October 31, 2020

Fortress Value Acquisition: An Interesting Opportunity In North American Rare-Earths (NYSE:FVAC)

8 min read
Rare-earth elements have been in the news a great deal recently due to a recent...

Rare-earth elements have been in the news a great deal recently due to a recent push from President Trump to increase the production of these elements in the United States in an attempt to reduce our dependence on China. This had a positive impact on the stocks of companies producing these metals, which are crucial to the manufacture of many items that are becoming very popular for our modern way of life. As some of these technologies become even more popular, it will almost certainly boost the demand for these elements. In this article, we will take a look at Fortress Value Acquisition Corp. (FVAC), which is simply an entity designed to purchase rare-earth metals producer MP Materials and quickly float it on the New York Stock Exchange.

About Rare-Earth Elements

As just mentioned, rare-earth elements are critical to the production of many technologies that we have come to enjoy in our modern way of life. This is largely due to the electronic and magnetic properties that these elements possess. There are seventeen of these elements:

Cerium

Dysprosium

Erbium

Europium

Gadolinium

Holmium

Lanthanum

Lutetium

Neodynium

Praseodymium

Promethium

Samarium

Scandium

Terbium

Thulium

Ytterbium

Yttrium

These elements are in fact relatively common in the Earth’s crust, despite the name. The reason that they are called rare-earth elements is because they are not found in any particularly high concentrations anywhere like most other elements are. This makes it difficult to exploit them commercially due to the high costs of mining them. With that said, there are a few areas around the world where these materials can be found in reasonably high concentrations such as China, Russia, South Africa, Australia, and the United States. The largest producer of rare-earth elements in the world is China, which alone accounts for more than half of the global heavy rare-earth element production.

As already mentioned in the introduction, rare-earth elements have a critical role to play in the production of many items that we enjoy in our modern lives. One of these is the production of both motors and batteries for electric and hybrid cars as well as in the production of magnets used in wind turbines. Thus, as the world seeks to “go green,” these elements will likely see growing demand and importance. Rare-earth elements are also used in the production of plasma and LCD screens as well as fiber optics and lasers. Thus, they have growing importance as the world becomes more interconnected and things like cloud computing increase the demand for high-speed communications. Clearly then, we can see that the demand for these materials will likely grow.

About Fortress Value Acquisition Corp.

As already mentioned, Fortress Value Acquisition Corp. is what is known as a special purpose acquisition company. Basically, the sole purpose of this company is to purchase rare-earth producer MP Materials from the hedge funds that currently own it. Thus, by buying Fortress Value, you are essentially investing in MP Materials in advance. In the fourth quarter, Fortress Value will purchase MP Materials and change its name and ticker symbol. Thus, in order to determine whether or not Fortress Value is a good investment, we should analyze MP Materials.

MP Materials owns the Mountain Pass mine in southeastern California:

Source: FrankKuin.com

The Mountain Pass mine has been operating for more than seventy years, although MP Materials has not been the owner and operator over all of that time. This makes the mine one of the oldest rare-earth mines in the world. It is also a very resource-rich one. As recently as 2008, it was estimated that the mine still had twenty million tons of rare-earth ore in place that consist of about 8.9% rare-earth oxides by volume. MP Materials provides a much more conservative estimate in its transaction deck however, stating that the mine has 804,000 metric tons of recoverable ore in place consisting of 8% rare-earth oxides by volume. Perhaps most importantly, the Mountain Pass is the only rare-earth mine in the United States. Thus, MP Materials is the only company that already has domestic production that will benefit from President Trump’s push to boost domestic production.

MP Materials actually points this out in its transaction deck:

Source: MP Materials

As it points out, there are a few other locations in the United States where competitors are researching the possibility of constructing a rare-arth mine but none of them have the resources wealth of the Mountain Pass mine so would not be able to boast the same level of production that the Mountain Pass mine has.

The acquisition of MP Materials will end up injecting $500 million into the company, which provides it with a growth opportunity. As already mentioned, the Mountain Pass mine is the only rare-earth mine currently operating in the United States. However, the company does not have the ability to process the ore that it produces. In fact, there are no rare-earth ore processing facilities in the Western Hemisphere. MP Materials is therefore forced to send its ore to China for processing. The company wishes to change this and will use the $500 to construct a processing facility at the site, which will obviously give the company the only rare-earth processing facility in the United States. The company also ultimately wants to produce magnets that are critical for the production of electric car engines. Overall, this will support President Trump’s executive order to increase the production of these critical resources in the United States. It intends to have the processing facility fully operational by 2022 but will not be able to have the magnet production online until 2025 or later so this is a medium- to long-term growth story.

Growth Opportunity

As already mentioned, rare-earth magnets are critical for the production of engines for hybrid and electric cars. This creates a growth opportunity because these vehicles are likely to become increasing common over the coming years. This is largely due to climate change fears. These fears have prompted governments around the world to implement a variety of mandates meant to promote electric or hybrid vehicles in an effort to reduce carbon emissions. We can see a summary of these mandates here:

Source: MP Materials

This can naturally be expected to increase the demand for rare-earth elements since they are critical for the production of these vehicles. In fact, it is expected to increase demand so much that the production of electric vehicles alone will consume the entire production of rare-earth elements within a decade:

Source: Morgan Stanley Research, MP Materials

Thus, the production of rare-earth elements must increase in order to meet the demand from industry. The high level of reserves available in the Mountain Pass mine positions MP Materials quite well to boost its production to meet this demand. The fact that the company will be able to process its own production on-site shortly following the acquisition helps too because it will not have to work with an external contractor to obtain the elements from its ore. This improved efficiency could improve the company’s margins, allowing the company to send more money down to its investors.

Another thing that will help to drive the company’s forward growth is the increasing prevalence of wind power. As with electric cars, rare-earth magnets are critical for the manufacture of wind turbines. In previous articles, such as this one, the demand for wind power globally is expected to grow significantly over the coming decades. This is also due to climate change fears. Over the next five years alone, the demand for new wind power turbines is expected to grow at a 7.8% compound annual growth rate:

Source: Wood Mackenize, MP Materials

The long-term growth story for wind power is even more impressive. In 2018, wind power provided 1.265 terawatts of electricity globally. This is expected to increase to 5.226 terawatts by 2040:

Source: International Energy Agency

Naturally, achieving this would require the produce of many more wind turbines to generate the added power. This will require rare-earth magnets for the turbines. If we assume that electric vehicles will take up the entire global production within a decade, we have to conclude that production of rare-earth elements must increase. This should prove stimulative to MP Materials’ forward growth.

Valuation

The company will have a post-transaction value of $1.5 billion, $500 million of which will be in cash. That value is at a price of $10 per share for Fortress Value Acquisition Corporation, which was the initial public offering price. If Fortress’s stock is more than $10, we are paying more than that for MP Materials. We want to determine whether the current valuation is fair given the potential that MP Materials has.

In order to do that, we should first value MP Materials. This is not an easy task because as noted earlier, this is the only rare-earth mine of any scale in the United States. One way that we can value it is by looking at the value of the company’s assets. The currently at the site have a replacement cost of $1.7 billion:

Source: Bakuta Capital Advisors, MP Materials

We can therefore use this as the value of the company as this is what it would cost to replace everything as well as the rare-earth production from its mine.

Now we want to determine what it cost to buy the company if one was buying Fortress Value today. As of the time of writing, Fortress is trading at $14.19 per share and has a pro forma 150 million shares. This gives the company an equity value of $2.129 billion. This is a pretty far cry from the $1.5 billion that was originally assigned to the deal. Remember though that the original deal valued MP Materials at an enterprise value of $1 billion because the $1.5 billion value also includes the $500 million that will be injected into the company to allow it to construct its processing facility. If we back out the $500 million, we get an enterprise value of the existing operations of $1.629 billion. That is a discount to the replacement cost of the company’s existing assets but it is admittedly not a significant discount. I would personally prefer a larger discount but the current price is not terrible when we consider the potential of the company. It may be worth dipping your toe in.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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