Strategic Materials

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MP Materials / Fortress Value - >>> Electric Vehicles, U.S.-China Trade and Commodities: Play Them All With 1 Stock.


Barron's

By Nicholas Jasinski and Al Root

July 20, 2020


https://www.barrons.com/articles/electric-vehicles-china-rare-earth-minerals-commodities-trade-spacs-merger-51595276024?siteid=yhoof2&yptr=yahoo


Electric-vehicle fever, U.S.-China geopolitics, commodity cycles, and special-purpose acquisition companies. A coming merger—that of Fortress Value Acquisition Corp. and MP Materials, an owner and operator of North America’s largest rare-earths mineral mine—will produce a stock that investors can use to play all of those forces.

Fortress Value (ticker: FVAC) is a special purpose acquisition company, or SPAC, backed by private-equity firm Fortress Investment Group. It announced an agreement last week to combine with privately held MP, valuing the miner at about $1 billion before proceeds. The deal will provide MP with the $345 million in the SPAC’s trust, in addition to $200 million from a private investment in public equity, or PIPE, from investors including Social Capital-founder Chamath Palihapitiya and Leon Cooperman’s Omega Advisors. After expenses, the cash will largely go to MP’s balance sheet to be invested in its next stage of growth.

This is a group of sophisticated investors putting real money into MP Materials, which will effectively go public through the transaction.

MP, which refers to the Mountain Pass mine in California, doesn’t produce just any old commodity. Rare-earth metals are 17 obscure elements at the bottom of the periodic table that show up in a variety of industrial, military, and technology applications. Rare earths include elements with strange names such as cerium, praseodymium, and neodymium, as well as superconductor component yttrium.

From time to time, rare earths come up in trade and economic-security arguments, because China dominates the market, producing about 60% of the global total. That is a large share, but rare earths are, well, rare. That 60% amounts to about 132,000 tons, a relatively insignificant quantity in the context of the global economy. The world’s production of copper—not even the metal in widest use—is about 20 million tons annually. The rarity makes them a factor in geopolitical calculations. U.S. officials have more than once referred to China’s heft in the rare-earths supply chain as a strategic threat.

The Mountain Pass site’s recent history involves now-defunct Molycorp, which began investing hundreds of millions of dollars in the mine around 2010. The timing was fortuitous for the fledgling company: Rare-earth metal pricing spiked in 2011 after China restricted exports. But trade restrictions eventually eased, prices fell, and Molycorp ended up filing for bankruptcy in 2015.

MP Materials was founded by part of the creditor group in the Molycorp bankruptcy restructuring. New owners can often acquire capital assets at a discount after the original operator goes bankrupt. That is what happened to satellite communications operator Iridium (IRDM). Also, Tesla (TSLA) bought its U.S. plant in Fremont, Calif., at a discount from General Motors (GM) during the financial crisis.

The growth of Tesla and other EV pioneers are also part of the MP story, but for a different, more important reason. Tesla is now the world’s most valuable car company, dwarfing century-old car makers such as GM, Ford Motor (F), and Fiat Chrysler Automobiles (FCAU). It has convinced investors that electric vehicles are the future. Nikola (NKLA), Fisker (SPAQ), and Hyliion (SHLL) have jumped on the trend, and are developing electric and hybrid cars and trucks. Each has merged or is planning to merge with a SPAC to go public.

But electricity-powered vehicles can’t move without high-end electric motors, which use magnets with rare-earth metals in them. Electric cars, with less than 2% global penetration of new-car sales in 2019, amounted to about 9% of total demand for MP’s rare-earth materials last year. That penetration of the global car market is expected to increase substantially in coming years, as consumers warm to the technology and governments around the world set EV targets.

James Litinsky is MP Materials’ chairman, and will also become CEO once the transaction closes later this year. He likens MP’s relationship with the EV developers as the entrepreneurs selling pickaxes and shovels to miners in the California gold rush of the mid 19th century. All EVs need electric motors, which need rare-earth elements for the magnets that make them work.

“Regardless of which EV company or battery technology wins out, we believe that rare-earth magnets are the best way to play electrification,” Litinsky says.

It might be, but MP doesn’t benefit directly from EV penetration any more than Alcoa (AA) benefits from the increasing use of aluminum in car bodies. But both companies indirectly benefit as the overall demand for the underlying commodities grows.

Growth is important for pricing and volumes and stock market success, but a miner and chemical processor are still in the commodity business. That means supply-demand dynamics are key. Being a low-cost producer is the best sustainable advantage. MP believes it has that moat, by virtue of having high ore grades, which require less work to get the same amount of metal. A 10% ore grade, for instance, requires 10 tons of material to be moved and processed to get a ton of salable product. A 5% ore grade means a miner is digging up and processing 20 tons of material for the same sales. More processing means more cost.

MP says its ore grade is about 8%. Lynas (LYC.Australia), an Australian rare-earth miner worth roughly $1 billion, says its ore grade at a key project is about 8% as well.

Ore grade is one part of the value equation, along with product mix. Right now, MP sends a concentrated ore to China for final processing. Management’s plan is to take the new capital from the SPAC merger and produce a finished product in the U.S. That would mean higher sales and margins than currently realized.

Business isn’t bad now, and it is cash-flow positive—not something that can be said about many of the newly public EV ventures. MP reported $10 million in adjusted Ebitda, short for earnings before interest, taxes, depreciation and taxes, during the first quarter. The company’s financial projections estimate $250 million in Ebitda by 2023, after the new processing plant is completed. Materials companies in the S&P 500 typically trade for about 10 to 11 times estimated next year’s Ebitda.

The deal with Fortress Value includes an earn-out for the sponsor shares in the SPAC, meaning that the postmerger stock price needs to rise to certain levels before sponsors can benefit. Half of Fortress Value’s 8.6 million postmerger shares—about 23% of the total—will now vest at $12, a quarter at $14, and a quarter at $16. That will reduce dilution for other shareholders, and underlines the fact that Fortress Value believes in the long-term potential of MP Materials, or else it wouldn’t have agreed to the earn-out.

A common fault for many SPACs is that sponsors can have more incentive to get any deal done than getting a good deal done. Fortress Value’s tweak to its sponsor shares is designed to address that criticism directly, and is a good sign for investors.

“When people talk with SPACs, the promote tends to be the elephant in the room,” says Andrew McKnight, CEO of Fortress Value and a managing partner at Fortress. “We wanted to get rid of that, and show that we really do believe in this asset.”

MP Materials’ current owners are also rolling over their entire stakes into the combined company rather than using it as a chance to cash out, another promising signal for investors.

Fortress Value stock spiked 10% on Wednesday after the deal announcement, but fell back slightly on Thursday and closed on Friday at $10.93. Shares rose 3.6% to $11.32 on Monday. The Dow Jones Industrial Average inched up less than 0.1% and the S&P 500 gained 0.8%.

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