LTHM - Livent-Allkem Merger: Is It Worth Buying The Combined Entity?

2023-05-15 09:13:22 ET

Summary

• Allkem and Livent's merger announcement has disrupted the lithium industry by creating the world's third-largest vertically-integrated lithium producer, reshaping the competitive landscape.
• In this article, I delve into the implications of the merger for the lithium industry and evaluate the asset portfolio of the newly combined entity.
• I also aim to estimate the upside potential of the stock of the combined entity by the end of 2023 while evaluating the risks involved in the merger.

On May 10, 2023, Allkem (AKE.ASX)( OTCPK:OROCF ) and Livent ( LTHM ) announced a definitive agreement to combine, in an all-stock merger of equals, valuing the combined company at US$10.6 billion, thus creating the world's third largest lithium producer.

Lithium M&A and competitive landscape

The merger and acquisition (M&A) activity in the lithium industry has experienced a notable surge in recent years. Some significant transactions include Tianqi Lithium Corp. ( OTCPK:TQLCF ) acquiring a significant stake in Sociedad Química y Minera de Chile ( SQM ) from Nutrien Ltd. ( NTR ), Rio Tinto Group ( RIO ) acquiring the Rincon project from Sentient Equity Partners, Zijin Mining Group ( OTCPK:ZIJMF ) acquiring Neo Lithium Corp., Sibanye Stillwater Ltd. ( SBSW ) acquiring Ioneer Ltd., Lithium Americas Corp. ( LAC ) acquiring Millenial Lithium Corp. and Arena Minerals Inc., Albemarle Corp. ( ALB ) acquiring Guangxi Tianyuan New Energy Materials, a converter in China that produces lithium carbonate and lithium hydroxide, and Orocobre acquiring Galaxy Resources to form Allkem.

Additionally, we have witnessed unsuccessful attempts at acquisitions. Tianqi, for instance, did not garner enough support from Essential Metals Ltd. ( OTCPK:PIONF ) shareholders, while Albemarle's all-cash acquisition offer was rejected by Liontown Resources ( OTCPK:LINRF ).

Three salient trends are reshaping the competitive landscape of the lithium industry, as illustrated in Table 1. Firstly, there is a noticeable consolidation among lithium mining companies, resulting in the emergence of a few key players. Secondly, major lithium miners are actively pursuing diversification strategies by expanding their operations into both brine extraction and hard-rock mining. Lastly, there is a growing trend of vertical integration, with lithium converters expanding their reach into mining activities, and upstream lithium miners acquiring or constructing lithium conversion facilities.

The consolidation happening within the lithium industry has the potential to provide lithium majors with increased bargaining power during negotiations with large battery manufacturers and/or automotive giants. As the industry consolidates, the larger lithium companies may find themselves in a stronger position to negotiate more favorable terms and conditions with their powerful customers. This shift in competitive dynamics could have a significant impact on shaping business relationships and agreements within the lithium supply chain.

The Allkem-Livent merger took place within the aforementioned context.

The asset portfolio after merger

The merger of Livent and Allkem results in the formation of a highly diversified asset portfolio, as illustrated in Table 2. This portfolio possesses the following key characteristics:

Firstly, the merger will bring about an increase in the company's scale, resulting in the generation of economies of scale. The combined entity will have significantly greater mineral resources and production capacity, as indicated in Table 2. According to the 2022 annual report of SQM , the estimated market shares in 2022 were as follows: SQM (20%), Albemarle (16%), Tianqi (7%), Ganfeng (6%), Allkem (4%), and Livent (3%). Consequently, the combination of Allkem and Livent would have positioned the merged entity as the world's third-largest lithium producer last year. The pro-forma combined revenue for 2022 would amount to US$1.9 billion, with an adjusted EBITDA of US$1.2 billion.

Secondly, the merger results in geographically adjacent projects previously held by the two companies. A notable example is the Sal de Vida project by Allkem, which is situated alongside Livent's Fenix project in Salar del Hombre Muerto, Argentina. This geographical proximity offers the possibility of combining these projects into a single operation, maximizing operational efficiency and reaping synergy. Similarly, Livent's Whabouchi project and Allkem's James Bay project, both located in Quebec, can be strategically managed in a coordinated manner, with their output directed towards a single conversion plant, namely Bécancour.

The close proximity of these projects creates unique opportunities to expedite development and reduce risk, fostering a robust pipeline of growth projects. This project pipeline is projected to facilitate a remarkable fivefold increase in brine lithium carbonate equivalent (or LCE) production capacity, a threefold increase in spodumene concentrate production, and a threefold increase in lithium hydroxide (or LiOH) production by 2027. This highlights the significant growth prospects that can be harnessed through the strategic integration and coordination of these geographically adjacent projects.

Thirdly, the merger serves to enhance operational flexibility and enable the capture of value across the vertically integrated value chain. The combined entity benefits from strategically positioned lithium chemical manufacturing facilities located in close proximity to customers worldwide. These facilities are situated in key locations such as Bessemer City, North Carolina ((USA)), Zhejiang (China), Nahara (Japan), and Bécancour (Canada). Toyota holds 6.16% of Allkem shares through its trading unit Toyota Tsusho Corp., which is also the 25% interest-holding partner in the Nahara operation.

Moreover, the merger allows for efficient utilization of resources within the combined entity. For instance, the spodumene concentrate produced at Allkem's Mr Cattlin facility can be supplied to Livent's conversion plant in China. This integration of operations ensures a streamlined supply chain.

According to Livent, the proximity and co-development of assets in Argentina and Canada have the potential to generate substantial operating synergies. These synergies are estimated to amount to a run-rate of US$125 million per year on a pre-tax basis, along with one-time capital savings of US$200 million. These projected cost efficiencies underscore the value creation potential resulting from the merger, further enhancing the overall operational performance and financial outlook of the combined entity.

Valuation and risks

Livent has announced its plans to increase its Bessemer City plant's LCE capacity by 5 ktpa in 2023. In its first quarter earnings report , Livent revised its 2023 adjusted EBITDA guidance from US$510-580 million to US$530-600 million, reflecting a growth rate of 45-64% compared to the previous year.

Allkem, on the other hand, is currently in the process of commissioning the Nahara plant, which successfully produced its first battery-grade lithium hydroxide in October 2022. The second stage of the Olaroz project, with a nameplate capacity of 25,000 tpa, is scheduled to commence operations in the first half of 2023, although Sal de Vida is not expected to start production until mid-2024. Wall Street analysts estimate that Allkem will achieve an EBITDA of US$938 million in 2023.

As a result, the new entity from the merger is poised to generate an estimated EBITDA of approximately US$1,500 million. Considering the one-time savings of US$200 million and an annual synergetic benefit of US$125 million, the post-merger combined entity could potentially reach an EBITDA of US$1,825 million, reflecting a 52% increase from the pro-forma 2022 figure.

When excluding SQM, which has faced market repercussions due to Chile's plans to nationalize its lithium industry , and Mineral Resources Ltd., which primarily focuses on iron ore operations, the lithium pure-play peers of Allkem-Livent include Albemarle, Ganfeng, Tianqi, Pilbara Minerals, and Sigma Lithium, as depicted in Table 1. These peers have an average EV/EBITDA multiple of approximately 7.3X. Based on this multiple, the post-merger combined entity is expected to have an enterprise value of US$13,348 million, suggesting a potential upside of 24% from the combined EV of Allkem and Livent.

I don't perceive any significant regulatory risk concerning the merger between Allkem and Livent. While the lithium industry is experiencing a phase of consolidation and vertical integration, it is still far from reaching a monopolistic state. In comparison, the battery manufacturers and automakers in the Western market are of a staggering size when compared to any individual lithium producer. They appear to be more concerned about ensuring the resilience of their supply chains rather than losing bargaining power to their expanding lithium suppliers. The aggressive acquisition activities of Chinese companies like Ganfeng and Tianqi have raised concerns among Western governments as they gain control over both lithium mining and refining operations. This is why the consolidation among Western lithium producers, including the Allkem-Livent merger, is all the more welcomed.

I believe that the merger will help mitigate executional risk moving forward. By combining the hard-rock lithium mining expertise acquired by Galaxy Resources at Mt Cattlin with Livent's 25 years of experience in brine lithium extraction at the Fenix project in Salar del Hombre Muerto, the new company forms a formidable team. With a combined liquidity of US$1.4 billion, minimal indebtedness, and positive cash flow generation, the new company is positioned with lower exposure to financial risk as it accelerates its growth strategy.

Despite the merger, the primary risk in the short term will continue to be the volatility of lithium prices and foreign currencies, much like when Allkem and Livent were separate entities. However, it is worth noting that lithium prices have experienced a sharp decline of 66% since November 2022. Considering the supply-demand outlook, there is reason to be optimistic about the medium and long-term prospects of lithium prices. By merging their strengths and resources, the new company is well-positioned to navigate these risks and capitalize on the potential opportunities in the lithium market.

Investor takeaways

Based on this analysis, it can be concluded that the merger between Allkem and Livent will result in a diversified vertically-integrated portfolio of assets. This merger offers numerous benefits such as economies of scale, operational synergies, reduced executional risks, and the promise of rapid growth following the business combination.

Considering the potential upside of 24% with moderate risks, investors who hold an optimistic medium to long-term perspective on lithium prices may find it worthwhile to consider establishing a position. Livent, as depicted in Figure 1, may be a preferred choice for such investors.

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