Description

Background: MP Materials mines rare earth elements (REE) through its Mountain Pass, CA mine, producing 38 MT of concentrate in 2020 or ~15% of global supply. Since emerging from bankruptcy in 2017, MP has refocused on recovering REE oxides such as NdPr that are used in permanent magnets (PM) in green tech like EV motors and wind turbines. MP has proposed a 3-stage process of downstream expansion into higher-value-added REE separation (stage one, production restart, complete ; stage 2 downstream separation scheduled for 2021). 

This year, MP (until recently) has ridden the SPAC and EV bubbles, and more recently the commodity price surge. While shares have been cut almost in half after peaking at 5x the 2020 SPAC deal price, I think the current value is still extrapolating short term pricing indefinitely, despite medium term supply dynamics looking ominous, AND giving MP full credit for flawlessly executing a Phase 2 project with enormous execution risk.  MP trades at 100x 2020 Adj. EBITDA, and at least 4x above a fairly bullish valuation of its entire proved and probable REE reserves. 

I won’t go into too much more background detail on MP’s business--for more, read the timely long thesis from rookie964 posted in September 2020. But, at the risk of over-extrapolating (“this time isn’t different”), I think it’s worth reviewing the long history of MP to provide some grounding: 

First Life:

•The Mountain Pass, CA mine opened in 1951 as Molybdenum Corp of America, acquired by Unocal in 1977.

•Chemical processing was halted in 1998 due to wastewater leaks. Production halted in 2002 due to excess supply from China, lack of tailings disposal capacity, and environmental failures.

•Chevron acquired the assets in 2005 with the acquisition of Unocal and in 2007 began separating rare earth elements using lanthanum to produce didymium and lanthanum products

Second Life as Molycorp:

•Private equity sponsors acquired the Mountain Pass rare earth mining business from Chevron Mining for $80 million in 2008

•IPO in 2010 raised $408 million

•Molycorp rode the prior green tech wave, temporary REE price spike due to China export controls, peaking at $6 billion market cap in 2010

•Filed for bankruptcy in 2015 with $1.7 billion in debt following low REE prices, failed execution of processing capacity build-out

Take a look at the timely Molycorp short write-up from gwb posted here on VIC in April 2011; again while conscious of the risks of assuming the past is indicative of the present (and MP is in better shape than the prior Molycorp, already producing ~3x), I think the big-picture supply-side dynamics remain similar, and some of the other parallels are pretty remarkable. In addition to the commodity price spike (albeit higher then) and China concentration fears, Molycorp/MP investors were banking on a promoted triple-digit IRR downstream expansion project… 

Third Life as MP Materials:

The Mountain Pass, CA assets were brought out of bankruptcy led by hedge fund JHL Capital with $20 million top-up payment in July 2017. Per JHL head  and now-MP CEO James Litinski, JHL first got invested as a “passing [distressed debt] trade” and they “kicked in a couple million bucks to keep it out of reclamation.” 

Mr. Litinski also described the predecessor Molycorp as a “promotion vehicle.”

The reincorporated MP Materials is refocused on developing the rare earths oxide NdPr (oxide of REEs Neodymium and Praseodymium) which is used in permanent magnets (PM) common in EVs and wind turbines.

MP announced the go-public via Fortress SPAC at $1.0B EV in July 2020. The market value has ballooned to +$4B on the back of multiple bubble themes and recent REE commodity price increases.

Reviewing the Bull Case:

• Rare earths are controlled by China, and face LT supply shortage, making MP’s position as only large-scale Western Hemisphere mine extremely valuable. US government is also supporting the secural of independent supply.

• MP is developing higher value REOs that will make for better business this time around

• Huge demand growth driven by batteries, green tech will lead to permanently higher REO prices

• Expansion Plan -- MP has a 3-stage Expansion Plan that is supposed to radically improve earnings power

• Stage I - restart of operations, ~40k MT annual REO concentrate production - already achieved

• Stage II - Downstream expansion into the separation and processing of rare earth oxides, expected completion 2022. MP expects to invest $210m in capex beginning in 2021 to build out processing capabilities. MP targets $250m of Adj. EBITDA by 2023 from Phase II, versus ~$40M last year

• Stage III - Target date “2025+” calls for metal alloy and magnet manufacturing. MP has no specific Stage III plan beyond “buy, build, or JV.”

Countering Bull Case

• Rare earths are abundant (e.g. cerium more plentiful), especially compared to demand (500-1000 years identified supply at current levels). 

• China is the dominant supplier not because of scarcity, but because REE mining is extremely labor intensive and environmentally toxic with historically low margin/market size

• Higher value REEs are only ~20% of MP’s total reserves, so while current mining strategy makes sense, we shouldn’t capitalize it permanently

• Manufacturers will ruthlessly substitute between REEs or use alternate technology with lower/no REE components if prices are elevated for long periods. Alternative technologies in wind turbines and EV motors already exist. Regarding the use of PM versus induction motors, Tesla’s top motor engineer in 2018 said, “…it's a trade-off between motor cost, range and battery cost that is determining which technology will be used in the future.”

• China actually does dominate refining, not base concentrate mining, but this is more a risk for MP than an opportunity. As detailed later, MP has a complicated relationship with a Chinese rare earth miner which currently buys virtually all of its concentrate. Chinese import restrictions would pose potential existential risks to MP. Tariffs already impacted the business in recent years, though price increases have much more than compensated lately. 

• Stage II Expansion - high execution risk

With the SPAC deal, MP laid out ambitious targets for the Stage II plan: to generate $252m Adj. EBITDA versus just $43m in 2020 or $82m in the Company’s initial 2021 guidance, and $121m at MP’s more bullish Stage I forecast. This implies triple-digit ROI (pretax) versus 2020, and still-aggressive +60% the bullish pre-expansion figures. 

The execution risk here is huge; Molycorp spent much of its $1.7B in capex to build out refining last go-around but failed. The company claims better technology/methods this time but the Chairman/CEO and COO are PE/distressed investors, and the prior CEO suggested the company was reliant on its Chinese partner for critical IP. 

LT Supply Dynamics Overlooked

With all the focus on EV-driven demand, the long term rare earths supply dynamics are being overlooked. 

Based on data I have compiled from the US Geological Survey, global REE supply has nearly doubled just in the past 3 years in response to demand, with MP’s resurgent production contributing close to 30% of the incremental production. But MP is not alone. Production has surged in China. Malaysia, and Australia, and miners are eyeing vast unexploited reserves in countries such as Angola, India, Greenland, Canada, and Brazil among many others. 

Source: US Geological Survey

MP’s reserves of about 1 million tonnes represents only 1% of global reserves (Joint Ore Reserves Committee-compliant figures) but true reserves are likely many multiples of this figure. For example, this excludes vast uncounted reserves in Myanmar, which already produces nearly as much REO as the US.

Beyond the cheap sources of supply in China and Myanmar, the list of potential international projects is long. Many may not come to fruition as planned. But it is worth highlighting some:

Pensana plc won approval to mine in Angola (Longonjo project), exploring UK (Saltend project) processing. The Longonjo NdPr Project (84% owned) was approved by Angolan president in April 2020. A Sep. 2020 Mineral Resource report estimated 313m MT at 1.43% REO grade including 0.32% NdPr . The UK REO separation facility at Saltend Chemicals Park in Yorkshire would purportedly cost US$100mm, and Pensana has “first phase” backing of US$125mm investment from UK Automotive Transformation Fund.

ASR is building a 5k mt processing plant in South Korea.

Greenland Minerals and Energy (GME) is an Australian company that owns the Kvanefjeld mine, with potentially 11M mt or 12x MP. Shenghe Resources is the largest shareholder, and partner. 

Tanbreez - developing Greenland mine

Lynas is the leading Australian producer; most advanced producer outside China next to MP. Lynas is processing in Malaysia via partner, looking to in-source (higher capex project). It also has a partnership with Blue Line in Texas (no production).

Recent price increases have been attributed to strong demand from China, stockpiling, and more recently fears of supply disruption from Myanmar following the February 2021 coup. REEs have probably gotten caught up in the broader commodity reflation trade as well. Commodity supply dynamics suggest this price spike should be short-lived, like the last one in 2010, as more supply comes on.

NdPr Market Price - Shanghai 

Complex Shenghe Relationship... How will it Affect Expansion Plan?

The investment group that took over Molycorp assets needed a partner with technical expertise, and brought in Shenghe Resources. Shenghe is a leading Chinese REE operator, publicly traded but sovereign-backed (self described as “mixed” ownership as “advocated by the government”). The Chinese government exerts centralized control over the REE sector, which is considered strategic.Shenghe’s mission includes building a diversified source of REE resources abroad, and Shanghe has already established partnerships in Greenland, Vietnam, Australia, Singapore…

MP signed an offtake agreement with Shenghe in 2017 to provide essential distribution of MP’s REE concentrate to Chinese processors. Shenghe currently purchases 99.5% of MP’s REE concentrate. 

In May 2020, the offtake agreement was amended ahead of the SPAC deal finalization and IPO. The purchase price mechanism was modified from a production cost basis with significant discounts and profit sharing for Shenge to a market price basis (net of tariffs and other costs), and Shenghe warrants converted to 7.5% equity stake in MP. The agreement, while seemingly more fair, did lead to a step-up in MP’s realized price per MT just as MP was negotiating its SPAC IPO. The agreement will terminate when Shenghe has recouped its prepayment funding (currently $60m)—roughly 2 years based on current formula inputs. 

Interestingly, this is around the same time MP aims to have its own fully operational processing capacity. Will Shenghe continue to support MP’s access to the Chinese market beyond this point, or will MP be able to replace distribution on as-favorable terms? This is a big question mark that I have not seen addressed. 

To add another wrinkle, former MP CEO Colin Nexhip revealed in 2018 that Shenghe was the “technology services advisor…getting critical IP back in US,” meaning MP lacked the technical expertise to independently develop refining capacity. MP disclosed in latest 10-K that technical services agreement has been terminated. Clearly the company believes it is on a better footing to pursue expansion independently now. But the potential loss of a once-critical partner should at least give investors pause.

Insiders/Secondary Views

Despite already having +$500M in cash, MP issued $690 million 5-year convertible “green” bonds on 3/26/21 at $44/share (zero premium). This was combined with a secondary offering: on 3/22/21, total registered secondary sale of 6.9 million shares at 22% discount by insiders including 4.6m shares by JHL (lockup provisions waived). Given the big existing cash position, it is hard to see any good reason for the issuance beyond an overpriced stock and conveniently creating demand for insiders’ shares via secondary offering to satisfy convertible arb borrow needs.

It looks like the remaining lockup on insiders/pre-SPAC investors (48% ownership) expired on May 17, 2021 (6 months post-IPO) and there was a shelf registration filed on the 13th. There could be heavy selling pressure ahead…

1Q21 Update

MP realized 132% Y/Y commodity price increases (+46% Q/Q), driving 3x sales, Adj. EBITDA to $33M from $5M in 1Q20. MP believes full completion of Stage III would roughly double 1Q margin ($4400/MT) at current prices.

Valuation Summary

MP trades at >100x  2020 EV/Adj. EBITDA, 32x consensus 2021 Adj. EBITDA of $135, and 17x aggressive 2023E SPAC EBITDA projections, which assume zero cost overruns or execution risk on future Stage 2 development. MP trades at 10x the book value of mineral rights ($437m)

Even at a moderate bull-case NdPr commodity price of $90 (vs.mid-80s currently), MP estimates 2023 Adj. EBITDA would be ~$362 (~11x current EV). Essentially, the currency share price seems to imply (1) currently elevated prices will persist indefinitely; (2) MP will flawlessly execute on a major expansion plan, with no hiccups or disruption to distribution; (3)...and then some. 

With between 20 and 30 years of reserves at the current production level, and lower supply of higher value REEs, MP will need to obtain additional reserves or successfully execute a seemingly nonexistent Stage III plan to justify such a multiple. 

Even permanently capitalizing above-historical realized prices and margins (at just 3.5% discount rate over 20 years), I estimate the value of all of MP’s probable reserves are just ~$7 per share. This ignores declining quality of reserve mix, cost deleverage.

Catalyst

Catalysts

• Further insider selling with recent lockup expiry

• Normalization of REE prices, additional competitive supply

• High execution risk of Phase II expansion plan

• Complex Shenghe relationship (currently sole purchaser) could expire within 2 years