FVAC And MP Materials SPAC Merger: Speculative Play On The EV Revolution And Rare Earth Metals
Aug. 5, 2020 2:21 PM ET|6 comments | About: Fortress Value Acquisition Corp. (FVAC), Includes: LYSCF, MCPIQ
Sai Paturu
Sai Paturu
Long/short equity, special situations, debt, research analyst
(15 followers)
Summary
FVAC and MP Materials will merge and bring MP Materials, an owner of a rare earths, mine public.
Mountain Pass produces NdPr and prices for NdPr are expected to rise in the future.
This is a unique way to get exposure to the EV revolution as permanent magnets that are made with NdPr are used by all electric vehicle manufacturers.
Mountain Pass has the best unit economics among its peers and is a world-class asset.
Further upside potential by moving downstream to produce magnets would make the business more resilient as it would move from a volatile commodities business to a fully integrated industrials company.
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Investment Thesis
MP Materials (MP), an owner of a rare earth mine, has announced a definitive agreement to merge with Fortress Value Acquisition Corp (FVAC). MP will use the cash raised from the merger to complete stage 2 and 3 of a plan to retrofit the Mountain Pass Mine and bring back the rare earth metal supply chain to the United States. Purchasing shares in this company would be a unique way to get exposure to the Electric Vehicle (EV) revolution. There are several original equipment manufacturers (OEMs) of EVs, which makes it challenging to identify which will excel in the long run. All EV powertrains, along with other defense applications, require permanent magnets that use the rare earth metals that come from Mountain Pass. Due to the increased desire for electric vehicles from consumers and due to their use in national defense applications, the demand for rare earth metals can quickly begin to exceed supply. MP Materials is in a position to be the only low-cost producer of rare earth oxides outside of China. The current share price has a 40% increase in NdPr already baked in. Due to strong tailwinds the price of NdPr can increase as much as 80% in the future. Investors who are extremely bullish on rare earth metal prices and EV vehicles should consider picking up the shares at somewhere below $10 to provide to limited downside.
Rare Earths Primer
Rare earths (REs), more formally known as lanthanide elements, are a group of elements used in various applications. Rare earths are not exactly rare but get their name because to access them; they must be separated. Digging up the ore is cheap, but separating them and producing Rare Earth Oxides (REO) is expensive (Rare Earth Supply Chain).
Source: Created by the author using info from Rare Earth Supply Chain
There are four areas where these rare earth metals are located. Each site has a different mix of rare earths within them and may require different extraction methods (Stormcrow Research Industry Report).
Major Rare Earth Mining Hubs
Mine / Location
Qualities
Bayan Obo (Inner Mongolia)
Lighter Rare Earths(NdPr)
Low-Cost Structure
Ionic Clay (Eastern China)
Low Grade
Heavy Rare Earths (Dy and Er)
Cheap
Often illegal in China
Environmentally Unfriendly
Mountain Pass (California)
Low Basket Value
High Ore Grade
High Production
Low-Cost Structure
Environmentally Friendly
20 % of the world's supply
Mt. Weld (Australia)
High Basket Price
Lower Production
High-Cost Structure
Mined in Australia and processed in Malaysia
Source: Lynas Company filings, Molycorp company filings, Stormcrow Research
Business
The Mountain Pass Mine, owned by MP Materials, is a unique asset as it is the only mine on the western hemisphere that can produce rare earth metals comparable in volume and quality as China. The company's management has a three-step plan to upgrade its business model. Stage 1, RE Concentrate production capabilities, has already been completed and is generating $25 million in EBITDA. MP Materials already sells RE concentrate to downstream refineries in China (MP Materials Transaction Deck).
In Stage 2, MP Materials will begin to produce Neodymium Praseodymium (NdPr), Lanthanum ((La)), Cerium (CE), and other Heavy Earth Rare Concentrate and sell these REs to blue-chip companies across the globe. The company plans to complete its separation facilities by 2022 to produce Rare Earth Oxides and by doing so increasing the margin.
NdPr, the critical REs in the mine, are used to manufacture permanent magnets that power movement in EVs, Wind Turbines, Industrial Automation applications, Robotics, Drones, and Electric Aviation. Examples of companies that use NdPr are Tesla, Nikola, Boeing, Lockheed Martin BMW, and Siemens.
Source: MP Materials Transaction Deck
In stage 3, MP materials will move downstream and begin to produce NdPr Magnets themselves. One unique advantage that MP Materials will have is that at stage 3, it will be vertically integrated so MP Materials will be shielded from any price fluctuations. By combining the downstream operations with the upstream, the company will transition from highly volatile commodities business to a more stable vertically integrated industrials company and may command a higher multiple. Management projects that, upon completion of stage 2, MP materials will produce an EBITDA of $252M based on the forward estimate of NdPr at $70 per kg. Stage 3 seems highly speculative, but Stage 2 has a high likelihood of success and is expected to be operational in 2022.
Source: MP Materials Transaction Deck
History of the Mine
Mountain Pass Mine was historically a valuable source of rare earth metals. Production started around the 1950s, and it supplied most of the world's REE consumption from between 1965 and 1992. In 2012 Molycorp purchased the mine and invested 1.7B. Unfortunately, due to low commodity prices and inferior separation methods, the company was unable to be profitable and had to be shut down again in 2015. At the time of the bankruptcy, Molycorp had over a billion dollars in debt. JHL Capital Group, QVT Financial, and Shenghe Resources Holding Co bought the mine while bankrupt for $20.5 million. The minority owners, Shenghe Resources Holding Co, is an exciting shareholder as they are rare earth separation company in China. As technical partners, they will likely transfer rare earth separation knowledge to the engineers at the Mountain Pass Mine. One drawback is that the US government may be apprehensive about giving aid to a company that has a Chinese technical partner (Reuters, American Quandry).
MP's management believes that Molycorp struggled to be profitable due to difficulties perfecting their rare earths separation process. Molycorp's management altered the production processes to maximize the production of Cerium. The side-effect of this was extended downtime of the facility. After MP materials management has taken over they have reverted back to the original process and have achieved a greater than 95% uptime (Investor Q&A MP Materials Presentation).
Mountain Pass Advantage
MP Materials is the only mine in North America that can compete against China in the rare earth resources market. The company represents 15% of the global supply chain and would represent 100% of the supply in North America. MP Materials is multiple years and billions of dollars ahead of these mines and has a higher ore grade (MP Materials Transaction Deck)
Lynas Corp's, Mt. Weld, located in Western Australia, is the only other non - Chinese mine that has the capability of competing with the Mountain Pass Mine. Lyna's Mt. Weld Mine in western Australia requires about 350MM of Capex, which is almost double the Capex need for Mountain Pass. Additionally, Lyna's mine will not have the necessary separation facilities to process these rare earth metals. They need to ship the RE concentrate to a separate plant in Malaysia to turn the concentrate into REOs which increases the cost structure. There is also a high degree of geopolitical risk for Lynas as their facility in Malaysia is under short term contract with the government and needs to be renewed in 2023 (Financial Review). A large share of Lynas's production already goes to Japan, which has been making the US vulnerable to supply chain disruptions (Real Vision). The Pentagon has recently signed an agreement with Lynas Corp to begin preliminary plans for a processing facility in Texas. Lyna's planning stage, which is likely to cost $30 million, will be completed in 2021 (Bloomberg). MP Materials will plan to have their processing facility completed by 2022 and has also received an unknown amount of funding from the Department of Defense. The Mountain Pass Mine is expected to produce rare earth metals in 2022 and is expected to have higher annual production (Investor Q&A MP Materials Presentation).
Mountain Pass Mine is also located in California. California is a state with some of the strictest environmental policies. Mountain Pass is ESG conscious and uses environmentally friendly mining processes. For example, water used in the paste tail facility is recycled. This process uses about 5% of the freshwater that would be used in a comparable milling and flotation circuit. Additionally, Basanite ore has much lower levels of thorium and uranium than other types of ore. MP Materials also has a facility where the waste can be dewatered and turned into solids eliminating the need for tailing ponds. It also has plans to update the Chlor - Aklali facility, which will allow waste to be recycled into reagents (Investor Q&A MP Materials Presentation).
Source: Lynas and MP Materials company filings
Unit Economics
In a commodities business, the producer that will outperform is the firm that can achieve the highest revenue at the lowest cost, which will allow it to withstand price fluctuations. Let's dig a bit deeper into the unit economics of rare earth mining.
The easiest method of producing the Rare Earth Metals is the Ionic Clay sites in Eastern China. Farmers often illegally pour fertilizer and salt over the clay to separate the rare earth metals. Mining using this method is known to cause cancer and respiratory issues due to the waste that is produced. This process, however, causes extreme environmental damage and is outlawed in China. It is estimated that in the Jiangxi province, to clean up the environment, it would cost around $5.5 billion. Although this method is cheap there is a steep cost to using it.
Mountain Pass is the second-lowest cost producer overall and uses a different process where basanite ore is mined for these rare earths instead. Basanite ore is known to have low-cost structure(Investor Q&A MP Materials) but also has the lowest basket price. In the investor relations, slide management states that the mine has a high ore grade at about 7.8%. While this is true, it does not show the whole picture because MP Materials is not going to be selling the ore, they are going to be selling processed REOs. Each mining location has various distributions of rare earths which each sell at different prices. Consequently, it would be more prudent to estimate the basket price of the rare earths and multiply it by the REO production capacity to assess revenue potential. To calculate the basket price, one should take the sum product of the ore percentages and the price of each Rare Earth Oxide. This calculation reveals that despite having a high ore percentage that Mountain Pass has the lowest basket value according to the forecast prices. MP Materials will have to sell more REO's to achieve the same revenue.
Source: Calculated by the author using forward estimates from Statista and REO distributions from Stormcrow Research
Revenue is only part of the story. One should also consider the cost of what it takes to produce one ton of REO. According to Greenfield Research/Molycorp company filings, it suggests that Mountain Pass has the lowest cost to produce a REO despite having the lowest revenue potential. This is supported by the fact that basanite ore is known for having the most economical cost structure. Since the company can produce at such a low-cost structure, it actually has the best unit economics, and it is estimated that MP Materials should have a margin of around 82% per ton of REO. From estimates, it appears that despite having the lowest basket price, Mountain Pass should have the best margin once it completes stage 2 of the retrofit. This would give Mountain Pass an advantage as it would be able to sell REOs at the lowest cost.
Source: Calculated by the author using Molycorp company filings
Rare Earth Metal Industry Analysis
China dominates rare earth metals market due to state-sponsored development. As it stands, China currently controls about 90% of the global rare earth metals production, which is estimated at 140,000 per year (45,000 tons illegal) (Stormcrow Research). Due to the recent US / China trade war, government officials have woken up to the fact that there are few suppliers of rare earth metals outside of Lynas Corp that are ready to produce.
Rare earth metals have often come up as a discussion point in the recent trade war. In 2010 after a dispute where a Chinese fishing vessel collided with a Japanese Coast Guard official, the price of rare earths skyrocketed as the Chinese tried to use them as a bargaining chip(Real Vision). The Chinese reduced their export quotas by almost 46%. Demand later cratered as supply chains adjusted to these soaring prices and used substitutes instead. It does not seem that the Chinese would use rare earths as a bargaining chip in a trade war because there is little use for rare earth oxides in the United States. The rare earth metals used to make magnets are finished in China, Japan, and Korea. The United States could easily buy magnets from either Japan or Korea. This action would hurt the Chinese, Japanese and Korean companies that manufacture the magnets as well as the US companies that would have to pay more for the magnets. In a trade war, the objective is to hurt the other country without causing harm to your own country. Yes, the US would have to pay a higher price for magnets, but it would cause collateral damage in the process to the producers of the magnets. Although rare earth metals have been used as a bargaining chip in the past, it is unlikely that they will be the subject of a trade war in the future. Other materials are likely better targets for a trade war, but the focus of this article is MP Materials (Stromcrow Research - Trade War).
Increased demand for EV's is going to cause Neodymium and Praseodymium to rise in the future. Based on the future demand of EV's, wind turbines, and national defense applications the supply can easily exceed demand. NdPr prices are projected to be anywhere from about $50/kg to $141/kg according to management's estimates (MP Materials Transaction Deck). It should also be noted that some of the rare earths are projected to decrease in the future. According to projections, the basket price of Mountain Pass's REOs are expected to increase 65%. MP Materials would benefit the most there is a medium level increase in the price of rare earths. If it becomes prohibitively expensive, then OEM's would begin to look for substitutes.
Source: Ore% are from Stromcrow Research and forward rare earth prices are from Statista
Transaction Analysis
FVAC, a special purpose acquisition corporation, is going to merge with MP Materials to bring it public. A SPAC commonly referred to as a blank - check company, is a company that currently does not have operations but intends to merge or acquire another company using the proceeds it raised during its IPO. When MP Materials merges with FVAC, it will become one publicly traded company and trade under the ticker MP. The transaction will be consummated in Q4 2020. Sources of the transaction include cash from the SPAC, Equity Rollover from previous shareholders, and a 200 million PIPE (Chamath Palihapitiya and Omega Family), and sponsor warrants. Existing MP Materials shareholder, JHL Capital group, QVT Financial, and Shenghe Resources Holding Company, own 62.4% of the new company. The firms are rolling over 100% of their current equity holdings into the new company.
Seeing such a significant ownership percentage being rolled over shows that the existing shareholders are confident about the company's future. The company was purchased at an equity value of $1473.2MM (147,332 * $10.00). Based on the management's 2023 EBITDA estimate of $252M, the company was purchased via the deal at an EV / EBITDA multiple of approximately 4.3x ($1473/252 = 4.3x). Also included in the transaction are Sponsor Promote Shares, Seller Incentive Shares, and Sponsor warrants in aggregate size of 26.6MM that kick in at different share prices. This would make the diluted shares outstanding, approximately 174m.
Another interesting point to note here is that the company does not have any significant debt. Although they will not benefit from the deductibility of interest expense, it does allow the company to seek more debt financing down the road if their cash flow or assets allows. For now, the company appears fully funded and should not need any additional funding. Molycorp was forced into bankruptcy as low commodity prices caused their cash flow to dry up and they missed an interest payment. The low debt structure should shield them from fluctuations in rare earths prices (MP Materials Transaction Deck).
Valuation and Scenario Analysis
Three valuation methods were used to value MP Materials. The first is using EBITDA's from management estimates, second is by calculating revenue and EBITDA from the basket price and the third was calculated by trying to determine the future revenue based on the Mountain Pass reserves. Averaging all the cases gives an expected value of $17.54
For the management's estimates valuation method, various EBTIDA estimates as provided by management were used to determine the share price. These estimates were based on the probable completion of stage 2 and the various NdPr prices. The financiers of the transaction paid a multiple of around 4.5x. Mining companies trade at a multiple of about 10x times. This is slightly higher than their closest competitor Lynas (9.5x). Assuming stage 2 the average of these cases comes out to $13.64
Source: Created by the author using the MP Materials Transaction deck
For valuation method 2, valuation based on the basket price of REOs, a basket price based on all of the rare earths in the Mountain Pass Mine was calculated and used. One bias inherent in the transaction deck is they put an overemphasis of NdPr in their valuation. This valuation adjusts for that effect. To value the company without the bias, one should use a basket price of rare earth metals and multiply it by the annual REO production capacity to calculate the appropriate revenue. Using this methodology results in an average share price of $11.07
Source: Created by the author using the MP Materials Transaction deck, Stromcrow Research, and Statista
The third valuation method, valuation based on reserves, the basket price is multiplied by the Proven + Probable quantity of reserves to calculate the revenue. Then the appropriate EBITDA margin was applied to estimate EBITDA. An EV/revenue ratio of 3.16x was used to calculate the enterprise value. The average of all three cases in this scenario is $39.35
Source: Created by the author using the MP Materials Transaction deck, Stromcrow Research, and Statista
Although there seem to be significant tailwinds to the price of NdPr and other rare earth metals it seems like the upside potential for an increase in rare earths is already baked into the stock price. If rare earth metals price increase and the company moves further downstream price there may be potential for more upside. Management's estimates account for a 40% increase in NdPr. Many sources are predicting an almost 80% increase in NdPr.
Source: MP Materials Transaction Deck
Management
The company has an interesting management team. One critique of the C - Suite is that the CEO, COO, and CFO all have financial backgrounds. This makes sense from a continuity standpoint since two hedge funds previously owned the mine. It does not make sense from an operational perspective. The Chief Strategy Officer and General Counsel's experience comes from a video game technology background, which is strange. It would be more fitting to see at least one person on the C - Suite with mining experience. That being said the company also has an operational leadership that has a strong background in mining. One attractive member of the MP Materials board of directors is Retired U.S Air Force General Richard B. Myers. This is an excellent person to have on the board since rare earth metals are widely used in national defense applications(MP Materials Transaction Deck).
Risks
There are several risks to this investment. The first is the extrinsic risk that the price of NdPr and other rare earth metals does not rise. China along with other competitors could already be expecting the rise in demand for rare earth metals and begin to ramp up production. Another risk is that in the future that the EV drive train could move away from permanent magnets and use other materials instead if the price of rare earth metals becomes prohibitively expensive. A third risk is if the company is unable to complete stage 2 of their plan to retrofit the mine. If this were to occur there EBITDA and revenue potential would fall significantly. In the perfect storm, low rare earth metals prices and failure of stage 2,the shares could trade as low as $2.59. The company may be profitable in this scenario but not as valuable as the current share price suggests.
Conclusion
FVAC / MP has a long term expected value of $17.54. Purchasing this stock would be a speculative way to get exposure to the EV revolution. Rather than betting on a specific OEM or auto manufacturer, magnets made of NdPr are used in all of the electric vehicles. These magnets are also widely used in defense applications as well. Mountain Pass is the best situation to capitalize on this trend as they are a low-cost producer of the REOs that are used to make the magnets. They also have the opportunity to move downstream produce the magnets themselves. NdPr prices are estimated to rise in the future due to consumer demand for electric vehicles, and this would be a speculative way to get exposure.
Disclosure: I am/we are long FVAC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.
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