UPDATE: Buy Lynas on rare earth strength

This is an update on our initial trade recommendation to buy Lynas Corp (ASX:LYC), a company that explores, mines, and produces rare earth minerals.

Yesterday, Wesfarmers Ltd (WES) announced a bid to acquire Lynas at AUD 2.25/share, representing a 45% premium to Lynas' last close. This offer was subject to Lynas having its Malaysian operating licensing intact for a reasonable period of time. This license is up for renewal in September but is conditional upon Lynas removing 450,000 tonnes of residue from Lynas Advanced Materials Plant (LAMP), which the company has said won’t happen. 

On that basis, considering Lynas was trading at AUD 2.40 in November 2018, before the Malaysian government imposed the licensing renewal conditions on the company, the bid is actually a 0% premium on Lynas’ fully licensed operations. With that in mind, it is no surprise that the offer looks considerably less generous and hence Lynas has rejected the offer unambiguously, with the CEO citing the bid as “opportunistic”. 

Lynas explores, mines, and produces rare earth minerals. Rare earths are counter-intuitively not “rare” but are difficult to find in deposits that are not contaminated with other materials and with a concentration high enough to be mined economically. Lynas operates the world’s highest grade operating rare earths mine in Mt. Weld (a collapsed volcano), Western Australia, and a chemical processing operation, Lynas Advanced Materials Plant, in Kuantan, Malaysia. 

Lynas is in a very unique position as it is only miner and processor/producer of rare earths worldwide outside of China. In a world of heightened geopolitical tensions, a non-Chinese supplier has a significant competitive advantage for some manufacturers and businesses wishing to diversify supply chains away from China. Chinese producers typically dominate the market have benefited from strong governmental support aimed at providing downstream consumers with a competitive advantage as the high-tech and green tech industries that rely on rare earths are crucial to propelling the next phase of China’s economic expansion. But although China is currently a major producer, the source is not sustainable and over the coming years China could become a net importer of rare earths, particularly of Dysprosium.

Rare earths are crucial for a number of high growth, high-tech commercial industries including hybrid and electric vehicles, renewable energy (wind turbines), energy-efficient lighting, LEDs, advanced electronics, chemicals, and medical equipment. Without rare earths a number of high-tech industry applications would not be viable. Take the iPhone, for an example: screens are polished with lanthanum and cerium and within the phone is a magnet made with neodymium and praseodymium. 

There should be little doubt that Lynas is sitting upon a valuable asset and could be the target of other bids in the future from Wesfarmers and other possible bidders. While the company is currently in a bind due to the regulatory clash with Malaysian regulators, the bid from Wesfarmer’s does not take into account Lynas' exclusive position as a non-Chinese supplier, and the long-term asset value given the current trajectory for rare earths demand and is likely seeking to capitalise on the company’s current vulnerable position.

Permanent magnets containing NdPr, of which Lynas is the second-largest producer globally, are a key enabler of electric vehicle technology, a sector which we expect to grow considerably in size becoming a game changer for NdPr demand.

The problem now is the license renewal issues in Malaysia, the outcome will be binary and Lynas will be able to negotiate LAMPs ongoing operations or they will need to exit Malaysia and find an alternative processing plant for the RE they mine. Smartkarma have an excellent analysis of the ongoing issues and potential resolutions of this current bid. 

This presents a key regulatory/political risk so for investors with a lower risk tolerance, taking profit at this point would present a 16% gain on the trade ideas entry price and would be advisable. The long-term investment thesis still remains intact, but those that continue to hold must be prepared for volatility in the share price emanating from heightened regulatory risk.