LAC - It's Time To Sell Arena Minerals

Summary

• After Lithium Americas made a bid to acquire Arena Minerals, in my view, it no longer makes sense to own the company.
• Upside is limited and there no longer remains much to speculate on relating to LAC.
• Instead, investors are likely best to sell their shares of Arena to buy LAC now, or move their profits into other prospective junior lithium companies.
• I plan to reinvest earnings from Arena Minerals into other prospective junior lithium companies.

Arena Minerals ( AMRZF ) has been one of my favorite lithium juniors for the past year or so, but Lithium Americas’ recent bid to acquire the company significantly alters my outlook. While I highlighted how great I feel this acquisition will be for Lithium Americas ( LAC ) in a previous article , this article will focus on why I believe it has made it time to sell for shareholders of Arena Minerals.

Acquisition

I think the first thing to note is that a competitive acquisition offer is highly unlikely. If we take the acquisition value of $227 million, we can calculate that Lithium Americas paid $405 per tonne of lithium carbonate in Arena Minerals’ resource estimate. Considering Ganfeng’s ( GNENF ) 33.33% stake in the project, Lithium Americas effectively paid $608 per tonne LCE. Now, despite my opinion that the current resource for the Sal de la Puna project is nowhere near representative of the project’s true size, that’s a significant premium to pay.

However, given its ownership of the adjacent Pastos Grandes project, Lithium Americas likely has far greater knowledge of the salar dynamics, meaning it’s not taking too much of a gamble on the resource upside. Furthermore, by acquiring Arena Minerals, Lithium Americas can now combine its Pastos Grandes project with Arena’s SDLP project to realize improved production synergies.

As such, the only reason that Lithium Americas is able to confidently pay such a premium is because it too has a significant project in the Pastos Grandes salar. The only other company that has a significant presence in the salar is Ganfeng which, as per Lithium Americas’ press release , has agreed to sell off all of its Arena-related securities. That means that Ganfeng, the only other company that would have a reason to make a competing bid, looks to be complacent in the acquisition and won’t get in the way.

So, now that we can assume that there won’t be any competing offers, let’s look into the details a bit more. At the time of the announcement, this offer essentially provided Arena shareholders with the ability to buy LAC at $21.61 per share. Since then, shares of Lithium Americas have increased almost 20%, while shares of Arena Minerals have appreciated by ~16.5% from the initial acquisition value. If the acquisition were to close today, shares of Arena Minerals would have an effective value of $0.585 per share - a 2.65% premium over its current price of $.57 per share (numbers as of the time of writing).

At face value, that doesn’t sound half bad. That’s a free 2.65%! But the transaction isn’t expected to close until Q3.

Because shares of Arena now trade in tandem with LAC, which has brought it just shy of its all-time high that it hit last April, a failure to be acquired would likely send shares in freefall. While I don’t see any reason that the transaction would be blocked, meaning the odds of this happening are quite low, I’m not sure it’s worth locking in a 2.65% premium over whatever Lithium Americas is able to accomplish in the next several months.

Alternative Strategies

The simplest strategy would be to simply move capital from Arena Minerals into Lithium Americas. Lithium Americas is my favorite company for the year and, if you do not yet have a position in the company, this could be a good opportunity to do so. However, Arena Minerals and Lithium Americas are very different companies and, if you are looking for a company more similar to Arena Minerals, other lithium juniors are probably better suited.

One company that I’ve started to like quite a bit recently is Green Technology Metals ( GTMLF ). I covered the company for members of Green Growth Giants , but I plan to release an article to the public in the near future, so keep an eye out for that. So, instead of looking at this as a loss, investors should treat this as an opportunity to move their profits toward new investments.

But, more broadly, I also feel that this is a good opportunity for me to clarify my interest in lithium juniors as an asset class. I have seen many comments that it may be more prudent to invest in current lithium producers to take advantage of high lithium prices. And while I do like some lithium producers, I continue to feel that lithium juniors offer the greatest upside.

Junior mining companies, in general, aren’t interesting investments because of the underlying commodity. Rather, they offer the opportunity for investors to get in early on a company that may produce a steady profit some years down the line. This is a risky business, as investors must trust management to explore, finance, develop, and operate a resource project successfully. But, if they do, early investors are handsomely rewarded.

In the lithium industry, one major risk of junior miners has been mitigated - financing. From H2 2021 to H1 2022, $4.21 billion went into the lithium industry from the private sector across 19 separate transactions. This is double the number of transactions from the previous 12-month period and 9x the value. That’s incredible strength, especially in the face of a weaker macroeconomic climate. Keep in mind that this data doesn’t include capital raised by secondary offerings, which has also been a critical component of the financing equation.

But the private sector isn’t acting alone to finance these junior lithium companies. Especially in the United States, national governments have started to take an active role in financing lithium projects. Last October, the United States Department of Energy (“DOE”) announced $2.8 billion of grants to a number of companies to help grow the domestic lithium battery supply chain. Nearly $400 million, or 14.2% of the $2.8 billion, went toward lithium production initiatives.

There’s even more financial support available through the $17.7 billion Advanced Technology Vehicle Manufacturing (“ATVM”) program but, rather than grants, the ATVM program provides companies with low-interest loans. ioneer ( IONR ) has already been granted a $700 million loan, contingent upon solving its Tiehm's Buckwheat problem, while companies like Lithium Americas also expect to utilize its resources. In no other industry do junior mining companies have access to 10+ year, low-interest, loans. Especially loans closing in on $1 billion.

So, even ignoring the appeal of these companies potentially entering the lithium market, lithium juniors offer a better investment proposition than any other class of junior mining company. However, I think it’s time to consider why investments in future participants in the lithium industry are desirable

Lithium Price Discussion

Lithium carbonate prices are currently down ~20% from their high of $88,500 per tonne in November, now trading at just over $70,000 per tonne. With any “commodity” (I still view battery lithium compounds to be specialty chemicals rather than commodities, but I’ll refer to it as a commodity for simplicity’s sake), a 20% price drop will make investors squirm. But let’s look at some simple market fundamentals.

Thanks to a prolonged period of undersupply, there are now a number of physical price buffers in place. The strongest of these buffers is growing lepidolite production, a low-quality lithium source that is currently being utilized by Chinese producers in an attempt to close the supply gap. Ganfeng estimates that, in 2022, lepidolite resources will be responsible for 85,600 tonnes LCE of the global lithium supply.

Representing 13.5% of the global lithium supply , lepidolite is therefore a critical component of the lithium supply chain. However, lithium production from lepidolite can cost anywhere from around $25,000 per tonne LCE for the highest grades, to almost $40,000 per tonne LCE for lower-grade resources. So, at bare minimum, lithium prices need to support this lepidolite production, otherwise the market risks losing this, now critical, production source.

Furthermore, a number of new Australian spodumene projects are rushing to production to take advantage of high lithium prices and try to fill the supply gap. However, many of these projects lack resource quality and production costs are closing in on $1,500 per tonne of 6% spodumene concentrate. With roughly 7 to 8 tonnes of 6% concentrate needed per tonne of lithium carbonate or hydroxide, the cost of raw material alone will be between $10,500 and $12,000 per tonne LCE.

Assuming most of this spodumene concentrate will be refined by third parties, we can assume that the cost to produce hydroxide from these operations will be anywhere from $16,900 - $19,750 per tonne LCE. With the growing lepidolite supply, market fundamentals don’t seem to support a price below $48,000 in a tight market.

In the event that supply outpaces demand by enough to cut lepidolite production, the low-quality spodumene operations offer a secondary buffer to support lithium prices of $23,700 per tonne. Both of these price estimates assume a 20% premium over the cost of production for the lowest-quality lithium operations.

Both of these estimates are substantially lower than the current spot price, but not even the most bullish lithium investors should expect these prices to be maintained. Critically, these estimates provide some assurance that Goldman’s $11,000 per tonne estimates for 2024 and 2025, and even its $16,372 per tonne estimate for 2023, are too low to be sustained by the market.

Furthermore, this is my bearish projection. It follows the assumption that supply will be able to meet, and surpass, current demand levels. That’s not really something I foresee happening. As Scotiabank analyst, Ben Isaacson, wrote in a recent report ,

“[Without] a slew of new advanced-stage projects moving to construction imminently, a holy grail for the industry to improve recovery rates, and/or an unprecedented pivot to improved secondary supply from recycling, it's hard to justify why prices should moderate toward the cost curve over the next five-plus years.”

Albemarle also recently updated its market outlook, producing the image below to visualize its projected lithium demand. With this extreme demand growth, Albemarle expects to see a lithium supply deficit of 800,000 tonnes LCE in 2030. While Albemarle’s forecast is a bit on the bullish side, my personal expectation is that we will remain in a deficit, or very close to it, for the foreseeable future as projects continue on their slow path to commercialization.

Regardless, for a bearish outlook, this all seems pretty bullish to me. Lithium producers on the bottom of the cost curve, and even many spodumene producers, will be able to turn outrageous profits. The low-end price forecast to sustain spodumene production is also more than double what most analysts were projecting in 2020.

If my assumption that lithium demand will continue to outpace supply is correct, these estimates aren’t won’t even be relevant as lithium prices will remain disconnected from the cost curve. However, as the worst-case projection, this all bodes pretty well for long-term lithium investors. So, considering the likelihood of prolonged lithium prices, and the financing opportunities it provides, current producers are certainly not the only way to play the strength of today’s lithium market.

Investor Takeaway

From what we currently know, I don’t think it makes sense for investors to own shares in Arena Minerals at the moment. In my view, doing so offers little upside and prevents investors from moving capital into alternative assets. One exception - The only reason I might recommend holding Arena Minerals is if you purchased shares in the company before Q3 2022 to convert profits from short-term to long-term capital gains. Because I first bought shares in 2021, I have sold off my position in the company.

This acquisition is a bit bittersweet for me because, from the perspective of a Lithium Americas shareholder, I think it’s fantastic. But it also means that I’ve lost, in a sense, one of my favorite junior lithium companies. Fortunately, after a number of lithium juniors got hit hard last year, there are a lot of good places to move the capital into.

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