-basis and an accompanying increase in energy density (kWh/kg). Within our previous and future assumptions (i.e. one plant for a mid-sized manufacturer) we can assume that the manufacturer will be selling their production to the market at prevailing prices and pocketing the 40% reduction to their costs.

Thus,
Cathode gross margin, post-40% cost reduction: 45%
Cathode gross profit, post-40% cost reduction: 10.20 USD/kg

Nano One has maintained that their preferred path to commercialization is a licensing strategy. Royalty rates vary wildly and are the most proprietary and opaque data points required for this analysis. Here, the only reasonable approach for our "base case" is to use a rate on the very low end - 10% of gross profit - and then, as with our other assumptions, bear in mind that for every multiple of the assumption, we may (happily) apply that same multiple to our final valuation.

Thus,
Royalty rate (%): 10% of gross profit
Royalty rate ($/kg): 1.02 USD/kg

As mentioned from the outset, in determining Nano One's market penetration, we have chosen the scenario of a single plant for a mid-sized manufacturer. We select an initial market penetration of 4% - representing an 11kT/year plant - which similar to the production of established ShanShan or Sumitomo, double the production of the aspiring JMBM, half the production of titan Umicore, well in line the with expansionary ambitions of current and aspiring manufacturers, and almost insignificant in an environment of average annual growth rates approaching 30%.

Thus,
Market penetration:
4%
11,240 tons/yr
11,240,000 kg/yr
31 tons/day
30,795 kg/day

The royalty revenues are thus as follows:

Royalty rate: 1.02 USD/kg
Market penetration: 11,240,000 kg/yr
Royalty Revenue: 11,467,325 USD/yr

In determining the net income from the cathode-related IP, a tax rate and operating expenses must be considered. A worst-case BC-resident corporate tax rate of 49% will be used (although Nano One will be the beneficiary of significant abatements and targeted tax credits). Operating expenses will assume that Nano One will continue aggressive R&D, either in cathode or applying its technology to one of its other fields of interest (heathcare, drugs, textiles, optics, energy, etc.), and as such we will use Nano One's 2016 expenses as representative.

Tax Rate: 49%
Operating Expenses: 2M USD
Net Income: 4,828,336 USD/yr

Nano One's market capitalization , and hence share price, is then a function of a chosen ratio - we choose to use a PE ratio, contextually set at 25 - and the share count, fully diluted:

PE ratio: 25
Net Income: 4,828,336 USD/yr
Market cap: 120,708,404
Shares, fully diluted: 68,855,442 (includes PP announced 22 Aug 17)
Share Price: 1.75 USD

So here we have our base case: $1.75 USD a share. We also now have the knowledge to quickly understand how scenarios outside the base case will affect the valuation.

Specifically:
Market penetration: For every additional 4% in market penetration, in a sector expanding production at nearly 30% per year - double the valuation.
Royalty Rate: For every every additional 10% of gross profit paid as royalty beyond the conservative 10% base assumption - double the valuation.
Tax Rate: For a halving of the tax rate - entirely possible after abatements and targeted tax credits - add 50% to the valuation.
PE Ratio: For a doubling of the PE ratio - double the valuation.

For example:
One such positive increase in all four of these assumptions would yield a share price of $7.85 USD.
A 30% royalty rate alone would yield a share price $5.25 USD.
A halving of the tax rate alone would yield a share price of $2.60 USD.
A second 11kT plant alone would yield a share price of $3.50 USD.
A PE ratio of 50 alone, thanks to Asian exposure from a Chinese A-listed partner or heavy interest, would yield a share price of $3.50 USD.
If Nano One's cathode technology becomes defacto, and captures a whole years worth of sector growth (30%) in an environment of robust demand, with no increase in the other assumptions: a share price of $13.13 USD.

It becomes readily apparent that even if Nano One only gets a small nibble of the cathode sector as in our "base case", the value created for current shareholders is enormous.

My disclosure is that I own approx 400k shares at a VWAP of approx 52c. The temptation to realize the gain is strong, however I reaffirm my initial conclusion: that Nano One will be a company that I hold for years to come, as their licensing strategy materializes into generous dividends, and their R&D expands beyond battery cathode to pharmaceuticals, textiles, and advanced materials. My feelings seemed to be shared by many of those involved.

$NNO $NNOMF $LBMB

Disclosure: I am/we are long NNOMF.