11 August 2011 Tantalus Rare Earths AG 1 FIRST BERLIN Equity Research TANTALUS RARE EARTHS AG – OVERVIEW 11 August 2011 RATING: Buy PRICE TARGET: €95.00 RETURN POTENTIAL: 212.7% RISK RATING: Speculative TANTALUS RARE EARTHS AG GERMANY / MINING Primary Exchange: Frankfurt Bloomberg symbol: TAE ISIN: DE000A0SMSL4 COMPANY PROFILE Tantalus Rare Earths AG, headquartered in Düsseldorf, is a junior German mining company advancing a 300 square kilometre rare earth and special metals exploration project in northwestern Madagascar. The property hosts heavy and light rare earths, tantalum, niobium, zirconium, gallium and hafnium. TRADING DATA Closing price (10.08.11) €30.38 Shares outstanding 2.35m Market capitalisation €71.42m 52-week range €11.90/50.00 Av. vol. (12 months) 1,492 STOCK OVERVIEW 11.2 16.2 21.2 26.2 31.2 36.2 41.2 46.2 51.2 56.2 Aug 10 Nov 10 Feb 11 May 11 50 100 150 200 250 300 350 400 Tantalus Rare Earths BNREMRS Index COMPANY DATA (as of 31 December 2010) Liquid assets €0.09m Current assets €0.27m Intangible assets €0.00m Total assets €1.56m Current liabilities €0.03m Shareholders’ equity €1.49m SHAREHOLDERS A NEW PLAYER IN RARE EARTHS EXPLORATION Tantalus Rare Earths (TRE) is due to present resource estimates on four of its six exploration targets as well as an extraction concept before the end of this year. We believe this newsflow could substantially narrow the gap between the current valuation and our price target. We initiate coverage with a Buy recommendation and a price target of €95.00. Looking for western champions Chinese producers have secured a near-monopoly position in rare earths in recent years by undercutting western suppliers. A 40% reduction in the Chinese export quota in 2010 sparked an explosion in rare earth prices and has created a clear need for new suppliers. Drilling and pitting results released so far suggest TRE may have the potential to become one of those suppliers. Resource estimate/extraction concept expected this autumn The company has completed over 13,300 metres of diamond drilling on its hard rock targets and dug 246 pits into the argillaceous laterite (clay) targets. Exploration work is proceeding apace and is expected to suffice for the completion of N1-43-101-compliant resource estimates this autumn. We also expect TRE to present extraction concepts for both the hard rock and argillaceous laterite-hosted resource by the end of the year. TRE has high tonnage, low grade resource Exploration results recently published by the company indicate that over half the 300km 2 concession is covered by rare earth-bearing argillaceous laterites. These results, combined with hard rock drilling numbers published in April and June, suggest a high tonnage, low grade resource. Radioactivity is low Thorium and uranium content of the resource on the TRE concession is low. TRE should be able to avoid the environmental problems which currently bedevil the Lynas project and afflicted Molycorp’s Mountain Pass property in the past. Emphasis on more valuable, heavy rare earth elements Exploration results so far have consistently shown that more valuable heavy rare earth oxides account for around 20% of total rare earth oxides on the TRE property. Near-term capacity additions from both Lynas and Molycorp are orientated towards light rare earths. Fully funded until early 2012/TSX listing planned TRE raised €7.1m in new equity capital during H1 2011 and is fully funded until early 2012. TRE plans a listing on the TSX Venture Exchange in early 2012 with a view to financing a planned processing plant. Our recommendation is Buy with a price target of €95.00 In our view, lack of both a resource estimate and an extraction concept account for most of the gap between TRE’s current valuation and our price target of €95. We believe that as these issues are addressed over the next four months, the share price will converge on our price target. Aston Nash/Master Synergy 55.3% BlueGold Capital Management LLP 11.3% Other/free float 33.4% Analyst: Simon Scholes, Tel. +49 (0)30 - 91 68 41 05 INITIATING COVERAGE
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11 August 2011 Tantalus Rare Earths AG
1
FIRST BERLIN Equity Research
TANTALUS RARE EARTHS AG
– OVERVIEW
11 August 2011
RATING: Buy
PRICE TARGET: €95.00
RETURN POTENTIAL: 212.7%
RISK RATING: Speculative
TANTALUS RARE EARTHS AG GERMANY / MINING
Primary Exchange: Frankfurt
Bloomberg symbol: TAE
ISIN: DE000A0SMSL4
COMPANY PROFILE
Tantalus Rare Earths AG, headquartered in Düsseldorf, is a junior German mining company advancing a 300 square kilometre rare earth and special metals exploration project in northwestern Madagascar. The property hosts heavy and light rare earths, tantalum, niobium, zirconium, gallium and hafnium.
TRADING DATA
Closing price (10.08.11) €30.38
Shares outstanding 2.35m
Market capitalisation €71.42m
52-week range €11.90/50.00
Av. vol. (12 months) 1,492
STOCK OVERVIEW
11.2
16.2
21.2
26.2
31.2
36.2
41.2
46.2
51.2
56.2
Aug 10 Nov 10 Feb 11 May 11
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150
200
250
300
350
400
Tantalus Rare Earths BNREMRS Index
COMPANY DATA (as of 31 December 2010)
Liquid assets €0.09m
Current assets €0.27m
Intangible assets €0.00m
Total assets €1.56m
Current liabilities €0.03m
Shareholders’ equity €1.49m
SHAREHOLDERS
A NEW PLAYER IN RARE EARTHS EXPLORATION
Tantalus Rare Earths (TRE) is due to present resource estimates on four of its six exploration targets as well as an extraction concept before the end of this year. We believe this newsflow could substantially narrow the gap between the current valuation and our price target. We initiate coverage with a Buy recommendation and a price target of €95.00.
Looking for western champions Chinese producers have secured a near-monopoly position in rare earths in recent years by undercutting western suppliers. A 40% reduction in the Chinese export quota in 2010 sparked an explosion in rare earth prices and has created a clear need for new suppliers. Drilling and pitting results released so far suggest TRE may have the potential to become one of those suppliers.
Resource estimate/extraction concept expected this autumn The company has completed over 13,300 metres of diamond drilling on its hard rock targets and dug 246 pits into the argillaceous laterite (clay) targets. Exploration work is proceeding apace and is expected to suffice for the completion of N1-43-101-compliant resource estimates this autumn. We also expect TRE to present extraction concepts for both the hard rock and argillaceous laterite-hosted resource by the end of the year.
TRE has high tonnage, low grade resource Exploration results recently published by the company indicate that over half the 300km2 concession is covered by rare earth-bearing argillaceous laterites. These results, combined with hard rock drilling numbers published in April and June, suggest a high tonnage, low grade resource.
Radioactivity is low Thorium and uranium content of the resource on the TRE concession is low. TRE should be able to avoid the environmental problems which currently bedevil the Lynas project and afflicted Molycorp’s Mountain Pass property in the past.
Emphasis on more valuable, heavy rare earth elements Exploration results so far have consistently shown that more valuable heavy rare earth oxides account for around 20% of total rare earth oxides on the TRE property. Near-term capacity additions from both Lynas and Molycorp are orientated towards light rare earths.
Fully funded until early 2012/TSX listing planned TRE raised €7.1m in new equity capital during H1 2011 and is fully funded until early 2012. TRE plans a listing on the TSX Venture Exchange in early 2012 with a view to financing a planned processing plant.
Our recommendation is Buy with a price target of €95.00 In our view, lack of both a resource estimate and an extraction concept account for most of the gap between TRE’s current valuation and our price target of €95. We believe that as these issues are addressed over the next four months, the share price will converge on our price target.
Company profile............................................................................................................................................................9
Historic and current exploration........................................................................................................................... 12
Scheduled presentation of resource estimates .................................................................................................. 15
Accessibility and infrastructure .............................................................................................................................. 15
The world market for rare earths......................................................................................................................... 16
Malagasy politics and mining code ......................................................................................................................... 20
Income statement ...................................................................................................................................................... 24
First Berlin disclaimer ............................................................................................................................................... 26
11 August 2011 Tantalus Rare Earths AG
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INVESTMENT CASE
Rare earths are strategically important and often have no substitute The world market for rare earth metals is relatively small (market value of US$8bn in 2010), but fast growing and strategically important. There is often no substitute for rare earths in applications in such diverse areas as electric vehicles, wind turbines, consumer electronics, glass, ceramics and metal alloys. Chinese control of the rare earth market (its producers currently cater to over 95% of world demand) has created a need for new suppliers. Tantalus Rare Earths (TRE) has not yet presented a resource estimate or an extraction concept, but drilling and pitting results released so far suggest the company has the potential to become one of those suppliers. Growing demand, shrinking supply Worldwide demand for rare earths in 2010 was approximately 135,000 tonnes split roughly 85:15 between light rare earths and more valuable heavy rare earths which are the focus of TRE’s project. Demand is expected to grow to 215,000 tonnes by 2015. Chinese producers have been able to achieve a dominant position in the rare earths market by undercutting western producers through a combination of lower wage costs and less stringent environmental standards. Since 2005 the Chinese export quota has more than halved from 66,000 tonnes to 28,000 tonnes this year. The reduction in the Chinese export quota has caused rare earth prices to explode. Since 2009 the prices of important heavy rare earths such as terbium oxide and dysprosium oxide have risen by 1,150% and 2,140% respectively. The Chinese export quota was put in place primarily to ensure coverage of growing domestic demand. Given that Chinese rare earth usage continues to grow, relaxation of the Chinese export quota is unlikely. Commodity price moderation likely from mid-decade but decline to 2009 levels unlikely With Chinese supply restrictive and prices high, western producers are bringing on new rare earths capacity. The two largest near-term capacity additions are the Lynas and Molycorp projects detailed in figure 10 which are scheduled to come onstream in 2012. However, both these projects emphasise light rare earths rather than Tantalus’ heavy rare earths specialty. A list of the most advanced heavy rare earths projects is shown in figure 11. Most of these projects are due to come onstream in 2014/2015. High levels of radioactivity place a question mark against the largest of these projects - Greenland Minerals’ Kvanefjeld mine. But it seems likely that new western capacity will cause heavy rare earth prices to decline from 2015. The possibility of a return to 2009 price levels however looks very remote given the likelihood of continued robust demand, restrictions on Chinese supply, rising Chinese wage costs and environmental constraints in the west. High tonnage/low radioactivity resource emphasising heavy rare earths TRE has not yet presented a resource estimate. First resource estimates (for four of the company’s six exploration targets) are scheduled for this autumn. However, conservative interpretation of drilling and pitting results released so far suggest 675m tonnes of rare earth-bearing clays (argillaceous laterites) hosting 135,000 tonnes of heavy rare earths. Significant additional light rare earth and rare metals resources, some of which are hosted in hard rock, are also likely. However, we have not taken these into account in our valuation which is based exclusively on the heavy rare earth resource. We estimate that heavy rare earths account for over 75% of the value of the resources on the TRE concession. The ore on the TRE concession is characterised by low levels of uranium and thorium. This means that TRE is unlikely to encounter the environmental problems currently being faced by Lynas. Low grade offset by easier mining and processing of clays We have modelled an average grade of 0.1% TREO (total rare earth oxides) with HREOs (heavy rare earth oxides) accounting for 20% of TREO. The overall TREO grade is low relative to the other western projects (see figure 11). However, it compares well with the average grades (0.05-0.2% TREO) of the ionic adsorption clay-type rare earth deposits in China. These ionic adsorption clays are currently the second largest source of rare earths in China. Easier mining (the clays are a
11 August 2011 Tantalus Rare Earths AG
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surface resource) and processing offset the low ore grade in China and we expect that this will also be the case on the TRE concession. Resource estimates, extraction concept to push share price to our €95 target. We initiate coverage with a Buy recommendation In our view the gap between the current share price and our price target is primarily attributable to the lack of a NI-43-101-compliant resource estimate and an extraction concept. TRE is scheduled to present first resource estimates (for four of the company’s six exploration targets) as well as an extraction concept by the end of this year. Providing that the resource estimates are at least in line with our assumptions and that the extraction concept is viable, we believe that this newsflow will push the share price towards our price target. Our recommendation is Buy with a price target of €95.
11 August 2011 Tantalus Rare Earths AG
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VALUATION
Lack of resource estimate, extraction concept explain gap between current valuation and potential TRE’s Malagasy project is still at an early stage. Substantial progress has been made in exploration but first resource estimates (for four of the company’s six exploration targets) will not be available until this autumn. In addition the company still needs to present the market with a viable extraction concept. These deficiencies coupled with the current out-of-favour status of junior mining companies have in our view produced a large gap between the current market capitalisation of TRE stock and the potential value of the TRE concession as a producing mine. Near term newsflow will be crucial Figure 1 below shows our enterprise valuation of €219.7m for TRE based on what we believe are conservative assumptions. TRE intends to present resource estimates for four of its six exploration targets as well as an extraction concept by the end of this year. Positive news on these topics could push the stock beyond our price target. Valuation based solely on HREEs within the argillaceous laterites Our valuation concentrates exclusively on the heavy rare earth elements within the argillaceous laterites. We have not considered the light rare earth elements, the rare metals or the hard rock resource. We have taken this approach for several reasons:
1. Accumulated geological information and drilling and pitting results make possible a reasonably well-founded valuation of the rare earth-bearing argillaceous laterite resource even in the absence of an officially sanctioned resource estimate. This is not the case for the hard rock resource.
2. The potential value of an operation mining purely the argillaceous laterites is in our
view well above the market’s current valuation of the firm. Because the argillaceous laterites are a surface resource and therefore easy to mine, any initial production would be likely to focus on them.
3. On the basis of information provided by SRK Exploration Services Ltd. at the end of
2010, we estimate that at current prices heavy rare earths comprise over 75% of the value of the resources on the TRE concession. Given that slated near-term capacity additions from Lynas and Molycorp both emphasise light rare earths, we expect this figure to increase over the next two years. Production from a future TRE mine is likely to emphasise heavy rare earths.
We assume 150km2 of argillaceous laterites….Recently released exploration results (26 July) suggest that over half the concession is covered by rare earth bearing argillaceous laterites. The area of the TRE concession is 300km2. We have assumed an area of 150km2
overlain by argillaceous laterites. …at average 3 metre thickness TRE has so far explored the argillaceous laterites on targets 1, 3 and 4. We estimate the weighted average thickness of the argillaceous laterites for which pitting results have been produced so far is 4 metres. In the absence of a resource estimate we base our valuation on an average thickness of 3 metres. This implies a total volume for the argillaceous laterites of 450 millon metres3. Assuming an average weight per cubic metre of 1.5 tonnes, this implies 675 million tonnes of ore.
11 August 2011 Tantalus Rare Earths AG
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Our valuation based on basket value of US$280/tonne vs. current US$500/tonne We calculate a basket value for TRE’s in situ heavy rare earths based on current commodity prices of US$500 per tonne of ore. We assume that TRE will begin mining in 2015. Over the long term, heavy rare earth prices are likely to be supported by robust demand growth, restrictions on Chinese imports, rising Chinese wages and environmental issues. However, by 2015 at least some of the heavy rare earth projects shown in figure 11 should have started producing and commodity prices are likely to decline. We have used a price of US$280 per tonne of ore throughout an assumed 15 year life for the TRE mine (2015-2030). The US$280 per tonne of ore assumption produces a total value of metal in the ground of US$189bn (€132bn). Valuation based on farm-out agreement and current capital structure Moves by TRE to mine and extract the resource on its concession would require additional financing. As we indicate under the financial position section of our report, we expect TRE to make a capital increase next year in order to finance additional mining equipment and an extraction plant. However, for the sake of simplicity we base our valuation on the assumption that TRE concludes a farm-out agreement. This assumption allows us to base our valuation on the current capital structure. Our valuation is €95 per share We assume that a farm-out agreement would entail royalty payments of 1% of ore value. On the basis of our US$280/tonne ore assumption, this would imply cashflows to TRE over the life of the mine of US$1.89bn. Our enterprise valuation of TRE of US$314.1m is based on discounting this figure by 83% to take account of the following:
1. assumed mine start January 2015 2. assumed 15 year mine life 3. 20% discount rate (reflecting uncertainty as to the whether resource estimates
forthcoming this autumn will support our tonnage and grade assumptions and the validity of our commodity price assumptions).
Our price target of €95 per share is based on adding the current cash balance of €3.5m to our
enterprise valuation of €219.7m.
1.TRE concession area 300,000,000m2
2. Area of concession overlain by rare-earth bearing argillaceous laterities 150,000,000m2
3. Average depth of argillaceous laterites (1. X 2.) 3m4. Volume of argillaceous laterites (2.X 3.) 450,000,000m3
5. Tonne:m3 1.506. Tonnage of argillaceous laterites (4. x 5.) 675,000,0007. Rare earth value per tonne US$2808. In situ rare earth value (6.x 7.) US$189bn9. Aggregate value of 1% royalty stream (1% X 8.) US$1.89bn10. Enterprise valuation derived from 1% royalty st ream discounted US$314.1m/€219.7mby 83% based on following assumptions: a) assumed mine start January 2015b) assumed 15 year mine lifec) 20% discount rated) US$:€ exchange rate: 1.4311. Cash balance August 2011 (€m) €3.5m12. Equity value €223.2m12. Fair value per share (€) 95.0 Figure 1: TRE valuation summary Source: First Berlin
11 August 2011 Tantalus Rare Earths AG
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SWOT ANALYSIS
STRENGTHS
• Current supply shortfall likely to widen further between now and 2013 World
demand for rare earth elements is currently growing at 20,000 tonnes (c. 10%) annually.
Capacity additions are unlikely to match this growth until 2013 at the earliest.
• Project orientated towards more valuable heavy rare earth elements TRE’s project is
orientated towards more valuable heavy rare earth oxides (HREOs). Drilling and pitting results
released so far indicate that HREOs account for around 20% of total rare earth oxides (TREOs).
Comparable figures for the large near-term capacity additions from Lynas and Molycorp are 2%
and 0.5% respectively.
• Very high tonnage, low grade ore body TRE is not scheduled to release an NI 43-101
compliant resource estimate until the autumn. However, recent exploration results indicate that
over half the 300km2 concession is covered by rare earth-bearing argillaceous (clay) laterites.
These results combined with hard rock drilling numbers published in April and June suggest a
very high tonnage, low grade ore body.
• Low radioactivity In keeping with the low grade of the ore body, the presence of radioactive
uranium and thorium is low. This suggests that environmental hurdles will be much lower for
TRE than they are currently for Lynas or were historically at Molycorp’s Mountain Pass site.
WEAKNESSES
• Project is still early stage The TRE project is still at an early stage. The resource estimate
scheduled for the autumn and the presentation of a viable extraction process should raise
confidence in the project and ease future financing.
• Unconventional management structure TRE’s management team consists of eight
persons, COO, Wolfgang Hampel; Chief Administrative Officer, André Klupsch; Executive
Directors Philip Gray, Lee Goldsmith, Paul Loudon, Ivan Murphy, Paul Richards and David Rigoll
(the majority shareholder). There is no named CEO.
OPPORTUNITIES
• Heavy rare earth element deficit may persist for some time The two largest near-
term non-Chinese capacity additions (Lynas and Molycorp) are both orientated towards
generally more abundant, less valuable light rare earth elements. This suggests that the current
deficit in heavy rare earth metals may prove persistent, thereby raising the strategic value of
TRE’s project.
• Memorandum of Understanding with China Non-Ferrous Metals (CNF) could lead
to off-take agreement The Chinese authorities are known to be concerned about a possible
future rare earth supply shortfall to their domestic industry. In order to secure supplies, the
Chinese authorities made an abortive attempt to acquire a majority in Lynas. They later
succeeded in taking a 25% stake in Arafura. CNF signed a MOU with TRE In April. Providing
that REE extraction from TRE’s ore body proves viable, we believe an off-take agreement with
CNF is possible.
11 August 2011 Tantalus Rare Earths AG
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THREATS
• Economic extraction may prove difficult TRE has not yet presented a viable extraction
process. Given the low grade of the ore, development of such a process may prove difficult.
• Malagasy politics are periodically turbulent but current authorities support mining
Malagasy politics since independence from France in 1960 have featured disputed elections and
two coups. The current Head of State, Andry Rajoelina, assumed the title President of the High
Transitional Authority of Madagascar following a military-backed coup in March 2009. A
presidential election was scheduled for 4 May 2011 but has been postponed until the end of the
year. Notwithstanding these irregularities, the current situation is tense but stable. The
authorities are supportive of international mining companies. Besides TRE, Rio Tinto Zinc,
Sherritt International, Diamond Fields International and Jubilee Platinum all have significant
producing mines or exploration projects on Madagascar.
11 August 2011 Tantalus Rare Earths AG
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COMPANY PROFILE
Low grade but high HREO ratio, low radioactivity, high tonnage TRE AG’s head
office is located in Düsseldorf, Germany. The company is listed on the open market segment
of the Frankfurt Stock Exchange. TRE’s main asset is a 300km2 rare earths-tantalum-niobium-
zirconium exploration project located in northwest Madagascar. TRE has identified six initial
targets to be explored. The exploration license is valid for ten years until April 2013 and is
extendable by two three-year periods. The annual cost of the license is US$45,000. The
license was originally acquired by Calibra Resources and Engineers and then transferred to
Zebu Metals in January 2008. TRE acquired the license from Zebu Metals in October 2009.
On the basis of preliminary estimates made by the consultant, SRK Exploration Services Ltd.,
at the end of 2010, we estimate that rare earth oxides would account for around three
quarters of any revenue from the project with the next most significant products - niobium
and tantalum - accounting for 10% and 7% respectively. Drilling results produced so far
suggest the rare earth ore at the Tantalus project is low grade. We estimate an overall figure
of around 0.13% of total rare earth oxides (TREOs). However, this is compensated by a
relatively high ratio of more valuable heavy rare earth oxides (HREOs) to light rare earth
oxides (LREOs) at 20:80, by low levels of radioactive uranium and thorium and also probably
Figure 10: Known major non-Chinese rare earth capacity additions
Lynas Lynas Advanced Material Plant scheduled to come online in Q4 2011Full capacity of 11,000 tonnes p.a. rare earth oxides to be reached by end H1 2012
Phase 2 construction entailing further 11,000 tonnes p.a. rare earth oxide scheduled complete Q4 2011. Phase 2 full capacity end H1 2013?
MolycorpCapacity of 19,050 tonnes p.a. rare earth oxide on stream by end 2012Capacity to expand to 40,000 tonnes p.a. rare earth oxide by end 2013
ArafuraCapacity of 19,050 tonnes p.a. rare earth oxide on stream in 2013
Source: companies
Figure 10 above shows the capacity introduction plans of Lynas, Molycorp and Arafura. These
three companies plan to introduce aggregate new capacity of 80,000 tonnes REO during the
period 2012-2014. Figure 11below details eight advanced heavy rare earth projects which are
expected to begin producing during 2014-2015.
Figure 11: Major HREE projects scheduled to begin producing during 2014-2015