Not a Rare to Spare
"I don't think the answer to Chinese aggression or Chinese threats is to continue to subject ourselves to Chinese threats." – US Senator Tom Cotton
To a chemist, the periodic table of the elements is a valuable tool. It sorts the building blocks of nature into groups based on important chemical properties and helps explain why certain chemical reactions are favored while others are impossible. Whether or not students are allowed a copy of the table for use during their exams can be a measure of the difficulty of the task before them, a thought which undoubtedly brings back not-so-fond memories for many of our readers. Here’s a typical example of a modern version of the table:
You’ll notice that two rows of 15 elements – the lanthanides and actinides – are almost always shown separately and below the rest. While this is mostly done for ease of printing, presenting the table in this way does slightly obscure the uniqueness of these elements, which is why we prefer the wide version of the table like the one shown here:
Lanthanides are mission critical to the global economy. Without getting too technical, lanthanides have unpaired electrons in their ground state configurations making them excellent candidates for use as magnets in anything with an electric motor. As efforts are made to move away from fossil fuels and to decarbonize our energy sector, the efficiency of electric motors in converting electricity to useful work becomes supremely attractive. Magnets are at the core of electric motor technology. There aren’t many scenarios in which our future work won’t be strongly dependent on motors, and therefore magnets, and therefore lanthanides. There are few viable alternatives.
And therein lies the rub: everybody wants them but getting them is tough.
Lanthanides form the bulk of what are colloquially known as the rare earth elements, although they aren’t all that rare. Rather, they are assigned that descriptor because economically feasible deposits of lanthanides are difficult to come by – when the elements are discovered in high enough concentrations to be mined, they are found together in complex mixtures that require substantial effort to further purify. The chemical reactivity of each of the 15 lanthanide elements is remarkably similar, with a strong and consistent preference for the +3 oxidation state. When things react in a similar way, isolating them in pure form from each other is expensive.
Of the lanthanides, Neodymium and Praseodymium are among the most valuable and the price of standard blends of their oxides have exploded to record highs in recent weeks. At the time of this writing, a kilogram of the blend costs $163 – up more than fourfold from the five-year bottom price of $35.
In a story arc that will be all too familiar to Doomberg readers, for decades the US had a near monopoly on the mining and refining of rare earth elements, only to cede control over most of the value chain to China. The Mountain Pass Mine, located in San Bernardino County, California, was discovered in 1949 and went into operation in 1952. Faltering under environmental concerns and competitive pressure from China, the mine closed in 2002. Here’s how Defense News describes the relevant history (emphasis added throughout this piece):
“In 1952, Mountain Pass opened. First explored as a uranium deposit, it soon supplied rare earths for the electronic needs of the Cold War economy. Until the 1990s, it stood alone as the only major source of rare earths worldwide.
By 2002, however, the mine was defunct. In the eyes of the U.S. government and major manufacturers, it no longer made sense to acquire rare earths from a U.S. source subject to stringent environmental regulations. Instead, the hard business of extracting useful minerals was exported to other countries, where environmental damage was safely out of sight. China happily obliged, allowing environmental harm to proliferate so long as the costs of rare earth mining were kept down.”
In 2008, Molycorp tried to resurrect the mine with an ambitious plan – dubbed Project Phoenix – to forward integrate into the production of ultra-high purity metals, alloys, and magnetic materials. With support from the US Department of Defense, the company completed a successful initial public offering (IPO) in 2010 and began trading on the New York Stock Exchange (NYSE). A series of technology failures and accounting scandals led the company to file for bankruptcy protection in 2014. Project Phoenix was a flop. The mine was purchased out of bankruptcy in 2017 for the paltry sum of $20.5 million, and the winning bidders included powerful investors from China:
“A buyout group backed by a Chinese company has been declared the winner at a bankruptcy auction for the Mountain Pass rare earths mine, the sole U.S. source of elements essential to electronics devices.
With a winning bid of $20.5 million, investment firms JHL Capital Group and QVT Financial were selected to take control of Mountain Pass, along with China’s Leshan Shenghe Rare Earth Shareholding Co., according to sources present at the competition Wednesday.”
Shenghe shared technology and helped capitalize the new company, eventually renamed to MP Materials Corp (MP), in exchange for offtake agreements and profit sharing. To this day, Shenghe remains MP’s only customer and the entire production of rare earth concentrate at Mountain Pass is shipped to China for final refining.
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In 2020, MP became a public company once again, this time through a reverse merger with Fortress Value Acquisition Corporation, a special purpose acquisition company (SPAC). Unlike most stocks that emerged from SPAC deals, MP has traded persistently well. At the time of this writing, the stock is trading hands for roughly $40 a share, or four times the initial deal price of $10. The stock is off 20% from its all-time high but compared to most previously hot SPAC stocks in its cohort, MP is an undeniable and smashing success.
The company has recently been the subject of two high-profile short seller reports, and on both occasions the news caused the stock to sell off precipitously. On October 26, 2021, Grizzly Research published a scathing report titled MP Materials Corp. (NYSE:MP): Rare Earth Shenanigans in Chamath Backed Company Will Likely Cost Investors Dearly. According to Grizzly, MP is nothing more than a repackaged failed business that was dumped on investors at sky-high prices. They point to similarities between MP’s strategy and what Molycorp failed to do, how insiders have been selling stock at an alarming rate, and the company’s substantial dependence on Shenghe. The stock fell 20% on the news, but quickly recovered and eventually made new highs. Here’s a thread from Grizzly Research’s Twitter feed that summarizes the key accusations:
On February 3, 2022, Bonitas Research issued their own short report on MP, rehashing most of the previous accusations made by the team at Grizzly, but also adding a new and explosive claim:
“We believe that since 2Q’21, MP and Shenghe executed an abusive transfer price manipulation scheme whereby Shenghe overpaid for MP concentrates to artificially inflate MP’s profits. The 2021 scheme conveniently coincided with the SPAC insider lock-up expiration so that MP Insiders could sell MP stock at artificially inflated prices.
As a result, Shenghe’s profits collapsed, MP’s profits soared, and MP Insiders dumped US$ 400+ million worth of MP stock in 2021 (this figure may increase as we await Shenghe’s yearly reported changes to MP shareholdings).”
The company took to Twitter to respond directly to the Bonitas report in a thread that can be found here:
The Industrials and Materials Sector team at Hedgeye Risk Management, headed by Jay Van Sciver (you can follow his Twitter account here), blasted the Bonitas report as “unsubstantiated, rehashed garbage,” and added MP to its Best Idea Long list. Once again, the stock fully recovered from the drop induced by the short report.
In full disclosure, no member of the Doomberg team has a position in MP, nor do we intend to open one (long or short) any time soon, if ever. Our interest in the company stems from our longstanding position that certain critical materials are worth producing domestically – a topic we’ve written about in the context of polysilicon, magnesium, and natural gas. If MP is successful in reshoring a piece of the rare earth elements value chain in the US, we’re all for it.
At the heart of the short seller allegations is the relationship between MP and Shenghe. In reading the company’s filings, listening to their most recent conference calls, and reading presentation transcripts of investor meetings arranged by various investment bankers, MP has been quite transparent about the relationship with Shenghe, the ongoing obligations tied their offtake agreements, and the company’s long-term commercial strategy. Also, Shenghe did provide tangible financial and technical support to MP during this most recent relaunch of the Mountain Pass Mine, and it should be expected that they would share in the spoils of success per their original agreements from 2017 and beyond.
The bottom line from this team of natural born skeptics: the allegations seem more sensational than reality would support.
For example, the Grizzly Research team focuses much of their attention on the “discovery” that Shenghe is effectively controlled by the Chinese central government, specifically by China’s Treasury Department. Does anybody think Chinese companies operating in the rare earth elements industry aren’t under the direct control of the Chinese Communist Party (CCP)? Last we checked, water is also wet.
Or take the Bonitas Research allegation that Shenghe is conspiring to prop up MP by absorbing losses on their own income statement to inflate MP’s earnings, thereby juicing the stock while they sell into the resulting strength. As MP points out in their Twitter thread rebutting the Bonitas report, Shenghe is a price-taking distributor, and pulling off such a scheme in a high-profile industry like rare earth elements is a little far-fetched. The net result of this unlikely conspiracy is a US-based company in the industry with a strong balance sheet and ready access to growth capital. If this is a trick of the CCP enacted via their proxy Shenghe, the geopolitical benefits to the Chinese aren’t obvious to us.
The remaining tangible allegations in the short thesis boil down to valuation, and here they may be justified. By most measures, the company is executing quite well, having delivered record production and sales volume in Q3 2021, exceeding what prior management teams were able to accomplish at the Mountain Pass Mine (the company reports Q4 2021 and full year numbers on February 24). Since NdPr and other rare earth elements are at extraordinarily high prices, annualizing the company’s most recent quarterly performance makes for a generous foundation upon which to measure its fair value. Nonetheless, using this approach gives us a sense of the optimism already baked in. Annualizing current prices, we arrive at $400 million a year in revenue and $1 per share of net income, for a price-to-sales multiple of 18 and a price-to-earnings multiple of 40. For a mining company – even one with a compelling national security and green energy narrative – MP is priced for perfect execution.
Investors are betting on the company’s ability to close the full supply chain loop, first by successfully demonstrating that it can isolate and purify individual rare earth elements onsite at Mountain Pass, and eventually by producing automotive-ready magnets in-house. Toward the latter goal – one which many believe is a stretch for the company – MP and General Motors recently surprised the market by announcing a new partnership:
“General Motors (NYSE: GM) and MP Materials (NYSE: MP) today announced the formation of a strategic collaboration to develop a fully integrated U.S. supply chain for rare earth magnets. Under the long-term agreement, MP Materials will supply U.S.-sourced and manufactured rare earth materials, alloy and finished magnets for the electric motors used in the GMC HUMMER EV, Cadillac LYRIQ, Chevrolet Silverado EV and more than a dozen models using GM’s Ultium Platform, with a gradual production ramp that begins in 2023.”
MP selected Fort Worth, Texas for the site of the proposed new magnet factory and will rely on the yet-to-be-completed refining operation at Mountain Pass for raw material supply. As risky and capital intense as these projects are, the company can certainly count on an unprecedented wave of strong support from the US government. Just last month, aggressive legislation was introduced in the US Senate in support of MP’s objectives:
“A bipartisan piece of legislation introduced in the U.S. Senate on Friday would force defense contractors to stop buying rare earths from China by 2026 and use the Pentagon to create a permanent stockpile of the strategic minerals.
The bill, sponsored by Senators Tom Cotton, an Arkansas Republican, and Mark Kelly, an Arizona Democrat, is the latest in a string of U.S. legislation seeking to thwart China's near control over the sector.
It essentially uses the Pentagon's purchase of billions of dollars worth of fighter jets, missiles and other weapons as leverage to require contractors to stop relying on China and, by extension, support the revival of U.S. rare earths production.”
Regardless of one’s view on the stock, the rare earth element story is worth watching, and MP’s success or failure will have ramifications that extend well beyond the stock price. The combination of national security interests, green energy applications, and the need for domestic onshoring of critical supply chain nodes are aligning in MP’s favor. Failure would be a sobering indictment on the ability of the US to retake control over its own economic destiny.
Count the Doomberg team as among those unabashedly hoping the company succeeds.
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