|More on Hykawy and his modus operandi, link, once again, from Stockhouse. Apologies to the original poster as cant recall (or find) who posted it. Nonetheless, required reading for those pondering over Hykawys 90c ORT target. For the record GWG has gone downhill ever since Hykawys's $2.25 target never surpassing the high of $1.25 seen in the chart below, it currently trades at 41c. Be aware that Mr Hykawy may possibly have another agenda than protecting potential ORT investors when he makes his bearish call. Kaiser calls him out here for some very questionable behaviour. See what you think after reading all of this!|
Great Western Minerals Group Ltd bears a close resemblance to its Australian listed peers in that it has spent more than a decade on rare earth projects without meeting projected production timelines, has seen its shares outstanding undergo an Australian style bloat, and follows the Australian practice of minimalist disclosure which makes it difficult to evaluate the company and its rare earth projects using the discounted cash flow valuation method. Unlike Canadian listed companies which must adhere to NI 43-101 which requires them to file on SEDAR detailed technical reports signed off by qualified professionals, ASX-listed companies have no such requirement and limit their disclosures to overly simplified summaries and presentation bullet points. Great Western gets away with flimsy Australian style disclosures because none of its projects have advanced beyond a resource estimate to a stage where economic assessment is justified, and in the case of Steenkampskraal, does not have the degree of title required to be in a position to make detailed technical disclosures. This has not stopped Canadian brokerage firm analyst Jon Hykawy from basing a $2.25 price target for Great Western on what appear to be self-invented numbers, promoting the stock through financial media without disclosing his employer's investment banking conflict of interest, and even pushing the ridiculous idea that Great Western valued at $1 billion is an acquisition target for Neo Material Technologies Ltd (NEM-T), a profitable downstream fabricator of rare earth based products with annualized revenues of nearly $300 million whose market capitalization is about $1 billion. That Neo Material, whose CEO flails at rare earth stock bubbles at every media opportunity, would pay $1 billion to acquire the tiny Steenkampskraal resource with its modest heavy rare earth composition is beyond preposterous.
In an effort to understand this $1 billion valuation for Great Western I have conducted my own discounted cash flow (DCF) analysis using the same approach I have applied to other advanced rare earth projects for which I have constructed DCF models using the mine and cost parameters published by the companies, and run the models at various rare earth oxide price sets to establish the after-tax net present value sensitivity of these projects to a wide range of prices from the most pessimistic three year domestic average to the most optimistic current FOB spot prices. I have not tried to risk-adjust the projects by applying different discount rates, choosing instead to apply the same 10% discount rate to all the projects so that I can understand how their valuations vary under the different price sets. I have also assumed they all start production one year from the present so that valuations are not skewed by different development timelines. In the case of Great Western I have relied on the company's published deposit data and, because the company has not disclosed any mine cost data, borrowed the cost assumptions made in the research recommendation that Great Western is a "Strong Buy" with a $2.25 price target.
My conclusion is that in the best case scenario where current FOB spot prices become the long term reality, Great Western will be worth about $1.38 per share if its fully diluted capitalization does not change. This same price scenario generates price targets of $20 for Avalon, $60 for Quest and $70 for Rare Element, $140 for Molycorp, $16 for Arafura and $4.40 for Lynas. In a more realistic FOB spot price scenario, such as the one JP Morgan uses in its Lynas and Molycorp research reports, a $0.40-$0.50 price target is appropriate for Great Western. With regard to claims that Great Western has an early mover advantage, I suggest that no such advantage exists. Great Western's plan to have Steenkampskraal in production by 2013 producing 2,700 tonnes of REO annually is optimistic; such a timeline requires Great Western to complete a feasibility study and secure approval for cracking and separation facilities by the end of 2011, and to construct and commission these facilities by the end of 2012. A likelier timeline if all goes well would be a production start in 2014 after Mt Weld and Mountain Pass have come on stream and taken some of the air out of current FOB spot prices for the light rare earths that will be the primary output from Steenkampskraal. But more to the point, Great Western's target output of 2,700 tonnes REO is inconsequential in solving the very serious supply problem looming not just for the "rest of the world", but for China as well.
Synopsis: Great Western is of no strategic significance to solving the world's rare earth security of supply problem due to the minor scale of its planned rare earth output, and as a standalone commercial enterprise it is fully valued for the best case scenario using very optimistic cost structure assumptions. At its current valuation Great Western qualifies as a bubble stock. This does not mean Great Western cannot go higher; in a true sectoral bubble where valuations blow past rationally based limits, it is impossible to predict when the bubble will stop expanding. The rare earth sector as a whole is not yet in a bubble, though certain individual stocks such as Great Western are exhibiting bubble behavior, and I do believe that rare earth stocks as a group will expand into a true bubble during 2011 as the magnitude of the supply crisis reaches a climax. I believe that the urgency of the rare earth supply crisis will result in sovereign wealth capital, multinational scale end-users, and major mining companies taking over the rare earth space from the juniors who through the accident of history ended up in charge of the world's most significant non-Chinese rare earth deposits. They will probably over-pay, but that may be the price that has to be paid to take responsibility for delivering the supply response to the demand problem away from junior companies struggling up the learning curve and battling a wall of skepticism. The good news for Great Western shareholders is that if I am right Great Western's stock price will head higher; the bad news is that if Jon Hykawy's macro rare earth narrative that rare earth mania is much ado about nothing is correct, Great Western is going to a penny.
If Great Western is inconsequential, why waste any time on it?
Given that it does not matter to anybody but Great Western shareholders whether or not Steenkampskraal comes on stream, it begs the question why I would waste any time evaluating Great Western. The bigger issue is that Great Western and its Steenkampskraal project have become synonymous with the message that the rare earth sector is itself inconsequential, that juniors with substantial advanced rare earth projects "are in a bubble" because there are no long term structural shortages for rare earths except perhaps for a couple minor rare earths called terbium and dysprosium, and that the only real winners will be tiny "mine to market" stories such as Great Western, Stans Energy and Ucore whose mining activity will require not much more than the services of a donkey, a pick, a shovel, a stick of dynamite, and a worker willing to wear a dosimeter. This message is being pushed hard by Jon Hykawy, Head of Global Research at Campbell Becher's Toronto based Byron Securities Ltd, who has emerged as the most prominent brokerage firm analyst to cover the rare earth sector and who is the author of the Byron research report which values Great Western at $1 billion. His dismissive comments about future rare earth demand and vocal sell recommendations for significant advanced rare earth juniors he never recommended as buys have put him squarely in the camp of the shorts whose attack on the rare earth sector has reached such a fever pitch that respected media such as Foreign Policy and Barrons have lowered their editorial standards to carry misleading and simplistic articles that seek to trivialize the rare earth story. There is nothing wrong with being a bear on the rare earth sector, but when you want to have your cake and eat it too, it is a different matter. Hykawy has acquired an aura of being an objective authority on the rare earth industry which has given him a pulpit to promote some rare earth companies while bashing others without disclosing that his objectivity is compromised through the special relationships his employer has with the companies he recommends. That is not fair play. My goal is to demonstrate why his price target for Great Western has no defensible basis and that his rare earth narrative is contradictory in that he simultaneously seeks to pooh-pooh the rare earth story, pop what he insists is a "rare earth stock bubble", and generate buying for those rare earth stocks his employer has financed, some of which already qualify as "bubble stocks".
Does BNN's Howard Green know Hykawy's boss has a ton of Great Western warrants?
For a recent example of Hykawy's narrative see the February 3, 2011 Interview with BNN's Howard Green in which he recommends Great Western without disclosing that Byron recently financed Great Western and receives a $60,000 monthly "advisory fee" payable in paper, a "company specific disclosure" missing from the boilerplate of his January 20, 2011 research report recommending Great Western with a $2.25 price target, which does, however, state that Byron has approved the report and takes responsibility for it. BNN's Disclosure Policy is very simple: "When it comes to disclosure, BNN's policy is straightforward: put the information on the table. Our viewers deserve to know whether someone has a financial stake in something being discussed. On-air guests who discuss or recommend securities are required to disclose positions held by themselves, members of their households and the firm they are representing. If we're talking about a stock, this could include either a "long" or a "short" position. Our guests are also required to disclose any investment banking relationship with the company linked to the underlying security, or other potential conflicts of interest that may exist. Disclosure is done verbally or with graphics, or sometimes both." Anybody who clicks on this video link can be forgiven for thinking that Jon Hykawy has no conflicts of interest when he recommends Great Western and Rare Element, both companies his employer recently financed and one of which is paying a fairly rich advisory fee for which the only plausible justification is his "rare earth expertise".
What sort of expert would claim to know what he cannot and should not know?
As to what sort of services Byron renders to Great Western every month in return for $60,000 one need only read this quote from Great Western's CEO Jim Engdahl: "Engaging Byron to provide strategic advisory services will be valuable to our company, given Byron's knowledge of the rare earths industry and the wide array of development options available, as our company moves toward becoming a fully integrated rare earths producer". Why the decades of rare earth sector experience and wisdom Russell Grant and David Kennedy bring to the table may not be enough becomes apparent when you hear Jon Hykawy declare in the Howard Green BNN video that the US Department of Defence's entire rare earth needs could be served by recycling power steering systems which apparently include permanent magnets containing neodymium, praseodymium, dysprosium and terbium but not the other rare earths that might find themselves a role in sophisticated technology like missile guidance systems. The casual listener might react, "wow, this guy is really smart, and I guess all this fuss about the military's vulnerability to rare earth supply shortages is nothing more than hogwash invented by the rare earth bulls". But think for a moment about what this glib statement implies. How does a Canadian stock analyst ferret from the DOD's defence contractors details about the specific rare earths and their proportional amounts that go into classified American military technology engineered to operate in extreme conditions, and extract from the DOD itself how many units of these classified technologies it requires on a business as usual basis as well as on an emergency contingency basis? Why has Jon Hykawy not been spirited away by the Chinese for interrogation or arrested by the FBI on suspicion of espionage? Why has the DOD not hired him? Why is Great Western paying Byron $60,000 a month for rare-earth related advice from somebody who pretends to know something about rare earth usage that he cannot possibly know?
One could dismiss Hykawy as just another example of a Henry Blodgett wannabe working for a lower tier Canadian brokerage firm if it were not the case that Jon Hykawy has defaulted into the role of a perceived rare earth expert which he has executed in a manner that is unproductive for the rare earth industry in general and is rather cynically skewed to promoting companies his firm has financed while bashing the rest. Even that would not be a big deal if he consistently disclosed his conflicts of interest and applied the same criteria and methods to all his evaluations so that nobody can wonder why one company merits "full benefit of the doubt" while others do not.
Hoidas Lake: the ghost that haunts countless presentations
Hykawy's top rare earth pick ("you're going to miss it, once it's gone"), Great Western Minerals group Ltd, spent much of the past decade and $12 million on the Hoidas Lake project whose 2009 production target evaporated in late 2008 when the company received a draft preliminary economic assessment (PEA) whose conclusions were never published. Reading between the lines we can conclude that the PEA was pretty negative. The location in northern Saskatchewan is remote, the resource size is modest with an average grade of only 2.39% TREO, the heavy rare earths represent less than 5%, and the mineralogy involves difficult rare earth minerals such as fluorapatite and allanite for which Great Western has never disclosed recoveries or cracking costs (the appendix pages in the Hoidas Lake technical report filed in 2009 on SEDAR which are supposed to present the results of metallurgical studies are blank aside from their titles). Nevertheless, Hoidas Lake lives on in numerous worldwide rare earth power-point presentations as a future source of rare earth supply when in fact the project is going nowhere unless Saskatchewan embarks on a road-building binge to provide access to this remote location or a remarkable metallurgical breakthrough is achieved. Neither is imminent, though Great Western has decided to allocate $2 million from its recent $35 million financing to further metallurgical studies. Recent metallurgical work that included Chinese entities did not yield overly encouraging results, though Great Western seems excited that Xstrata's lab found bastnaesite is present as a rare earth bearing mineral. Maybe the next study will deliver a breakthrough, but until then I refuse to include Hoidas Lake in any supply projection timelines and assign zero value to this project.
The Deep Sands Deal: a Darwin Award candidate
In an effort to secure a large rare earth resource in the United States the junior went after a heavy mineral sands deposit in Utah called Deep Sands, but got snookered into a bizarre deal that cost Great Western $6 million for a 25% right to the rare earths while the owner retained operational control and a 100% economic interest in the titanium and zircon minerals from which the monazite will have to be separated. They say a winner has many fathers, while a loser is an orphan, and right now Great Western's board members are all insisting that DNA tests should be conducted to determine the paternity of the Deep Sands fiasco. In any case, development of Deep Sands would be a throwback to the pre-Mountain Pass era when the world secured its rare earth needs by processing heavy mineral sand deposits for their monazite content. That era faded into oblivion after the world's military machines decreed that nuclear reactors should forego thorium in favor of uranium which, unlike thorium, generates a waste product called plutonium that is highly suitable for the development of nuclear weapons. Once thorium became a fairly abundant radioactive waste product from processing monazite, monazite from heavy mineral sands literally became too hot to handle.
GWTI: no mine and a vanishing market
Around 2005 Great Western management came up with the concept of "mine to market" and proceeded to acquire downstream operations which fabricated specialty alloys that required rare earths as critical inputs. First it acquired Michigan based Great Western Technologies Inc (GWTI) which makes the alloy powders required by lanthanum hungry NiMH batteries, the sort that presently power hybrids and which Great Western's biggest booster expects to be displaced by lithium ion batteries. Great Western does not disclose its financial data broken down according to operating divisions so it is impossible to tell how much revenue and profit or loss GWTI generates; one suspects that the revenues are inconsequential and the losses justified by the promotional mileage Great Western gets from talking about the downstream processing capacity of its facility in Troy, Michigan.
LCM: acquiring a "market" with a serious need for a "mine"
In 2008 Great Western acquired a more substantial downstream fabricator of rare earth based alloys called Less Common Metals based in England for $10 million. LCM sources its rare earths from China and fabricates a variety of rare earth based alloys of which the most important is the alloy that goes into samarium-cobalt magnets which are favored for high performance conditions not adequately served by the cheaper and more widely used neodymium-iron-boron magnets. LCM was an ambitious acquisition for Great Western because it forced the junior to take on debt during the 2008 Crash whose accompanying recession hurt the rare earth sector.
A $675 million payday for the EBITDA number crunchers behind Molycorp
Molycorp, which was bought from Chevron in late 2008 by a consortium headed by Denver based Resource Capital Funds, came snooping during the first half of 2009 with an eye to acquiring LCM. But RCF is a conservative and far-sighted creature which looks so far ahead of the curve it sometimes ends up navigating according to its rear view mirror, and that view in 2009 certainly encouraged a cautious predatory stance that Great Western management wisely rebuffed. While Mark Smith, who migrated from Chevron to head Molycorp after its RCF led buyout, has turned his hair grey pounding the pavement on behalf of Molycorp's story and his rare earth vision, the RCF venture capitalists whom some regard as kindred spirits of Rick "EBITDA" Rule have been almost reluctantly dragged along with their heels braced, and are now facing a monstrous payday in the form of a secondary offering of 13,500,000 shares which has been priced at $50 per share. JP Morgan and Morgan Stanley will raise $675 million for RCF and fellow Molycorp seed shareholders, more than has been raised by Molycorp for the re-development of its Mountain Pass project. In addition the brokers plan to sell $180 million in convertible preferred stock whose proceeds will go into Molycorp's treasury.
Quant logic for never being wrong: if you sold too soon, sell stock short, and repeat until right
That there is such an investment appetite for Molycorp paper probably came as a surprise for Jon Hykawy who set a target price of $28.40 for Molycorp last year (while the stock was cheaper) and issued a sell at $29.50 when that target was hit. Anybody who listened to Byron's rare earth expert was probably less than pleased when the stock subsequently passed $60, along with the shorts who have piled on a position approaching 8 million shares. Hykawy doubled his wrong bet with renewed sell recommendations rather than quietly commiserating with Bernard Baruch who at the age of 87 lamented that he made all his money selling too soon. Instead he joined the chorus of shorts fretting about the January 26 end of the lockup period for the Molycorp seed shareholders, perhaps remembering his stint as a technology analyst during the dot-com bubble a decade ago. One can understand the shorts trying to spook Molycorp shareholders into selling, but how is it possible that the most prominent rare earth analyst would not appreciate that the Molycorp seed shareholders consist of a small group of very sophisticated investors unlikely to pound out their paper at the first opportunity?
Is it possible to do worse than lose all your money listening to Wrong Way Hykawy?
Wrong Way Hykawy also has sell recommendations at considerably lower prices out on Avalon Rare Metals Inc (AVL-T: $7.38) and Quest Rare Minerals Ltd (QRM-T: $6.24) initiated on August 31, 2010 at $3.14 and $3.61 respectively. Avalon and Quest are two juniors not previously recommended by Hykawy nor financed by Byron which are working on very substantial Canadian solutions to the world's rare earth security of supply problems. In late January 2011 he also added Lynas to his hit list, dropping its $1.50 price target to $0.85. After tweaking the numbers in his trumped up DCF model for Avalon's Nechalacho project he discovered it was necessary to boost Avalon's price target from $3.40 to $3.45, in effect reiterating an open short sell recommendation that has now lost more money for investors who listened to him than they would have lost by going long a stock that drops to zero.
Place your bets: Jon Hykawy, PhD, MBA, versus Rodney Cooper, P.Eng, MBA
Hykawy, not content to simply have an avoid out on Quest, generated a $0.40 price target in late January so that everybody can see how much money they could make shorting Quest. This was clearly a shot across the bow of Dundee analyst Rodney Cooper who on January 26 published a detailed research report which established a price target of $8.88 for Quest after Cooper cranked up Quest's PEA cost assumptions and punished the projected cash flow with an 18% discount rate. One can just imagine Dundee's Ned Goodman calling up Byron's Campbell Becher to ask what Becher's PhD/MBA knows that Goodman's P.Eng/MBA missed, especially given that Hykawy's crystal ball reveals that dysprosium and terbium are the only rare earths that matter, rare earths of which Quest's Strange Lake has plenty to offer but of which Hykway's rare earth buys will supply inconsequential amounts, in particular Great Western, his top pick.
Except in the case of Rare Element which Byron financed, Hykawy seems to have a deep distrust of numbers qualified professionals have signed off on in technical reports, to which he is entitled, but at the same time he does not have much difficulty with informal numbers provided by companies on which no qualified professional has signed off. In the analyst community it is acceptable to be biased toward pessimism or optimism so long as one applies a consistent analytical method, but when the application of analytical tools generates outcomes which correlate with the existence of a conflict of interest, the analyst starts looking like a corporate finance poodle.
Great Western turns to Steenkampskraal as its supply solution
Molycorp failed in its effort to acquire Less Common Metals because it knew Great Western's existing rare earth projects were worthless and hoped to get the operating division on the cheap. LCM was a jewel of an acquisition for Great Western, which not only secured a meaningful downstream rare earth related business, but also the decades of rare earth experience represented by LCM's Russell Grant and David Kennedy. It probably did not take long for Kennedy and Grant to figure out that Hoidas Lake and Deep Sands were dead in the water, and grassroots plays such as Douglas River and Benjamin River as well as an assortment of farm-in projects were crapshoots which at best might deliver rare earth supply in 2018 and beyond. Realizing that it had nothing in terms of upstream mine output for its downstream operations, Great Western management dealt with the need to secure a supply of rare earth oxides from outside China for LCM by negotiating an off-take deal with Rare Earth Extraction Co Ltd (Rareco) for mixed rare earth oxide concentrates from the Steenkampskraal deposit in South Africa, a former thorium mine during the fifties that Rareco tried to develop as a rare earth mine during the nineties.
Betting that the margin exists mainly downstream from separated rare earth oxides
The off-take deal, finally formalized on August 10, 2010, had a peculiar structure in that it required Great Western to provide all the capital needed to put Steenkampskraal into production, and entitled it to purchase the production based on published FOB rare earth prices. The deal reflected management's belief that profits in the rare earth sector resided mainly in the value added by fabricating advanced alloys and materials which required rare earths as critical inputs. In this regard Great Western was following the model of Neo Material Technologies Ltd which has developed a downstream specialty metals business largely based in China in order to secure rare earth oxides at domestic prices for products exported to western manufacturers. Neo Material does not control upstream rare earth mine production, though it is now trying to move upstream by working on non-Chinese projects such as the tailings at the Pitinga tin mine in Brazil.
Great Western management reasoned correctly that it was unwise for LCM to maintain long term reliance on Chinese rare earth supply, but failed to anticipate that a dramatic divergence between FOB and domestic rare earth prices would emerge as a result of a shift in Chinese rare earth policy in 2010. The Rareco off-take deal made sense in early 2009 when FOB spot prices were priced 15%-25% higher than domestic prices which largely reflected Chinese export duties. But the off-take deal became untenable after June 2010 when a Chinese decision to sharply cut back export quotas and initiate a consolidation of its rare earth mining industry in order to get rid of illegal and polluting operations sent the FOB prices of the cheap rare earths soaring.
LCM not a Willy Wonka factory where Oompa Loompas work for nothing
The sharp divergence between FOB and domestic spot prices poses a major threat to the viability of Less Common Metals as a British fabricator of rare earth based alloys and magnet materials. As already mentioned, Great Western discloses almost no financial and technical detail about its GWTI and LCM downstream operations which would allow an analyst to evaluate these businesses. What we can see is that the combined GWTI/LCM divisions generated revenues of $10,613,654 for the nine months ending September 30, 2010 which yielded operating income of $3,145,673 for a gross margin of 30%. Quarterly reports indicate that the margin ranges from 25%-30% (the margin for the most recent quarter was 27%). GWTI/LCM, however, appear to be losing money. The expenses section of the income statement includes two items which do not appear to be related to the parent company's Saskatoon based office. "Wages and benefits" sucked up $2,314,747 during the recent 9 month reporting period, and "Other direct overhead" sucked up another $1,015,103 for a total of $3,329,850. It is reasonable to attribute these expenses to the downstream divisions because separate expenses including "General and Administration" at $1,139,583, "Professional Fees" at $206,092 and "Investor Relations" at $475,724 totaling $1,821,399 sound about right for the overhead of an active public company such as Great Western. Assuming this is a correct allocation of expenses, the GWTI/LCM operating income for the 9 month reporting period shrinks to a loss of $184,177. For the quarter ending September 30 the loss increases to $205,200.
How do you pass on raw material price inflation when your competitors don't share your input pain?
Because Great Western does not disclose relevant financial details about its operating division such as what percentage of "cost of sales" is represented by rare earth oxides, nor how many months of future raw material consumption is held in inventory, a reliable analysis of the impact of the soaring FOB spot prices is impossible. However, given how much emphasis Great Western management and its supporters put on downstream processing capacity as a way to add value to rare earth oxides, and their willingness to pay FOB spot prices to Rareco for security of supply, one has to assume that rare earth oxides are a significant component of GWTI/LCM's cost of sales. It is also reasonable to assume that LCM management, being sensitive to the Chinese supply situation, was not operating LCM on a "just-in-time" procurement basis and probably had at least 3 months worth of samarium, gadolinium, neodymium and dysprosium oxide inventory on hand when China slashed the export quotas for the second half of 2010 at the end of June last year. It is thus reasonable to assume that the third quarter financials do not reflect LCM's need to pay FOB spot prices to replenish the inventory needed for its fabrication business. Unfortunately, the charts below show that LCM faces a serious problem if it has to turn to the FOB spot market to buy the four key rare earth oxides it needs for its fabrication business: samarium and gadolinium for its samarium-cobalt magnets, and neodymium and dysprosium for its Nd-Fe-B magnets.
In particular note the samarium chart which shows that the FOB spot price for samarium oxide spent most of the past decade at $4.50 per kg or lower and was priced at a 100%-150% premium over the domestic oxide price. Samarium oxide is one of the few rare earths whose supply experts almost unanimously expect to remain in surplus indefinitely. This was perfect for LCM's business model because it specialized in making samarium based alloys required by its non-Chinese customers. But look at what has happened since China's quota reductions at the end of June 2010. The FOB spot price for samarium has soared 1,255% from $4.50/kg to $61/kg, while the domestic spot price has increased less than 5%. Since the announcement of the H1 2011 export quotas the FOB spot price has doubled, suggesting that there are some very desperate non-Chinese buyers in the market who are paying 2,133% more for samarium oxide than their China based competitors. Could this be LCM paying through the nose to make sure its furnaces have raw material to melt?
If LCM was losing money before the FOB price spike, what will it lose now?
Great Western claims that LCM supplies 20% of the global demand for samarium-cobalt alloy. The 2006 supply statistics for China suggest that samarium oxide is about 2% of total rare earth supply. Based on predictions that TREO supply in 2010 was 125,000 tonnes, this means about 2,500 tonnes of samarium oxide were produced in 2010. Since samarium oxide is mainly used for samarium-cobalt magnets, we can assume that LCM's 20% share translated into 500 tonnes of samarium oxide. At the FOB spot price of $4.50/kg that would have represented $2,250,000 worth of raw materials, which is readily accounted for by LCM's cost of sales. If LCM has to pay the $61/kg FOB spot price today to buy 500 tonnes of samarium oxide for its 2011 production of samarium-cobalt alloy, it would have to pay $30,500,000, which would eclipse the $13-$15 million revenues LCM generated in 2010 (assuming the fourth quarter is consistent with the first three quarters). Given that the remaining 2,000 tonnes are available in China at $2/kg for a sum total of $4 million, one has to wonder why LCM's customers will continue to buy any samarium-cobalt alloy from LCM. These calculations are speculative because Great Western does not disclose what LCM's raw material consumption and inventory management strategy are. But they illustrate the sort of devastating impact China's two tier pricing system can have on non-Chinese downstream businesses such as LCM.
The situation is not quite so bad for the other rare earth oxides LCM consumes. Gadolinium is 425% higher while neodymium is only 155% higher than domestic prices. Gadolinium is mainly used as a doping agent so that price increase is likely bearable, and the domestic price for neodymium is tracking the rise of the FOB price and may even catch up. The good news is that dysprosium and terbium oxide, the much hyped "heavy" rare earths, have FOB spot prices that are only 33% and 39% higher respectively than their domestic counterparts, which largely reflects the 25% export duty and the VAT that does not get refunded when they are exported.
Will LCM suspend its samarium-cobalt alloy production?
It is very doubtful that LCM's samarium-cobalt alloys are so unique and essential that it will be able to pass much of the price differential on to its customers, which means that LCM will either have to suffer significant losses while it waits for the Steenkampskraal cavalry to ride to the rescue or suspend this product line. Great Western's disclosures do not allow us to estimate what impact these raw material price increases might have. Given that during Q4 of 2010 Great Western advanced $2 million to LCM for the installation of an additional furnace which will allow a 50% expansion of production capacity, one must pray that it is for products that require rare earths which have a much lower FOB-domestic price differential. What is a business that is not profitable on annualized revenues of about $14 million worth? What will it be worth if input costs rise sharply without an accompanying ability to pass the higher costs on to customers because those customers can buy similar products from Chinese producers who enjoy substantially lower input costs? What is the value of a goose egg that is not golden?
Non-Chinese downstream processors cannot compete as long as 500% plus differentials exist between domestic and FOB REO prices
The shift in China's export quota policy has trapped Less Common Metals between a rock and a hard place made so much the more frustrating because Great Western and Rareco wasted nearly two years trying to outsmart each other rather than fast-track the re-development of Steenkampskraal. While some seem to think the rare earth crisis erupted out of nowhere during the second half of last year, others saw this coming more than two years ago. The Chinese initially designed their export quota strategy to encourage end-users to shift their manufacturing capacity to China to secure supply for their downstream products, a move which would shift more jobs of an advanced nature into China's economy and facilitate the transfer of western intellectual property into the hands of Chinese industry. This implicit strategy of extortion and theft did not exactly bolster China's case as western nations complained to the WTO over unfair trade practices, and so the Chinese wisely shifted the rationale behind their quota strategy to a dual story of environmental protection and resource conservation with which developed nations could hardly argue.
China wished to stop subsidizing cheap rare earth prices by applying the sort of environmental standards and emission controls developed nations take for granted with regard to mines and chemical plants on their own soil. This desire was more than a cynical ploy because China's growth has reached a stage where confidence about its long term sustainability has blossomed and pressure was building among its people for a higher quality living space. The rising confidence about China's long term ambitions and recognition that innovation and "clean" oriented policy were driving demand for rare earth based technology also stirred concern about the longevity of China's rare earth resources which until recently had been viewed as "near infinite", much as the Middle East's oil reserves were once viewed.
China has already witnessed its transition from net exporter to net importer in the case of some metals such as molybdenum and tungsten, and is keenly aware of its dependency on imports for raw materials such as iron, nickel, and copper. In particular concern has arisen over the ion adsorption clay deposits in southern China, a low cost source for the less abundant "heavy" rare earths and which were being exploited in a very wasteful and polluting manner. As a by-product of weathering processes these deposits exist only at the surface; drilling deeper once these clay deposits have been depleted will not discover new deposits of this nature. The consolidation and supply management strategy was thus conceived to conserve China's rare earth resources for the long run.
China's supply-demand projections indicate a major supply squeeze
Ironically, by early 2011 Chinese authorities were already conceding that by 2015 China would be a net importer of rare earths. This represents a death knell for cheap rare earth prices even within China unless non-Chinese supply comes on stream heavily during the next five years. Given global demand growth projections, Chinese signals that it would limit annual rare earth production to no more than 100,000 tonnes between now and 2015, and the disappearance of 20,000-30,000 tonnes of illegal annual production, much of which was being smuggled out of China and which represented a significant secret dependency above and beyond the export quotas, it is conceivable that high FOB spot prices could prevail for the next five years as domestic Chinese prices gradually rise. The arithmetic also suggested that if China's domestic demand growth matched the 10-15% rates its officials project for the rest of the world, China within a few years would have a very hard time keeping its "promise" to maintain annual export quotas at 30,000-35,000 tonnes while limiting its production target to 100,000 tonnes.
Rareco off-take agreement worthless after June 2010
This was not good news for Great Western and LCM which under the Rareco off-take deal would have to purchase rare earth oxides from Steenkampskraal at elevated FOB prices. At risk was LCM's ability to maintain its downstream margins and pass on the higher rare earth cost to customers who had the option of purchasing similar products from Chinese competitors who benefited from lower domestic rare earth input prices. Finally in November 2010 Great Western did what it should have done right from the start: negotiate a deal with Rareco principals which enables Great Western to acquire Rareco and secure a 74% direct stake in the Steenkampskraal project.
The first sign of a shift took place in September 2010 when Great Western purchased a 20.8% interest in Rareco for $3 million or about $0.30 per Rareco share. A month later Great Western closed a $35 million short form financing at $0.33 through Byron Securities and Salman Partners with Byron acting as the lead agent. The 106,060,606 units included a half warrant exercisable at $0.45 until October 19, 2012. Byron and Salman received a $2.1 million commission and 6,363,636 broker warrants exercisable on the same terms as the unit warrants. Some readers might be shocked to learn that Byron is free to sell Great Western stock from these warrants any time there is a rush of buying when Byron's analyst touts the stock on BNN. This also applies to the shares Byron receives in lieu of cash for the $60,000 monthly advisory fee. The proceeds were earmarked as to $5 million for repayment of a loan related to the LCM acquisition, $2 million for Great Western's various grassroots exploration plays, $2 million for equipment expansion at LCM, $2 million for Hoidas Lake metallurgical studies, $15 million for "conditions precedent of the off-take agreement", and $6.5 million for working capital.
The prospectus for the October financing provides almost no disclosure about Great Western's assets, referring readers to the Annual Information Form (AIF) filed on September 20. The description of the off-take agreement is ambiguous but seems to suggest that among other things Great Western must fund a feasibility study and provide project financing by December 31, 2011 to fulfill the terms of its off-take agreement. The use of proceeds seems to suggest that the cost of the feasibility study and project financing will total $15 million, but one cannot know because nowhere does Great Western provide disclosures about the capital and operating costs associated with putting Steenkampskraal back into production. In its corporate presentations Great Western does provide operating cost estimates associated with producing 2,700 tonnes of rare earth oxides, but this includes the cost of operating a separation facility which Great Western intended to do outside of Rareco, as well as downstream processing costs. Great Western was able to raise $35 million with almost zero disclosure about the asset upon which the bulk of the money will be spent. All we got was some history about Steenkampskraal in the AIF, a disclosure deficit that can only be explained by the fact that Great Western had no title to the project and thus had no right to know and no obligation to disclose any technical detail about the project.
Rareco agrees to a takeover bid that values Steenkampskraal at $18.5 million
On November 22, 2010 Great Western announced its intent to make a takeover bid for the 79.2% of Rareco it did not already own by offering 3 ZAR (South African rand whose exchange rate on Feb 10, 2011 was 1 CAD for 7.2886 ZAR) for each Rareco share or about $0.41 per share. Purchase of the remaining 37,764,700 Rareco shares would cost Great Western about $15.5 million, bringing the total purchase cost of Rareco for 100% to $18.5 million. Success of the takeover bid would give Great Western full control of Rareco and effectively nullify the terms of the off-take agreement. It would also wipe out the $15 million working capital Great Western had earmarked for completion of the feasibility study and project financing. The offering circular was delivered to Rareco on December 21, 2010, but, contrary to CEO Jim Engdahl's promise in the November 22 news release, was not filed on SEDAR. The offer, which was endorsed by Rareco management, is open until February 28, 2011. On January 24, 2011 Great Western announced that it had taken up 23,528,308 Rareco shares under the offer, bringing its Rareco stake to 70.2%. Because Rareco has been around since 1989 and was publicly listed on the Johannesburg Stock Exchange until its delisting in 2006 it is not clear how much of the remaining paper will be tendered and if Great Western will get enough stock to conduct a mandatory acquisition of the remainder. This could be a problem because right now Great Western has only a 52% indirect stake in Steenkampskraal; if the remaining Rareco stock is owned by shareholders holding out for more, Great Western may not be in a position to do through Rareco what is in the best interest of Great Western shareholders.
Has Rareco sold Manhattan Island for a bag of beads?
An obvious question is why after nearly two years of stringing Great Western along with a rather dumb off-take agreement whose benefits were skewed in Rareco's favor, and with the rare earth crisis escalating during the second half of 2010, did Rareco management headed by Trevor Blench suddenly decide to sell out for only about $18.5 million in cash? Several possible explanations offer themselves. It may be that Rareco management realized it had overplayed its hand by insisting on a deal that hindered Great Western's ability to deliver on Jack Lifton's prediction that Steenkampskraal would be the first non-Chinese rare earth mine to come on stream. After two years during which nothing concrete got done at Steenkampskraal while Great Western sorted out its financial problems, the balance of power shifted from Rareco to Great Western which in effect had until the end of 2011 to default on its commitment to deliver a bankable feasibility study and raise financing, by which stage the project could have been sterilized by all sorts of problems unearthed by an Environmental Impact Assessment (EIA) and the worker safety conditions formal mine approval would require from various bodies including the South African National Nuclear Regulator.
A radiation assessment of the richest rare earth-thorium deposit in the world
The conditions under which Great Western will receive approval to proceed with redevelopment of Steenkampskraal are not clear, but a clue can be found in the Background Information Document SRK Consulting published in November 2010 to kick off the EIA process. The approval process will include a "radiation assessment" which will no doubt be a hot button topic in the public hearings the approval process will require. Steenkampskraal ranks among the richest thorium deposits in the world and as such poses a radiation hazard to workers who will enter the underground mine and handle ore whose rare earth and thorium grade can spike as high as 45% TREO and 8.5% thorium. Thorium is nowhere near as dangerous as uranium, but it does produce ionizing radiation which causes genetic mutations that can eventually lead to cancer. While the danger of high levels of radioactivity is well understood, the effect of continuous exposure to low levels of ionizing radiation such as posed by the underground workings of Steenkampskraal is another matter. In this regard Steenkampskraal has made an interesting contribution to medicine through a doctoral dissertation on the Effects of exposure to continuous low doses of ionizing radiationcompleted by Kathleen Anne Meehan in 2001 and published by Cape Technikon.
Steenkampskraal's contribution to radiation related cancer research
The former Steenkampskraal Mine has several open stopes which bats have adopted as their winter hibernation homes. Establishing what, if any, effect low doses of ionizing radiation have on humans is a difficult problem because cell mutations that could lead to cancer can be caused by a wide variety of environments to which humans get exposed over extended periods, of which cigarette smoke is not the least. The Steenkampskraal Mine operated from 1952 until 1958 during which the mine operator took steps to improve ventilation after radiation surveys raised concerns. It is unclear why the mine shut down in 1958 but it may to have been due to safety issues. In 1962 the mine reopened with more stringent safety measures and shorter worker exposure periods, but it shut down in 1963 when the market for thorium vanished.
Inhabitants of bat cave lucky they don't live long enough to get cancer
After the mine was abandoned a local bat population occupied the caves, roosting in them during the winter months. Bats have an unusually long lifespan of 30-40 years which they tend to spend in the same habitats. Although the Steenkampskraal bat caves had been emptied of their rich thorium ore, there was enough residual thorium present to expose the bats to continuous low levels of ionizing radiation of the sort that is present in certain occupational settings. Dr Meehan's study involved measuring cell mutations in two Steenkampskraal bat caves and a control group in another bat cave which had no measurable levels of radiation. The scientific thesis was that if continuous exposure to low doses of ionizing radiation does cause cell mutation, then the Steenkampskraal bats should have a statistically significant higher level of mutations than the control group. Dr Meehan's study did in fact produce such an observation, and concluded that long term exposure to the sort of radiation present in Steenkampskraal does cause cell mutations which can lead to cancer if the exposed "individual" lives long enough. The study was careful to point out that the mutation effect on bats does not automatically map to human beings, but it did recommend that any plan to reopen Steenkampskraal should involve workers wearing dosimeters and the provision of a monitoring system to measure individual sensitivity.
No worry, the Areva guy will make the radiation folks happy
It is probably too late to track down what happened to the people who worked in the thorium mine during the fifties, especially given that the underground miners are unlikely to have been white folks whose longevity exceeded that of blacks under the apartheid system. But in North America where native people were the preferred miners during the uranium boom of the forties and fifties there is a bitter legacy about the anomalous levels of cancer among the survivors. It would be foolish to believe that the radiation risk assessment will be a simple rubber stamp in the Steenkampskraal mine approval process, and it is a good thing that Great Western has brought on board Mohamed Madhi, former chairman of Areva South Africa who knows a thing or two about dealing with radioactivity and is unlikely to try to cut corners and get blindsided when it turns out that South Africans take radiation issues very seriously.
Ventilation and short bursts of mining can reduce radiation exposure
A bigger headache may be the Steenkampskraal mine site which is badly polluted. The mess left by Anglo is not Rareco's liability, but mine approval will likely require a cleanup plan. Since the mess consists of radioactive broken ore and tailings which Rareco lists as a rare earth resource, the regulators may require Rareco to process this lower grade material first before hauling fresh high grade ore from underground. Rareco has already decided not to house workers at the site; they will have to commute 70 km from the closest village with a population of 4,000. Miners will probably not have to spend much time underground. Great Western's planned output of 2,700 tonnes REO annually converts into a production rate of 40-100 tonnes per day. Rather than have miners underground every day, Great Western will likely pull ore out of the mine at higher daily rates over short intervals and stockpile the ore. This will prevent high worker turnover caused by workers hitting their radiation dosage limits too quickly. As far as finding workers willing to work in a thorium mine, South Africa's unemployment rate is 24%, with the unofficial rate as high as one third. If there is anything that would delay Steenkampskraal's production startup, it would likely be related to establishing a radiation management plan that satisfies the regulators.
You mean a "new order mining right" doesn't mean I can start blasting and cracking ore tomorrow?
Contrary to what one might infer through a loose reading of Great Western's news release and its headline about a "mining permit", there is no approval yet to develop and operate the Steenkampskraal Mine. The announcement on June 3, 2010 that the "old order mining right" had been converted by South Africa's Department of Mineral Resources to a "new order mining right" was a technical process which hinged on compliance with the Black Economic Empowerment (BEE) requirement that "historically disadvantaged people" own 26% of any resource assets in South Africa by 2014. This conversion had to be initiated by a certain deadline, and while it does not constitute approval to build a mine, it was indeed an important milestone without which title would have been cancelled. A mining right is more like a mining lease which is not the same thing as a minig permit. Incidentally, the "mining right" expires on November 19, 2011 with "further renewals subject to the terms of the lease" which Great Western does not specify, leading us to believe that renewal is just a paperwork event that does not entail any loss of title risk.
Are the 26% BEE owners going to insist on profiting from Steenkampskraal?
The Steenkampskraal new order mining right is owned by Steenkampskraal Monazite Mine (Pty.) Ltd (SMM) which in turn is owned 74% by Rareco and 26% by the Steenkampskraal Workers' Trust (SWT). No disclosures have been made about the terms through which the SWT was given a stake in SMM, what future contributions SWT must make, what sort of payout it gets, and who the members of the SWT might be. The nature of a BEE can be a touchy topic. African National Congress Youth League leader Julius Malema has been calling for the nationalization of South Africa's mining industry on grounds that the ANC has twisted the BEE concept into a "black elite enrichment" scheme from which little benefit has flowed to the vast majority of South Africa's "historically disadvantaged people". Nationalization of South Africa's mining industry would be a disaster, but when you have a country with 24% unemployment, a lot of young unhappy people, a dysfunctional power infrastructure, ethnic rivalries between the Zulus and other groups, and a new business elite of older blacks, resource nationalism is a risk. The specific problem with the BEE ownership structure is that it will require Great Western to figure out a transfer pricing scheme that keeps SWT happy. From what I can infer SWT is not expected to have a stake in the separation facility Great Western plans to build, presumably in South Africa and probably not at the mine site which is far removed from where people with the necessary technical skills are likely to live or want to live. I assume that a BEE will also end up owning 26% of the separation facility, which South Africa is unlikely to let be built in another country.
Perhaps Trevor Blench and crew sold out for $18.5 million because they feared that with Great Western running the show and possibly getting distracted by a surprise discovery on one of its grassroots plays, Steenkampskraal might take a lot longer to get into production than expected. Had they been more cooperative early on when Great Western really needed a win-win deal that absorbed Rareco into Great Western quickly, the project would be more advanced today and the Rareco shareholders possibly richer.
Maybe Rareco insiders took $18.5 million because it is better than nothing?
Or it may simply be the case that Rareco management suspects Steenkampskraal is a dud because of its small scale just as Anglo concluded during the mid eighties when it revisited Steenkampskraal as a rare earth project. Last year ideas were bandied about whereby Great Western and Rareco would merge, which would have been just a paper conversion that probably did not impress the Rareco principals. Rareco knew Great Western was financially challenged in 2009, gambled on a deal that involved Great Western taking on all the capital risk while the operating profit flowed to Rareco, and changed their mind after Hykawy adopted Great Western on May 31, 2010 through a research recommendation based on the mistaken assumption that the difference between Steenkampskraal's operating costs and FOB spot price based revenues accrued to Great Western rather than Rareco and SWT. They baited Great Western by selling 20.8% of Rareco to Great Western for $3 million funded through Byron, and when Byron went on to raise another $35 million while Hykawy dazzled fund managers with talk about how rare earth stocks were in a bubble except ones that he endorsed, they acquiesced to a switch where half the funds raised by Byron would go to buying out 100% of Rareco.
Given that Hykawy has since then published a price target of $2.25 for Great Western that values Great Western at over $1 billion based largely on the rare earths that Steenkampskraal will supply to the downstream processing operations of Less Common Metals, with a $17 million separation facility inserted in between that will supposedly recover the 7.5% of Steenkampskraal rare earth content that qualifies as heavy rare earths, one has to wonder if Rareco management will go down in history as being on par with the Indians who sold Manhattan Island for a bag of trinkets. However, we don't think the Rareco insiders are naive, and none of Great Western's disclosures suggest that Jim Engdahl and Gary Billingsley believe Steenkampskraal makes Great Western worth anything near $1 billion. So we decided to extract what Steenkampskraal mine parameters were available and construct our own after tax NPV sensitivity analysis to determine what Steenkampskraal might be worth under various rare earth oxide price scenarios.
Great Western has disclosed no capital or operating cost parameters
Great Western has not published any cost structure data which allows one to construct a discounted cash flow model for the Steenkampskraal project. The only cost data I have seen was in a Great Western powerpoint presentation made in Switzerland in May 2010. This "preliminary cash flow projection" was apparently based on historical data presumably generated by Rareco. It envisioned annual production of 2,700 tonnes of REO generating $120-$122 million in annual revenues with cost of sales at about $88 million. This cost converted into $32.60 per kg TREO which seemed awfully high. If we assumed a 100% recovery for underground mined Steenkampskraal ore grading 16.74% as indicated by the non-43-101 compliant historic resource estimate prepared for Rareco by an independent consultant in 1996, Great Western would have to mine and process 16,200 tonnes per year which converts to a daily processing rate of 45 tpd using a 360 day year. On these terms the operating cost per tonne of ore works out to $5,432 per tonne, a figure far too high for what is supposed to be easy to crack monazite ore. It turns out that Great Western's costs included the production of downstream products of the sort LCM produces; so we in effect have no data from Great Western with regard to what it will cost to mine and crack the monazite ore and separate the resulting rare earth oxides. We also do not have any capital cost figures though I have heard that a separation plant capable of separating light and heavy rare earth oxides will cost only $17 million compared to the $360 million SNC-Lavalin estimated on Avalon's behalf for a 25,000 tonne separation plant that can handle the heavies. We will presumably find out the cost structure when SRK delivers a feasibility study a year from now. The best we can do is utilize the cost assumptions Byron's Jon Hykawy has come up with to support his $2.25 price target for Great Western (a $1 billion valuation based on 464 million fully diluted shares).
Wanted: a spreadsheet that can detect fictitious ore
Hykawy assumes a capital cost of $55 million for an operation that will produce 2,500 tonnes of REO during the first 2 years, increasing to 5,000 tpy in years 3-5, and jumping to 10,000 tpy in years 6 and beyond. In our DCF model we have limited output to 2,700 tpy starting with the underground resource of 117,500 tonnes grading 16.74% TREO which we process at 45 tpd over a 360 day year. This production rate depletes the high grade resource over 7 years, after which our model switches to processing the 37,000 tonnes of broken ore grading 5% TREO during the next 3 years. Our Steenkampskraal model thus has a mine life of 10 years which will produce 21,520 tonnes of rare earth oxides. Our assumption of a 100% recovery is most definitely too high, but Great Western, despite production records from the fifties when supposedly rare earths were recovered along with the thorium from the monazite, and feasibility work done by Rareco during the nineties, has not disclosed any recovery numbers. We cannot extend the mine beyond 10 years because it is inappropriate to assume the existence of ore that has yet to be discovered, and assume the availability of monazite sands located on property Great Western does not own. We do note that Jon Hykawy's model shows Great Western producing 40,000 tonnes of REO during the first seven years of production which puzzles us quite a bit. To get our $700 per tonne operating cost we linked Hykawy's annual operating cost assumption to the projected output and mapped it to our 16,200 tonnes of ore mined annually via the 16.74% grade of the historic resource estimate. We do not know on what these costs are based, and if anybody accuses us of using imaginary cost figures, we plead guilty while arguing that we are only duplicating the assumptions used by Hykawy, though we do stop short of including fictitious ore. We have assumed that Great Western will eventually own 100% of Rareco, but assume that it will have only a 74% interest in the separated rare earth oxides whose revenue value we base on various REO price scenarios presented below. We think it is unlikely that Great Western's separation facility will be located outside of South Africa, and do not believe Great Western would get away with moving Steenkampskraal concentrate out of SMM on terms which give Great Western 100% of the value of separated rare earth oxides that are either sold into the market or exported from South Africa to its downstream operations in Michigan and England. We have used a 10% discount rate because that is what we have applied to the discounted cash flow models we have constructed for other advanced rare earth projects.
Rare Earth Oxide Prices US $/kg as of February 3, 2011Rare Earth OxideFOB 3 Year
AverageFOB SpotDomestic 3
|1) FOB and Domestic average and spot prices as of January 27, 2011 - Metal-Pages|
|2) JP Morgan prices used in Sept 29, 2010 research report as basis for DCF valuation that set A $1.71 price target for Lynas, where no REO given, 3 year FOB averages were used|
Cash Flow Metal Price Sensitivity AnalysisGreat Western Minerals GroupSteenkampskraalSouth Africa
BreakevenDomestic SpotDomestic 3 Year AvgFOB 3 Year AvgJP MorganFOB Spot
Mine ParametersCost ParametersOther Parameters
|Parameter Source:||GWG News/Byron-Hykawy||Scenario Author:||JK||Primary Metal:||REO|
|TREO Price $/kg :||$9.02||$16.61||$8.63||$18.44||$32.95||$76.91|
|Recoverable Rock Value $/t:||$1,509.95||$2,780.51||$1,444.66||$3,086.86||$5,515.83||$12,874.73|
|Average Annual Revenue (initial 7 years):||$24,461,158||$45,044,327||$23,403,524||$50,007,067||$89,356,446||$208,570,691|
|Average Annual Pre-Tax Cash Flow (Initial 7 years):||$13,121,158||$33,704,327||$12,063,524||$38,667,067||$78,016,446||$197,230,691|
|Pre Tax NPV:||$5,234,720||$104,131,146||$153,085||$127,975,738||$317,038,602||$889,830,021|
|After Tax NPV:||($40,770)||$73,091,776||($3,996,480)||$90,364,283||$226,833,138||$639,242,960|
|After Tax Cdn Price/Share:||$0.00||$0.16||($0.01)||$0.19||$0.49||$1.38|
|Internal Rate of Return:||10.0%||49.9%||7.0%||58.0%||116.9%||278.8%|
|Tonnage||117,500||Capital Cost||$55,000,000||Fully Diluted||464,162,209|
|Grade||16.74%||Annual Sustaining Cost||$0||Net Interest||74.0%|
|Primary Metal||REO||Net Smelter Royalty||0.00%||CAPEX Funding||100% Equity|
|Primary Recovery||100%||Marketing Cost||0.0%||Years to Startup||1|
|Primary Production||2,712 tonnes||Mining Cost $/t||$0.00||Mine Life||11|
|Mining Method||Underground||Processing Cost $/t||$0.00||CAD:USD Exchange Rate||1.00|
|Processing Method||Cracking/Separation||Transportation Cost $/t||$0.00||Discount Rate||10%|
|Milling Rate tpd||45||Cracking/Separation Cost $/t||$700.00||Tax Rate||28%|
|Operating Days||360||G&A Cost $/t||$0.00||Payback Tax Holiday||Yes|
|Ore Mined Annually (t)||16,200||Reclamation Cost $/t||$0.00||Cost Inflator||0%|
|Waste to ore Ratio||0.00||Miscellaneous Cost $/t||$0.00|
|Concentrate||0.0%||Total Operating Cost $/t||$700.00||Currency||USD|
|1) Years 1-7 mine in situ 117,500 tonnes at 16.74% TREO, years 8-11 mine 37.000 tonnes at 5% TREO broken ore - historic 43-101 non-compliant estimate|
|2) 100% recovery assumed, will be lower when GWG completes metallurgical study|
|3) Capital and operating costs taken from Byron Research Report dated January 20, 2010 - actual source and basis unknown - GWG has not disclosed financial parameters underlying its plan to develop Steenkampskraal|
|4) Costs assume inclusion of separation facility|
|5) Entire operation is assumed to be shared 74% by Rareco and 26% by BEE entity|
|6) Warning: None of these numbers are supported by Great Western disclosures upon which a qualified professional has signed off, which disclosures are not expected until SRK delivers a feasibility study at the end of 2011. They reflect the assumptions that underpin the Strong Buy recommendation with a $2.25 price target of a widely publicized research recommendation which gives Great Western "the full benefit of the doubt". We believe that the feasibility study will demonstrate that these cost assumptions are wildly optimistic.|
Analysis: Our after tax net present value sensitivity analysis of the Steenkampskraal rare earth project indicates that the feasibility of Steenkampskraal hinges very much on current FOB spot prices becoming the long term reality, an outcome to which we assign a low probability, especially with regard to the more abundant light rare earths such as lanthanum and cerium which represent the bulk of SKK's output, and the heavy rare earth yttrium which is the bulk of SKK's heavy rare earth composition. These rare earths have undergone substantial price inflation since China slashed its export quotas in June 2010 which so far has not been significantly echoed by domestic prices. We expect that by 2015 there will be significant rare earth production from mines outside of China, with supply growth during 2015-2020 from non-Chinese sources pushing rest of the world production above Chinese production. In this scenario of diversified rare earth supply the pricing mechanism will revert back to that of globalized commodities such as copper. Domestic Chinese and FOB prices will converge. The big unknown is at what level they will converge, which will depend on rare earth specific application demand growth trends. While we think FOB spot prices will come down, we also think domestic spot prices will rise. At current domestic spot prices Steenkampskraal is barely feasible, and commands an after-tax net present value of only $0.16 per share. In the best case scenario of FOB spot prices the NPV is only $1.38 per share, suggesting that at $1 the market has priced considerable optimism into Great Western. What we find disconcerting is that the NPV using JP Morgan's price set is only $0.49 per share, suggesting 50% downside from the current stock price in the rare earth oxide price scenario we find plausible as a long term reality. We do not assign any value to Great Western's downstream operations at this time because they do not appear to have been profitable before FOB spot prices rose sharply, and will likely suffer severe losses if they are forced to purchase their raw materials at prevailing FOB spot prices while waiting for Steenkampskraal to come on stream. It will be another two years before Steenkampskraal produces any rare earth oxides with the most optimistic timeline, and three years with what we view as a more realistic timeline. Downstream processors such as Neo Material who have their operations based in China will have preferential access to rare earth oxides during the supply squeeze that will unfold during the next two years as the Chinese trim their production back to 90,000 tonnes and the two leading supply contenders, Lynas and Molycorp, work to bring their mines on stream with supply that has already been pretty much allocated to specific customers. Downstream processors not based in China which have to rely on exported Chinese rare earth oxides during the next few years are going to get killed. Sadly, if Great Western and Rareco had not wasted the past two years on a flawed off-take agreement, Less Common Metals would not be in its current predicament. We are frustrated that Great Western has provided such limited disclosure about its advanced rare earth projects and downstream divisions, and look forward to the day when we can digest the same level of disclosure currently available for Bear Lodge, Nechalacho and Strange Lake, projects whose successful development would contribute substantially to solving the world's rare earth supply problem. We are disappointed that the after-tax NPV produced by our Steenkampskraal DCF model for the best case rare earth price scenario turned out to offer such little upside from the current $1 stock price, especially because we believe the capital and operating cost assumptions are too low and the REO recovery too high. It is also interesting to see that when we give the "full benefit of the doubt" to the numbers published by Quest and Avalon, Jon Hykawy's top short sell recommendations (when an analyst issues a sell for a stock he has never recommended as a buy, it qualifies as a short sell recommendation), and apply the same valuation metric as we did to Steenkampskraal, the upside under the best case rare earth price scenario is 200% for Avalon and 900% for Quest compared to 38% for Great Western. Because Steenkamspkraal is such a tiny resource whose annual 2,700 tonnes REO production over ten years is almost a rounding error in projected global demand terms, there is no justification for assigning any strategic premium to Great Western as there might be for Nechalacho and Strange Lake where only a fraction of the in situ resource is targeted for production during the next 10-20 years. Stocks like Quest and Avalon cannot be characterized as being in a bubble because their current valuations are far below what they would be if the best case scenarios became reality. The same cannot be said for Great Western which is already priced to reflect the best case scenario even though considerable uncertainty and risk remain to be removed from the DCF model in terms of project fundamentals. Great Western has become a bubble stock.