Technology Metals Monthly – Can we sort out Rare Earths Project financing?
May 2016 saw the start of the impact of China’s new policy to internally stockpile rare earths. This could be seen in some early month rises across the suite of REO products. However, this wasn’t maintained. I am trying to get some internal China views on this but that will have to wait for a little more time. Also I promised to continue my thoughts into the financing “issue” that is surrounding not just rare earths developers but also in many other endeavours as well.
Tracking back to last month’s introduction into the risk : reward conundrum and the apportioning of NPV, we discussed that:
“Rio Tinto funds its capital either from cash flow or by borrowing money. It can safely divert cash to new capital works (with an ROI of +15%) rather than directing that cash to dividends because the shareholders are long term dividend focussed and see long term value in growth. I repeat, note what is occurring here. Rio Tinto is risking either it’s own money or is borrowing from banks. It is taking almost all of the risk. So what proportion of the profits (NPV) of that capital works should go to Rio Tinto. Well, all of it of course. They (Rio) risked it, they (Rio) deserve the reward.
Now look at a small cap exploration company looking to develop a REO project. Company capitalised at $25 million; has $5 million in cash; and needs $1 billion to develop a +20% ROI project. Things are very different. The money doesn’t come from within; there is no chance of shareholder funding (public equity); there is no chance of borrowing the money; so what is the solution to the conundrum?”
In my thought development, I questioned you last month as to how you saw the apportioning of NPV (or output) versus risk. That risk being in the form of the CAPEX required to develop the Project.
Query: in the following table are varying amounts of that $1 billion CAPEX paid by XYZ, please think about what the answers are to the empty boxes in the table.
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Unfortunately, the correspondence was very one-sided. There were no estimates from you with your thoughts. So I will plough ahead and all you will get is my one-sided view of this aspect of the finance world.
Let’s think about who gets value from the project. The State gets royalties. Fair enough, as do land-owners, stakeholder groups and others as part of a value dispersement. Employees, management, executive and the Board? Well they get paid through wages, salaries, director fees, bonuses. Again fair enough. But do they get a share of the NPV. They are risking nothing in the pursuit of the NPV so I would venture that they do not get a share of that NPV. Now I know you want the shareholders to get a sizeable sum, but should they? What risk are they taking? They have taken part in the IPO and contributed perhaps $5 million. Maybe some further stock issue along the way has boosted that to $10 million, but why do the shareholders deserve a sizable chunk when someone else is going to take the risk with the $1 billion? I will come back to the value model for shareholders later. Now I want to fill in the risk:reward table from above. My view!
You can see that I like simple models. Whoever takes the risk gets the reward! So who puts in the money? I am thinking that after the financial performances Molycorp and Lynas that the $25 million capitalised REO developer will get nothing from the banks or similar financiers. They will be pushing to get anything sizeable from their shareholders. The only chance is third parties. And who may they be? Off-takers, traders, down stream users, governments supporting strategic industry development. That’s right. I think that unless a shareholder contributes significantly to the Project development cost then they get no return on the eventual NPV! But there is a model for them to profit. Not saying that this process is a cure all for all projects out there in the doldrums, but the logic sure works for the economic side of my brain. Unfortunately, due to words and content restrictions the last piece of the funding puzzle will have to wait until next month.
Important Events of the Period
There is so little of real significance happening in the non-China REO world that I will not embellish with too many words. Bullet points highlighting the important articles in InvestorIntel is all that is needed this month.
- Rare Earths miner Lynas wins debt reprieve
- Canada Rare Earths enters into Agreement to purchase a Rare Earth Separation Refinery situated in Laos
- Tasman and Flinders announce merger
- Alkane Resources Ltd. bags $12.4 million to develop Dubbo Zirconia Project
- Peak Resources commissions leach recovery pilot plant for Ngualla
The development news coming out of China is not that outstanding either. But it is what you would expect from a successful production chain going through its day to day business with growth matching demand side movements.
- A demand prediction of global rare earth metals market volume to grow at CAGR of 10.19% till 2019.
- Rare earth stockpiling pushed up prices in China
China development news.
- Tohoku University developed a new kind of advanced exhaust-gas catalyst without precious metals and rare-earth elements
- China Northern Rare Earth invest 50 million yuan for construction of State Key Laboratory of Baiyun Obo Rare Earth Resources
- New energy vehicles grow fast during the first three months of 2016
- Supply-side structural reform of rare earth industry unfolds formally
- Zhongke Sanhuan and Qiandong Rare Earth to jointly build a special alloy company
- The second batch of rare earth commercial reserve released
- Permanent magnet straddled-type monorail train unveiled in China
In themselves, these China developments are not fundamentally showing an REO changed world. Just one that is on-going, building and is continuing to value add. The non-China REO world needs to start the process of catching up. But it cannot do that until the financing model is defined.
That answer comes next month.
Mr Mackowski is a qualified engineer in mineral processing with over 30 years technical and operational experience in rare earths, uranium, industrial minerals, nickel, kaolin ... <Read more about Steve Mackowski>