Tesla’s Supply Chain – Triumph of Hope over Experience?

They say that second marriages are the triumph of hope over experience but we can’t help thinking the same of Tesla’s “belief” that when miners said to it that they would be able to provide enough Lithium, Cobalt and Graphite for its Gigafactory it actually believed them. We can’t escape the feeling that the texting acronym ROFL (Rolling On the Floor Laughing) was made for exactly this situation.

However for a long time Tesla have painted themselves as being “the smartest guy in the room” and yet are we really supposed to swallow the line that Tesla actually believed that a whole swathe of projects in metals critical to their project would come to fruition when educated and informed people in the mining space knew that they would not? It would appear to be more of a case of didn’t want to know rather than didn’t know…

In this piece we shall follow on from the firestorm that John Peterson created in his piece last week with a specific look at how credible the chance of any of the many projects in the three metals of import actually becoming productive was over the last five years.

Lithium

We have been covering this metal since late last decade. Prior to that point (like Rare Earths) there had been so few players that they were well below any analyst’s radar. Moreover, with the pre-2008 focus on staples like precious metals and base metals, the specialty metals scarcely got a look-in. Our first exposure was the Rincon asset then embedded in an ASX-listed entity Admiralty Resources. Lingering effects of the 2008 crisis eventually forced Admiralty to divest this is to Cayman Island based resource fund, Sentient, who have held it ever since. At the time we thought this was the vanguard of the Lithium push that would break the Cartel and fill the demand gap in the middle of this decade. Instead the asset appears to be totally becalmed and it most definitely has not filled any gap, real or imagined.

Then came the Lithium boom. The great star performer was Talison Lithium which was cobbled together out of the old Greenbushes asset (ergo, a past-producer) and the assets of Salares Lithium in Chile. The high-point of the first flush was this company being bought for over $600mn by a Chinese group in league with Rockwood (one of the Cartel).

What was an initial field of around twenty lithium wannabes has shrunk by half over the last five years and is only now showing an uptick in interested new entrants. But as they say in the classics, “too little too late” to save Tesla’s bacon. It’s probably worth repeating here our Lithium Lifecycle chart, as a picture tells a thousand words:

lifecycle_lithium2016

An interesting microcosm of Tesla’s dilemma is that it signed a much vaunted deal with Bacanora Minerals. That fired up the stock price of BCN but did not bring in a single dime from Tesla in terms of investment. The attitude seemed to be “announce the deal, lift the price, go finance yourself”.  Easier said than done as we all know when the capex is north of $100mn. Understandably BCN has started to lose some of its rosy glow and the task of raising all the funds has now fallen upon the company. However even with the best will in the world (and easy money) this project would be years away from production.

If Tesla had really believed in this project or any other one, it should have taken a strategic stake and made funds available to move things along. Frankly, it did not.

Cobalt

This metal has until recently been one of the least talked about in the battery supply chain probably because it has an LME quoted price and thus this has given many the illusion that it is a “major trade metal”. Wrong! To put this in perspective the LME warehouses only have 614 tonnes of this metal in stock. Not exactly a base on which to build a major battery industry and still get a good night’s sleep.

But doesn’t it come as a by-product of major mines in other base metals? Oh, you mean the copper mines of the DRC with their on-again, off-again restrictions on exports and conflict mineral overtones? Or do you mean the big nickel mines, such as Ambartovy and Moa Bay that are scarcely fountains of cashflow for their owners (e.g. Sherritt et al.)? It is most correct to say that any manufacturer of size relying upon major base metals mines to continue providing them with cheap by-product Cobalt had better dust off their candles and light them to the Gods of Mining. The quantities produced from these mines is essentially driven by demand for the major metals and no major is going to ramp up copper or nickel production at a loss, or at breakeven, just to keep Tesla supplied with the Cobalt it needs.

As can be seen below has been on a long slide and has only just started to tick up. Frankly its price could double, but if the prices of nickel and copper have not moved commensurately, then it is unlikely majors will ramp up production.

Cobalt_price

This brings us then to the subject of primary Cobalt mines. These are rare unicorns indeed. Much air has been expended on this subject over the last fifteen years but little has been achieved in terms of bringing mines to production. The USGS produced a report on the Cobalt production outlook in 2013 and it included a frighteningly long table with the names of Cobalt projects that had been stopped in their tracks, mothballed or permanently decommissioned.

Cobalt_closed_mines

Below is our Lifecycle graph for the listed Cobalt developers, that we know of. This is the scantiest population of any of our “lifecycle graphs”.

lifecycle_cobalt

Formation Metals (FCO.to) is the obvious candidate for Tesla to “take out” if Tesla starts getting serious but even then, the project would probably not fully supply Tesla’s needs. Then it might need to move on to the NiCoCo project of Fortune Minerals (FT.to) to be fully self-sufficient. The others are all too early stage or too small to be realistic help in ameliorating Tesla’s looming Cobalt crunch.

Graphite

For a mineral that is literally as common as dirt, the surprising thing is how little has been achieved by the “wannabes” which makes us think that they just “wannabe bought”. The most suspicious thing is that for a mineral that has minimal processing requirements and very simple mining requirements (quarrying, pretty much) the capexes being touted are truly eye-popping. This brings us to our usual suspicion (very prevalent in the glory days of REEs) that the companies pump up the capexes because if the capexes were smaller than their cash-pile or financing ability then cheeky investors (and offtakers) might say “well, why aren’t you building it?”. This impolite stating of the obvious is a sure conversation killer.

In any case this is all history now as most graphite companies that did not speed towards development now find themselves short of cash and staring the Grim Reaper in the face. Names like Elcora and Flinders are either in production or on the cusp, while some of those that most vigorously played the “Tesla card” in their promotional efforts are down to their last shilling with little hope of reviving their credibility.

Tesla should move on one of the more stricken players, take it over and then announce that it has satisfied all its foreseeable needs. The mind boggles as to what that will do to the valuations of the other “wannabe Tesla suppliers”.

Conclusion

There is an old adage of “put your money where your mouth is” and frankly Tesla has shown zero sign of expediting any of the projects that it has waved its magic wand over. That nothing has happened to move these projects forward thus makes us feel that Tesla’s magic wand is limp indeed.

If this failure to abide by the commandment “Secure Thy Supply Chain” has gone unheeded then whatever the market dishes up to the company once it starts to explain away sourcing difficulties will be well-deserved. Did Tesla seriously think it was going to get a free ride from beaten down miners who can scarcely afford to pay their light-bills let alone developing mines with capexes north of $100mn. With Tesla still having a market cap of over $26bn, it could acquire for stock the most likely player in each of the Lithium, Graphite and Cobalt spaces for less than 1% dilution. Think about it…




Mutual Backscratching as a Survival Technique

Miners are so desperate these days that they will grasp at any piece of flotsam drifting by if it helps keep their heads above water. Survival is the name of the game and managements are now starting to realise that the self-same investors on their register that tell them “whatever you do don’t dilute us” are also the same investors who cry poor when management comes around seeking funds to keep the lights on.

As a result of these “do as I say, not as I do” core shareholders some companies have experimented with a new(ish) form of mining investment vehicle has appeared in London in recent years. We are not sure if its appearance here is due to a favorable legislative environment for this type of structure or just a case of coincidence. It is definitely one that we were unfamiliar with in North America. Some good quality companies have been attracted to it and it certainly fills a need for companies, but it can also result in an investment writedown that managements may not expect when they embark on the transaction.

Having recently stumbled upon a company confessing its experience I thought it useful to review the phenomenon and give some thoughts on how problems might be avoided.

Cartoon Polar Bear

How It Works

Essentially it is a form of mutual backscratching at the financing level. The vehicle for this “financing” is an investment trust which invests in mining companies. So far, so good. However what happens is that the investment trust makes its initial investment and then the mining company subscribes for shares in the trust for an amount less than or equal to the value of the trust’s investment in them. Then the mining company gradually sells the trust’s shares into the market in the process exiting the holding and realizing cash for whatever its investment needs might be.

A further twist is that the trusts are sometimes kickstarted by pooling orphan holdings of disparate (or associated) mining investors to create the initial portfolio. This brings the danger that the debut portfolio may consist of unwanted odds and sods or quasi-unmarketable parcels. The trust should in theory not take on board holdings that don’t take its fancy or suit the long term strategy but the temptation is always there to bulk up from the get-go by accepting whatever is offered as the shedding of unwanted portfolio holdings by foundation shareholders may ingratiate the trust’s management with its key holders.

Some of the Players

The first abortive attempt at one of these trusts in recent times was Grafton Resource Investments which came out of the gates post the 2008 slump with a less than sexy collection of bits and pieces and never got beyond the ugly duckling phase. It lingered on mainly invested in unlisted entities, but was eventually delisted and wound up.

After an interregnum of a few years a heavier group of promoters got behind a new vehicle which was called Praetorian. This trust had as founder shareholders, so we heard; groups such as the family office of the Fleming family (remember Robert Fleming, J.P. Morgan Chase Asset Management and BlackRock which seeded it with cash and some of their smaller non-core mining holdings. Praetorian was promptly listed on the London Stock Exchange and one of its first investments was to take a stake in Maya Gold & Silver, a story I have long liked in Morocco. Other major holdings in its portfolio are or were A Cap Resources (ACB.ax), Equatorial Palm Oil plc  (PAL.L), Galileo Resources plc (GLR.L), Polar Star Mining Corporation and Savannah Resources plc (SAV.L).

More recently another version, going by the name of GRIT (standing for Global Resources Investment Trust – GRIT.L) has been making some minor waves taking stakes in smaller miners on the “I’ll scratch your back if you scratch mine” variation on the theme. Amongst those to avail themselves of GRIT’s financings are Mineral Mountain Resources (MMV.v), Jaxon Minerals (JAX.v), Tirex (TXX.v), Orovero Resources (OVR.v) and Cornerstone Metals (CCC.v). Some of the management of GRIT, also overlap with Grafton’s team.

The story at GRIT has not been a happy one in recent times (as the price chat below shows). Whether this is the fund’s fault or not we shall not opine. It can be said however that in these times of ongoing distress in the mining sector it is all too easy for a miner to toss out shares of an investment trust than struggle to raise some shekels by more conventional means.

GRIT_price

A Recent Experience

While poring over the accounts of Elcora Resources recently, I noted that they too had availed themselves of financing from one of these structures. On March 10, 2014 Elcora issued 4,200,000 common shares of Elcora at $0.19 per common share in exchange for 443,136 ordinary shares of GRIT at £1.00 per share. The Elcora shares were subject to a hold period expiring July 8, 2014.

In the December accounts of Elcora we stumbled on the tidbit that there was a realized loss of $273,210 on sale of marketable securities as a result of Elcora selling part of its shareholding in GRIT. This left it with an unrealized loss of $153,989 on the remnant of the holding. It would appear that Elcora took around a hit of around 70% on the GRIT holding. And yet GRIT at this time are UP on their Elcora investment…

Conclusion

Anything that gets financings out the door with minimum pain or cost for all concerned is a good thing. In fact looking at these structures we cannot help but be reminded of the symbiotic relationship that used to exist between London- (and Edinburgh-) based investment trusts that existed for well over a century until a relative eclipse of this model in the last decades of the 20th century. Interestingly the model has been dusted off and come to the rescue of the mining sector.

If a small amount of money tides over a miner until better days it is not a good thing but as we can see in some cases the miner does well and yet it must take a hit on its stake in the investment trust because some of the other investments of the trust have dragged down its NAV.

The secret here is to do your financial backscratching with one of the better stockpickers in the space. And (just think about it) if they are good stockpickers they may not want to make an investment in your company!