I found EGP Capitals 30 April 2022 Update to be a very accurate and well-rounded breakdown of the current positions for both PPK and LIS. A great insight to the successful demerger of PPKME……An unquestionable description and logical explanation of why both companies are severely undervalued……
from EGP Capital 30 April 2022:..........
"Li-S Energy: - We had a meeting with Chairman and CEO of LIS in the first week of April. They had just returned from 4 weeks in Europe meeting with battery manufacturers, prospective customers, and the like to discuss how the LIS battery and Lithium Nano-Mesh offerings can improve the next generations of batteries. There was visible excitement on the CEO’s face for the first time I can recall, he has always seemed so prone to focus on the many obstacles that must be cleared for success to result.
The biggest thing I took from the meeting was the insistence that the development timeline will take as long as it takes, there are certain steps that must be completed in sequence and there is no meaningful way to accelerate this process. This became clear in response to a question I asked about whether it would make sense to take an equity investment from a prospective industry partner to accelerate the commercialisation. LIS are insistent that they have more than enough capital to progress through the required steps to commercialise and even if they had twice as much money, it would still take basically the same amount of time. They did acknowledge that despite not needing the capital that they understood validation via co-investment from an industry major would be a valuable signal for investors.
Regarding research progress, they are stepping through this process nicely. The expansion of the battery factory on the Deakin campus announced early April will provide the capacity to prove the commercial bona fides of the Lithium Sulphur battery. They have already tested a 4-layer battery which maintained similar characteristics as the single layer battery referenced at IPO. That being the case, the 10, 20 and 50 layer steps in the process are unlikely to alter the significant efficacy advantage the Lithium-Sulphur battery commands.
The second largest takeaway from the meeting was the re-confirmed prospectivity of the near-term commercial opportunities for Lithium Nano-Mesh. Lithium Metal batteries are considered the next step in battery technology with meaningfully better performance than Lithium-Ion. Lithium Metal batteries are much more similar in construction to Li-Ion batteries, meaning the costs to retrofit gigafactories to produce them would be relatively modest. LithiumSulphur batteries remain much better that Lithium Metal but would require more meaningful capital cost to reconfigure factories. The issue for Li-Metal has been dendrite formation which Lithium Nano-Mesh can solve.
There was likewise greater confidence expressed that the Li-S battery will also be cost-competitive, which combined with the technological superiority greatly enhances the probability of commercialisation.
Deriving a valuation remains difficult with the timing of revenues hard to predict, but these facts about EV’s remain: 1. LIS possess the best currently known battery technology. 2. There were almost 7 million EV’s (EV is shorthand for both enterprise value and in this case electric vehicle, I have assumed henceforth readers understand which is meant when I use the term) sold globally in 2021 and there are expected to be 27 million sold globally in 2030. 3. The size of EV batteries for currently offered vehicles is 30-200 kWh and averages 90kWh. 4. The current cost of batteries is US$132 kWh meaning the EV battery market is currently worth about US$83b per annum and if battery prices were to remain static (they will likely fall in pricing somewhat) then the EV battery market will be worth US$320b per annum by 2030. This is only the prospective EV market, the cumulative value of the many other applications (drones, power tools, PC’s, mobile phones, aircraft etc) for lighter, longer lived battery technology probably amount to a similar dollar value.
By 2030, the addressable market will therefore likely be in the vicinity of half a trillion US dollars annually. A sliver of this market would create a multi-billion-dollar business. To derive a valuation, we need to probability weight the likelihood of success. My expectation is that there is a better than 50% chance LIS end up with a product or more likely a royalty stream (from licensing their technology) in the market within 5 years. Assume that by 2030, Li-S technologies can be found in just 5% of batteries sold globally, this is US$25b of batteries annually.
If the royalty plus the margin Li-S get from selling EGP Concentrated Value Fund – 30 April 2022 5 the Boron Nitride Nanotubes (BNNT) their licensee require amounted to only 0.5% of the total revenue Lithium Sulphur batteries generate in 2030, that amounts to a US$1.25b revenue stream. Assume there is an incredible amount of corporate bloat creep into the business by this stage (unlikely) plus some COGS for the BNNT and you might get to a US$1b profit before tax (PBT). Such a capital light business in a hyper-growth industry will likely attract at least a 30x PBT multiple for a US$30b valuation.
Cut that in half by our 50% probability of success we get US$15b (~AU$21b). Discount this valuation by an aggressive 15% per annum over the next 8 years and you would get a roughly AU$7b net present value (NPV) for LIS if my estimates of a 50% probability of success and only 5% market share capture within 8 years is possible (and assuming my 0.5% revenue capture is accurate). The current EV of LIS is about $360m which implies the current LIS share price is undervalued by about 19.5x.
That is not to say LIS should trade at $13.20 per share right now, but we need a fundamental basis about which to frame valuation, others are welcome to apply their own probabilities, but my point is that the current valuation imputes an incredibly low probability of success, or an incredibly low revenue capture.
This being the case, perhaps a better alternative is to invert this and instead back-solve the probability of success for LIS the market is effectively ascribing at the present valuation. 1. $360m current EV x 15% equity discount rate implies a ~$1,100m prospective EV in 2030. 2. Using our US$30b (AU$42.25b) 2030 valuation if only 5% of the battery market was captured by Li-S Lithium Sulphur batteries and only a 0.5% revenue capture (which both feel very low given how far ahead of any competing technology the Li-S battery is), this implies a 2.6% probability of commercial success at the current valuation.
In my estimation, whether you frame the valuation on an NPV basis using conservative assumptions, or on a probability of success basis, the current valuation grossly undercounts the prospective worth of the business on a probability weighted basis.
PPK Holdings: - The announcement of the demerger of the PPKME (Mining Equipment) business (.PDF) on the last trading day of April gives an outstanding insight into how shareholder friendly and capital allocation savvy the board and management of PPK are. This business earned a $2.3m profit in the first half and generated $3.4m of operating cashflow. The business is booming at present and profitability should grow steadily for the next few years. The business is being spun out in a highly tax effective way (in-specie dividend and capital reduction) at only a $16m valuation, or less than 4x earnings.
The tax-effective way the business is being spun out and the fact that it is a mining services business servicing coal miners is valuable to PPK shareholders in two main ways. Firstly, numerous prospective PPK investors with ESG mandates have been unable or unwilling to invest in PPK to date, despite the massive prospective gains BNNT can bring to several critical renewables and sustainability applications, the demerger eliminates this impediment. Secondly, as a standalone business, PPKME will be able to focus on value creation independent of the distractions the incredible growth opportunities in BNNT business presents the PPK board, the substantial acquisition being considered that is outlined in the demerger document demonstrates this.
The main reason investors are attracted to PPK remains the BNNT opportunity. PPK holds about half of the LIS business outlined above, which is itself deeply undervalued if our analyses are correct. But the real valuation kicker for PPK will be sales of BNNT, in that regard, batteries are just one of numerous industries where sales are likely to be generated in coming years. There are already real sales occurring globally for BNNT, as per the table overleaf from PPK’s primary rival in BNNT production (Tekna), they were producing and selling more than 33 kilograms of BNNT per annum as far back as 2019, with their production price falling by about 3.5% per annum from US$823/g in 2014 to US$687/g in 2019. If Tekna’s falling production cost trend held over the past few years, their production cost will now be about US$617/g this year.
By contrast, with the unique BNNT production process PPK and Deakin have perfected, I estimate the can now produce BNNT at below US$50/g (and is still improving on a “Moore’s Law” trajectory according to management). If that estimate is accurate, it means PPK could make a 91.9% gross margin by selling BNNT at the same price as the production cost of the main BNNT production rival."
PPK will sell their BNNT far below that price in fact, PPK’s BNNT Technology website has a price of US$300/g for orders of 201-500g, and by negotiation for larger orders. When you can profitably sell your product at less than half of your primary competitors cost of production, you have a very attractive business provided there is a market of meaningful size for your product. The creation of a market has been the “pinch-point” for BNNT sales. The issue I am persuaded is that most prospective users of BNNT remain unaware of the existence of the breakthrough. There are dozens of companies in dozens of industries that should already be experimenting with BNNT. My strong suggestion to management has been that they should send a few grams of free samples to the top 100 research universities globally. They should probably do the same with the top 20 or 30 players in a handful of the most obvious industries where BNNT is likely to have applications. For example, there are more than 20 aerospace companies with revenues exceeding AU$10b annually, these 20 companies should all be sent some BNNT if for no other reason than to ensure they are aware it exists.
Despite the lack of sales announced for BNNT to date, the value that can be generated in that business is astronomical. Assume my estimate of US$50k/kg for PPK’s production cost is accurate, furthermore, assume they can find buyer/s for 1000kg per annum of BNNT. At US$200k/kg, which is a price roughly 1/3 of their competitor’s production cost, PPK would make US$150m (~AU$210m) in gross margin out of the sale of this relatively modest quantity of BNNT.
PPK have already stated that on a single shift 5-day week, they can produce about 500kg of BNNT per annum with their installed capacity. Expand this to 7-day multi-shift operations and they could comfortably produce two tonnes per annum, or more than $400m of annual gross margin if the end market can be found. A tonne of a relatively new nanomaterial may sound like a lot, but by way of comparison, Carbon Nanotubes (CNT’s) are forecast to ship about 3,400 tonnes in 2022. CNT’s were discovered in the lab only a few years before BNNT’s, but they were able to be produced commercially much earlier than the PPK/Deakin process made BNNT economically viable. BNNT have a much wider range of potential applications than CNT’s, given their broader range of characteristics. That being the case, the likelihood of there not being a multi-tonne market for BNNT within a few years seems unrealistic.
If we were to assume the LIS batteries outcome described above is a logical end market for BNNT by 2030, what does that imply for market size? EV batteries are currently between 180kg-1,330kg (the Hummer EV!). If we assume given their better efficacy that the median LIS EV battery weighs only 200kg by 2030 and that there is only 10 grams of BNNT required for construction of each EV battery, then given our calculations in the LIS section above about 5% EV market share capture, then there would be 1.35m EV’s produced with BNNT in the battery, then the EV market alone would have created 1,350kg of BNNT demand annually. If our assumption that the EV market was only about half of the end market for LIS batteries, then there is another 1,350 kilograms. Add in any modest success in hardened alloys, precious metals, ballistic glass and other yet uncontemplated uses and it is hard to conceive of there not being at least 5 or 10 tonnes of demand for BNNT by the end of the decade. Under the conservative 2030 demand assumptions of only about 10 tonnes, even if production costs fell considerably, it is unlikely the >$200m of gross profit the sale of a single tonne of BNNT could generate now would not be meaningfully higher at ten tonnes of sales.
The primary risks as ever remain two, firstly that the anticipated demand for BNNT does not materialise. With so many prospective uses currently under investigation, this seems like a long shot. The second is that other players figure out how to produce BNNT at a price that makes PPK uncompetitive. Given they are currently producing at less than 10% of the cost of their main competitor, this also seems like a distant prospect. If neither of these two major risks materialise, PPK should have a clear runway to create a multi-billion-dollar business."
(20min delay)
