Friday, August 19, 2016

Dissension Discount at Focus Graphite

Earlier this week Focus Graphite, Inc. (FMS:  TSX-V or FCSMF:  OTC/QB) announced results from recent drilling tests at its Lac Tétépisca graphite project in northeastern Québec.  The drilling indicated a significant graphite zone 60 to 100 meters wide and extending down from a main graphite corridor that is 600 meters in length.  The company has been working on this area since 2012, in hopes of adding to its adjacent Lac Knife graphite resource. 
A feasibility study published in August 2014 indicated potential for 7.86 million metric tons of proven and probable graphite mineral reserves in the Lac Knife project.  Focus Graphite had previously tested spherical graphite made from Lac Knife ore concentrate in battery coin cell tests.  Management has since touted the natural flake graphite at Lac Knife as highly marketable for use in lithium ion battery anodes. 

Production of spherical graphite from flake graphite is no simple feat,  requiring considerable refinement and processing.  The first steps are typical for handling mineral ores from a mining operation:  crushing and grinding follow by flotation and separation.  Dried ore concentrate is then milled and put through a step called ‘spheroidization,’ in which graphite flakes are mechanically ground into spherical shapes and coated with a thin film of amorphous carbon.  The shape decreases surface area and increases density, two characteristics that lead to better performance of the graphite in a battery anode. 
Spherical graphite was originally perfected in Germany decades ago.  Left unprotected by patents, China’s ambitious resource sector was quick to commercialize the process, using mostly synthetic graphite make from petroleum coke.  Indeed, China has remains the only source of spherical graphite in commercial volumes. 
Graphite supplies and especially the spherical graphite that is most highly prized for battery anodes present something of a conundrum for battery manufacturers.  For example, Tesla Motors (TSLA:  Nasdaq) has publicly declared a high priority on sourcing environmentally friendly batteries for electric cars.  China’s spherical graphite is anything but easy on the earth, beginning with the energy and chemical intensive transformation of petroleum coke to purified graphite.  Graphite producers based in North America are counting on the supply chain goals of companies like Tesla to gain advantage in the graphite market.
True enough natural flake graphite producers like Focus Graphite will have a ‘green’ advantage over synthetic graphite producers.  The hitch is that spheroidization process.  It is barely pronounceable!  More importantly it requires considerable knowhow in chemical and mechanical engineering.  Production of spherical graphite has been described as more art than science.  Even the saavy Chinese producers experience wastage near 60% to 70%.  Mining companies typically have great skills in resource exploration, testing and extraction, but advanced processing steps like spheroidization are new territory. 
Thus resource developers like Focus Graphite have many challenges ahead to deliver graphite to the market that can capture enough value to pay for the costs of extraction.  The company’s website suggests the mine and plant construction will require as much as $165 million in financing.  The company had early discussions in 2015 with Caterpillar Finance Services Corporation related to Lac Knife.  More recently Focus Graphite has announced closings of two tranches totaling CDN$1.9 million in a private placement of common stock that is aimed at raising a total of CDN$4.0 million. 
The recent private placement is well short of financing needed for the mine and plant operation, but it will support testing of Lac Knife and Lac Tétépisc graphite for use in batteries as well as in graphene production.  Graphene is atomic scale carbon, one of the components of graphite.  Early tests show exceptional promise for high-strength metal alloys, electric circuits, display screens and water filters among other uses.  Focus Graphite entered into an off-take agreement with an affiliated company, Grafoid, Inc., a developer of graphene materials.   
Grafoid had been a subsidiary of Focus Graphite until the operation was spun out a couple of years ago.  Indeed, Focus Graphite remains the majority shareholder of Grafoid and the two companies share the same chief executive officer.  In March 2016, Grafiod began discussions with a potential joint venture partner, Xiamen Tungsten Co., Ltd., a manufacturer of tungsten carbide in China.  The relationship looks attractive from the standpoint of Xiamen’s relationships with battery manufacturers in China.  Grafoid announced Xiamen could purchase as much as 7.0 million of Focus Graphite’s 7.9 million shares in Grafoid.
Formalization of that agreement could be a windfall for Focus Graphite, providing the company with a return on its early development efforts in graphene technology.  In my view, if consummated, such a deal could also give new credibility to those very closely forged off-take agreements.
Investors have a choice of shares trading on the Toronto Venture Exchange or quoted on the OTCQB service run by OTC Markets in the U.S.  Volatility is significant in through either venue, but volumes are more ample on the TSX-V.  The stock is currently trading near the middle of its 52-week price range.  For all practically purposes the shares are priced as an option on management’s ability to craft and execute on a winning strategic plan.  There has been some disagreement from within on just what that plan should be, ultimately resulting in the replacement of the Don Baxter as chief operating officer.  Baxter had been appointed president and chief operating office in September 2013, but by May 2015, Baxter was on the way out after disagreements in direction.  Investors taking a position in the stock now could take advantage of the apparent ‘dissension’ discount’, taking the view that Lac Knife and Lac Tétépisca graphite resources are worth more under control of any company than the current depressed market cap.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein. 

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