Idea Brunch with Brian Laks of Old West Investment Management
Brian on Tin, Commodities, and Loving Deep Value
Welcome to Sunday’s Idea Brunch, your weekly interview series with underfollowed investors and emerging managers. We are very excited to interview Brian Laks!
Brian is currently a partner and portfolio manager at Old West Investment Management, a concentrated long/short investment manager. Before joining Old West in 2016, Brian worked as a research analyst at Nuveen. Brian manages the Old West Opportunity Fund which was up 67%, net of fees, in 2021 and 11%, net of fees, through Q1 of 2022.
Brian, thanks for doing Sunday’s Idea Brunch! Can you please tell readers a little more about your background and what attracted you to Old West Investment Management?
I got interested in investing at a young age and was able to witness both the late 90s tech bubble as well as the commodities and housing boom and bust a decade later. I studied business and finance in college and interned for a Tiger grandcub before starting my career as an energy analyst at Nuveen.
My initial focus was on oil and gas exploration and production companies, and I also covered related areas such as oil services, midstream, refining, and chemicals. There was also some overlap with the metals and mining team on things like coal and uranium, which had been a big position for us. We took a very granular approach to our analysis, aggregating individual well data to construct our own type curves and develop an estimate of well economics. We would model production up to the field level and ultimately to company-level profitability. Starting out as an industry specialist has helped as my role has broadened because it provided a framework to dive deeply into an area once we have identified it as a candidate.
I met the CIO of Old West at a dinner in 2016. We were both interested in gold, having been 5 years into a downturn after the 2011 peak. They were value investors looking for opportunity in things that were out of favor, and many areas of natural resources fit the bill. We had lunch a few times after that and were surprised to see how much our views aligned, and I joined them as an analyst a few months later.
One of the first ideas I brought to them was uranium. It had endured a long downturn driven by oversupply but the fundamentals appeared to be turning, albeit slowly. We began to build positions over the next couple of years as our conviction grew, but eventually felt it was prudent to cap the exposure to maintain a level of diversification in our funds. We launched the Old West Opportunity Fund in 2018 to focus on ideas like that and allow investors who didn’t mind the additional concentration to have a vehicle to express those views.
I consider myself a deep value investor almost to an extreme, looking for very large dislocations between price and value. It’s an interesting thought experiment to try and imagine what types of situations can lead to the biggest differentials. It might be a deeply cyclical industry or a company that has fallen on hard times and is restructuring. It’s often a company or industry going through great change or transformation and we have a view that the future will look much different than the present. We tend to focus on smaller companies because they are usually less known, leading to a higher chance that they might be mispriced.
The benefit of identifying outsized potential is that it allows us a longer time to be correct and still earn an exceptional rate of return. We have been known to build positions for years before the market gives us the rerate we were expecting. Of course, we would prefer to shorten this timeline by seeking to identify potential catalysts.
In your primary research areas, clean energy and critical minerals, there are a lot of schemers, promotion, and misleading investor presentations. How do you determine what’s substantive and investable versus just promotion?
I’ve probably analyzed hundreds of energy and mining projects over the years and have developed a pretty good sense of what is real and what’s not. A lot of it comes down to the people involved, their track record and whether they have done it before. It’s no small feat to take a project from discovery through permitting and construction into production, so teams that have that sort of experience are viewed with more credibility.
One of the benefits of having worked at a large asset manager like Nuveen was that we had excellent access to management teams. I was able to meet with hundreds of C-level executives during my time there and it was very instructive to see the differences in communication style and how they presented their companies in good times and bad. That experience has been extremely helpful when evaluating management teams today.
Management compensation and company share structure can also give important clues. We look for excessive share issuance and how they are spending the money. Early-stage companies need to raise money to fund their exploration and development and we realize that some dilution is necessary, but many so-called lifestyle companies continually dilute shareholders to pay salaries while the project advances slowly or not at all. Usually, a quick scan of their financial statements can confirm if that is the case.
For companies that do pass the initial screen, we look for the technical reports that have been filed on the projects. Many potential red flags that may be glossed over in bullish investor presentations can usually be found here. As projects advance, companies include forecasted operating models to determine financial feasibility. We can reconstruct these models to run sensitivities on commodity prices and capital/operating costs to see what the company can earn under various scenarios, and it also allows us to see what is currently being priced in. Valuation techniques are largely the same among different industries, but there are some notable differences when looking at mining companies. For one, projects have finite lives as reserves are continually depleted by production. This makes it a somewhat simpler analysis as it can be constrained entirely to the forecast period without needing to make any assumptions for terminal value. With uranium, it was clear a few years ago that the companies were trading at only a fraction of what we believed the value should be in a normalized price environment.
In an excellent interview with the Yet Another Value Podcast, you talk a lot about the tin market. Can you tell readers a little about why the tin market is important and why it’s an attractive investment opportunity today?
Tin is one of several areas we have been researching as part of our broader work on clean energy and critical minerals that began when we were analyzing the uranium industry. It came on our radar a few years ago as yet another example of a metal with an impending supply deficit. Many of the investments that interest us today have current or forecasted imbalances in supply and demand that we believe will lead to long-term price strength and benefits for producers or developers that can bring on new supply.
Tin is the main component of solder, the conductive metal that connects electronic components in circuit boards. It is thus a key material for most advanced technologies and plays a crucial role in electrification, one of the primary means proposed to achieve a clean energy transition. Even though it is ubiquitous in daily life, it is only a small part of the final cost of the products in which it appears, and as a result, buyers aren’t as sensitive to changes in its price. That inelasticity of demand is something we look for when comparing different commodities because it usually means the market can support higher price levels without much demand destruction. The lack of acceptable substitutes also contributes to this, as other candidate metals have either inferior attributes or much higher costs.
The proliferation of semiconductor content in all types of devices is a secular trend that we believe will require increasing amounts of tin in the coming years. The transition to 5G and an Internet of Things requires denser wireless networks and more data centers to process all of the information. Electric vehicles use roughly twice the amount of tin as an ICE car, and even those are seeing more chip content as the entertainment and driver assistance capabilities expand. The deployment of solar power is another big driver of demand. Photovoltaic ribbon is a form of copper wire that has been coated in tin and used to connect individual solar cells within PV modules. These trends and others have seen annual demand growth for tin accelerate from the 1-2% range historically to more like 3-4% today.
Supply, on the other hand, is concentrated in a handful of players that are struggling to maintain production. China and Indonesia are the two largest producers, combining for half of world supply, and both are facing resource depletion. Tin is not widely distributed geographically, with production concentrated in a small number of geologic provinces, and a long period of low prices has discouraged investment in new project development. The growing demand and shrinking supply have led to a shortage that is expected to get worse over time. There are very few quality projects that can fill this supply gap, and many others require higher prices to be developed which we think will have to occur in order to balance the market.
The market is small, only about 2% the size of copper, and thinly traded which naturally leads to higher levels of volatility. We can use this to our advantage when short-term market forces cause prices to disconnect from long-term fundamentals. We believe the current environment is providing just such an opportunity and why we think it makes sense to be building positions today.
On the podcast, you talk about Alphamin Resources (TSXV: AFM – CAD$966 million), a large tin producer with operations in the Democratic Republic of the Congo. Why do you like Alphamin specifically and how do you think about the risks of having assets in the DRC (e.g., government seizure or a changing regulatory environment)?
When looking for investments in any commodity, we typically prefer low-cost producers because they are better able to weather commodity price fluctuations. Low costs can be achieved in a number of ways, but two of the primary determinants are size of the deposit and grade of the ore. Alphamin’s Mpama North is the highest grade tin mine in the world, with a reserve grade above 4%, and one of the lowest cost producers. The grade of the ore appears to increase as they explore deeper, with drill results frequently above 10% tin and a recent intercept grading above 40%, which would make it some of the most valuable ore of any commodity. Recent exploration results lead us to believe they will be able to add additional reserves and greatly prolong the mine life.
The mine produces 4% of the world’s tin and they are in the process of constructing a second mine adjacent to the first which will increase their production by nearly 70%.
The high grades and simple processing requirements translate into very high returns for the project and a short payback period. With an estimated construction cost of $120 million, at current tin prices the additional production will generate over $80 million in annual EBITDA.
Both mines combined would take their production to 20k tons per year, nearly 7% of world supply. Their costs are under $15k per ton, meaning at a tin price of $25k they would generate $200 million per year in EBITDA. This is on a current market cap of only $700 million and they are sitting on $138 million in net cash, more than enough to self-fund the second mine. The tin price reached $50k per ton on supply concerns earlier this year before pulling back, and we expect the price to resume its upward trend as the long-term supply/demand imbalance outweighs short-term recession fears.
The company announced a strategic review last year to look at ways to maximize shareholder value. They initiated a dividend and considered an outright sale but given the market environment decided the best path to unlock value lay in reserve and production growth. The two mines will occupy only a small part of their land package which they believe is prospective for additional deposits of tin and which they are currently exploring. The former CEO has stated that he believes the best ore body is yet to be found, and we are very optimistic about the exploration potential.
Jurisdiction risk is one of many we consider when looking at a project. While the country may rank higher in that dimension, many of the other risks we consider are much lower. Having a marginal project in a low-risk jurisdiction can be just as problematic. Even countries that are considered safe can have their own issues with permitting or environmental regulations which may delay or even prevent the development of a project. We believe there is a growing recognition in the industry that the insatiable demand for important commodities will force companies to operate in more challenging jurisdictions. The country is extremely mineral-rich and will play a major role in supplying the clean energy transition, as the world’s largest supplier of cobalt and the largest producer of copper in Africa, and there are hundreds of active mining permits in advanced development.
They have made major strides in recent years to improve the operating environment for businesses, and many large mining companies are beginning to revisit their attitudes toward it. Barrick Gold’s Kibali project is the largest gold mine in Africa and its CEO was recently in the country expressing his commitment to the region. Ivanhoe Mines brought on the Kamoa-Kakula project there in the last few years, a shining example of success and on track to be one of the largest high-grade copper mines in the world. Even BHP has discussed buying into the Western Forelands exploration project near the Ivanhoe mine, a notable shift for the company that had previously sought to reduce exposure to the region.
Alphamin specifically is viewed very favorably by the local community and has received support all the way up to the national level. They are in a remote region and allocate a portion of their revenue to community development, having built roads and schools, and are a major source of employment. While certain risks may be elevated, we think the combination of asset quality, low valuation and exploration upside offer compelling compensation.
What are some other interesting ideas on your radar now?
There are a handful of other tin assets that look attractive to us. The majority of projects we have seen are low quality, but there are few with tin grades above 1% that we have been following. We believe the dearth of investable options will prove to be a benefit as prices rise because capital flowing into the sector will be concentrated to a limited number of companies.
In addition to tin, we are also seeing opportunities in copper. It is a much larger market but similarly important to the future of electrification. The investment thesis for many of these metals is quite similar with looming supply deficits not easily met without higher prices and significant investment in new projects. There was a large high-grade discovery made last year that we have been following closely. The group that discovered it has a long track record of success and is very well capitalized, a rarity when considering exploration-stage companies. They had already defined an attractive project a few years earlier but subsequent drilling beneath the deposit revealed a massive occurrence of additional mineralization. The scale of the project is enormous and it is incredibly rich not just in copper, but also in silver and gold. The follow-on drill results have been phenomenal, with intercepts routinely topping the charts of gold and silver miner results. Earlier this year a major mining company made a large investment in the company which we view as a strong sign of support for the future of the project. It also gave them the funds to operate multiple rigs which should provide a steady cadence of news flow this year.
We also continue to maintain a substantial weighting to the uranium sector. The fundamentals for nuclear power and uranium demand continue to improve and we think it will play a key role in achieving climate goals. We have written and commented extensively on the sector over the last few years which your readers can find online if interested. More generally we think the current market environment is beginning to offer an attractive entry point for investors with a longer time horizon as short-term fears have dominated the headlines. The long-term supply deficits in many commodities will require significant time and money to remedy. If commodity prices remain low those investments are less likely to be made, further exacerbating future price shocks.
Brian, thank you for the great interview! What is the best way for readers to follow or connect with you?
Readers can visit our website at oldwestim.com to find our contact info and an archive of our letters and interviews. We encourage those interested to reach out as we are always happy to discuss our ideas. You can also find me @brianlaks on Twitter.
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