2023-10-31 03:25:25 ET
Summary
- Li-Cycle Holdings is operating in the battery recycling business with strong backing from industrial giants such as Koch, Glencore, and LG Chem.
- The company is at an inflection point as it transitions from its Spoke to Hub facilities.
- This week's press release announcing the pausing of its first hub project raises serious doubts about its ability as a going concern as its envisaged business model unravels.
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Preamble
I've dedicated the past couple of months to researching Li-Cycle Holdings ( LICY ). While I perceived it as a highly risky investment, given the various associated risks such as management, execution, changes in battery technology, competition, and potential dilution, it seemed like a worthwhile gamble due to it trading closely to book value and its upcoming inflection point with the launch of the first hub. Just last week, I went so far as to submit an extensive analysis on this platform.
However, this week's press release has completely altered my perspective. It has raised serious doubts about every bullish argument I had considered. The decision to halt construction on the Rochester Hub, citing "escalating construction costs," appears dubious, as their estimate for completion by June 30, 2023, would need to double, which I find to be an unlikely scenario. This suggests a more concerning issue at play: the economic viability of the Hubs, initially claimed to generate an 80% EBITDA margin, is simply not given. This not only invalidates all bullish arguments but also greatly heightens the risk of bankruptcy and complete loss for shareholders. The market has taken notice, with the stock falling by half since the start of the week, now valuing the company at about USD 219 million. Although this valuation is well below book value of USD 430 million as of June 30, 2023, I doubt it provides any meaningful protection because most of the equity is tied to the Rochester Hub for which a write-down is likely.
Furthermore, a liquidity crisis is on the horizon, as the USD 375 million DOE loan is directly linked to the completion of the Rochester Hub, and the company's current business model (Spokes) is uneconomical and hemorrhaging cash, which is evident from historical financials. Lastly, management has lost all credibility due to a series of missteps and can't be relied upon to steer the company back on track.
In summary, without the hubs, the company faces several challenges:
- An uneconomical, cash-hemorrhaging business model with no improvement in sight
- A looming liquidity crisis as the DOE loan (USD 375 million) is contingent on the Rochester Hub's completion and is unlikely to be disbursed if the hub is abandoned.
- A management that has lost all credibility and is unlikely to turn the company around
- "Stranded" assets (Rochester Hub) to likely force a write-down close to or in excess of book value.
Even by the standards of SPACs, the fall of Li-Cycle is remarkable and serves as a cautionary example for those engaged in SPAC investing.
Company Background
Li-Cycle stands as a prominent global company specializing in the recovery of lithium-ion batteries (LIBs). Founded in 2016, the company has developed a proprietary recycling and resource recovery process known as "Spoke & Hub." This process involves two key stages:
- Spokes: At the Spokes, a mechanical size reduction process called shredding is used to break down batteries intended for recycling. These batteries are then separated into three main components: black mass, shredded metals, and mixed plastics. Black mass contains various valuable metals such as nickel, cobalt, and lithium. It serves as an intermediate product, offering significant advantages in terms of ease and safety during transportation when compared to lithium-ion batteries.
- Hub : At a Hub facility, the black mass from the Spokes will undergo a separation process within the hydrometallurgical circuit. This process will result in the production of individual raw materials that meet the required purity standards for use in battery production. The final products derived from the black mass will encompass nickel sulfate, cobalt sulfate, and lithium carbonate.
The company claims to be one of the largest dedicated LIB recyclers in North America through its four operational Spokes located in Kingston (Ontario), Rochester (New York), Gilbert (Arizona), and Tuscaloosa (Alabama). Furthermore, the company is in the process of developing its first commercial-scale Hub in Rochester. As of last week, it was anticipated to commence the commissioning process in phases, with the initial stages slated to begin in late 2023. The company is also expanding to Europe, where it is establishing new Spokes. These include operations in Magdeburg, Germany (the "Germany Spoke"), which began operating in August, Moss, Norway (the "Norway Spoke"), expected to commence logistics operations in 2024, and Harnes, France (the "France Spoke"), expected to commence operations in 2024. In May 2023 (and September 2023), the company announced a partnership with Glencore (more specifically Glencore International AG which is 100% subsidiary of Glencore plc) to conduct a feasibility study and subsequently establish a Hub facility in Portovesme, Italy, known as the "Portovesme Hub." Notably, the Portovesme Hub will repurpose a portion of Glencore's existing metallurgical complex. The Portovesme Hub is projected to have a processing capacity of up to 70,000 tons of black mass annually, resulting in a production of approximately 15,000 to 16,500 tons per year of lithium carbonate. Furthermore, it aims to produce up to 18,000 tons of nickel and 2,250 tons of cobalt contained in mixed hydroxide product ("MHP") per year. Both parties are looking at splitting the project into two phases with Phase 1 expected to start operations by mid-2024. Based on 11,000 tons of black mass capacity, the company expects to produce 1,500 tons of lithium carbonate, up to 3,000 tons of contained nickel, and up to 500 tons of contained cobalt per year during Phase 1. Phase 2 remains unchanged from the original project plan and is slated to start between late 2026 and early 2027.
The whole network as of today looks like this
Company Filing, own calculation
The Press Release That Changed Everything
On 23 October 2023, early in the morning, the company issued a press release that announced its decision to pause construction on its Rochester. The decision is a result of "escalating construction costs" which are expected to render the previously disclosed budget of USD 560 million and the outstanding share (USD 250 - 300 million) insufficient and they will conduct a comprehensive review of the project (including its scope, budget, and construction cost).
Discussions with the DOE are ongoing regarding their USD 375 million loan commitment.
Lastly, they plan to release their Q3 2023 results on November 13, 2023, which will include further updates on their near-term plans and the project review.
This PR has completely altered my perspective. It has raised serious doubts about every bullish argument I had considered and raises the specter of bankruptcy and a complete shareholder wipe out.
Financial Impact
Revenue and Profitability
The hub is an essential part of any investment thesis and without it, the company is left with an uneconomical, cash-hemorrhaging "Spoke" only business model.
While the company managed to achieve significant revenue growth through its Spoke facilities, it's important to note that operating losses also increased. Revenues have grown rapidly to more than USD 35.4 million in FY22, compared to USD 7.3 million for the 12 months ending October 2021. However, being in its early stages, this expansion has come at the cost of operating losses, which amounted to USD 134.3 million for the 12 months ending June 2023 (or USD 109.2 million for FY22).
That is, however, unsurprising as the company only sells the black mass from its Spoke facilities without further processing in a hub. Not only does the black mass sales arrangement not prescribe any value to the lithium content but also black mass is only an intermediate product with limited value if not processed further.
Company filings, own calculation
Therefore, the Rochester Hub, along with the entire hub business, plays a crucial role in any bull case due to its significant impact on revenue, profit margins, and cash flows. As of last week, estimated at a total cost of USD 560 million, the facility is currently under construction and was set to commence operations in early 2024
Based on my assessments, the Rochester Hub is estimated to hold a total revenue potential of approximately USD 592 million. These calculations are based on the company's projected 2024 prices for Nickel, Lithium, and Cobalt (please refer to the attached screenshot with period-end prices from BMI as of June 2023) as well as a 100% utilization.
In the medium term, the European Hub, known as "Portovesme," is expected to be the primary driver for the company's expansion. Notably, Portovesme boasts a capacity nearly twice the size of the Rochester Hub. Based on my calculations, the revenue potential for the first phase is around USD 140 million, and for the second phase, it surpasses USD 1 billion. These projections are based on the same calculations and assumptions applied to the Rochester Hub. However, the biggest question is the financing for which the company, neither for phase 1 nor for phase 2, has provided guidance. Overall, total revenues have the potential to reach around USD 600 million in the medium term and surpass USD 1 billion as soon as Phase 2 of the Portovesme hub commences operations (assuming a 50:50 JV split).
Profitability-wise, the company had initially guided for an 80% EBITDA Hub margin in its SPAC presentation. However, even if you were, using a more conservative stance with peer group EBITDA margins of around 25% (slightly lower than the analyst forecast for 2025 (26.5%)) you would have an EBITDA Multiple of about 9.3 for 2025 which gradually declines to 3.2 in 2027. This compares analyst consensus EBITDA multiple of about 4.5 for 2025 (2.25 for 2026, based on estimates compiled by Capital IQ) as of last week and a peer group multiple of 16.7 (Mid Cap; current FY) and 12.3 (Mid Cap; FY+1). Even if the company were to fall short of these profitability targets, it would still trade at an attractive forward EBITDA multiple compared to its peers.
Company Filings, own calculation
Profitability-wise, the company had initially guided for an 80% EBITDA Hub margin in its SPAC presentation.
Even if we take a more cautious approach, considering peer group EBITDA margins of approximately 25% (slightly lower than the analyst forecast for 2025 at 26.5%), the company would still offer an appealing forward EBITDA multiple compared to peers, at around 9.3 for 2025, gradually decreasing to 3.2 in 2027. This contrasts with the analyst consensus EBITDA multiple of about 4.5 for 2025 (2.25 for 2026, based on estimates compiled by Capital IQ) as of last week, as well as a peer group multiple of 16.7 (Mid Cap; current fiscal year) and 12.3 (Mid Cap; next fiscal year).
Company filings, own calculation
However, it's essential to note that this calculation only remains valid if the hubs are indeed constructed and operate according to plan. This week's press release, announcing the decision to halt construction on the Rochester Hub, makes that outcome appear increasingly unlikely. In such a scenario, the company is left with a spoke network that is economically unviable on a standalone basis and is likely to remain so. With limited capital and liquidity resources, the company cannot afford to postpone the operation of the Hub.
Liquidity
As illustrated by the historical financials with the company incurring ever-increasing operating losses, the company is hemorrhaging cash - USD 40 million in Q2 on an operating basis which is USD 160 million annualized. Additionally, the company initially projected total investments in the range of USD 285 to 345 million by the year's end. This includes USD 250 to 300 million for completing the Rochester Hub and USD 35 to 45 million for expanding the Spoke Network. While it's uncertain how much capital the company has spent thus far, it brings them perilously close to their available cash balance of USD 288 million as of June 30, 2023.
Company filings
To bridge this gap, the company had secured a conditional commitment from the DOE for a USD 375 million loan, which would have boosted the total cash balance to approximately USD 664 million. This amount should have been more than adequate to cover both the capital expenditures and the ramp-up. However, the loan is contingent on the successful completion of the Rochester Hub, and it's improbable that it will be disbursed if the hub project is abandoned. This leaves the company in a precarious financial position, with cash reserves drying up shortly early Q2 next year based on the current (operating cash burn)
Company filings, own calculation
Company filings
The company has registered a shelf offering of USD 200 million that they have the option to utilize. However, it is improbable that they will opt for this route because it would lead to substantial dilution for current shareholders. Furthermore, it's uncertain who would be willing to back such a move. Even existing backers, such as Koch Industries and Glencore, are likely to be hesitant to support this action due to its substantial magnitude. They have also refrained from acquiring direct stakes in the company, instead opting for convertible debt, which is indicative of their cautious approach.
Business Model
The decision to halt construction on the Rochester Hub, citing "escalating construction costs," appears dubious. Based on my calculation and on the condition that the DOE loan closes, they should have enough liquidity to cover both the capital expenditures and the ramp-up even in the case of "escalating construction cost.
Company Filings, own calculation
This suggests a more concerning issue at play: the economic viability of the Hubs, initially claimed to generate an 80% EBITDA margin, is simply not given. This is corroborated by the fact that they had the option to utilize their shelf offering or secure funding from their current supporters, but their decision not to do so carries a significant message.
Management
Lastly, management has lost all credibility due to a series of missteps and can't be relied upon to steer the company back on track. To list a few:
- The Rochester Hub was initially expected to cost USD 175 million. In the meantime, they revised their CAPEX projection twice to USD 485 million (+- 15%) in December 2021 and USD 560 million at the beginning of 2023. While some of it can be explained by an increase in the nameplate capacity (from 60,000 tpa LIB to 90,000) and inflationary effects in the aftermath of COVID/Russia-Ukraine, the more than 3 times increase is definitely troubling and required the company to seek additional financing (which it received). The same applies to its Spoke facilities.
- The company received a conditional commitment from the DOE for a loan of USD 375 million in February 2023. Management had initially expected the loan to close by mid-2023, only to push it back to September 2023. The September deadline has also been missed.
- The SPAC presentation contained numerous questionable assumptions which have not been met. This includes the network expansion (i.e. Asian Expansion is on hold), positive EBITDA for FY22, and total CAPEX at around USD 950 million. While lots of SPAC forecasts proved too optimistic, it is nevertheless disappointing that management chose to go the same way.
On top of that, Mr. Johnston (same as Ajay Kochhar, both founders) recently (August 2023) filed Form 144 which stated their intent to sell a rather significant number of shares (i.e., around 12.5% of Kochhar's holding and more than half for Johnston). Previously, they had not sold a substantial amount of stock. Lastly, Mr. Johnston was fined and banned by the TSX Venture for its role in the Desert Lion Energy Inc. bankruptcy - however, this was disclosed in the SPAC merger filings.
Stranded assets and Book Value
The market has taken notice, with the stock plummeting by half since the start of the week, now valuing the company at approximately USD 219 million. Although this valuation is well below the book value of USD 430 million as of June 30, 2023, I doubt it provides any meaningful protection because
- most of the equity is tied to the Rochester Hub, and a potential write-down would erase most of the equity. (PPE (Property Plant & Equipment) stands at USD 449.1 million as of 30 June 2023)
- (operating) losses will only increase over time as the Spoke Network is nonviable on a stand-alone basis
Company filings, own calculation
Overall conclusion
Li-Cycle seemed like a worthwhile gamble due to it trading closely to book value and its upcoming inflection point with the launch of the first hub. However, this week's decision to halt construction of its first hub has completely altered any investment thesis - without the hubs, the company faces several challenges:
- An uneconomical, cash-hemorrhaging business model with no improvement in sight
- A looming liquidity crisis as the DOE loan (USD 375 million) is contingent on the Rochester Hub's completion and is unlikely to be disbursed if the hub is abandoned.
- A management that has lost all credibility and is unlikely to turn the company around
- "Stranded" assets (Rochester Hub) to likely force a write-down close to or in excess of book value.
This not only invalidates all bullish arguments but also greatly heightens the risk of bankruptcy and complete loss for shareholders. Even by the standards of SPACs, the fall of Li-Cycle is remarkable and serves as a cautionary example for those engaged in SPAC investing.
For further details see:
Li-Cycle Holdings: The Tale Of A Failed SPAC