Index Member Comment - July 12, 2012: Matamec's One-Two Punch Kipawa Knockout Deal
Matamec Explorations Inc announced on July 12, 2012 that it had sold 49% of the Kipawa rare earth deposit for $16,000,816 to Toyotsu Rare Earth Canada Inc in what amounts to a tragic tale of the country bumpkin in the big city. Toyotsu is presumably a division of the Toyota Motor Corp, though we cannot be sure, because Matamec does not follow the practice customary for such an important deal by a junior which involves explaining in the boilerplate at the bottom of the news release what both parties are "about". All we read is "About Matamec". When you read the details of the news release, which is clearly a "not so great" English translation of a French original, you will have one of two possible experiences depending on whether or not you are a shareholder. If you are a shareholder you will feel in your throat an upwelling of your last meal. If you are not a shareholder, and of average or better intelligence, you will be thunderstruck with awe over the genius and chutzpah displayed by Matamec president Andre Gauthier in inventing a new type of poison pill to entrench management at the expense of not just minority shareholders, that impotent class defended by "egalitarian justice" minded "left-wingers", but also that nebulous class of generally very influential "major" shareholders defended by "property rights" minded "right wingers". What I refer to is the second agreement described by the news release, but before I address that abusive part which enabled me to experience both emotions today (Matamec is not the subject of an open KRO recommendation), let's look at the tragic part first.
Toyotsu will immediately pay $8.5 million to earn a direct 25% interest, and be obligated to provide another $7,500,826 as required by cash calls from Matamec, which is operating the execution of a feasibility study (FS) that upgrades the development scenario of the preliminary economic assessment (PEA) published earlier this year. Upon Toyotsu contributing a total of $16,000,816 towards Kipawa it will be deemed to have earned another 24%, bringing its Kipawa stake to 49%.
The phrase "feasibility study" decorates just about every document published by Matamec, but what turned me off from Matamec when the Toyotsu deal was first announced in late 2011, is the fact that completion of a feasibility study has nothing whatsoever to do with the "first agreement", which simply states that Toyotsu will contribute $16,000,816 towards a feasibility study, and once this funding limit has been reached, Toyotsu will form a 49:51 joint venture with Matamec to fund further work. The stark reality is that Matamec gave away 49% of Kipawa for a $16 million funding contribution to a party whose strategic interests are different from those of Matamec, which is to maximize the cash flow from Kipawa rare earth production.
The good news about this "first agreement" is that it implies that Toyotsu is happy with the internal testing it conducted on the flow-sheet the late Les Heymann developed for the eudialyte mineral which is the primary rare earth host in the Kipawa deposit, as well as the Norra Karr deposit in Sweden owned by Tasman Metals Ltd. But that is also what makes the "first agreement" tragic. Anybody reading about Matamec for the first time via this news release would never guess that Toyotsu going ahead with the 49% purchase was conditional on internal verification that Matamec has indeed cracked the silica gelling problem associated with eudialyte which is the reason no eudialyte dominated rare earth deposit has ever been put into commercial production. Of course, I am assuming that Toyotsu Rare Earth Canada Inc is an entity which has access to Toyota's vast testing facilities and know-how, and is not some tax-haven registered shell company whose principals have no relationship to Toyota whatsoever. (Google the name and see if you find any hits that do not come from Matamec's disclosures.)
What makes this tragic is that $16 million is unlikely to be enough to deliver a feasibility study by Q2 of 2013 whose feasibility criteria meet independent third party standards. Andre Gauthier is delusional in thinking that a $16 million contribution limit is more than enough to deliver a feasibility study that is "bankable" or so "definitive" that it enables Matamec to raise its share of CapEx on a stock price basis that reflects the net present value implied by the feasibility study rather than some steep discount from that number as currently prevails in the resource sector. The reality is that within a year Matamec will be back on the dilution treadmill trying to raise its 51% share of expenditures required to bring Kipawa to a production decision, a decision which ultimately Toyota controls because it will be the "banker" to the development of Kipawa.
Andre Gauthier, however, thinks of himself as anything but a country bumpkin being skinned by city slickers, and the "second agreement", which pertains to the joint venture that will be formed after Matamec spends $16 million on Kipawa, seems to dictate that any spending beyond $16 million must be a unanimous decision by both parties. This would seem to imply that if President Gauthier refuses to recommend any further work after Toyotsu vests for 49%, Kipawa's development comes to a standstill. By concentrating this decision making power into the hands of the Matamec board, it would seem that President Gauthier has the power to force Toyotsu to renegotiate the relationship with Kipawa on terms that benefit Matamec shareholders, a power that would only have force if Toyotsu turns out to desperately need the heavy rare earths with which the Kipawa deposit is well endowed.
Unfortunately, this term of the joint venture agreement also gives Toyotsu absolute power to indefinitely postpone development of Kipawa by simply disagreeing with President Gauthier, something which to avoid is really hard to do. If Toyotsu turns out not to need Kipawa for its internal end-user applications, it simply writes off $16 million as just another bad derivative trade, though not like those made by investment banks which tend to be naked bets on volatility. The $16 million investment in Kipawa is a true hedge, thanks to the Matamec management entrenchment component of the "second agreement".
The "second agreement" includes a clause which appears to decree that if there is a change of control of either Toyotsu or Matamec, the Kipawa stake owned by the party undergoing a change of control will be deemed to be offered to the other party for 60 days at a fair market value determined by 3 qualified independent valuations, one chosen by Matamec, one by Toyotsu, and the third chosen by both or one chosen by a Japanese or Canadian auditor agreed upon by Toyotsu and Matamec. Presumably the fair market value will be an average of the three valuations, which, given the uncertainty of rare earth oxide prices during the next decade, will likely be skewed toward a pessimistic set of parameters.
Matamec has not explained to us who controls Toyotsu, presumably because anybody with half a brain "knows" that it is a subsidiary of Toyota Motor Corp, which is unlikely to "sell" a single-purpose subsidiary to another party. However, in a world where offtake agreement controlled mine supply of critical materials has only a nominal value linked to "quoted prices", and a real but secret value linked to the net present value of cash flow generated by the commercialization of products or technology which have a critical dependence on a raw material input whose cost is a fraction of the product's total cost, it is conceivable that Toyotsu could eventually assign a zero value to its 49% Kipawa stake, either because its parent has successfully engineered away its critical dependence on rare earths, or latched onto an easier and less expensive supply of such needs, making it happy to sell the 49% stake to a third party for the sunk cost.
Such a proposed transaction would enable Matamec to buy back the 49% interest based on a fair market value, which formula is not good news for Matamec shareholders. If the amount is $16 million or less, it implies that Matamec's 138 million fully diluted shares are worth $0.12 or less. If it is more, an amount that matches Matamec's market capitalization, Matamec will have to raise the equivalent of its market cap to get back 100%. The whole point of "fair market value" is that in the absence of some secret strategic advantage which the market cannot by definition price, there is no gain for equity shareholders, especially in a situation where Matamec already owns a nominal 51%.
But when you read the news release it becomes quickly apparent that this clause relates to the possibility that another party might gain control of Matamec by voting in a new board of directors by mustering more than 50% of the votes in a proxy battle. So not only does it imply that if a legitimate third party makes a bid for 100% of Matamec, Matamec's main asset could be sold to Toyotsu at a value that is considerably less than what is being offered to take out Matamec, which difference could be assigned to Matamec's other "assets" such as the land surrounding the Kipawa deposit, but it also implies that any vote of more than 50% of outstanding shares to change management, will trigger the sale of the primary asset. If this bizarre version of a "shotgun" clause survives a legal challenge, Andre Gauthier will be hailed as a dark genius who figured out a way for management to emasculate "minority" and "majority" shareholders. Is it any surprise that the TSXV in its unending quest "to do the wrong thing" has already given conditional approval to this agreement?
If you have read this far it is either because you are a shareholder who wanted to understand why your last meal was welling up in your throat after reading this latest Matamec "milestone", somebody in President Gauthier's shoes eager to learn a new way to entrench yourself as management of a junior in which you have a less than 2% equity stake, or just somebody endowed with a morbid interest in the sordid affairs of juniors, I hope I have helped you out.
The tragedy of this deal is that no legitimate third party will ever make a takeover bid, especially if the original plan to bestow 100% offtake rights on Toyotsu is incorporated into the offtake agreement whose completion has been kicked down the road, but it is entirely possible that a mysterious offshore entity called "FukuMatamec" makes a bid for more than 50% control, which unleashes the process whereby Toyotsu can buy the only valuable asset for an amount that is an average concocted by three beancounters.
This possibility is what compels me to reject the idea that Matamec non-shareholders should celebrate the "genius" of President Gauthier's management entrenchment strategy, for it is very flawed in so far that its goal might be to leave decision-making power in the hands of management, a management that could very well be doing this with the well-intentioned goal of benefiting all Matamec shareholders. It is an unwitting betrayal of the interests of all Matamec shareholders, and even management itself, though with regard to the latter it may not be so unwitting. The news release discloses that Matamec has paid $310,000 to acquire 2 NSR royalties totaling 1.25% from a private company of which 3 Matamec directors are also directors. Matamec's skimpy disclosures indicate that there are NSR's ranging 1% to 2.25% redeemable at prices ranging from $250,000 to $500,000. In a sign of management's lack of commitment to full disclosure, it is impossible to calculate what it would cost for Matamec to use its contractual rights to eliminate all royalty encumbrances of Kipawa.
The news release does not state that the $310,000 purchase eliminates all royalties. If the purchase did, why not make this clear given the murky earlier disclosures? Either management is incompetent, or some royalties must remain, which raises the question as to why the news release states that the purchase of the royalties was a "condition precedent to the execution of sale and purchase agreement and the joint venture agreement". Who insisted on this condition? Obviously Toyotsu would want to get rid of royalties which in the case of rare earths are a legal timebomb due to the uncertainty of pricing the "net smelter" output. But then it should be all of them, not just some. Is it possible that Matamec management insisted that certain of its members get a bonus by having the company prematurely offer to buy out some of the royalties well before they have any commercial value?
It really is unfair to expect President Gauthier to anticipate all these subtle issues and head them off by himself. So what was the nature of the "wisdom" provided by Matamec advisory board members Sean Roosen and Bob Wares? Whatever it was it did not prevent a dual agreement with Toyotsu which worsened a deal that was already bad for Matamec shareholders in its original form. Spec Value Hunters should steer clear of Matamec, and hope that the dude pilloried by Otto Rock of IncaKolaNews provides an alternative reading of the Matamec text.