By Chris Berry (@cberry1)
For a PDF copy of this note, please click here.
One of the key takeaways from my recent visit to PDAC was that everyone’s looking. By this I mean everyone, be they investors, company executives, bankers, or private equity players is looking for something in Energy Metals. The distinction lies in exactly what everyone is looking for. While the traditional equity investor just wants the pain of this resource bear market to stop, there are those who I spoke with that are looking at this market as fertile territory for M&A. I could not agree more and my belief lies in one simple idea:
While we have witnessed billions of dollars of value destruction in recent years, we haven’t seen a commensurate amount of demand destruction in most Energy Metals.
This is a crucial point to keep in mind as the entire resource industry slowly reshapes itself to adjust to excess capacity built up in recent years. If demand destruction were the problem, they you wouldn’t see lithium or cobalt demand running well ahead of global GDP. You also wouldn’t see some of the recent deals going through I’ve discussed.
New technology value chains are evolving through industry consolidation with Samsung SDI’s (006400:KRX) purchase of Magna’s (MGA:NYSE) battery pack business and Polypore’s (PPO:NYSE) sale of itself to Asahi Kasei (3407:TYO) and 3M (MMM:NYSE). These deals are much higher up on the value chain, but are indicative of large companies positioning for market share in what many believe to be an industry (batteries) set to usher in a Fourth Industrial Revolution. With South Korea and Japan owning over 90% of the global battery business, these deals are further proof of the private sector tightening their stranglehold on increasingly valuable industries. Additionally, these deals are a much more encouraging sign for innovation and value creation versus share buybacks which really only support already sky high equity prices in many instances.
During SQM’s (SQM:NYSE) recent quarterly earnings call the company offered insights into the Energy Metals markets and referred to the lithium market as “strong” and assumed that both prices and volume would slightly increase this year. SQM owns over 25% of the lithium market globally, and although lithium only accounts for less than 10% of their revenues, it is comments like these that reinforce my conviction for stable lithium demand going forward.
So the real questions to consider are: What does this mean for the rest of the value chain? Where do you focus?
Earlier this week, Alcoa (AA:NYSE) agreed to purchase RTI International Metals (RTI:NYSE) for $1.5 billion in stock. In describing the deal, Alcoa Chairman and CEO Klaus Kleinfeld stated,
“Alcoa is accelerating its value-add growth engine by acquiring titanium leader RTI. We are combining two innovators in materials science and process technology, shifting Alcoa’s transformation into a higher gear.”
I thought this statement was particularly pertinent as it demonstrates another theme I think it set to accelerate in the blurring of lines between traditional industries and technological advancement. Though the market thought the deal was expensive for AA, clearly the company has realized that with aluminum prices under pressure, focusing on building a higher margin value chain in a growth industry (aerospace) is a sound strategic move.
And this is my central point: as major players alter their business models to muscle in on growth industries, new value chains are created which can enhance margins and ultimately drive returns. While it’s important to remember that these “sea changes” in industries can take longer than one would assume, I think the message for investors is clear:
A focus higher up on the value chain is key for wealth creation going forward.
Other major industrial giants such as POSCO (005490:KRX, PKX:NYSE) or BASF (BAS:ETR, BASFY: OTCBB) surely wouldn’t be spending so much time and money in these small but growing industries if the size of the prize weren’t much larger, would they?
So as the global economy struggles towards escape velocity growth, the moves by these companies are speaking loud and clear: the next generation value chains will increasingly focus on the use of technology to drive returns. The Energy Metals space is particularly well-suited for this transformation and this is why I think you’ll see an increasing amount of M&A going forward.
As these new supply chains are built, naturally raw material availability is a consideration and this is the window of opportunity for the Energy Metals juniors. I still anticipate seeing a great deal of consolidation in the junior space and am frankly surprised it hasn’t happened sooner. It remains to be seen whether or not much (or any) of the necessary consolidation is accretive to shareholders, but nevertheless as the major players consolidate, raw material access will be important.
It is because of these themes of raw material availability and technology and innovation powering forward that I think you’ll see a sustainable scandium value chain operating within five to ten years.
The overwhelmingly good news is that we’re at the beginning of a wave of M&A in the Energy Metals space. Some reasons for this include relative balance sheet strength (for the majors), interest rates at historically low levels (for now), underserved high growth markets, and technology continuing to power forward underpinning steady demand. Some of this is based on necessity, but the majority of it is opportunistic. It is those companies that have integrated technology to achieve low cost production which stand to gain the most going forward and I’ll be reviewing some of these ideas in a future note.
The material herein is for informational purposes only and is not intended to and does not constitute the rendering of investment advice or the solicitation of an offer to buy securities. The foregoing discussion contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (The Act). In particular when used in the preceding discussion the words “plan,” confident that, believe, scheduled, expect, or intend to, and similar conditional expressions are intended to identify forward-looking statements subject to the safe harbor created by the ACT. Such statements are subject to certain risks and uncertainties and actual results could differ materially from those expressed in any of the forward looking statements. Such risks and uncertainties include, but are not limited to future events and financial performance of the company which are inherently uncertain and actual events and / or results may differ materially. In addition we may review investments that are not registered in the U.S. We cannot attest to nor certify the correctness of any information in this note. Please consult your financial advisor and perform your own due diligence before considering any companies mentioned in this informational bulletin.
The information in this note is provided solely for users’ general knowledge and is provided “as is”. We at the Disruptive Discoveries Journal make no warranties, expressed or implied, and disclaim and negate all other warranties, including without limitation, implied warranties or conditions of merchantability, fitness for a particular purpose or non-infringement of intellectual property or other violation of rights. Further, we do not warrant or make any representations concerning the use, validity, accuracy, completeness, likely results or reliability of any claims, statements or information in this note or otherwise relating to such materials or on any websites linked to this note. I no shares in any companies mentioned in this note.
The content in this note is not intended to be a comprehensive review of all matters and developments, and we assume no responsibility as to its completeness or accuracy. Furthermore, the information in no way should be construed or interpreted as – or as part of – an offering or solicitation of securities. No securities commission or other regulatory authority has in any way passed upon this information and no representation or warranty is made by us to that effect. For a more detailed disclaimer, please click here.