Red Flags at Bear Lodge
Turning our attention to the tiny Canadian speculative outfit, we could not help but find the ticker amusing: REE. Sadly, we had immediate memories of the pain Internet.com created near the top of the dot.com bubble. Rare Element currently has a market cap of over $400 million. Their latest financials show about $10 million of assets and zero revenues. They had $5 million of cash on balance sheet at their last filing. According to their last 20-F, Rare Element has two full-time employees and five part-time employees (see here). This "exploration and development" company has spent less than $7,000.00 over the past three years (see here). The management team has put out a steady stream of press releases, but we have little doubt that these promotional releases will ultimately be irrelevant for Rare Element until we are much closer to the middle of the decade.
The name of the property where Rare Element is conducting its RE element testing is Bear Lodge, located in the northeast corner of Wyoming. Spartacus Capital, the predecessor company to Rare Elements, acquired the Bear Lodge mine in 2002 for less than $1 million. The company expects production of the plant to begin in 2015. According the Rare Elements own documents, over the past 38 years, three highly sophisticated mining companies, MolyCorp, Hecla Mining (HL), and Duval Corporation, owned and explored Bear Lodge for RE elements. After 44 drill holes, none these sophisticated miners continued to drill, all choosing to abandon their efforts and eat the sunk costs. We believe one of the reasons is the low ore grade of Bear Lodge. According to Rare Element's investor presentation, Bear Lodge has an ore grade of 3.5%, less that half of MolyCorp's Mountain Pass (8.2%) and a third of Lynas' Mount Weld (13.6%). Based on our research (we ask readers to conduct their own research on this topic), this makes Bear Lodge's prospects for successful operation extremely dependent on RE element prices staying at existing levels. If our earlier assumption is correct (along with the apparent conclusion of three highly sophisticated miners), and prices of RE elements normalize, it will be uneconomical to mine Bear Lodge (assuming the asset even possesses enough to participate in the future of this over supplied market). So while many RE stocks have increased significantly on higher RE prices, most, including Rare Elements, will never be in a position to take advantage of today's prices.
Given the abundance of RE elements worldwide, access to RE may not be that problematic, but processing RE elements into usable raw materials is expensive, difficult and environmentally destructive. In fact, Mountain Pass was originally shut down not only due to a flood of cheap RE elements from China, but also for environmental concerns. To justify Rare Element's lofty current market cap, we believe prices of RE not only need to stay extremely high, but Rare Element must build processing capability. A Bryon Securities report estimates this would cost Rare Elements $350 million. In addition, Rare Elements would have to overcome significant permitting and environmental concerns, along with significant start-up expenses. With two full employees, a tiny balance sheet, and prospects for significant dilutive equity deals, common sense suggests something does not pass the smell test.
We put little value on Rare Element's other projects: gold mining at Bear Lodge and Eden Lake. Eden Lake is a property Rare Element acquired recently for less than $1 million. Rare Element management also claims potential for gold mining. Earlier this year, Newmont (NYSE: NEM) walked away from a JV they had with Rare Elements on this property for a sum total of $27,000 worth of paid expenses (6/8/2010 filing outlines the termination of their JV). Newmont will receive a net smelter royalty should anything be found, but cut their losses on development and exploration (they spent almost $3 million in development and refused to spend more). So Bear Lodge was basically given to them for free by Freeport in exchange for a net smelter royalty, which they repurchased for a total of $50,000 from Freeport and Newmont. Given the sophistication of Newmont, we believe gold project offers little value.
Red Flags Around Management
The quality of a management team is extremely important for any small cap company. But when your management bench is as small as Rare Element's, assessment of management is vital. We found it curious that Rare Elements shares its address in their filings (325 Howe St., #410, Vancouver, British Columbia, Canada V6C 1Z7) with at least six other businesses (Pacific Opportunity Capital run by Chairman and CEO Donald Ranta, CFO Mark T. Brown and Secretary Winnie Wong; Animas Resources [ANI.V]; Tenant Payment Systems; Avrupa Minerals LTD. [AVU.V] formerly Everclear Capital; Cordova Industries; and Sutter Gold Mining Inc. [SGM.V].
Our concern was already elevated given the commingled nature of the office address, but nothing could have prepared us for the shock of seeing management's bios and history. Most management teams we talk to are consumed with running one company. We believe it is a significant red flag that critical members of Rare Element's management team are engaged with more than five companies currently. It is our understanding that Rare Element's secretary Winnie Wong and CFO Mark T. Brown are principals of something called Pacific Opportunity Capital LTD that shares office space with Rare Elements. Mark T. Brown's bio in the 20-F lists 18 companies where he is the current or former CFO or director. Almost all of these companies are Canadian-traded penny stocks. A simple google news search reveals that Mark T. Brown has issued press releases for at least three other companies in the past two weeks, including Pitchstone Exploration, Avrupa Minerals and Tarsis.
Chairman and CEO Donald E. Ranta was previously with Greenstone Resources, a mining play that is currently trading in the penny territory. Mr. Ranta is also on the board of Avrupa Minerals, along with the CFO Mark T Brown and secretary Winnie Wong. Secretary Winnie Wong was (until recently) also the secretary of Portal Resources [PDO.V], an oil and gas penny stock. She is also the CFO for something called Avrupa Minerals, currently trading in the 41 cent range in Canada. Then there’s Apoquindo Minerals, of which she is also the corporate secretary, and there is Animas Resources LTD [ANI.V] of which she is CFO (another 43 cent stock). She’s also been associated with Fox Resources as their CFO, Deal Capital as President, and Mediterranean Minerals as CFO.
Conclusion
One recent rational voice in RE elements is the CEO of Neo Materials [TSX: NEM], Constantine Karayannopoulos. As a company with 85% market share in processing neo powders, Karayannopoulos is heavily incentivized to promote RE elements. However, in several recent presentations, he has expressed concerns around the bubble in RE elements. By way of background, Neo Materials has exclusive access to mine heavy rare earths at the Pitinga mine in Brazil, a fact investors have seemed to overlook when comparing NEM's stock to other RE names. On September 15, 2010, Karayannopoulos stated:
It's very, very dangerous for people to be committing hundreds of millions of dollars to projects that will take another five years or more to see the light of day.
He went on to caution, as if he were specifically alluding to Rare Elements:
At the end of the day, rare earths are not that rare. Bubble economics aside, there just isn't enough value in the ground to justify digging the stuff up and processing it.