The Missing Piece in the EV Puzzle: Why Battery Recycling offers Huge Potential

In the Thesis Portfolio Investment Committee, we often have huge debates trying to figure out what are the likely ways forward in tackling environmental issues. Specifically, as the world seeks to cut emissions and head for a greener future, we try to ascertain which fuel will replace fossil fuels. Some members of the Committee are very bullish on nuclear as the ultimate clean fuel. While I can totally see the superiority of this much cleaner fuel source, I personally feel nuclear faces pretty significant short-term challenges to greater adoption.

My own personal view regarding the whole clean fuel debate is that, like all technological progress to date, it will be an iterative process: i.e. based on small ‘imperfect’ improvements as new solutions emerge out of technological advances, rather than the scenario of a sudden ‘Big Bang’ of a brand-new ideal solution with absolutely no downside!

Most of us in the Committee are very excited both ideologically and from an investment standpoint about the enormous potential of EV’s (Electric Vehicles) replacing combustion engines. I personally believe this will happen sooner than people think for a number of both consumer choice led and increasing supply reasons.

So if I am right, and electric vehicles rapidly gain mainstream adoption, they will almost certainly be initially powered by the ‘imperfect’ but still greener than fossil fuels solution of lithium-ion batteries. Thinking this through: what to do with all the spent batteries? In my opinion, there would have to be an important and sizable sector focused on recycling these used car batteries as not only are they an embarrassing environmental problem for the EV manufacturers, but they do also actually contain valuable metals!

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As of yet, there is no real lithium battery recycling sector as such, but I’m pretty convinced that just looking at the ambitious EV car plans of most leading auto manufacturers, there will need to be an enormous one going forwards! I would even go as far as to say that auto manufacturers will have every incentive to basically finance the growth of this battery recycling sector themselves in order to take away this potential problem in the way of their billion dollar growth plans!

The naysayers point out that this recycling is uneconomic (i.e. currently unprofitable) and anyway, batteries are a terrible solution. But in line with my views on the typical path technological progress as a whole seems to take, I think this is completely missing the point: battery-powered cars are an undeniable improvement on combustion engines and so will gain mass adoption despite their imperfections. And they will gradually get better in performance terms and their prices will fall from here too to a point where there will be very little advantage at all in a traditional combustion engine car. In that scenario, battery disposal/recycling will become an embarrassing and growing reputational problem that big EV sellers will be very willing to pay someone else to deal with. From the outset, given the greater priority placed on the environmental agenda, they will need to be ‘seen’ to be solving this new problem, irrespective of the initial economics. I would go as far as to say that this recycling is strategically critical in containing the negative outputs from the production of electric batteries against a backdrop of the car industry’s advanced plans for a huge ramp-up in EV sales across North America and other developed economies.

What’s more, returns achieved on this recycling is a moving target and they are very likely to increase: growing volumes will undoubtedly improve the returns for the companies undertaking this recycling as will any new technological advances from here!

So within this context, today I’d like to tell you about a leading lithium recycling company I have uncovered, which only recently went public through a SPAC deal with Peridot. I caution that this is probably the earliest stage company I have ever written about here. Therefore I have less information than I would like, and it certainly is a higher risk/higher reward proposition. However, I personally believe they have a pretty good chance of success, and I will explain my reasons below.

A word on SPACs: A SPAC is a new way for early stage companies to list on public markets. It stands for a ‘special purpose acquisitions company’ which is essentially a shell company set up by investors with the purpose of raising money through an IPO to acquire another company. There was huge excitement around SPAC deals earlier this year as smaller investors rightly sensed the huge opportunity of finally being able to gain exposure to really exciting early-stage companies in the way venture capitalists typically do. This euphoria led to enormous cash raises for the lucky few who managed to list as a SPAC early on and that includes the company I’d like to introduce you to today - Li-cycle. The share prices then typically shot up even further on listing but there has more recently been a sizable correction in SPAC prices, often in the order of 50% falls from recent highs, which makes them far more attractive from a valuation perspective.

Thinking about this strategically, this is an important competitive advantage for Li-cycle and the other companies that already achieved their SPAC deals: any new competitor would now find it very difficult to raise the same amount of money as they did to compete with them head on and whatever happens to funding markets now, companies like Li-cycle have secured the vast majority of the cash they need for their ambitious plans, somewhat de-risking the opportunity for us as investors. Brilliant! Over the coming weeks, I will be telling you about other attractive companies that have recently listed through SPAC deals as I believe that for the reasons given above, this is actually an ideal hunting ground for attractive investment opportunities, especially in this uncertain economic growth climate.

Equity Research Report


Source: MSN Money (Price data as of 28.10.2021) Past performance is not indicative of future performance. Returns may increase or decrease as the result of currency fluctuations. (Figures refer to price data between November 2020 and October 2021)

Business Description

Li-Cycle is the World’s leading listed pure-play EV battery recycler and is in fact the largest recycler of lithium-ion batteries in North America. Li-Cycle explains that they are aiming to bring the circular economy to the electric vehicle industry. The diagram below is how the company describes the near elimination of waste through the continual reuse of extracted resources. It contrasts heavily with our current linear approach to production of “take, make, and dispose”.

Pynk Community Equity Research Li-Cycle - Business Description
Li-Cycle Investor Presentation (Source)

Li-Cycle already has a fully operational recycling facility in Kingston, Ontario capable of processing 5,000 tons of spent lithium-ion batteries per year. A second facility in Rochester, New York commenced commercial operations in late 2020 and should see the company’s total recycling capacity across its two facilities grow to 10,000 tons.

Through a hydrometallurgical process, the company is able to create battery-grade lithium-ion materials from any type of spent lithium-ion battery. It claims to be able to recover at least 95% of nickel, lithium-carbonate, and cobalt from lithium-ion batteries through its zero-waste process. This compares favourably to the industry average recovery of less than 50%. Further, the company is able to process all types of lithium-ion batteries regardless of their previous application, chemistry, or state of charge.

The investment analyst community is starting to recognise the potential of the company. Analyst Dan Ives at Wedbush gave the shares a bullish endorsement with a price target of $14.

“The company is a pure-play lithium-ion recycler as it breaks down battery waste to extract the precious materials lithium, nickel, and cobalt to cycle them back out into the supply chain,” Ives wrote in a note to clients. “In the age of rapid battery expansion, Li-Cycle has primed itself to continue its dominance across the battery recycling sector, manufacturing battery waste into raw materials in an environmentally conscious and efficient manner while being in the sweet spot of a pending green tidal wave with battery recycling front and centre.”

Overview of the Business

Li-Cycle was founded in 2016 and specializes in the recovery of materials from battery manufacturing scrap and end-of-life batteries, including lithium, cobalt, nickel, and manganese products. It has developed a patented process with 12 formalized trade secrets that use standard equipment.

Pynk Community Equity Research Li-Cycle

Pynk Community Equity Research Li-Cycle

The company claims that its technology can deliver a recycling efficiency rate of up to 95%, which considering smelting of lithium-ion batteries usually has an efficiency of less than 50%, is a vast improvement.

Li-Cycle currently has over 40 commercial contracts and off-take agreements through 2030, and among its partners are the world’s largest global automotive and battery makers.

The company currently has two operating facilities with a combined capacity of 10,000 t/y and plans to grow its capacity by over 30 times in the next five years to become a global leader.

Scale of the Opportunity

The scale of the problem and opportunity is significant as 15 million tons of spent lithium-ion batteries are expected to reach the end of their lives by 2030. This presents an enormous opportunity for a company like Li-Cycle, and they will seek to consolidate their leadership position in North America and grow into global leadership from there.


Source

Pynk Community Equity Research Li-Cycle - Lithium Ion Batteries

Pynk Community Equity Research Li-Cycle
Source: Peridot

Zero Carbon Alternatives to Transportation: A Critical Need for The World

The need for the world to move towards zero-carbon alternatives in transportation is undeniable. The electric vehicle revolution would help slow anthropogenic climate change, lead to cleaner and quieter cities, and hopefully the near extinction of oil spills. This is part of the wider narrative that has driven ESG investing from fringe to vanguard of the global financial markets. However, the reality is not so black and white as the production of electric cars and green energy come with their own unique set of environmental setbacks. These have formed important parts of bearish narratives that have so far failed to stick because they have mainly been posited as an excuse to not move towards sustainable solutions at all.

IP and Technology

Not to get into the technical too deeply, Licycle asserts that they recycle batteries in a new and novel way (see below) which is far different from how batteries are currently recycled:


Source: PDAC investor deck

That’s remarkable as spending on R&D since 2018 adds up to a total of only $3 million!


Past performance is not indicative of future performance. Source: PDAC Proxy Filing

That isn’t the complete story because the company was founded by Ajay Kochhar and Tim Johnston in 2016. Perhaps some of the heavy R&D lifting happened in the initial stages by the founders. The founders both came from a company called Hatch and Ajay seems to have the right tech background:

Ajay gained extensive technology and project development experience through progressive roles with Hatch’s industrial cleantech and advisory practices. While working in that space, he garnered in-depth engineering and project management experience through clean technology development in the lithium, cobalt, nickel, copper, gold, lead, zinc, molybdenum, and rare earth metals industries. His technical expertise spans the entire project lifecycle, from conceptual and pre-feasibility studies to construction and commissioning.

I’m not sure how this compares to competitors but the company extracts copper and precious metals and at the end of its process there’s black-mass left which includes cobalt and nickel. Glencore is taking that off Li-Cycle’s hands if the purity is good enough and perhaps the dirty work happens on their end. Glencore doesn’t seem to mind engaging in a bit of reputational arbitrage now and again!

I think we can take comfort on the technology by the fact that Li-Cycle has been showered with awards like the 2021 Big Innovation Award presented by Business Intelligence Group and named to the World Circular Economy Forum’s list of Circular Economy Solutions Inspiring the World. It is also a 2020 and 2021 Global Cleantech 100 Company and a finalist in the 10th Annual Business Green Leaders Awards.

Existing Supply Contracts

LiCycle has supply contracts with 41 customers (but no names are mentioned apart from Traxys). Somewhat disingenuously perhaps, the logos of Ford, Tesla , Rivian, Volkswagen, Amazon, etc. are given by the company in the presentation (see below) but don’t expressly represent supply contracts. This could simply be due to confidentiality clauses in these contracts and encouragingly in the proxy documents, it actually says the company has a supply agreement with Ultium Cells which is a JV of General Motors and LG Energy Solution.


Source: PDAC Proxy Filing

Valuation Upside

The company recently went public through a SPAC deal with Peridot Acquisition Corp at an equity valuation of $1.67 billion. The transaction saw the company raise gross proceeds of $615 million, including an upsized PIPE of $315 million to fund CapEx for new recycling facilities.

Li-Cycle achieved revenue of $903,000 during its fiscal year 2020. While comparatively small compared to its market cap, this was up 1731% from the previous year and is forecast to grow to $12 million for 2021. The company has guided for this to rise at a compound annual growth rate of 200% to $968 million in 2025. Li-Cycle expects to hit EBITDA profitability by 2022 with a margin of 3.6%. This is expected to rise to a margin of nearly 56.5% in 2025.

Pynk Community Equity Research Li-Cycle - Earnings Margin
Li-Cycle Investor Presentation (Source)

The capex required for these plans over the next five years is significant and stands at $985 million. However, the company can finance a majority of that thanks to its SPAC deal with Peridot. Furthermore, given the strategic importance of this recycling to the auto manufacturers, I would not be at all surprised to see some of the further investment needed coming from these customers as they will want to accelerate LiCycle’s build out so that it is commensurate with the growing launch of EV’s.

The company went from no sales in four years prior to 2020 to $500k. Its projections are for $12 million in 2021. That would be an impressive 24x of its 2020 revenue. After that it projects consecutive one year jumps to $75 million, $264 million, $700 million. Li-Cycle’s forward 1-year revenue multiple stands at 170x, this however drops to 27x using forecasted revenue for 2022. Somewhat surprisingly, the business is valued at just 3.2x EV/EBITDA based on 2024 projections, which looks extremely cheap so investors are certainly not overconfident.

The very ambitious growth forecasts announced by the company rely on not just contract wins but also on the price of battery metals staying around current levels. Of course should metal prices rise further from here as inflation bulls argue, then this would be very supportive of the valuation case. Hence, the company’s share price in the near-term may be driven by the price fluctuations of lithium-ion battery metals and any potential shift in government policy. Any tightening of governmental environmental policies aimed at reducing environmental harm will of course be a boost: stricter environmental law pertaining to mining enacted across the globe would likely have not only the impact of greater demand for LiCycle’s services, but also perhaps the direct impact of increasing the price of battery metals.

Risks

Li-Cycle is a very interesting company in a new segment which seems almost certain to grow very fast. However, the early stage that the company is currently at means there are several factors that could derail the bull thesis:

1. The Future of Lithium-ion Batteries

There is no guarantee that this type of battery will retain its market share in the future. For example, there are several companies focusing on fuel cells and Toyota plans to launch a revolutionary solid-state battery this year.

2. Prices of Battery Metals

While the revenue and EBITDA projections of Li-Cycle are impressive, it has to be noted that the company is forecasting pretty high prices for nickel, lithium carbonate, and cobalt over the next few years.

Pynk Community Equity Research Li-Cycle - Predicted Prices for Metals
Past performance is not indicative of future performance. Source: Peridot

If prices of these products stay at today’s levels or decrease, the financials of Li-Cycle may be disappointing in 2024 and 2025.

3. Technical Issues

Scaling up is never easy and technical issues are common. In fact, there was a similar recycling start-up company called Aqua Metals back in 2015. It had an award-winning and revolutionary technology just like Li-Cycle and the financials also looked great. The theory was that a single plant capex of $29 million could deliver close to $15 million in annual EBIT. Various technical setbacks and five years later Aqua Metals has quarterly product sales of less than $0.1 million.

4. Funding Shortfall

Li-Cycle will have $566 million in the bank, but this is still short of the $985 million required for capex over the next few years. There is no guarantee that the company can obtain additional funding and going the share issue route could result in significant dilution for investors.

5. Loss Making

The company is at an early stage and loss making. Licycle will only fully ramp up its core business in 2023-2024 and achieve profitability in 2026.

6. Ambitious Forecasts

As highlighted above, the company has very aggressive growth forecasts so the company could significantly disappoint investors if execution doesn’t go as planned.

7. Very Low R&D

It’s remarkable as at first sight, it looks like the spend on R&D since 2018 adds up to a total of only c.$3 million! However, as I highlight above, the numerous environmental technology awards and the technological background of the founders perhaps argues this figure isn’t really the full story.

Conclusion

Electric vehicles (EVs) are often criticised for not being really green as some of the metals used in lithium-ion batteries such as lithium and cobalt require the opening of many new mines. Nevertheless, virtually every auto manufacturer is planning to use lithium ion batteries in their EV’s as it is simply the best solution we have so far technology wise. With EV sales projected to soar over the next several years, the number of lithium-ion batteries that need to be recycled will grow at a rapid pace.

And this is where Li-Cycle comes in. In my opinion they are sitting pretty in a very unique situation: they provide a pressing ‘solution’ to the embarrassing by-product of the ambitious push of most auto manufacturers into EV’s. It’s hard to imagine that these manufacturers won’t jump at the prospect of solving this spent battery problem, almost irrespective of the cost!

In terms of market positioning, Licycle is the largest pure-play recycler of lithium-ion batteries in North America and aims to become the leading recycler of lithium-ion batteries in the world. The financial projections look compelling but will require huge investment and competent execution from this very early stage. The business is valued at just 3.2x EV/EBITDA based on 2024 projections, which looks extremely cheap. Keep in mind though that this is a high risk/high reward type of investment opportunity. The company is effectively a startup and its goals and the resulting earnings forecasts are very ambitious. A lot can go wrong along the way! Overall, despite being somewhat speculative and being reliant on a bright future for lithium-ion batteries, I believe Licycle represents an exciting and very attractive high risk/high reward investment opportunity.

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This material is not investment research in accordance with the legal requirements designed to promote investment research independence and is also not subject to any prohibition on dealing ahead of the dissemination of investment research and as such is considered to be a marketing communication.

All investments have the potential for profit and loss and your capital may be at risk.

Past performance is not indicative of future performance.

The price may increase or decrease as a result of currency fluctuations.

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