The Energy Report: What's been going on in the lithium business since your last interview in October?
Jonathan Lee: Demand, which has enjoyed double-digit growth year over year (YOY), continues to outstrip supply. Higher growth from the battery sector has had many of the companies playing catch-up with their buyers. Talison Lithium Ltd. (TLH:TSX) completed its expansion in June. FMC Lithium Corp. (FMC:NYSE) also expanded its facility early this year, but it has been having some weather-related delays, which have added further supply constraints. The lithium price increased roughly 15–30% YOY. It's really been a very strong market for lithium suppliers since last October.
TER: The big excitement is this just-announced takeover bid by Rockwood Holdings Inc. (ROC:NYSE) for Talison. Of course, Talison is much bigger in the lithium business than Rockwood, which is a bigger company overall. What's the story behind that deal?
JL: Over the past several quarters, Rockwood made a strategic decision to grow its lithium business. Although it has a smaller, higher-cost asset in Nevada, its low-cost-advantaged property is in Chile. Its options were to either expand its facility in Chile or acquire Talison, which is what it has decided to do. It is paying cash in an outright purchase, so the shareholders of Talison will not be able to gain any of the upside synergies. From a straight valuation point, it looks dilutive to Rockwood Holdings, but it does make logistical sense if Rockwood wants to expand its lithium business. Talison has a strong hold in China.
TER: Unlike the mining or oil and gas industry, lithium has a limited number of players. What effect will this deal have on the industry in general and other players in it?
JL: This deal consolidates the market into three major producers, rather than four. To a large extent, it shows the capital commitment for growth in the market. All the market participants agree they want long-term growth. There is capital flowing into this industry and we continue to believe that it's going to be strong in the near term. This is the second acquisition this year in the lithium industry. Galaxy Resources Ltd. (GXY:ASX) acquired Lithium One Inc. (LI:TSX.V) in March in an all-stock transaction. Whether or not we'll see more consolidation is unknown, but I think we'll see some of the industry players, especially buyers of lithium products, become more aware of the industry dynamics.
TER: Is this a done deal or could other potential buyers enter the picture?
JL: I think there are two strategic buyers that would potentially bid up for the project. One is FMC Lithium Corp., which is one of the four majors that produce lithium products. The other strategic investor would be a Chinese company like Tianqiu Lithium, which is a state-owned enterprise that currently sources 100% of its material from Talison. However, the Australian Foreign Acquisitions and Takeovers Act, which mandates a vetting process to make sure Australian assets are not sold to foreign entities, could make for some potential pushback against a Chinese company purchasing it. For FMC, with $75 million in cash at the end of Q2/12, we think it will be more difficult to come over the top with a larger offer.
Another pushback that could impede the Rockwood/Talison deal is the antitrust issue. Prior to this acquisition, Talison owned around 35% of the lithium market. Chemetall had roughly about 20% of the market. Together, they would control over 55% of the marketplace. So that could put a potential kibosh on the whole deal. It really comes down to what the Federal Trade Commission, the Department of Justice and other regulatory bodies dictate is an antitrust issue and what it considers lithium products, because many of the products are sold into different marketplaces. The argument could be made that it's not a monopoly or that there are no antitrust issues. In short, it's not an entirely done deal.
TER: How long could this get dragged out if everybody gets to put in their two cents?
JL: As an example, the AT&T/Cingular acquisition took less than a year. It's pretty difficult to put a timeline on it.
TER: If this goes through, it looks like it could be a nice payday for your clients and other people who got into Talison early. When did you first start recommending the stock?
JL: I started recommending it in June 2011 around $4. Once it completed the expansion, you could see the earnings growth coming in sequential quarters and the share price was starting to reflect that. At $6.50/share, it's a big win for our investors.
TER: Is this going to have much effect on the smaller players or do they have to get further along in the development process before people start taking shots at them?
JL: It's still early to determine whether or not they would. Most are still exploration/development companies that have not produced significant amounts of lithium. However, many of these companies also have joint ventures or strategic alliances. Given the small number of participants in the space, you could see the strategic alliances, many of which involve Japanese and Korean trading houses, get more involved with the process by making investments to move these projects forward. Nonetheless, we believe that there are only a few viable entrances into the space.
TER: Let's talk about some of the other companies that you cover in the industry at this point. Bring us up to date on whichever ones you think are worthy of note.
JL: We like Orocobre Ltd. (ORL:TSX; ORE:ASX) as a Speculative Buy with a $2.25 target price. The company has received all the permitting to go ahead with its project in Argentina from the expert committee. It is now attempting to get debt financing from Toyota Tsusho Group (TYHOF:OTCPK). This agreement is a step closer to putting in the capital infusion needed to move the project forward.
A second project that's right next door with a very similar type of salar is Lithium Americas Corp. (LAC:TSX; LHMAF:OTCQX), which just completed its definitive feasibility study. We have a Speculative Buy on that company with a $2.20 target price. It received approval from the environmental agency in Jujuy Province. It's now waiting on the expert committee for project environmental approval. It also has two strategic investors in Magna Resources Ltd. (MNA:CNSX) and Mitsubishi Corp. (MSBSHY:OTCPK). Those two projects are the farthest along. I think you'll see a commitment made from at least some of those joint venture partners in the near term, probably within the next six months. Given the Talison/Rockwood deal, I think it puts more pressure on the trading houses to move forward with their commitments to ensure that they are able to get a healthy supply of lithium products.
TER: Is there any concern that Argentina's government may do something strange here?
JL: I think that's the biggest risk in many of these salars in Argentina. It has the potential to be a low-cost producer, but there is a significant amount of economic and political risk in Argentina. Inflation is also fairly high in the country and there are import and export delays. There's also the short-term devaluation of the Argentine peso to consider. Country risk remains the biggest problem with Argentinean projects.
Yet we believe that most of the salars will be the low-cost producers going forward. Even though they are in Argentina, we think those are the best-in-breed assets around the world outside of the four existing, major producing assets. I think they can overcome political risk.
TER: You've discussed Rodinia Lithium Inc. (RM:TSX.V; RDNAF:OTCQX) in the past. What's going on with that company?
JL: Rodinia has a small salar in Argentina and is very cheap. It does have a joint venture with Shanshan Tech Co. Ltd., which is a battery manufacturer in China. Talison currently sells a lot of its materials to Tianqiu Lithium, which converts the lithium product that Talison sells into lithium carbonate for batteries. Shanshan is most likely a buyer of that material. If the Talison deal gets approved, it'll be interesting to see how the operation is run under Rockwood and if it keeps the same customer base under the same terms and relationships, because Tianqiu Lithium does source well over 90% of its material from Talison. I think it's imperative that the relationship stands pat, or somebody like Rodinia may benefit, given Shanshan's relationship with Tianqiu Lithium and, subsequently, Talison.
TER: Rodinia is fairly cheap. Is there any chance somebody is going to take a shot at it, or do most of the other people have enough to handle already?
JL: Most of these companies, especially on the junior exploration or development side, are finding that capital doesn't come cheap in these markets. This has been the biggest hindrance to project development, as it has been for many other mining projects on the Toronto Stock Exchange. Stocks are depressed and if anything were to be done, it would be on a share swap, which doesn't really move projects forward. Capital costs are also rising, which is probably the biggest risk besides political and country risk.
TER: It's pretty frustrating to see that the cost of debt capital is virtually nothing these days, and yet companies can't get money.
JL: That‘s true, but in the mining industry as well as in other industries, we've seen significant cost overruns on many mining projects over the past year. That's creating some pushback from many of the debt facilities that would come to the market.
TER: Are there any other stories that you'd like to talk about at this point?
JL: I really think the Argentinean story is the place to be. There are near-term producers in Galaxy Resources Ltd. and Rodinia Lithium Inc. that should potentially be in production by Q1/13. Both have completed their financing, and Galaxy is producing. Canada Lithium is supposed to be commissioning in Q4/12 or Q1/13, which would be welcome news to have another supplier.
TER: Where is the market headed, and what should investors be looking at if they're really interested in lithium?
JL: I think there is significant opportunity in the space. As I mentioned earlier, we've seen double-digit growth in the past year on a price and volume basis. Demand continues to be strong and we fully believe that will continue. We think it really comes down to costs. Low-cost producers have a major advantage, because if there are any downturns in the space, you want to be on the lower end of the curve. Most of the best assets are already taken by Talison, Rockwood and FMC, so the next player needs to be cost competitive.
TER: How are lithium prices expected to behave in the short term?
JL: Very well. Talison raised its prices in December 2011 and again in July 2012. FMC and Chemetall did the same in mid-2011, then at the end of the year and again in the middle of 2012. All of the companies have announced price increases on many of their lithium products. That's a big indication that demand is outstripping supply, above and beyond what these companies had forecasted. There's a big lag in expansion so this price environment should persist for the time being.
TER: We'll just have to stay tuned and see how things shake out. Thanks for speaking with us today, Jonathan.
JL: Thank you.
Jonathan Lee is a battery materials and technologies analyst with Byron Capital Markets in Toronto. As a member of Byron's research department, Lee's primary focus is on the battery materials sectors, which includes lithium, vanadium and cobalt.
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DISCLOSURE:
1) Zig Lambo of The Energy Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report: Talison Lithium Ltd., Lithium Americas Corp. and Rodinia Lithium Inc. Streetwise Reports does not accept stock in exchange for services. Interviews are edited for clarity.
3) Jonathan Lee: I personally and/or my family own shares in the following companies mentioned in this interview: None. I personally, and/or my family are paid by the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview.
