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A Rare-Earth Steal at a 45% Markup

David Fickling
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A Rare-Earth Steal at a 45% Markup

(Bloomberg Opinion) -- It always pays to read the small print.

On the face of it, Wesfarmers Ltd.’s A$1.5 billion ($1.1 billion) offer for rare-earths producer Lynas Corp. looks outrageously generous. The bid comes at a 45 percent premium to the target’s last close. For most of the past five years, a slump in the rare-earths market and a regulatory tangle in Malaysia, where Lynas processes its Australian-mined ore, has seen it worth less than a third as much.

That’s where you have to check the footnotes, though. Any takeover deal comes with conditions, but one Wesfarmers bullet point is particularly significant. A transaction will be subject to “ensuring that relevant operating licences in Malaysia are in force and will remain in force for a satisfactory period following completion of the transaction”, the company said Tuesday. Fair enough, you might say – but if those licenses were in place, Wesfarmers’ offer would look a good deal less generous.

The longstanding problem for Lynas has been that the waste products from rare-earths production are pretty unpleasant stuff – a plaster-like substance known as phosphogypsum that’s hard to recycle because it contains traces of radioactive thorium and uranium. That fact has contributed to almost a decade of uncertainty around its Malaysian processing plant as local politicians have objected to the tailings dumps associated with the facility.

Right now, Lynas is going through another round with the regulators. Its license is up for renewal in September, and Malaysian authorities have announced they’ll only permit that to happen if it first exports its existing waste stockpile of around 450,000 metric tons. That’s not possible in such a short time frame, according to Lynas.

Looked at this way, Wesfarmers’ offer is a sort of call option on Lynas getting the necessary licenses in place. Any bid is conditional on the waste issue being resolved – which means the real question is whether the bid is sufficiently generous for a fully permitted target company.

It’s hard to argue that it is. Lynas was worth as much as A$1.8 billion last May, before the election of a new Malaysian government threw the permitting issues into jeopardy.  If the company was valued at the 19.5 times blended forward 12-month price-earnings ratio it attracted back then, rather than the 10.5 times multiple it’s on at present, it would be worth substantially more – and that’s not even counting the fact that analysts have already cut their earnings estimates for the stock in half to account for the regulatory uncertainty.

Despite its disastrous takeover of the Homebase home improvement chain in the U.K., Wesfarmers, a conglomerate that has its roots in a Western Australian fertilizer business, has a reputation as a canny buyer and seller of assets. It took over the Coles supermarkets business and performed a textbook turnaround in 2007, and sold out of its coal mines at decent prices.

That means that other players may take an interest. Rare earths are crucial for producing high-tech components such as LEDs and efficient motors, and the market is overwhelmingly dominated by Chinese producers – a worry for manufacturers in Japan, Europe and the U.S., who fear Beijing’s control of their supply chain. As the only wholly non-Chinese rare earths producer at present, Lynas is in a unique position. 

Lynas’s senior lenders are a joint venture of Japanese trading house Sojitz Corp. and the state-owned Japan Oil, Gas and Metals National Corp., and Sojitz has a long-standing offtake agreement. They’ve had plenty of opportunities to take over Lynas over the past decade and would probably be quite happy to see the company pass into the control of a stable group like Wesfarmers, but it’s not impossible they will launch a rival bid. Glencore Plc, which likes to get crucial positions in lower-volume key commodities such as zinc and cobalt, is another possible suitor.

Lynas is an even rarer beast than the suite of minerals it produces. Bidders should expect it to be priced accordingly.

To contact the author of this story: David Fickling at dfickling@bloomberg.net

To contact the editor responsible for this story: Matthew Brooker at mbrooker1@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

David Fickling is a Bloomberg Opinion columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.

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