Wesfarmers’ unexpected bid for rare earths specialist producer Lynas Corp is the sort of wheeze that causes old financial journalists and analysts to spark up and start guessing about what’s really going on.
Wesfarmers CEO Rob Scott certainly shook the investment community last week by offering $1.5 billion for the trouble plagued Lynas, albeit very conditionally.
As Paul Rickard wrote so colourfully in Switzer Daily last week, “Is Wesfarmers a buy or has its MD had a brain explosion?”
I won’t argue with Paul’s conclusion that Rob Scott’s company isn’t necessarily a buy at present, but I would suggest that Scott has seen something in Lynas that the rest of us haven’t.
One, he’s got a lot of spare cash to play with post the spinoff and market listing of Coles, and money is something Lynas has by comparison struggled to find, at least at the same rates of interest.
Lynas mines its rare earths at Mount Weld in WA but processes them in a purpose built $800 million facility at Kuantan in Malaysia, or tries to.
The big headache is that the Malaysian Government is unhappy about two sorts of waste that Lynas is producing, one being just over a million tonnes of what’s called neutralisation underflow residue (NUF), the other being less than half that amount, at 452,000 tonnes, of slightly radioactive water leached purification residue (WLP).
Most particularly, it’s given Lynas until September 2 to get the latter residue out of their country.
My erstwhile colleague Matthew Stevens, now at the AFR, says the estimate for taking the WLP gunk away and storing it somewhere sensible is $130 million.
And he notes that the current management of Lynas has said it may have to suspend production within six months, given that the September 2 deadline is “unachievable”.
It’s at this point that Rob Scott and Co have come along with a $2.25 a share bid described by the Lynas board as “highly conditional, indicative and non binding.”
Scott could scarce but agree that it’s non binding, given that it’s contingent on Lynas retaining its licences “for a satisfactory period following completion of the transaction”, whatever that means, plus plus plus. He’s hedging his bets.
As are share market investors. They marked down Wesfarmers shares from just over $35 pre the bid, to around $33 during the week, followed by a tepid bounce to $34.47 yesterday.
It’s never a surprise when a bidder’s stock loses a bit of altitude while analysts juggle numbers but it’s fair to say that on this occasion the prices of both bidder and biddee have underwhelmed.
Lynas shares initially kicked up from a pre-bid level of $1.55 to a high of $2.17, which is still eight cents below the bid, and are now bumping around that level.
Clearly the arbitrageurs, who hop into a stock that’s been bid for and hope to see a higher bid emerge, are keeping their powder pretty dry.
Rob Scott appears to be in no rush to do anything like that, pointing out in a note on Friday that the $2.25 a share offer assumes that the licensing drama can be satisfactorily resolved.
“Our proposal and the premium in the offer price assume a sustainable solution is delivered to overcome the current regulatory issues that have weighed on Lynas for many years and we look forward to hearing the company’s solution”, he said.
That’s a mite cheeky, since the Lynas crew clearly don’t have one.
But it got me thinking. It’s widely known that Chinese companies control around 80% of the world’s supplies of rare earths, and clearly Lynas has an open goal in front of it, if it can keep going. Rare earths are particularly important in magnets that have myriad high tech uses.
The Lynas board has said it’s not impressed by the bid, saying it had “concluded it will not engage with Wesfarmers” etcetera.
But what is Lynas doing in Malaysia anyway, and couldn’t it process the material elsewhere?
The key to the drama may well be that the relevant Malaysian authorities gave Lynas a 12-year tax holiday some six years ago when the plant was being planned.
Beware of Greeks bearing gifts, the Trojans used to say after the mishap with the wooden horse full of soldiers.
So what about processing the material onshore?
As far as I understand it, it probably wouldn’t be practically feasible to process the rare earths on site at Mount Weld, which is about half way between Perth and the Northern Territory border.
Wesfarmers’ well established chemicals and explosives base is at Kwinana, just south of Perth.
Turning out fertiliser, explosives and industrial gases isn’t quite the same as processing rare earths but you get the drift: if anyone’s going to come along and try to turn Lynas round, Wesfarmers has a good claim to being the potential saviour. Western Australia’s not short of real estate and indeed Lynas originally planned to process the stuff at Northam, some 50km inland from Perth.
The $1.5 billion being put on the table is a bit dwarfed by the massive deleveraging delivered by the spinoff of Wesfarmers’ Coles holding, which dropped several billion dollars into Wesfarmers’ coffers last November.
In summary, Wesfarmers has been looking a bit tentative since scrapping its attempt to “bunningise” the Homebase empire in the UK.
That’s no excuse for wasting money closer to home, but you could make an argument that Wesfarmers has bought itself a call option in its Lynas bid that it will only exercise if the licensing cards fall the right way. And even if anything goes wrong thereafter, it does have a tentative Plan B in potentially processing the rare earths somewhere near Kwinana.
Conclusion: I’m not as pessimistic as Paul was but I can see there are a lot of moving parts in Rob Scott’s proposal. I’d only make a tentative dabble in Wesfarmers based on this new bid.
And Wesfarmers is unlikely to throw in a higher bid any time soon, so you can probably give Lynas a miss unless you are playing a long game and can make light of the current difficulties.