July 26, 2018
A few weeks ago, Bacanora Minerals announced that they would be raising $100m via an equity placement to go towards construction of their lithium mine in Mexico. Three days later however, they quickly scrapped those plans, citing volatility in commodity markets, and challenging market conditions. The company has already raised more than half of their necessary construction capex, and will raise the rest via sources other than equity. So while the stock sold off a bit, understandably no one made a big deal about this news.
However, we still wanted to explore the company’s reasoning a bit, as the financing environment and availability of capital is a key consideration for the many companies looking to enter the lithium production space.
Not So Easy
While those investors currently holding onto lithium stocks certainly want to see their share prices go back to the highs, there’s a bigger issue at play here. Bacanora, and Nemaska before them, are demonstrating that it isn’t so easy to raise money for lithium projects in the current environment. With stock prices well off of all time highs, raising money via equity placements are more challenging and expensive for those companies needing cash. Furthermore, the depressed stock prices demonstrate the lack of faith in the industry by investors, which ultimately leads to higher interest rates on debt as well.
Sticking with the Nemaska example, they gave up 10% of the company to Masa Son at a very favorable valuation for him, while raising the remainder of the project capital from a combination of equity, streaming deals with royalties, and debt with double digit interest rates. Given that the company is a pre-revenue miner, expensive funding isn’t really shocking to us. But forgetting that fact for a moment, and looking at the funding package as an investor, it definitely is not cheap. Nemaska will have to pay over $35m per year in interest expense alone, not to mention the sales proceeds they will have to hand over to Orion as part of the streaming deal.
Now we don’t bring this up to be bearish on Nemaska, especially since we still count ourselves as investors. The appeal for the company and investors alike is clear: if you believe in the long term lithium story, and any particular producer’s staying power in the industry, accepting an expensive deal is worth the short term pain in order to secure long term market share. After all, Albemarle did make a similar bet when they decided to lever up to 4x to acquire Rockwood a few years ago, which more than paid off for them. We mention the expensive factor because it highlights what companies have to be willing to accept in order to bring their projects online.
Effect on Oversupply
Everyone’s worried about oversupply from all of the new projects coming online over the next decade, which has had the effect of depressed stock prices and high short interest in the sector. However, the often ignored side effect of these fears is a tougher financing environment for new projects.
We’ve always believed that good projects will get funding, and many of the industry participants we speak to tend to echo this sentiment. Ignoring the fact that the capital might come with a high price tag, what about the rest of the projects that aren’t in the top tier, but would still be profitable? If only the best projects get funding, then by default not all of the expected new supply will come online in the timeframe anticipated by the market. This conundrum is one of the reasons why we still believe oversupply worries in the next few years are over blown as we’ve touched on in the past.
Spread Those Tentacles
Finally, there is something that will somewhat mitigate the effect of a lack of traditional financing for projects: continued partnerships, JVs, and consolidation in the industry. We’ve already seen tons of deals take place, be it offtake agreements, equity stakes, JVs, or some combination of those. But if access to capital is a challenge for projects or it starts to get too costly, upstream players, incumbent lithium producers, and those coming online soon will all be beneficiaries. They’ll be able to use their balance sheet flexibility and cash flow to spread their tentacles into different projects that need capital at terms favorable to them.