In May, Lepidico Ltd (ASX:LPD) announced a trio of transformational initiatives. The first of these was an all-share offer to acquire Desert Lion (TSXV: DLI), according to which LPD will pay 5.4 shares for every one Desert Lion share. The second was a one-for-nine renounceable rights issue to raise up to A$10.8m via the issue of 372.9m new shares (plus warrants) at a price of A$0.029/share. The third was a supply and marketing alliance with Gulf Fluor for the supply of sulphuric acid, including the provision of land for the construction and operation of Lepidico’s Phase 1 Plant project in Abu Dhabi. Our last note considered the strategic rationale for the three initiatives; this report looks at the valuation implications.
Business description
Lepidico provides exposure to a portfolio of lithium assets via its wholly owned properties, JVs and IP in Australia, Canada and Europe. Uniquely, it has successfully produced lithium carbonate from non-traditional hard rock lithium-bearing minerals using its registered L-Max® process technology.
Potential to double life of Phase 1 Plant project
To operate its Phase 1 Plant at a rate equivalent to 5,000tpa lithium carbonate equivalent, we estimate that Lepidico will need to mine c 0.6Mtpa of ore to produce c 58,000tpa of lepidolite concentrate. Whereas we had previously assumed that this would be supplied from Alvarrões, LPD’s acquisition of (merger with) Desert Lion holds out the possibility that this could now be sourced from its Namibian resources. While neither asset has the resources to supply a Phase 1 Plant for much beyond a decade, both together could supply it for more than two. As a result, we are provisionally (subject to resources being upgraded to reserve status) assuming that Lepidico will be able to extend the life of its Phase 1 Plant project from 10 to 20 years. Self-evidently, either or both could also contribute feed to Lepidico’s Phase 2 Plant project in due course.
Valuation: 7c per share (fully diluted)
In our recent report Alvarrões resource increases 290%, published on 12 April 2019, we estimated that execution of a 7t/hour (5,000tpa lithium carbonate equivalent) Phase 1 Plant would result in free cash flow to Lepidico of A$71.2m per year once steady-state production had been achieved, which we valued at A$0.0684/share, after assuming US$30m (A$41.8m) of equity funding at the then prevailing share price of 3.1c. In the light of the three initiatives announced in May, our per share valuation has increased to 6.92c, notwithstanding a 30.0% increase in the number of Lepidico shares in issue which, all other things being equal, would normally imply a 20.5% pro rata decline in value. More than anything else, this increase demonstrates the effect of the Desert Lion resource potentially extending the life of Lepidico’s Phase 1 Plant project from 10 to 20 years. Note that this valuation does not attribute any value to Lepidico from the Phase 2 Plant or any other development options.
Three transformative announcements
During May, Lepidico announced three transformative initiatives. In the approximately chronological order in which they occurred, these were as follows:
- A one for nine renounceable rights issue involving the issue of up to 372.9m new shares at A$0.029/share and 186.5m new listed options (exercisable at a price of A$0.05/share in three years’ time) in Lepidico to raise A$10.8m. The issue closed oversubscribed on 31 May, such that the company then decided to place a further 8,620,690 fully paid ordinary shares at A$0.029 with 4,310,345 options attached to raise an additional A$250,000. Investors should note that Edison calculates a Black Scholes valuation for the options (using Lepidico’s annual historical share price volatility) of 1.0c apiece (cf 1.4c at the time of our earlier note, on 9 May – the decline being the result of the decline in Lepidico’s share price since then, from 3.2c to 2.6c). Nevertheless, this remains equivalent to a value of 0.5c per share (there being half a new option issued per new share).
- An all-share offer for Desert Lion (TSXV: DLI), whereby Lepidico will pay 5.4 shares for every one Desert Lion share in issue, or 633.8m shares in total, valuing Desert Lion at A$18.4m (C$17.1m, US$12.7m) at the time of writing, or A$0.1566/share (C$0.1455/share). On 28 June, Lepidico announced that Desert Lion shareholders had overwhelmingly voted in favour of the acquisition at its annual general and special meeting of shareholders held the day before, with 99.22% of votes cast approving the transaction. Now that the court hearing for the final order to approve the transaction has also been successfully concluded (announced 5 July), the process of closing the transaction is purely mechanical and administrative and is expected to be completed later this month. In light of this, management teams from both Lepidico and Desert Lion are in the process of travelling to Namibia to ensure a smooth post-merger transition and to commence exploration activity immediately following the deal’s closing.
- A supply and marketing alliance with Gulf Fluor for the supply of sulphuric acid, including the provision of land for the construction and operation of Lepidico’s Phase 1 Plant project in the Industrial City of Abu Dhabi (ICAD).
In our last note, Lepidico (Acquisition, rights offer and Gulf Fluor alliance, published on 9 May), we considered the strategic rationale for the three initiatives, but did not immediately update our valuation, which is the function of this note.
Pilot plant updates
Apart from one slight hiccup, which caused its brief suspension (but is not expected to have any material effect on either costs or timings), the operation of Lepidico’s pilot plant has now begun. The salient features of the first campaign to date are:
- The establishment of generator power on site, allowing wet commissioning of the final items of mechanical equipment to be undertaken.
- The completion and sign-off of the programming of pilot plant instrumentation.
- The completion of the hazard and operability (HAZOP) study.
- The concentration of a 15t sample of lepidolite sourced from the Alvarrões mine in Portugal to produce 5.5t of concentrate with a grade of 4% Li2O, of which one tonne has been classified as leach feed.
- The commencement of lepidolite concentrate leaching, with ramp up to continuous operation at a feed rate of 15kg/hour and the imminent production of first lithium sulphate, amorphous silica and sulphate of potash (SOP).
The first pilot plant campaign is expected to run for approximately four weeks throughout July. In the meantime, Strategic Metallurgy has developed the process design criteria for LOH-Max™ and provided it to Lycopodium to undertake the engineering of a LOH-Max circuit for the Phase 1 plant at the same time as engineering a LOH-Max circuit for the pilot plant.
Data from the first pilot plant campaign will be used to critically evaluate all construction materials and mechanical equipment in the plant. The findings from this assessment will then be used to develop a plan for optimal, sustainable operation of the pilot plant in October 2019 at the same as it is retrofitted for LOH-Max operation. At this point the pilot plant will be designated a “Demonstration Plant”, suitable for providing lithium chemical samples for the first three stages of lithium chemical qualification. A second Demonstration Plant campaign is then provisionally scheduled for November.
Valuation considerations
The principal effect of Lepidico’s three initiatives is the increase in the number of shares in issue as a result of the rights issue and Desert Lion acquisition, which is summarised in the exhibit below.
Inevitably, both share issues are dilutive to our valuation, albeit the effect of the dilution relating to the rights issue shares will be partly mitigated by the funds raised, while the effect of the dilution relating to the Desert Lion shares will be mitigated by the assets acquired.
Desert Lion
Exhibit 2, below, outlines Desert Lion’s balance sheet as at its last year end (31 December 2018) and our estimate of its likely balance sheet as at 30 June 2019, both in Canadian dollars (its reporting currency) and Australian dollars (for the purposes of subsequent consolidation into Lepidico’s balance sheet). In the period between 31 December 2018 and 30 June 2019, we expect that cash will have been almost exhausted in the normal course of the running of the company, while C$4.4m in interim share issues will have been used to reduce trade payables:
For the purposes of our financial forecasts (see Exhibit 8), we have therefore consolidated this balance sheet into Lepidico’s as at the latter’s FY19 year end on 30 June 2019. Relative to its forecast net assets of A$14.7m as at end-June 2019, Lepidico’s consideration of A$18.4m for Desert Lion’s equity can thus be seen to include A$3.7m of goodwill, which we expect will be written off against reserves upon consolidation.
As stated previously, in mitigation of its issue of shares in consideration of Desert Lion, Lepidico will be acquiring tangible assets, particularly in the form of DLI’s resources, which are summarised below (including slimes):
LPD’s acquisition consideration of A$18.4m equates to an enterprise value multiple (including the convertible bond liability acquired) of US$149.89/t attributable lithium carbonate equivalent (LCE). This is a premium to the average value of US$53.84/t LCE (US$34.55/t for resources in the indicated and inferred categories) for non-spodumene, non-brine lithium deposits that Edison calculated in its annual report, Gold stars and black holes: Analysing the discount: From resource to sanction, published in January 2019. Excluding the strategic consideration (ie that these resources provide Lepidico with supply-side optionality for the development of its Phase 1 and Phase 2 Plants – see below), we would therefore ordinarily value such a resource at US$3.4m (attributable), or A$5.0m, or 0.09 Australian cents per fully diluted Lepidico share (ie post-rights issue and post-Desert Lion acquisition etc).
Alternatively, on 1 November 2018, Desert Lion published the results of a preliminary economic assessment (PEA) on its Namibian Lithium project. For an initial capital expenditure of US$275m, it calculated that the project had a post-tax NPV8 of US$109m and a pre-tax internal rate of return of 29% at a lithium carbonate price of US$13,000/t. Within this context, LPD’s acquisition price of US$14.9m (including Desert Lion’s convertible liability) equates to 17.2% of attributable NPV8. This compares to an average value of 11.7% for companies at PEA stage calculated in our report, Gold stars and black holes: Analysing the discount: From resource to sanction, which would imply a valuation for Desert Lion of US$10.2m, C$13.7m or A$14.8m (or 0.25 Australian cents per fully diluted Lepidico share).
Synergies and development optionality
The NPV calculated by Desert Lion and its consultants for its Nambian Lithium project was based upon a conventional mining and concentration operation at the mine site in conjunction with the operation of a chemical plant at Walvis Bay to produce lithium carbonate. Given its L-Max and LOH-Max technologies, such a chemical plant would be, at best, superfluous to Lepidico and, at worst, a liability. By contrast however, the resources of the project are of significant strategic interest.
In order to operate its 5,680tpa lithium hydroxide monohydrate Phase 1 Plant (equivalent to 5,000tpa lithium carbonate equivalent), we estimate that Lepidico will require a reliable feed of 58,000tpa of lepidolite concentrate. Whereas we had previously assumed that this would be supplied by Alvarrões in the first instance, we estimate that it could also be sourced from mining (and concentrating) Desert Lion’s Namibian Lithium project resources at a rate of c 0.6Mtpa. A conflation of Desert Lion’s resource base with that of Alvarrões is as follows:
It can be seen from this exhibit that neither Alvarrões’s nor Desert Lion’s resources alone are capable of supplying its Phase 1 Plant project at such a rate for an extended period of time. However, together they are capable of doing so for almost 30 years (with the proviso that inferred resources are eventually upgraded to the indicated category so that they may then become part of the mineral reserve inventory). As a consequence of Lepidico’s acquisition of DLI (and for the purposes of its financial modelling), Edison has therefore assumed that the company will now be able to extend the life of its Phase 1 Plant project from 10 to 20 years. Self-evidently, in due course, either or both could also contribute feed to Lepidico’s Phase 2 Plant project. Other assumptions that Edison has made regarding a mining and concentrating operation at Desert Lion’s Namibian Lithium project (largely derived from its PEA – see above) are as follows:
Based on these assumptions, we estimate that Lepidico will be able to produce lepidolite concentrate from DLI’s Namibian Lithium project assets at a cost of US$343.07/t (CFR). This compares with the US$385/t at which we previously assumed that its Phase 1 Plant project would have purchased concentrate. The extent to which LPD’s Namibian Lithium project may sell concentrate to the Phase 1 Plant project above cost is an issue of transfer pricing within the group. For the purposes of our financial analysis however, we have assumed that the mining and concentrating operation will continue to sell concentrate to the Phase 1 Plant at US$385/t (CFR) and that the resulting ‘profit’ generated from this 9.1% margin will be taxable in Namibia at a rate of 37.5%. The fact that Desert Lion owns only 80% of the project will also give rise to a minority interest in the net profit earned. In addition, we have also assumed that the enlarged group will incur US$4.93m in additional operational expenditure in FY20 and FY21 on exploration and definition drilling, mining and engineering studies and concentrator and tailings test-work.
Other
Apart from the effects of dilution inherent in the rights issue and the Desert Lion acquisition, other factors for which we have adjusted our valuation are:
- The decline in Lepidico’s share price from 3.2 Australian cents per share to 2.6c at the time of writing. We continue to expect that Lepidico will look to (part) finance its Phase 1 Plant project via US$30m in equity fund-raising in FY20, which we assume will be conducted at the prevailing share price (which therefore affects future assumed dilution).
- Foreign exchange rates. In the wake of the Australian general election in May the forex rate has fallen from A$1.3936/US$ to A$1.4494/US$. Moreover, the new Liberal majority government is expected to pursue economic policies that are consistent with low domestic interest rates (albeit these are set by an independent central bank) and a weak Australian dollar.
The other significant change in our assumptions concerns timing. As noted in our last report, within the last few months, Lepidico has undertaken a number of initiatives that will affect the timing of its feasibility study on the Phase 1 plant project. These include:
- The extension of the Phase 1 Plant project feasibility study to incorporate an LOH-Max circuit for the production of lithium hydroxide (cf lithium carbonate from the L-Max plant alone).
- The evaluation of a plant development at ICAD.
- The redesign of mining activities at Alvarrões to reflect the expanded resource (see our note Alvarrões resource increases 290%, published on 12 April 2019).
Lepidico’s ICAD trade-off study is anticipated to be complete in the second half of 2019. The engineering required to incorporate an LOH-Max circuit into the plant is expected to be completed in the fourth quarter of calendar year 2019. Ore reserve delineation, mine design and scheduling at Alvarrões is expected to be finalised in early 2020. Once these studies are completed, they will then be incorporated into the final feasibility study in early 2020 at the same time that Lepidico will be seeking to finalise its offtake and financing arrangements. In recognition of these considerations therefore, whereas Edison had hitherto expected first revenue from the Phase 1 Plant project in FY21, we have now deferred this by six months to FY22.
Valuation
In the light of the issues considered above (and notwithstanding the 20.5% pro rata decline in value that alone would be expected from a 30.0% increase in shares) our valuation of Lepidico has actually increased from 6.84 Australian cents to 6.92c. A graph of our updated EPS and (maximum potential) DPS forecasts for the first 20 years of the Phase 1 Plant project life (cf 10 years previously) is as follows:
More than anything else, this increase demonstrates the effect of the increased life that the additional resources at Desert Lion potentially confer on the Phase 1 Plant project, as shown in the waterfall chart below:
Note that this valuation is fully diluted in that it accounts not only for shares issued in respect of the one-for-nine rights issue and Desert Lion acquisition, but also for assumed US$30m equity issuance in FY20. It also treats the convertible bond as conventional debt. However, the note may be converted into Desert Lion equity at a price of C$0.20/share (equivalent to a Lepidico share price of 4 Australian cents at the time of writing) at any time prior to maturity, which is 10 December 2020. Originally bearing interest at a rate of 12% pa to be settled in cash and shares, in April DLI issued the financier, API, with shares to convert the note into a zero-coupon instrument. Nevertheless, if the convertible is instead fully converted into 108m Lepidico shares, our valuation reduces by fractionally less than 1%, to 6.85 Australian cents per share.
