Asymmetrical risk opportunity: MP Materials
Successful investing is about identifying great asymmetrical risk opportunities and doubling-down on them. Often the second part is the harder one since it requires the investor to self-actualize and becoming more resilient to adversity.
*** I’m currently long MP Materials (NYSE: FVAC) ***
Right Mindset
To develop the right mindset, you have to start focusing more on the potential gains and less on the losses. Risk-averse decisions tend to lead to value traps. Usually, stocks are falling for a good reason e.g. Ford, Occidental Petroleum, or Delta Airlines. There might be some bounces here and then, but the overall downward trend is quite clear. Their balance sheets are burdened with massive debt, and their revenue growth is stagnating or even contracting. Therefore, the potential upside is limited.
From time to time, there might be a possibility for a contrarian bet. Still, it’s rather speculative, e.g. the government will bail them out, or they can meet their debt maturities through asset sales.
Instead, the investor should focus on companies that offer higher upside potential. Often the setup is far more promising with valuable assets that provide a great margin of safety and a competitive advantage offering the company multi-decade growth potential. These companies might seem riskier, but their faith is not already determined. In such a scenario, the return will outweigh the risk many times.
One of these examples is MP Materials (NYSE: FVAC). In my last article, I discussed why you should be long MP Materials. In this article, I will explain why this investment offers a tremendous asymmetrical risk opportunity.
“Most people in their life and business reduce risk to the point where the probability of success goes higher, but the consequences of success are inconsequential. Instead, people should try more to reduce the probability of success and increase the consequences of success.” — Vinod Khosla
MP Materials
On Wednesday, July 14th, MP Materials, owner and operator of Mountain Pass, the only rare earth mining and processing site of scale in North America, announced a definitive agreement to merge with Fortress Value Acquisition Corp. (NYSE: FVAC).
Fortress Value Acquisition Corp. (NYSE: FVAC) is a special purpose acquisition company (SPAC) sponsored by an affiliate of Fortress Investment Group, that allows MP Materials to be listed on the NYSE under the new ticker symbol “MP” once the merger is completed.
The combined company will have an estimated post‐transaction equity value of approximately $1.5 billion, with over $500 million in net cash to fund its growth strategy. It will create the only pure-play rare-earths investment opportunity in the Western hemisphere.
So, how does this mining business offer an asymmetrical bet on the future?
1. Margin of safety
At the current valuation, MP Materials offers a high margin of safety as investors are paying just 88% of the $1.7 billion invested capital. The previous company Molycorp invested heavily in the Mountain Pass mine and its facilities before going bankrupt due to increased competition out of China.
MP Materials bought the mine out of bankruptcy for $40 million in 2017 and want to focus mostly on Neodymium (Nd) and Praseodymium (Pr) to create permanent magnets.
Unlike many startups, the company is already profitable. In 2020, the company will achieve around $100 million in revenue and $20 million in EBITDA.
2. Growth opportunity
How much does your commute weigh? Such an odd-sounding question can describe the reality that many products and services are based on extracting minerals from the earth.
Every energy-producing system must be built from materials extracted from the earth. With the accelerated movement towards electrification like e.g. EVs and wind turbines, the demand for many materials, especially rare earth materials, will rise significantly. For example, the world currently mines about 7,000 tons per year of neodymium. This element is essential for powering wind turbines and EV motors. The World Bank estimates a 1,000%–4,000% increase in neodymium demand just for wind turbines until 2050.
As MP Materials will be the only rare-earth supplier at scale in the Western hemisphere, it can completely seize the massive transformation. According to the company’s forecast, it will grow its sales from $75 million in 2019 to $415 million in 2023 at an impressive CAGR of 53.3%. By 2023, the company could increase its earnings power up to $252 million of adjusted EBITDA.
3. Road to success
In the investor presentation, MP describes its current execution strategy, which consists of a three-stage plan to reestablish the critical industrial input within the United States:
- Stage: Supply China with RE concentrate — This stage is complete generating over $100 million in revenues.
- Stage: Refine NdPr, La, Ce at Mountain Pass, CA, for global distribution — This stage is in process and should be completed by 2022.
- Stage: Create NdPr Magnets — This stage will be followed after stage 2. The estimated revenue is not taken into account.
4. Great long-term investors
Some experienced long-term investors took notice of this asymmetrical opportunity and already doubled-down. Chamath Palihapitiya and Leon Cooperman led a $200 million pipe financing. Leon Cooperman is quite a figure on Wall Street after having an illustrative career at Goldman Sachs before launching his Omega partnership. In 2016, he retired and converted Omega to a family office.
Chamath Palihapitiya made a string of successful investments via his company Social Capital and personally. To name a few: Amazon, Slack, Virgin Galactic, Golden State Warriors, and Bitcoin. He compares this investment opportunity to Intel in the 80s and 90s:
“In many ways, rare earths are to electrification what Intel was to the PC Boom of the 1980s and 1990s: a common component in every solution. Being long Intel in those days was equivalent to being long the PC revolution. In my mind, this is the same point in time.” — Chamath Palihapitiya
Chamath Palihapitiya has shared his investment thesis on Twitter.
5. Investment theme of the next decade
In the face of uncertainty caused by the COVID-19 pandemic and climate crisis, sustainability and resilience are becoming leading investment themes of this decade.
Due to the consistent decline in battery costs, electrification is getting accelerated from electric vehicles to utility-scale energy storage systems for renewable energy. Investing in MP Materials allows you to get exposure to the electric transformation. NdPr-magnets are a standard component for electric motors that are used in EVs and wind turbines and are currently irreplaceable.
During the COV-19 pandemic, many nations, especially the United States, have started to embrace supply chain resiliency as a critical part of national security. China has been the dominant force in the rare earth supply chain controlling up to 85% of it for the last two decades. The United States has issued many executive orders to ensure that it has secure and reliable supplies of critical materials and will probably issue many more calls to action to secure this strategic important good.
Conclusion:
MP Materials (NYSE: FVAC) offers investors an asymmetrical risk opportunity to bet on the electric transformation:
- High margin of safety due to the capital investment of $1.7 billion and achieved profitability
- Growth opportunity due to the accelerated electrification
- Strong three-phase execution plan for commercialization and additional high-margin business of NdPr-magnets
- Conviction of long-term investors like Chamath Palihapitiya and Leon Cooperman
- Investment themes of the next decade: sustainability & resilience
*** I’m currently long MP Materials (NYSE: FVAC) ***
