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Edison Investment Research-Valuation at 3.98c per share, page-47

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Grasti

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11/10/18

23:51

Post #: 36093719
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Originally posted by Sharpey ↑

Hi all, here's my critique of the report. There's a few things I'm not keen on. Hope it helps:

Critique of Edison valuation

Assumptions underlying the valuation:

No value is ascribed to the full scale developments of P2, P3 etc

P1 will cease to operate in 2031 and have no value when it is shut down

LPD would be in a position to start paying a dividend in 2022, and would pay one each year until 2031

P1 will be funded by a mix of debt and equity

The equity component will be $30m and the new shares will be issued at the current share price of 1.9c

P1 will cost US$42.6m (~AU$60m) to build

So let’s discuss the quality of these assumptions.

I don’t have a problem with only valuing the company on P1 at the moment, as P2 is still highly conceptual and hasn’t even had a scoping study delivered to provide rough numbers. This is a reasonable assumption, as we don’t know that P2 is going to definitely happen and if it does, what it would look like. It is prudent to consider the company as if P1 were the only operation it is building and may ever build.

Valuing the project with discounted cashflows over 10 years without including a terminal value is a bit off, as far as I’m concerned. For this to part of the valuation to be accurate, they’re saying that the company builds it, runs it for 10 years and then bulldozes it.

Is that reasonable? It is entirely possible that P1 is only run for 10 years, or only run as a profit centre for 10 years, before becoming an R&D lab or something for LPD. But that would only happen if P2 etc have gotten off the ground.

If we’re seriously valuing the company only on P1, and considering a situation where P2 is never built, then I think this assumption needs to be adjusted. After all, if P2 doesn’t work out for some reason, what are the team going to do, throw in the towel or focus on getting P1 working as best as they can to extract the maximum value?

And would they arbitrarily shut down their only operating plant after a decade, with no residual value, or would they continue to operate it as a going concern?

When valuing a mine, you would give it a fixed life like that, because when it runs out of minerals to mine, that’s it. But a refinery? It doesn’t make sense to just knock it down after 10 years.

When doing NPV analysis, there is usually included a concept of “terminal value”, which is simply the value you put on an asset as if it were to continue to operate at its current level of profitability indefinitely into the future. It is often a very large part of the valuation, due to it representing all of the future value. It is commonly used because it is odd to assume that an asset like this would just stop operating if it were to continue being profitable, as discussed above.

In this case would add another $255m to the valuation, using their annual profit of $52m, discount rate of 10% and a growth rate of 2%. That brings their valuation up from $173.3m now and $319.6m in FY22 to $428.9m and $575.2m.

If you divide $575m by the 5.5bn shares they seem to be suggesting will be outstanding in 2022, you would get 10.3c.

Tied to this issue is that of dividends. They’re suggesting a dividend of $0.0095 per year while the share price is $0.053. A 17% (I believe grossed-up) dividend yield while the business itself is heading towards a brickwall in 2031. That’s prioritising dividends over future business viability to an extent that would make even Telstra blush.

Paying out dividends while at the same time having such a firm end-date to your business would be insanity. The definition of moon-man talk.

So if the 2031 end-date for the business is true, then the dividends wouldn’t happen. If the 2031 end-date isn’t true, and the dividends do happen, I guarantee you won’t get a 17% grossed up yield. Take the franking credits into account and make it a 6% yield, and you have a share price of 11c based on their numbers.

It’s not exactly the 10.3c above, but its close.

I wouldn’t count on any dividends starting in 2022, as the money will almost certainly be piled back into building P2.

Moving on, the plant will almost definitely be funded by a mix of equity and debt. The debt is more likely to come in the form of prepayments from customers, which typically don’t attract interest, but is still a type of debt.

I don’t think they have the mix of debt and equity right, and I don’t think the company could raise $42m at the current share price. That would be a 2-for-3 capital raising, or an insanely large institutional placement. You can’t tap shareholders for that much of a top-up, but an institutional placement is possible. I don’t think the board would go for it given their level of ownership, and that the last two raisings have been equitable for retail shareholders, but it is possible if it were the only option.

What’s more likely, I think, is a large proportion of the funding comes from prepayments from customers. US$25m repaid at 40% of each shipment could be repaid within the first 2 years of operations, while still leaving enough margin for the business to operate. That would leave AU$17.6m that needs to be raised, which is far more realistic. It would probably be a stretch at the current price, but it would be possible.

On top of that, I doubt very much that the share price will remain at 1.9c after the feasibility study comes out. If the company is delivering an NPV of $200m+, you would expect a share price of more than 6c. Even $150m would justify 4.5c.

A capital raising of $17.6m at 1.9c would mean issuing 929m more shares.

A capital raising of $17.6m at 4.5c would mean issuing 392m more shares.

Compare that to the 2.2bn shares they have factored into their model, and you can see the dilution is considerably less.

On the capital estimates, I believe there is a typo in Exhibit 9, where it says the plant would cost US$60m, which be about $AU80m. I’m fairly certain that is supposed to be US$42m or AU$60m, which then lines up with Exhibit 16. I think that is fair, as the expenditure on the feasibility study has already been made, but the expenditure on equipment will be slightly more to accommodate a larger plant.

Anyway, if you factor in the above points, you’ll get many different iterations, but more likely to find a share price between 10c and 15c.

So yeah.

Pretty certain the company paid for this research, but I hope it wasn’t much, because it’s not brilliant and doesn’t paint the best picture for the company’s growth potential. I could have done something better for a handful of options and a jug of beer at the AGM, just saying.

Cheers

Expand

Hi @Sharpy, thanks for your thoughts on the Edison investment research report.

A few things that I have found very unusual about this report and its release are:
- the report appears to have been commissioned by Lepidico, and I assume that this would be to entice prospective new investors and bolster the resolve of current holders;
- the projected valuation through to 2022 seems very low at 5.3c/share (and yes, they have adopted conservative assumptions to arrive at this value); and
- LPD has only recently listed options LPDOA following the rights issue, with these having a strike price of 4.5c at Sept 2020.

In my mind, for Lepidico to commission Edison to undertake the analysis and have them prepare this report, and then for Lepidico to also email it out to various people (presumably as marketing material) is very out of character. It is virtually an endorsement of the findings, hence it also puts in jeopardy the chance of the options being exercised come 2020.

I strongly believe that the company is going places, but the burden that this report now imposes, and the impression that it was released with the company's approval will, I think, put a real dampener on share price appreciation for a while.

I'm hoping that management put together a letter explaining some of the parameters of the analysis, and if Edison were instructed to adopt a very conservative approach. Also makes me wonder at how they arrived at an exercise price of 4.5c for the oppies by late 2020 if they feel that the valuation will only be 5.3c at 2022.

Kind regards to all holders, especially those that are passionate and hold for the long term.
Last edited by Grasti: 11/10/18

LPD Price at posting: 1.8¢ Sentiment: Buy Disclosure: Held
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