Brief Australia: Lynas: Between a Hard Place and Just Rock and more

In this briefing:

1. Lynas: Between a Hard Place and Just Rock
2. January Chip Revenues Down 15.6% Year-On-Year
3. MYOB Setting Up As A Riskier Trade
4. Aussie Equities Reporting Season Wrap: March 2019
5. GrainCorp (GNC AU): Better Late than Never Move to Get an LTAP Binding Proposal

1. Lynas: Between a Hard Place and Just Rock

Lynas Corp Ltd (LYC AU) has been in the news of late for all the wrong reasons.

The change in Malaysia’s government last May appears to have caught up with Lynas’ rare earth processing plant in Kuantan – or Lynas Advanced Materials Plant (LAMP) – a facility that has faced persistent environmental opposition since its initial proposal in 2006.

The LAMP’s licence stipulates that residue/waste should be recycled, and if that does not occur, then stored in a permanent disposal facility (PDF). Removing/Exporting the residue was the last resort. Lynas is still in the first phase of the licensing guidelines, having submitted a plan to build the PDF but Lynas has not received specific instructions where to build this facility. 

Events reached a head on the 4th December 2018 with two pre-conditions imposed by the Minister for Energy, Science, Technology, Environment and Climate to rolling over the processing licence by September this year:

By some accounts, there is 500k+ tonnes of WLP, conceivably requiring in excess of three years to export. This resulted in Ernst & Young concluding (page 15) in the interim results (released last week) there is a material uncertainty for Lynas to continue to operate on a going concern basis.

Irrespective of whether the licence was provided to Lynas without adequate due process (as has been speculated) or whether the LAMP is indeed an environmental concern; the fact remains the Malaysian government has reneged on the previously agreed-upon three-step licence process, and that is wrong.

This is a binary outcome: either Lynas re-negotiates on the residue management and LAMP’s ongoing operations; or Lynas ceases operation in Malaysia and its rare earth deposit is just a bunch of rocks – until an alternative processing facility is established.

A Brief Timeline of Events

The Residues of LAMP

The LAMP produces two solid residues, the Neutralization Underflow Residue (NUF) and the Water Leached Purification Residue (WLP). 

• The NUF is a magnesium-rich gypsum and is non-toxic, non-carcinogenic, non-ecotoxic, and non-radioactive.  NUF can be used to “condition poor agricultural soil, and to rejuvenate and rehabilitate unproductive and depleted land“.
• The WLP residue is classified as a radioactive material and has the same radioactivity level as the feedstock material used in the LAMP process (about 6 Bq/g of Th). This material is classified as low-level radioactive material. The LAMP operation does not enhance or alter this natural radioactivity. 

The Terms of the Licence

WLP is managed under the terms of the Full Operating Stage Licence (FOSL), first granted in 2014. The terms of FOSL state that WLP residue should be recycled, and if that fails, then it should be stored in a Permanent Disposal Facility (PDF). Exporting WLP is only to be considered in the event neither recycling nor PDF are possible.

• The WLP is currently stored in temporary storage facilities on site (temporary residue storage facility (RSF)) and in accordance with the current licence. The RSF is designed and constructed and is managed to meet the requirement of a PDF within the LAMP.
• Lynas’ PDF Planning Framework and Site Protection Plan were approved by the Atomic Energy Licensing Board (AELB) on February 25, 2014. The Pahang State Government has given its consent to the location of the PDF in Pahang, should it be required. AELB is holding a US$34mn bond on behalf of Lynas to build the PDF. 
• Occupational and health exposures monitored since 2012 have shown that risks to employees from radiation and chemicals are well within the permissible limits.

The Details of the 4th December Reports

Both reports are in bahasa Malaysia. 

• The Review Committee Report found Lynas’ operations are low risk and compliant with applicable laws. However, on page 94 it does state:

  • The Executive Committee found that there was an increase in heavy metal concentrations for nickel, chromium, lead and mercury in-ground waste. Nickel and chromium are carcinogenic substances for human beings.

  • One recommendation by the Committee was to determine the location and build a PDF for the WLP residue, including identifying sites for PDF construction before the renewal of the next licence.
  • The report said to “Be prepared to export WLP residues from Malaysia if the PDF location is not identified or approved.“
  • The review committee comprises six members according to this link.  

• The Minister for Energy, Science, Technology, Environment and Climate Change (MESTECC) reported two new pre-conditions for its licence renewal on 2 September 2019 and future permission renewals in relation to residue management, those being:
  • The export of WLP residue before 2 September 2019; and the submission of an action plan on the disposal of NUF (current approval valid until 15 February 2019).
    • Following consultation with the government and regulators, an agreed pathway for the management of NUF was reached on the 14 Feb.
  • This pre-condition is inconsistent with the Review Committee’s recommendation on the PDF facility for WLP residue. The Review Committee said that Lynas should be prepared to export WLP residues from Malaysia only if the PDF location is not identified or approved.
  • All senior management of MESTECC were appointed following the 2018 general election. The AELB is an agency/department under MESTECC.

On the Political Front

After being elected as a Member of Parliament for Kuantan in 2008, Fusiah Salleh spearheaded the “Stop Lynas Rare earth Refinery” campaign.

• This campaign cause was buoyed by the Mitsubishi  Chemical Corporations incident in Ipoh in the 80s and 90s, together with the 2011 Fukushima nuclear disaster – although the latter is not wholly pertinent.
• Bowing to pressure the AELB conducted a review of LAMP in 2011 and ultimately claimed they were not able to identify any non-compliance with international radiation safety standards at the plant. Environmentalist pointed out this report did not address the long-term waste management nor the possible contamination of surface water and atmosphere by radioactive waste material.
• Despite extensive and ongoing opposition, Lynas was offered a 12-year tax holiday at the onset, and was issued a 2-year full operating licence in 2014. 
• The re-election of Mohammad Mahathir in 2018 provided a more sympathetic ear to the campaign’s voice compared to that under Najib Razak (PM from Apr-09 to May-18), resulting in the Review Committee to conduct the environmental impact assessment of LAMP. 
  • Indeed, projects and investments made by Najib are being reviewed such as LAMP and Belt & Road proposals.
• Fusiah Salleh was appointed the chair of this Committee, although she withdrew her position in October to “prevent Lynas from shifting the focus from the real issue“.  She is currently the deputy minister in the PM’s department.

Just How Radioactive?

It’s low but it’s not nothing – there is no such thing as zero harm. One issue, to me, is a decent layman’s overview of the radiation. In previous slides issued by Lynas it mentioned the limits for members of the public to be 1.0 mSv (milisievert) per year, while Lynas’ residue radioactive content is 6 Bq (becquerels)/g Th-232. 

Converting becquerels to sieverts is easier said than done. Conversions in the table via this link provide some context; it also shows Thorium 232 to have the second highest half-life, and the highest inhalation dose.

Arguably the radiation of this waste is low – and further backed up in this IAEA report (page 20) – but the reality is, if so low, why not process in Australia in the first place? And why are rare metal processing plants generally thin on ground worldwide?

Where Can It Be Exported?

Lynas has an estimated 500,000+ tonnes of WLP stored on site. Even filling one FEU (40-foot container, carrying 40 tonnes) every two hours around the clock, would take at least three years to clear the backlog – not factoring into account new residue being created. A price tag for the export of the residue has been estimated at A$60mn.

But who would (or can) accept this waste?

• This report is a little over two years old, but on page 18, to the exception of Malaysia, rare metal processing only incurs in China (the world leader), Estonia, and India (marginal production). There appears to be some purification/separation/refining in Kazakhstan and Russia, but there is limited data. 
• Australia’s Arafura Resources (ARU AU) is expected to build its own rare earth separation plant in Australia, having previously touted the idea of building such a plant in South Korea. 
  • Sending the waste back to Australia appears to be the go-to response from various quarters in Malaysia. But this is a heavily regulated space.
  • Legislation should not be captured under this Nuclear Waste Storage and Transportation (Prohibition) Act 1999 as the residue is not derived from a nuclear plant. 
  • It may be captured under the Hazardous Waste Act, based on the definitions under the Basel Convention. Here is also a list of Basel Convention members. 
  • A 7-year old article mentions that “National legislation stipulates that Australia will not accept responsibility for any waste product produced from offshore processing of resources purchased in Australia such as iron ore, mineral sands and the rare earth produced by Lynas Corporation.” I have yet to sight this legislation.
  • According to the AFR (paywalled), Robin Chapple, a Greens member in the Western Australian Legislative Council, said the safest place for the radioactive waste would be Western Australia, where it was originally located. Which makes a degree of sense, assuming the waste is in dry form, not liquid, which could then potentially leach into the water table. Of interest, Chapple has been a vocal critic of Lynas in the past.
  • The Australian government may make an exception to such an import in that the radiation is understood to be exactly the same as when it left Australia. And the expected approval of the Arafura plant may suggest an openness to importing this waste. 
• China won’t accept this waste – it has its own environmental issues to deal with after years of rare earth production. 

Establishing a Plant in Australia

Arafuna has secured Northern Territory (NT) and Australian government environmental approvals for its project in Australia. However, mining regulations in Australia are state/territory based – what is approved in NT does not necessarily translate to approval in WA, where Mt Weld is located; but it should help.

CEO Amanda Lacaze was quoted (paywalled) in the FT saying: 

We could reorganise our assets with time in a way that would allow us to continue to serve our customers. Short term we may need to partner in China; longer term we would re-establish our operations outside of China. Australia is a pretty good place.

“Re-establish” potentially includes disassembling/re-assembling LAMP, but this is not stipulated. Lynas’ PPE has a net book value of ~A$600mn, including rotary kilns, centrifuges, solvent extractors and pumps, most of which presumably could be shipped and railed to Mt Weld, or in close proximity, fast tracking the construction time. Assuming necessary approvals are in place. 

A Show of Support

Since rumours of the Review Committee surfaced, Greencape Capital has increased its stake in Lynas to 9.27% from 6.13%; while FIL has increased its holding to 7.32% from 5.01%. Both shareholders increased their stake after the 4th December reports.

2. January Chip Revenues Down 15.6% Year-On-Year

The Semiconductor Industry Association in the US released the latest WSTS figures for January chip revenues.  Monthly revenues are down 15.6% from January of 2018.  While this is not a surprise to our clients it is frightening to those who anticipated that 2019 would be a continuation of the bonanza enjoyed in 2018.

3. MYOB Setting Up As A Riskier Trade

When I wrote about KKR’s purchase of 17.6% of MYOB Group Ltd (MYO AU) from Bain in October – a trade which got KKR to a 19.9% holding, my take on it was that the deal was probably a bit light. It was not outrageously bad because a) Bain agreed to sell their 17.6% at A$3.15 vs the A$3.65 IPO , and b) something like 93% of volume traded since the IPO in May 2015 had taken place below the proposed indicative offer price, but it was still one of the few platforms on which someone could take a stand to compete against the likes of Xero Ltd (XRO AU) and Intuit Inc (INTU US), it was not overly expensive as SaaS platforms went, and its online presence was growing rapidly.

The full write-up is MYOB: KKR Launches a Proposal. Lightish?

About three weeks later, KKR bumped their indicative offer to A$3.77/share, and MYOB opened its books to allow KKR due diligence. That suggested the price was in the range of the acceptable to MYOB’s board (but that A$3.70 was borderline). 

Then KKR did its due diligence, global equities continued to fall out of bed (down 10+% in two months for many major indices including Australia’s S&P/ASX200), KKR’s due diligence process came down to the wire, and the final bid presented came in at A$3.40, with a very short “take-it-or-leave-it” deadline. The immediate reaction of MYOB’s board was, as David Blennerhassett wrote in Friday Deadline Looms As MYOB Snubs KKR’s Reduced Offer,

Following completion of due diligence and finalisation of debt funding commitments, KKR has revised the offer price to $3.40 per share. …  The board has informed KKR that it is not in a position to recommend the revised proposal, however it remains in discussions with KKR regarding its proposal. (David Blennerhassett ‘s emphasis)

Four days later, KKR and MYOB entered into a Scheme Implementation Agreement (SIA) at A$3.40/share, putting MYOB at a A$2bn market cap.

David Blennerhassett discussed the SIA and the upcoming schedule of events in some detail in MYOB Caves And Agrees To KKR’s Reduced Offer. MYOB’s board unanimously recommended shareholders vote in favour of the Offer in the absence of a superior proposal and subject to an independent expert concluding the Offer was in the best interest of shareholders. There was a specific “go-shop” provision through the 22nd of February – when MYOB was expected to release FY results. No offer was forthcoming. KKR had matching rights but if they did not match an offer which was 5% higher and all-cash, then KKR would be obliged to sell its shares into the higher offer.

The New News

While not new new, US-based hedge fund – somewhat well-known for being involved in M&A situations – started accumulating a position in MYOB in January and has reached a stake of 9.99%. This was declared on Monday. On Tuesday Manikay sent a letter to MYOB (discussed below). This morning MYOB responded saying “The MYOB Board continues to unanimously recommend the Proposal subject to no Superior Proposal being forthcoming, and the receipt of an IER [Independent Experts’ Report] concluding that the Proposal is in the best interests of MYOB Shareholders.”

The Scheme Booklet is currently with ASIC and is expected to be despatched “in coming weeks” (original schedule was for mid-March with Scheme Meeting April 19). The wording in the MYOB release suggests that might get pushed back a little, meanwhile Manikay is likely to make more noise.

4. Aussie Equities Reporting Season Wrap: March 2019

• Australia rallied strongly through a relatively solid reporting season, with the benchmark ASX 200 posting a strong 6% gain in the month. EPS was a little disappointing, given that only 50% of stocks that reported beat consensus estimates, with weaker-than-expected revenue the main culprit.  EPS growth for FY19 was downgraded by 1.1%pts to 3.5%, but analysts left EPS growth unchanged in 10 out of 19 industry sectors.  Materials, Pharmaceuticals, Consumer Services and Energy saw the largest downgrades relative to history after reporting half-year results.
• Government is having a Heavy Hand on Results. The Royal Commission in Financial Services is lifting compliance costs for the Banks, Wealth Managers and Mortgage Brokers.  Similarly, the Royal Commission into Aged Care is raising the same costs for stocks in this industry.  More stock-specific examples of Government intervention include AZJ, SKI, LYC and CAR (tighter credit supply from Banks).
• Cost pressures seem generally well-contained. US tariff-related cost pressures eased, but threats remain until a trade deal is negotiated with China.  Compliance costs are hitting Banks, Wealth Managers, Mortgage Brokers and Aged Care stocks.  However, the market seems to be more comfortable with the outlook. 
• Growth Stocks Not Raising Guidance Were Hit. Growth names such as COH, CSL, TWC and TWE that delivered strong results without an upgrade to full-year earnings were dealt heavy blows.  However, stocks such as WEB, which revealed new growth opportunities were rewarded handsomely.
• Good Management of Consumer-facing Stock Saves the Day. Filling slowing demand with higher-margin product offering delivered for JBH and SUL, while good performance from offshore stores came to the rescue for HVN.  DHG saw weaker listings but fought this by selling higher margin products to agents.  However, some stocks struggled.  FBU, BLD, BAP ABC all succumbed to housing weakness.
• Grasping the Infrastructure Opportunity. CIM, MND and SVW all delivered on the back of the upswing in public and mining infrastructure spending.  In contrast, LLC’s struggling Engineering Division is a good example of how a poorly managed business misses out on opportunities when industry conditions are buoyant.
• Model Portfolio Implications. We will soon update our model portfolio, but reporting season showed there is probably more upside in Resources than we thought at the end of last year.  The worst seems to have passed for the Banks, but we struggle to see significant upside in earnings.  We will retain a defensive bias in the portfolio, but most likely reduce it somewhat.

5. GrainCorp (GNC AU): Better Late than Never Move to Get an LTAP Binding Proposal

Graincorp Ltd A (GNC AU)‘s ability to generate shareholder value remains in doubt as LTAP enters its fourth month of due diligence. Yesterday, GrainCorp announced the first result (but overdue) of its portfolio review – the deal to sell its Australian bulk liquid terminals business to ANZ Terminals for A$350 million.