Cadence Minerals — Steadily cantering through

The following sections seek to provide an overview of the value attributable to Cadence based on the most up-to-date technical information available, including the PFSs for Cinovec and Yangibana published in April 2017 and March 2016, respectively. A summary table of the valuation assumptions we use for our revised DCF valuation for Cinovec and Yangibana is given in Exhibit 4 and an overview of the group valuation in Exhibits 9 and 10. As Cadence does not have a direct interest in the Cinovec project, we value EMH on the basis of Cadence’s equity interest only. The Yangibana concession, in which Cadence has a 30% direct interest, is the smallest of the three concessions that will be mined, and we do not have clarity over the timing of Cadence’s attributable cash flows from the potential mining of this project. As such, we only provide an illustrative value for Cadence’s interest in this project.

The Cinovec tin-lithium project is held 100% by EMH, in which Cadence has a 20.76% equity interest. Cinovec is on the German/Czech Republic border, 100km north-west of Prague, in an area that was historically mined for tin for more than 600 years. EMH estimates that 40,000 tonnes of tin have been extracted from the area over this period. Nonetheless, with 2.8Mt of contained lithium in the indicated and inferred resource categories, it is the largest lithium deposit in Europe, the fourth largest, non-brine lithium deposit in the world and a globally significant tin resource.

Hitherto, Cinovec had very little modern drilling data completed on it and, consequently, EMH was initially only able to complete a very rudimentary scoping study analysis on the project.

As a result, a comprehensive drill programme at Cinovec has been underway since the end of 2015, with drill results released to the market as assay data became available. Importantly, results confirmed historical drill data, which facilitated the estimation of an updated JORC-compliant resource. Although, the lithium grade at Cinovec is relatively low (c 0.5% to 1.0% range), it is rendered economically viable by meaningful tin, tungsten and potash credits. The following exhibit provides a typical long section of Cinovec mineralisation (a long section is just a cross-section view where dips of strata and orebodies are shown in their apparent rather than true aspect).

Significantly, the geology of the payable ore is largely flat or shallow dipping and massive enough to be amenable to mechanised mining using long-hole, open stope methods. In addition, the paramagnetic qualities of zinnwaldite also make it amenable to wet high-intensity magnetic processing to produce a concentrate and hold out the prospect of Cinovec’s being the world’s lowest-cost, hard rock producer of lithium carbonate.

On 19 April, EMH released the results of a pre-feasibility study (PFS) prepared by the company, based on technical reports undertaken by consultants Hatch, Ausenco, Bara Consulting and Widenbar & Associates, among others. Whereas EMH’s earlier scoping study was based on an as yet uncommercialised proprietary process technology, for the purposes of the PFS it was concluded that conventional roasting technology would deliver higher lithium recoveries at a lower operating cost and lower technical risk, with fewer impurities and a lower dependence on by-product credits. As a result, the PFS materially re-imagined the project at a higher grade (as a consequence of the intervening exploration drilling) to produce 28% more battery-grade lithium carbonate equivalent (LCE) per annum and three times more potash.

As before, natural gas is available and can be delivered to the project fence by pipeline to supply low-cost energy for roasting the mica concentrate, as well as heating the underground mining operations. At the same time, the project’s electricity requirement of 22MW can be provided by constructing a 1km overhead line to the existing (grid) switchyard in Teplice. Dewatering will supply the bulk of process water requirements, although potable and industrial water for processing make-up requirements can also be purchased from the local municipality.

The major technical parameters of the Cinovec project PFS are provided in Exhibit 4. At a lithium carbonate price of US$10,000/t (vs US$7,500-10,000/t currently), a sulphate of potash price of US$520/t (vs €410/t currently), a tin price of US$22,500/t (vs US$19,850/t currently) and a tungsten price of US$330/mtu (vs US$206/mtu currently), however, the project was calculated to yield a 21.6% pre-tax internal rate of return (IRR) per annum and a net present value (at our standardised 10% discount rate) of US$392m.

Owing to Cadence not having a direct interest in Cinovec and only having a minority equity holding in EMH, we do not use the PFS to attribute any direct value from Cinovec to Cadence. Nevertheless, it is noteworthy that the NPV10 calculated for Cinovec in the PFS equates to a value per EMH share of US$3.03/sh (or A$4.05/sh) compared to an EMH share price at the time of writing of A$0.995, ie EMH’s shares are trading at 24.5% of the calculated NPV of the project.

The project is located in north-west Western Australia, approximately 300km east inland from Carnarvon. Cadence has a 30% direct interest (free-carried to BFS) in the Yangibana deposit, which comprises approximately 16% of the Yangibana project, by pit tonnage (see Exhibit 2). Hastings is project manager with a 70% interest. Note that no detail was given in the Hastings Technology Metals’ PFS announcement of 8 April 2016 as to the timing of mining at Yangibana.

In the meantime, however, the project has stated JORC code-compliant resources of 12.4Mt at an average total rare earth oxide (TREO) grade of 1.10%. This is a relatively low grade for a rare earth project. Significantly, however, there has been enrichment of strategically important ‘critical’ rare earth elements, which is the reason that Hastings has targeted production of only the most lucrative rare earth elements as detailed below. Note that the term ‘critical rare earths’ was first coined in a US Department of Energy Critical Materials Strategy study in 2011 and refers to five specific rare earth elements: dysprosium, europium, neodymium, terbium and praseodymium.

The development scope outlined in the 8 April 2016 Yangibana PFS summary details the production of six ‘target’ oxides. These oxides are the precursor feedstock to refined rare earth metal, as well as a host of other alloys. Hastings’ six target rare earth oxides are:

Four of these six target oxides are deemed ‘critical’ by the US Department of Energy, owing to their lack of production outside China and their use in numerous high-tech, military and green-tech applications. Samarium and gadolinium are also important due to their scarce supply outside China.

The Yangibana project PFS details a pre-tax NPV valuation at an 8% discount rate of A$700-750m. We caution that this valuation is based on the projections of REE prices given by Hastings’ consultants in Exhibit 12 and we provide a comparison with REE spot prices and those REE prices used by Alkane Resources to underpin the value of its flagship Dubbo Zirconia Project in NSW, Australia.

Exhibit 3 provides detail on the overall cost of production at the Yangibana REE project. Note that the unit cost values given below relate to the production of concentrate, while the price deck gives values per refined REE metal; as such, these two values should not be compared directly.

Subsequent to the publication of its PFS, Hastings announced a major resource upgrade at Yangibana in January 2017 and also, in March, that it had successfully completed continuous beneficiation pilot plant testing. The significance of the latter, in particular, was that it a) successfully validated the Yangibana flotation process, b) confirmed 70% TREO recovery at a final concentrate grade of 23% TREO, c) provided a clear indication of progress from bench scale to commercial production, d) successfully generated bulk samples for downstream engineering equipment design testwork, and e) generated concentrate for subsequent hydrometallurgy pilot plant operation.

On a 100% basis, the ore tonnages set out in Exhibit 2 for the Yangibana deposit constitute only 16% of the total ore tonnages mined across all three deposits. Cadence’s 30% direct interest in the Yangibana deposit therefore provides Cadence with c 5% of the total tonnages mined across all deposits.

For illustrative purposes, 5% of the entire project’s value based on the outcome of the PFS (we have reconstructed the DCF based on the detail provided in the 8 April 2016 announcement) potentially results in a c A$35m or c £18m valuation, which equates to 0.23p per Cadence share (pre-tax, undiluted and at a 10% discount rate).

Self-evidently, the application of a 5% factor applied to the NPV of a project based on a mine plan back-engineered from the detail provided in a regulatory ASX announcement on the basis of pit tonnages alone is subject to a degree of error and the reason that Edison describes this valuation as ‘illustrative’ only. Our ultimate valuation will depend upon a number of factors including, not least, the scheduling of the Yangibana pit tonnages relative to those of Bald Pit South and Fraser’s. Alternatively, value could be imputed to Yangibana via Hastings market capitalisation. In this case, Hastings market value of A$46.2m for a 70% interest in the Yangibana project implies a A$66m valuation for a 100% interest and a A$19.8m valuation for Cadence’s 30% interest – or 0.15p per Cadence share.

The following exhibit gives the valuation assumptions in the technical reports, which are used to assess the value of the projects in which Cadence has direct and indirect interests.

The Sonora lithium project includes concessions owned by two subsidiary companies, Megalit and Mexilit. Cadence directly owns 30% of Mexilit (ie excluding its indirect interest held via its Bacanora shareholding) and, as such, is 30% owner of the El Sauz, El Sauz 1, El Sauz 2, Fleur and Fleur 1 concessions. The concessions held under Megalit are solely owned by Bacanora Minerals and are named La Ventana and La Ventana 1. Cadence’s current equity holding in Bacanora Minerals is 19.8% and, as such, its effective interest in Mexilit is 43.9%.

In January 2016, we suspended our original 2.40p valuation. This tentative value of 2.40p was based on our then top-level understanding of cash flows from Sonora and Cadence receiving a 40.06% share of cash flows from the Fleur-El Sauz concessions at the start of production. However, uncertainty as to the actual mine schedule and, in particular, the balance and timing of mining from the Fleur-El Sauz concessions (in which Cadence has a 30% direct stake) as opposed to the Ventana concessions (in which it has no direct interest) has caused us to temporarily suspend this valuation, pending greater clarity from the partners on this issue, and to instead revert to a resource-based valuation, in which Cadence’s direct interests in the various concessions are valued with respect to Bacanora’s resource multiple as follows:

Excluding its borate interests, Bacanora’s enterprise value of C$149.4m, or US$109.2m, thus equates to a resource multiple of US$18.28 per in-situ tonne of LCE resource (cf a global average valuation of US$25.72/t LCE as calculated in our report, Normalisation augers well for exploration, published in October 2016). Using US$18.28/t LCE as an appropriate benchmark, Cadence’s directly owned attributable resource (ie excluding its indirect interest via its shareholding in Bacanora) of 1,224kt of in-situ LCE would therefore have a pro rata value to Cadence of US$22.4m, or £17.3m, or 0.22p per Cadence share (see Exhibit 10).

Cadence began acquiring its 16.3% equity interest in TSE-listed MMS in March 2016. The company is an early-stage lithium exploration company, with 17 exploration licence applications waiting to be granted in the highly prospective Pilgangoora region of the Pilbara, in northern Western Australia. While these applications are approved by the Western Australian authorities, MacArthur will undertake further reconnaissance activities over these licence applications. This will involve sampling of identified pegmatites and further helicopter reconnaissance of its Pilbara acreage.

Other Western Australian lithium resources are given in the following exhibit. Note that Talison is 49% owned by Rockwood Holdings (NYSE: ROC) and is in production. Galaxy Resources and its JV partner General Mining produce lithium from its Mt Cattlin mine. Both are outside the Pilgangoora region.

The lithium resources closest to MMS’s licence applications are those of Altura Mining’s Pilgangoora lithium-tantalum project and also Pilbara Minerals’ similarly named Pilgangoora lithium project. The grade and size of these resources are presented alongside their global peers in Exhibit 6. As can be seen below, Pilbara Minerals’ resource is a relative outlier in terms of its size, as it is the largest of the hard rock, spodumene-type deposits and is exceeded only by the very large brine deposits (Kings Valley, Salar de Olaroz, Cauchari-Olaroz and Sal de Vida) as well as Bacanora Minerals’ and Cadence’s Sonora deposit and EMH’s Cinovec, which are clay-based.

The aim for MMS will be to replicate the size and grade of Pilbara Minerals’ lithium resource of 80Mt at c 1.26% LiO2 (note: this is presented in LCE terms in Exhibit 7). As of 4 May 2017, Pilbara Minerals had a market capitalisation of A$479m, although this is also likely to reflect the market valuing its near-term production asset, Tabba-Tabba tantalum. Current EV/t valuations for each of the companies operating in the Pilgangoora region are given in the following exhibit for reference.

The value of companies operating in the Pilgangoora region is largely driven by companies that have recently entered or are due to enter production shortly. Only Dakota Minerals is at a similar stage of development to MacArthur, although the former has released a maiden resource estimate, which MMS has yet to do.

MMS currently has a market cap of C$12.6m, compared with Dakota Minerals’ A$20m (C$20m).

Inevitably, our new valuation remains largely based on KDNC’s equity interests:

However, between 38.5% and 56.25% of the total valuation now also depends on the value and/or the potential value of its direct mineral interests as well. The following exhibit gives a breakdown of our overall valuation for Cadence based on its equity interests and direct project ownership.

On this basis, our current base case valuation for Cadence is a total of 0.80p, including 0.23p attributed to the early-stage value to which Cadence is exposed via its direct interest in Yangibana. Further upside is self-evidently linked to further increases in the value of Cadence’s lithium-focused equity interests – especially the potential for MMS to see a significant increase in its market value when its exploration licences are approved by the Western Australian government.

Sonora holds one of the world’s largest lithium resources and benefits from its being both high grade and scalable. The project, which is located in an existing mining district and has excellent access to infrastructure, consists of 10 contiguous concessions covering 104,064ha and is located 190km north-east of Hermosillo in Northern Mexico.

On 15 April 2016, Bacanora published its technical report on the PFS for Sonora. The main conclusions of the study are shown in Exhibit 11.

Edison estimates that Bacanora’s total economic interest in Sonora is 82.52% (effectively a time-weighted average of its 100% interests in the underlying concessions and its 70% interests). On this basis, the NPV8 of the project (US$542m) equates to US$3.63 (£2.81) per Bacanora share on an attributable basis (cf Bacanora’s share price of 85p at the time of writing).

Ordinarily, Edison would use a valid and timely PFS as the basis for its valuation of Cadence’s direct interest in Sonora. In this case, however, given uncertainty surrounding the exact timing of the ore in the concessions in which Cadence has a 30% direct interest versus those in which Cadence has no interest, we have instead opted to value Cadence’s attributable resource on the basis of the in-situ resource multiple implied by Bacanora’s current market valuation, pending greater clarity on this issue. While apparently somewhat recidivist in nature, such an approach is also, a priori, more conservative in nature and, we believe, therefore not inappropriate under the circumstances, albeit it inherently implies an equivalence between all resource tonnes in the various concessions that has yet to be confirmed or determined.

The rare earth market is highly opaque so it is difficult to ascertain appropriate pricing data for each metal. Therefore, we have compared Hastings’ consultant’s (Adamus Intelligence) estimate (April 2016) of long-term rare earths pricing against that used in Alkane Resources’ financial assessment of its Dubbo Zirconium Project (August 2015). For the five metals that both projects have in common, other than for samarium, which is produced in low volumes at the Yangibana project, all rare earth prices used by Hastings are significantly higher than those used by Alkane Resources, and both are significantly higher than spot. For reference, in the following exhibit we show the value of Yangibana based on its PFS using both price decks and also at spot.

For an illustrative value of Cadence’s 30% interest in Yangibana, please see page 4.

For sale agreements to be signed for rare earths projects, a critical-path component is a proven flow sheet design tested at the pilot plant (not bench/laboratory) scale. The sale of rare earths, whether in oxide, carbonate or refined metal form, requires years of testing with samples from the pilot plant sent to potential customers for quality assessment. Laboratory-scale bench-testing of the flow sheet design cannot provide the assurance of product quality and consistency of output from a rare earth project that a pilot plant can. We believe this aspect of Yangibana’s development could take upwards of one to two years to complete on an expedited basis – notwithstanding Hastings’ plans to sell only six rare earth oxide products. Following completion of a pilot scale test programme, commercial offtake agreements can then be finalised and any project financing arranged.

Cadence’s audited FY15 financial results were announced on 6 June 2016. At end December 2015, Cadence had cash of £0.9m. This was after net cash outflows of £1.0m, £6.4m in investments (of which £5.7m relates to payments for available for sale financial assets) and net financing of £5.5m.

Financings comprised £2.3m (net of costs) from the issue of shares, £3.2m in proceeds from its Yorkville equity swap agreement, net borrowings of £1.7m and finance costs of £0.4m.

Post-period, Cadence raised £3.55m via the issue of 645.6m new shares at 0.55p each, primarily to US institutions. Cadence invested a total of £832k into two lithium-focused development companies. This consisted of Cadence increasing its then ownership of EMH from 11.9% to 19.8% at a cost of £670k, and acquiring a then 15.5% stake in MMS for £162k (C$300k at a rate of £0.54/C$).

On 9 August 2016, Cadence also announced that it had successfully issued a US$15m convertible loan note to a strategic Mexican investment fund. The note is convertible into shares of Cadence, at a price of 0.65p, has an expiry date of 12 months from the date of issue and bears interest at a rate of 5%. Cadence can opt, cash permitting, to settle the note at any time prior to maturity. As of 31 January 2017, US$0.95m of the note’s US$15m face value had been converted into equity. Each converted dollar of the principle also carries 40 ordinary share purchase warrants with an exercise price of 0.80p (ie potential dilution of 600m new shares in total).

On the basis of the above financing and investments and our assumption of central costs totalling £2.0m for FY16, we estimate that Cadence had £6.2m in net debt at the end of FY16.