Rio Tinto have taken advantage of the lithium industry’s woes by swooping for Arcadium (NYS: ALTM). Here’s a breakdown of the takeover, what Rio will get for its money and whether we think they got a good deal.

What’s happening?

Rio Tinto have agreed to acquire lithium firm Arcadium for USD $5.85 per share in a deal worth roughly USD $6.67 billion or A$10 billion.

If the deal goes ahead as expected, it will bring an end to Arcadium’s brief but bruising time as a public company since it was created in a merger of equals between Alkem and Livent. That deal was completed in January 2024, at a time when lithium prices had already fallen drastically from their 2022 highs.

As it turned out, there was more pain ahead. The takeover price is some 20% lower than the price that Arcadium started trading at post-merger, even after Rio paid a handsome premium of over 30% to get the deal over the line.

What does A$10 billion buy Rio?

A$10 billion buys Rio one of the world’s five biggest lithium producers by capacity and highly attractive assets firmly towards the bottom of the cost-curve.

Arcadium’s two in-production lithium carbonate assets in Argentina are among the world's lowest-cost resources of their kind. So low, in fact, that the assets were still profitable at the multi-year low lithium prices of $7000 per ton in 2020 and the company has still recorded quarterly profits through the recent downturn.

This position in the bottom quartile of the cost-curve for lithium carbonate underpinned the Narrow Moat rating that Morningstar’s Seth Goldstein assigned Arcadium as a stand-alone company.

Even at low points in the cycle, it is likely that the company’s assets will be able to deliver profits above its cost of capital. As our global mining analyst Jon Mills put it, miners positioned towards the low end of their respective industry cost-curves generally stay profitable even in the worst commodity bear markets.

Potentially buying at a good point in the cycle

Rio’s purchase is counter-cyclical. By that I mean it has come at a time where lithium prices are at a fraction of the levels seen in recent years and sentiment towards the industry couldn’t be much worse.

The drop-off in price to current levels of around $10,500 per ton was the result of a classic boom-bust cycle, as supply increases in 2022 and 2023 overshot healthy growth in demand driven by electric-vehicle adoption.

In a recent research note on lithium, Seth Goldstein expressed confidence that prices will eventually recover towards $20,000 per ton as lower spot prices see suppliers with higher costs leave the table. The $20,000 per ton figure reflects his estimate of lithium carbonate’s marginal cost of production, the price level at which he thinks supply and demand would be balanced.

By buying at a low point in the cycle, Rio appears to have secured a bargain price for Arcadium’s assets. Goldstein’s most recent Fair Value Estimate for Arcadium as a stand-alone company was US $10 per share, or almost double the price that Rio have agreed to buy the company for.

Greenfield assets bring potential upside

According to Goldstein, the US $5.85 deal price could probably be justified by current production volumes alone. Rio could therefore unlock extra upside from Arcadium’s development portfolio, which is home to two assets in Canada and two more in Argentina.

Rio will obviously have to fund the development of these assets from here. But its experience, scale and cash resources potentially should put it in a better position to execute on this than Arcadium was.

Both Livent and Allkem struggled with project development in the past and failed to bring on these new resources in time to benefit from the boom-era prices in 2021 and 2022.

How material is this to Rio?

When you compare Rio’s outlay of A$10 billion for Arcadium to its market cap of almost A$200 billion and 2023 earnings of almost $15 billion, this isn’t exactly a transformative deal. And for all the talk of this being a ‘major play’ on lithium, Jon Mills says “Rio is still all about iron ore”.

Mills expects the purchased lithium assets will contribute “around 5% to the enlarged Rio’s midcycle earnings”, compared to about 75% from iron ore, with the remainder comprised of copper and aluminium.

Of course, the acquired assets could become more material to Rio’s overall earnings if lithium prices eventually settle at a significantly higher level.

Will the other mining majors be tempted?

With all of that in mind, my first thought was that this seems a bigger deal for the lithium industry than it is for Rio. Could it be a starting gun for more major buyouts? A way out of the misery for the industry’s beleaguered stocks?

Mills isn’t so sure. Mostly because he doesn’t see another obvious buyer for the biggest lithium assets out there.

“Glencore and BHP aren't interested in lithium because they differ to Rio in thinking the long-term industry cost curve is too flat, meaning there will be less difference between the unit costs of the lowest and highest cost producers compared to a steeper industry cost curve such as copper” he said.

“They think this would make it hard to buy or develop a mine that stays in the lower half, or ideally in the lowest quartile, of the cost curve over the cycle.”

Mills has noted a tendency for mining majors to follow each other’s moves in the past. But, for now, there seems to be a real divergence in opinion when it comes to lithium assets. And the pool of miners with 1) the cash resources or market capitalisation and 2) the expertise to make a major lithium deal isn’t exactly huge.

As a result, a buyer from elsewhere – potentially an automaker or an energy company like ExxonMobil looking to diversify away from oil and gas – may be more likely.

Rio looks fairly valued

After the deal was announced, Mills upgraded Rio Tinto’s Fair Value estimate to $112 per share to account for what our analysts believe is a value-accretive transaction for the company.

This modest bump reflects the small nature of the takeover relative to Rio’s size and the fact that iron ore is set to remain the key driver of earnings going forward. At a current share price of around $120, Rio shares look modestly overvalued and have a 3-star rating.
On the other side of the coin, Seth Goldstein adjusted his Fair Value estimate for Arcadium down from $10 to the announced deal price of $5.85 per share.

Goldstein also downgraded the company’s capital allocation rating to Poor from Standard. This reflects his opinion that management agreed to sell at a price far below the company’s intrinsic value and therefore destroyed value for shareholders.

Rio Tinto

  • Economic moat: None
  • Fair Value estimate: $112 per share
  • Share price October 15: $122 per share
  • Star Rating: ★★★

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Terms used in this article

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company's future cash flows, resulting from our analysts' independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn more about how to identify companies with an economic moat, read this article by Mark LaMonica.