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Grizzly Rock Capital's Kyle Mowery + Mike Holt on secular tailwinds for silicon metal producer $GSM (podcast #196)
Kyle Mowery and Mike Holt, CFA, Managing Partner / Portfolio Manager and Senior Analyst, respectively, at Grizzly Rock Capital joins the podcast today to discuss their thesis on Ferroglobe PLC (NASDAQ: GSM), a leading producer globally of silicon metal, silicon-based and manganese-based specialty alloys.
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Transcript begins below
Andrew Walker: Hello, and welcome to The Yet Another Value Podcast. I'm your host, Andrew Walker. If you like, this podcast would mean a lot if you could rate, subscribe, review wherever you're watching or listening to it. With me today, I'm happy to have on the team from Grizzly Rock and Covest Capital, Kyle Mowery and Mike Holt. Guys, how's it going?
Kyle Mowery: Good. Great. Thanks for having us back.
Mike Holt: Yeah, thanks for having us.
Andrew: Hey, thanks for coming on. Happy to have you guys on for the second time. I think the first time was with Jake, not Mike, though, right? So we've got the same old guy here, but a new secondary.
Kyle: [inaudible] experienced or experienced.
Andrew: That's right. But before we dive in, let me just remind everyone, nothing on this podcast is investing advice. Please go consult a financial advisor. We're going to talk about a reason price stock, but it files 20 Fs. It's pretty cyclical, so people should just remember it's not investing advice. Please do your own work and consult a financial advisor. That out the way, Kyle, Mike the company you want to talk about is Feral Globe. The ticker is GSM. It is super interesting because the story has changed a lot since kind of things got weird in 2019. Things got weird during 2020. The story's been changing a lot. Maybe the market hasn't picked up on some of the inflection points here, but I'm rambling. I'll turn it over to you, Kyle, Mike, what is Feral Globe and what makes them so interesting?
Kyle: Yeah, so Feral Globe is a billion-dollar market cap business with sort of a sorted history of financial leverage. It was a busted merger, although the merger strategically made sense, the business was over-levered. But all those issues, in our opinion, are behind us and now there are secular tailwinds. So before we dive in too far, they are a producer of silicon metal, which is pretty early on in the supply chain into aluminum steel, and most importantly, solar panels. You cannot make solar panels without photovoltaic cells, and you need silicon metal to make those. So it is largely a solar play with the de-levered balance sheet. So I know a lot of folks are probably groaning this one bit, a lot of guys, but it's actionable in our opinion and we just wanted to unpack it here a little bit today.
Andrew: Mike, did you want to add anything on there?
Mike: Yeah, I think what Kyle said is right, and we think there's a lot of structural changes that have been made to the business that aren't being recognized in the value of the stock at all, and it's kind of a smaller industry that maybe doesn't get a lot of headlines, but has some real interesting demand dynamics going on over the next decade plus. So we're pretty excited about this opportunity.
Andrew: Perfect. So I guess the first thing, there's so many different places we can go. The company did an analyst day back in May, 2022, where they kind of went through the history and some of the exciting stuff. But I guess maybe let's start with, people are going to hear, Hey, this is a commodity producer. They're connected to solar. I think we will talk about China exports and China dumping in a second, but I guess the first thing people are going to ask is how do you value this company? EBITDA two or three years ago is basically nothing. They're guiding to $270 to $300 million in EBITDA. How do you value this company? Where are we in the cycle? Is this top, is this bottom, is this mid-cycle? How are you looking at that?
Kyle: Yeah, so we value it on free cash flow, on street numbers. The stock with zero financial leverage is trading at about a 23% to 24% free cash flow yield on next year's numbers. Next year, we Grizzly Rock are in and around $375 on EBITDA. We think that's largely mid-cycle. We think bottom of the cycle is probably in the $200-ish range. Reason is they've done $200 million of cost cuts here, and then in 21, they had over $800 million of EBITDA. So yes, highly cyclical, which is why the business should not have financial leverage, which it does not. But yeah, that mid-cycle number, which our number is 375, but we actually think that number goes far higher with the solar growth based on the inflation reduction act. So we can get into that in a little bit. But...
Andrew: Mike, I'll just also serve you the- Kyle mentioned unlevered, and I think the two things there are A, if you look at the balance sheet, they do have debt on the balance sheet. So people might look at that and say, what do you mean unlevered? And then the second thing that kind of struck me is if you go back to 2019 and 2020, this was a business that, not that it was wildly overlevered, I think it might've been on the heels of the merger in 2015. It wasn't wildly over the levered, but it did, it definitely had leverage and one of the things that struck me is they, not to spoil the plot, but they've brought down leverage a lot. So maybe we can talk about unlevered balance sheet, how they got their leverage down, and maybe later in the conversation we'll talk about capital allocation going forward.
Mike: Yeah, so when you look at this business in 2019, it was near bankruptcy. The results were pretty horrible and that largely stemmed from not properly executing the merger. There was so much low-hanging fruit on these combined businesses and so when you look at these businesses scale makes a ton of sense. Having a global asset footprint makes a ton of sense. But they didn't have things like simplistically centralized buying. They didn't share best practices across their facilities. You had kind of a culture clash with the US-based assets historically globe specialty metals and the private European assets for Atlantic. So there was a lot of culture clash and issues that weren't addressed. The new management team, CEO, Marco Levy came in January of 2020 and brought in Bain to do a big look at their cost structure.
Brought a lot of his guys in from his past at Dow. Guys that have a lot of experience in operations and businesses like this and they were able to identify a massive amount of cost cuts. Since then they've executed on those cost cuts and it also coincided with a period of rising silicon metal pricing. So you can kind of see from 2020 to 2021 to 2022, as these contracts reset, as these cost cuts flowed through, they were able to generate an incredible amount of free cash flow to effectively delever the balance sheet. So when you look at the balance sheet now, we think they flipped to net cash. This quarter, they're working on kind of the optimal capital structure. They've historically called out a $200 million of gross debt that may come lower just given the current rate environment and the financing markets for metals and mining businesses. But effectively they're going to run from now forward as a completely unlevered company, net cash positive, and we think with that becomes a lot of capital returns to shareholders.
Andrew: Yes, and just to defend myself, I said they weren't widely over-levered. At the end of 2019, they had $400 million in net debt, which I think Kyle kind of said, Hey, maybe trail EBITDA approaches $200 million. Yes, there's real CapEx here in stuff, but that's not a wild amount of leverage. The issue was at the end of 2019, the business results were awful and when you have awful business results with a cyclical business in any debt, it's always a problem. Okay. So Kyle, before we dive into a couple of different things, I just want to ask you, you mentioned sales side's got them at like 20% plus free cash flow next year. The IRA story, it's not like the company's shy about telling people, Hey, we're going to be a big beneficiary of the IRA, everybody kind of knows that solar is probably a thing. We will talk China in a second, but what do you guys, when you look at this business, and people can see what people think the price circuits are, I think you guys have a deck that people can maybe email you or figure out a way to get- We can talk about that later. But when you guys look at the business, what are you seeing that you think kind of the street, the market, everyone is misunderstanding that's kind of presenting an alpha opportunity here?
Kyle: Sure. So the first is they absolutely operate in commodity markets. However, they're the number one producer in the US and the number one producer in Europe, and based on the climate-related bills, the IRA and the net zero bill in Europe mandate supply chain be domestic, including all the way back to the source of materials. So when you have a secular tailwind for solar, it's going to benefit the number one player from a volume perspective. So what we are underwriting is massive increases in volume for this company, right? Because of solar, it's not a play on the price going higher, although we do think the price does go higher as all these solar plays come on. It's really about volume and where are they going to get the volume? It's Feral Globe. So you're taking a historically perceived as a commodity business.
You got a steady aluminum and steel, and these are cyclical in markets and you're transforming the business to having a secular tail driver of massive, massive volume that has to come from onshore. So where's it going to come from? It's necessarily Feral Globe and so the confluence of those events deemphasizes the commodity aspects of the business of the end markets. Plus you have the cost cuts which have been proven out, and you have the capital return, and zero financial leverage allows you to have the operating leverage to the commodity as a positive. Does that make sense?
Andrew: It makes total sense. Let me dive into that a little quicker. So you mentioned commodity business. Anyone who's done anything in these company and anything commodity knows it's all about supply and demand, right? And boom, times when demand is higher than supply, prices go up and these guys make money and bust times when demand is lower than supply prices go basically to marginal cost. It's awful for everyone. Things get shared. I guess the three things I want to ask is, number one, just globally, what does the supply-demand curve look like? Because I do think a lot of capacity came out during COVID. There might be China over capacity. I think China's building a lot so maybe we can talk about all that. Number two, you mentioned the play on the IRA. So if I am right in understanding what you're saying, it's, hey, even if we went into a scenario where globally we're oversupplied and the US we're kind of going to be undersupplied because there'll be all this IRA demand and it can only come domestically, and who's that going to benefit? It's going to benefit anyone. In the US, they have disadvantaged positions. So you've kind of got that boom cycle there. There was a third point I was going to make, but I actually just threw a ton at you. So let's comment on those. I can refresh you on anything, and I'll try to think of my third point.
Kyle: Mike, why don't you hit supply demand in China?
Mike: Yeah. So the way to think about this market is kind of in two separate segments. So when you think about the non-Chinese consumption and supply, those countries run at a deficit. So they are importers from China. China is the swing ton historically. What's been interesting though is two pieces. You have one as Kyle mentioned, kind of the onshoring elements, the criticality of supply chains. So you've seen both the US and Europe apply the critical raw material to silicon metal. So they want to be more focused on domestic production and not importing. So when you look at the US, Feral Globe produces 80% of the production. In the US, there's a couple of other small players that produce the 20%, and then the rest is imported from Brazil.
In Europe, Feral Globe has about 40% of production. Another 30ish percent comes from a publicly traded company called AlChem and then it's a bunch of small producers. So when you look at the global supply picture, it's very fragmented outside of China, outside of Feral Globe. They're by far the largest player and they also have the ability to bring on capacity. From a China perspective, China has been focused on less exports of energy-intensive commodities like silicon metals. So what you've seen in recent years is they've been shutting down a lot of production in the inner part of China because it's largely coal-powered. There's environmental issues. It takes extra cost to ship it out to the coast and then ship it.
And then they're also focusing on their own supply chain. So solar supply chain. So what you've seen is the domestic consumption in China of silicon metal is growing rapidly, and between the capacity that they shut off, they are bringing on some new ones. But it's largely offsetting what they're shutting off. The supply picture there is largely staying flat, but their consumption is growing. So you're seeing those tons coming out of China. They've already shrunk by over 200,000 tons over the past three or four years and it's expected to decline 35% over the coming years. So that leaves the rest of the world at a structural shortage of silicon metal especially when looking at these demand drivers like solar and, and like battery that could easily double the consumption of silicon metal in the next 10 years.
Andrew: That was perfect. That's perfect. Kyle, I don't know if you want to take it, or Mike if you want to take it, but just domestically thinking about the IRA, does domestic supply go into structural shortage regardless of what's happening internationally just because of the IRA?
Kyle: It depends on what's going on in say, the automotive market. Right now we got UAW strike and industrials around and around you go, there's always going to be some problem somewhere in the world. So I think, the way I think about it from 30,000 feet is the solar growth takes up a ton of demand. We actually have the company and these are our numbers, spending a little bit of money to convert some production from Pharaoh silicon, which Pharaoh is iron, iron in general industrial products into solar silicon metal productions, silicon metal, 60% of the EBITDA for the business last year. We think that grows over time a lot higher. We also think they are going to expand capacity in North America to meet this growing demand.
But yes, in the end, the macro does matter here, which quite frankly is one of the reasons why the stock is where it is. Even though we're telling you all these wonderful things, go forward. Why would someone not buy the stock right now? Well, macro, right? If we get a big recession, maybe demand falls a bit regardless of the solar growth because the solar growth's really going to start picking up into next year, '24, and then '25 and beyond. So, it's absolutely real, the macro does still matter,
Andrew: On macro, the nice thing here is you see this in a lot of places. I think there are a lot of places- I always think back to Bobat[?] coming on the podcast and be like, Hey, the old economy, like if you make something, if you've got a chemical plant that costs a billion dollars to make over the past seven years, they probably haven't made any more. You're just in structural shortage and yeah, if we have a recession, things are going lower in the near term. But the nice thing about GSM and a lot of these industrial and commodity players is they've had this boom pricing for the past couple of years. They've paid off all their debt. So yeah, the stock's not going to double in a day if we go into a big recession, but you know what, it's also not going to go bankrupt and two years ago you couldn't say, Hey, could this company- and I say this company, not just GSM, a lot of these commodity companies, you couldn't say they could survive a recession. Now their balance sheets are so strong, unless we go into a 10-year great depression, they're going to survive and you'll still get that structural shortage. It'll just be a year, two years, 36 months from now.
Kyle: With solar, our numbers for 25 are about 30% higher on EBITDA simply from that. So for the down cycle, to take that completely away would be very rare, right?
Andrew: How much of their earnings is coming from solar currently?
Kyle: So last year about 14% was going into this market, our numbers that are in 2026, that number's going to be something like 50. So it's going to go up in order of magnitude, it's essentially going to triple and when it does, that will also lead to an increased perception of the business. So we're not using lofty multiples on this business. I think in our base case, we're using a five, maybe six, and upside case ev debater type, multiple free cash flow. It's going to be in the double digits for sure on our intrinsic value. But as the numbers step higher, you don't need multiple expansions to get the stock from the low fives to say 15. In and round of triple is basically coming from free cash flow generation, capital return to shareholders, and really just getting in gear with what the IRA has asked the US industrial economy to do.
Mike: I'd just add to that too when you think about that mix shift, the other important pieces, these contracts are now going to be long-term. The solar production and some of these other high-value markets require high-quality quartz to meet the product specifications. Feral Globe is 70% backwards integrated into quartz. They announced that they just bought another or are working on buying another quartz mine. So that number's going to go up. So when you look at some of these players, they need a specific quality of silicon medal. Feral Globe's one of the only ones that can meet that at scale. So not only are they going to have a mixed shift to solar customers, but these are going to be on long-term contracts and they talked about this a lot when they brought up their South Africa plant. Those volumes, they only brought it up on a two to three-year volume commitments from customers. So, this isn't a company that has any plans to bring on speculative supply. You're going to have to commit to it long-term in order for them to increase production.
Andrew: So look, you've got EBITDA multiples and earnings multiples here, which is great. Ultimately, that's how a business is going to be judged, especially if you've got a structural shortage here. But I just want to ask asset valuation and the reason I ask this is because at their 2022 investor day, they had some really interesting quotes. I've got one right here. Our industry has high barriers to entry, it's capital intensive, technical know-how, blah, blah, blah. Most recent greenfields have failed because they have some of these capital-intensive elements you have to survive through the cycle. They couldn't survive, they weren't well placed for logistics. They didn't have access to quarts or power that you've talked about. We can talk about European power issues in a second. I just want to ask you, when I look at GSM and right now, if I've got my model up, I think you're paying about, and it's got an EV of literally roughly a billion dollars, it almost perfectly comes out to a billion. So that's nice, and easy math. How would you just kind of look at this on an asset valuation basis? If I was like, Hey, Kyle, Mike, we're going to go raise a ton of money and we're going to go build out the Feral Globe, like global footprint, what would that cost to replace?
Mike: Yeah, I can take this one, Kyle. So when you look at a Greenfield facility, it costs around $350 million to make a 60,000-ton silicon metal furnace. So Feral Globe roughly has around just to keep the math simple, 300,000 tons of production. So just on a replacement cost alone, that gets you to, $1.7, $1.8 billion EV just on the silicon metal, not including their other segments. The other piece that if you mentioned a lot of these facilities has failed is silicon metal isn't something that you just go mine, it takes six tons of raw material to make one ton of silicon metal. So, it's coal, it's electrodes, it's quartz, it's wood chips. So there's not many areas where you can build a plant that are going to be able to source these all in a cost-competitive manner.
And then on top of that, Ferroglobe has vertical integration into the most important raw materials. So, from an asset standpoint, these are incredibly valuable assets. It takes three-plus years to build and get the permitting for a new plant. It takes another six to 12 months to get it running at full production. So the supply is very limited from that standpoint. But what's interesting is Ferroglobe has the ability to increase their production by 50% through a couple of Pharaoh silicon furnace conversions, and a few Brownfield projects. So when you look at their potential, they could, down the road be a 450,000-ton silicon metal provider. Again, when you look at that to build a greenfield $350 million for 60,000, that math gets super interesting based on the current EV and giving no credit to their other segments. So...
Andrew: So I guess if I was just taking all the numbers, if I said, Hey, replacement value here is probably one and a half billion dollars, and that's not even giving them credit for a plant that's already built is probably going to be better located than what you and I could source the permits, the time value, getting everything up. But ultimately that would all work out. But it replacement value is probably $1.5 billion and you're buying the business for a billion dollars. So even ignoring, the supply-demand picture, the IRA, everything, you're probably buying it below replacement value and when you buy stuff below replacement value, that tends to work out pretty well unless management really poops the bed.
Mike: Yeah, absolutely, and they have some really good assets and good cost-competitive areas. So that combined with the global footprint, you can't replicate the global footprint when you're selling to customers that are global, that really helps as well. So yeah, we think these assets are incredibly value and misunderstood by the market given the demand that's coming for silicon metal.
Andrew: Let's talk a little bit. So I'm looking at your deck. Weak management, right? A lot of people think of this company and think weak management. They think back to the 2015 merger, poor integration, the company almost goes bankrupt. I think people look at the new CEO comes in and I think he's done a pretty nice job, but I do want to talk on management in particularly, there's a controlling shareholder here, right? I think it's group OVM, they own about 50% of the stock and if things have gone really well from 2020 to today, and maybe they get credit for that, but if things go really poorly from 2015 to 2019, they probably get credit for that too. So I want to talk about measurement and particularly the semit control shareholder because I did get some people who were like, Hey, somebody owns 50%, they filed a 20F, they bad merger historically. Like, are minority shareholders going to be the ones who actually make money here? Are they going to just make money here?
Kyle: Yeah, let me take a stab there. So first of all, on management, we are big fans of CEO Marco Levy. We think from an operating and commercial perspective, he's done an excellent job. He is definitely not the quote-unquote standard US small-cap CEO, he prefers to speak softly and let his actions do the talking, which is wonderful except when it comes to promoting the stock. So that's a separate topic. But in terms of execution, since he's come in, it's been exemplary and we in fact thought they were going to cut the guide based on macro on Q two call they didn't, they held the guide based on those cost cuts, which was just, again, additional proof that we even as bulls were not giving them credit for because it hadn't been borne out yet, and now it is being borne out.
So we think he is doing an exceptional job. With respect to the large shareholder yes, that's the legacy family that owned the Pharaoh Atlantica asset. We believe there is alignment there. Now, the negatives in terms of if an activist were to look at this, then they wouldn't be able to do anything. There is yes, a controlling shareholder. However, that controlling shareholder has expressed a continued through their chairman, through the executive chairman expressed a desire for capital return and capital return aligns us, whether it's share of purchase or dividends and I think they're going to do both towards the end of this year and then picking up as we go forward. I think you're going to do both. So I do think the alignment is there, there's professional management and I think this stock was in the high teens before and the same shareholder was there. So we don't see any reason, we don't see any way that capital can sort of go other than to everyone equitably and [inaudible].
Andrew: I want to [inaudible] capital allocation. Go ahead, Mike.
Mike: Yeah, I was just going to add in, you mentioned minority shareholders getting screwed in other things, and when we think about a catalytic path in terms of the stock working, the company in 2021 had to issue some punitive bonds that they're currently paying off and will pay off the res this fall. Those bonds don't allow capital returns to shareholders. So we think once the company pays those off and lays out a plan that's going to get a lot of people to take a look at this and realize that they are going to receive a lot of this cash flow and there's going to be with the growing demand of silicon metal, a lot of it to come back to shareholders.
Andrew: We'll talk capital allocation a little more in one second, but just one more on group OVM. So I think that you sent 50% and then this year's 20F showed that they own kind of like 43%. So it looks like they sold a decent bit over the past year or so. I'm not sure if I was misreading it or if there was something else going on or something, but just longer term, they're obviously in favor of capital returns. I heard some people say, Hey, maybe these guys like need more than capital returns. What do you think their plans are longer terms? They've been in here for almost 10 years at this point, if I'm thinking about it correctly, are they going to hold this for 30 years? Do they want to sell their stake? Because they want to sell their stake, do they sell the whole company? Do we see a big secondary where the company buys back a lot of stock? How do you think about those dynamics?
Kyle: So it's a good question, but it's not a question that we're in a great position to answer, right? As minority shareholders, we've effectively asked that, especially around the sell-down. We kind of said, guys, why are you selling down? And they said, well, we the family need some money and most of their other businesses are private and so this was one area that had liquidity. Also, just mathematically, if they start buying back stock next year, their ownership percentage of the business actually would then kind of revert back up. So in a way it's it's just a timing thing on capital allocation, like Mike said, the dividends were not available. The working cap flowing through the bonds are going to get paid off now, capital return begins, et cetera.
So, longer term, yeah, really don't know. I don't necessarily see this company as strategic strategically valuable to a large player. They serve a lot of the big global chem guys like say, Dow, right? They're a global supplier to Dow. I don't know that they need to be owned by Dow. So my guess is this operates as an independent asset and with the global growth in solar, and we haven't even gotten to battery yet, there's a battery anode play as well. So there's a lot of growth for this company in the public markets in our view.
Andrew: Yes. No, that makes total sense. I guess A, the pod boys run the world now and when they see a 43% shareholder who's selling down a little bit, I think the first question a lot of people with a Bloomberg is going to pull out as, Hey, am I stepping in front of a secondary, or also, hey, it's a 50% owner, they've got the executive chairman, they sold over 10% of their stake in a year. Do they know something that Kyle and Mike don't because Kyle and Mike are pointed in a rosy picture and the largest shareholders selling it. I think everything you guys said makes sense. I haven't really dug into the needs at Group OVM, but I'm certain you guys heard it too, it seems like they did want some cash. Capital allocation, I think we've mainly discussed it. You guys talked about the restrictive bonds that they raised in 2021, I think they did an equity rights offering back then too, if I'm remembering correctly. Is that right?
Kyle: Yeah, they did.
Andrew: Yeah. So 2021, obviously heels of COVID whole globe shut down. They do that to survive, once they pay them off, which is later this year, they're not even hitting, go read the Q two call, go read the 2022 investor day. They've said, we know we need to get capital back. So do you guys think it- I think a lot of people think it's going to be small dividend plus a share repurchase program. Is that kind of what you think or how do you all think about that?
Kyle: Yeah, that's what the management has said, the board is leaning towards, but they haven't stated that. I do think that a dividend would be wonderful in terms of opening up the shareholder base to other players. This company is widely under owned especially in the long-only community, especially in the ESG community, because...
Andrew: I talk to tons of people, you're the first people who it is commodity levered controlled, so maybe it's not surprising. You're the first people who've ever mentioned it to me.
Kyle: Yeah. We actually have a pretty reasonable history in terms of investing in businesses that are transforming into environmentally friendly at invest for Kids in 2019 here in Chicago. We presented Darling. Darling now is known to be a renewable diesel player, a giant renewable diesel player through their Valero partnership, Diamond Green Diesel. But previously it was valued as a has-bee low-margin cyclical renderer, and this is a very similar setup with respect to the business in the mirror is different than the business through the windshield because of solar and battery and onshore mandates by politicians and by the way, these are fully bipartisan, right? Everyone is behind this. The IRA is secular, blue gets decarbonization, red gets jobs, everyone wins, right? So largely this is something that's baked in. It's just not recognized by especially the long only environmentally sort of focused investors. We think that changes the company still if you're on Bloomberg doesn't even screen as unlevered, even though today it is unlevered, right? And they are going to have capital return, even though today there are some of those bonds that are outstanding that preclude capital return. So what we're looking at is the next six to nine months, this company is going to screen vastly different than it does today.
Andrew: There's one thing there you said that I just want to poke on real quick. You mentioned, hey, the IRA by part season, and I don't really disagree with you. Obviously, there was a fight over getting it passed, but as soon as it passed, as Biden likes to point out, hey, the Republicans love to go to their community to say, look at all these jobs I brought to you, even though they fought tooth and nail, like they voted it down and now they're saying, look at all these jobs. I don't disagree with you, but I could see, especially this is plugged into solar, right? I could see if you had a change of administration, IRA is the law, it'd be tough to overturn, especially with all the jobs and everything, but could you see the- I don't think it breaks the thesis anyway, but could you see the IRA getting changed to the point where, hey, maybe they don't have this kind of US stranglehold that we're kind of hoping for. That really gives you the- when you're investing in an economy player, you want a super normal profit cycle where the cash flow is just rolling in and you kind of get 60% of your EV in two years or something.
Kyle: Yeah. Well, it's both and maybe I'll start and have Mike kind of finish. I mean, first of all, by the time we get to 2025, we think the numbers are going to be way higher. By the time a new administration is even sworn in, the numbers have already inflected in a pull-through. The Koreans are building a giant plant down in Georgia. There's another plant going in in the state of Colorado. These are massive plants and just physically speaking, these products are measured in tons. They're all hard to transport around the globe and then as Mike mentioned, the Chinese are largely using their own domestically. So it's a bit of a both. Yes, we think the solar growth is there per the IRA, we do think it's bipartisan and it's also hard to feed these factories with foreign source products even in that sort of environment. Mike...
Andrew: Mike did you add anything?
Mike: Yeah, think so. If the solar demand doesn't pull through in the US, when you look at the current markets, they're very structurally favored to domestic producers. So the US is at a massive production gap between what they consume and what is supplied domestically and it's massively tariff-protected as well. When you look at tariffs on China, it's over 100%. So I think you can look back in history and look at globe specialty metals when it traded on its own, which was these assets, that was a very highly valued business in the public markets. The average EBITDA multiple was a above eight times because of its consistent through cash generation. So you're looking at a market that even if solar demand doesn't meet our expectations, is at a structural deficit and you do have some growing drivers as well. When you think about light weighting of vehicles, when you think about aerospace and defense, when you think about aluminum beverage cans, a lot of these end markets are still growing. So we think that market, even without a massive solar inflection is still reasonably attractive, and the margin of safety is plenty to make this investment.
Andrew: I'm just laughing because I know you guys spend most of your time in industrials when you say when it was standalone, it got a pretty great multiple illustrating for eight times EBITDA standalone and if you and I were looking at anything else, we'd be like, it's a great multiple eight times next year's sales. If we were looking at a tech company or something. Just on supply, so you mentioned the two huge plants coming into North America, and look, I've just started researching this, I'm really interested in it, but I've just started research. So just for my own edification, like you've got these two new plants coming in and Kyle mentioned, hey, this is a business on tons, it's expensive to transport and that just kind of changed what I was thinking when I read the investor day. They talk about Chinese dumping that doesn't really fit with, hey, these are really expensive to transport and the new plants coming online didn't fit with the, hey, most green fields fail because it's really difficult. Can you just kind of help me bridge the gap between those two?
Mike: Yeah, so I think in Europe the plants coming online and so that's where a lot of the Chinese tons go. There's no Chinese tons that go into the US, and so when you think about the European market, they've made a big emphasis on protecting the domestic silicon metal producers. You've kind of seen it with their French asset and their Spain assets, these long-term favorable energy contracts talking about as a critical raw material and the rumblings are that they are going to increase tariffs on that to further protect the pricing. So when we think about the plants coming online, that's US base plants that are coming online. So those aren't receiving any domestic tons. But when you look at these investments, I think people are looking at the demand that is potentially coming and these projects in the US that are looking to secure their supply chain in advance.
You can't build a solar panel without silicon metal. So if somebody's going to make an investment, they want to have that silicon metal consumed. So I think these aren't speculative tons, it's based on an incredible amount of demand that's being communicated by customers. So we would love if no supply is coming online, but when you think about the US markets, we still think they'll be at a structural deficit even if these plants are built on time and are able to compete from a cost standpoint and raw material standpoint.
Andrew: Kyle, did you want to add anything there?
Kyle: No, Mike's got it.
Andrew: Great. Quickly, Mike, you mentioned Europe a little bit. I do just want to mention everybody remembers in 2022, it seemed like the most important chart in the world was how much European natural gas prices were trading for and if you're going to do anything industrial or commodity, it takes a lot of power, right? And these guys have talked about, hey, one of our advantages, Mike, you mentioned earlier they have 70% of quartz internal. They also said, Hey, I think like 35% of their coal is internally sourced, which isn't huge, but it is a decent bit. But one of the issues, they've got Spanish and French assets, electricity prices, power prices go through the roof, these things become the less than marginal producer. I think Spain gave them like $35 million of really low-cost funding to help. But I just want to ask on the European side, what's kind of the outlook for the European assets there?
Mike: Yeah, sure. So from the Spanish assets, those really haven't been running at all. The company has been working to secure long-term power contract that makes them cost-competitive not only in Europe but globally. They mentioned on the last call that they have one power agreement that's going to start in January one of 2024, and they expected the final one for those Spanish assets in the coming months. So I wouldn't be surprised if that's finalized when we're hearing the third-quarter earnings calls. The French assets they are on a three-year agreement that incentivizes them to shut production in one queue during those winter months, and then they get more cost-competitive energy throughout the year. So they have been doing that, that goes for two more years. They can run the assets if they want, but it's just a question of where pricing is versus the power contracts.
So we obviously don't have visibility into what those power prices are but from what management has said, and we have no reason to not believe them as those put them in a really cost-competitive energy standpoint globally. And I think what they've done and what wasn't done historically is in periods of weak end market demand, they're shifting production to their lowest cost assets. So, with the Spanish assets offline, they're shifting it to their South African plant, which is very cost-competitive globally, and their US assets. So we think they've done a great job kind of managing that and I think when looking at last year's performance and this year's EBITDA guide, even with a very tough macro environment in Europe, it kind of shows that they're doing the right things and numbers have a really good chance to go up as things continue to normalize.
Andrew: Well, two last questions for me, and then I'll give you guys any final thoughts or anything. So on the, I think it was the Q two call, but I read a decent bit, maybe I'm mistaken, they mentioned that they were going to license their EV patents off, and that just was kind of interesting to me because you guys talked about, hey, we don't build in, they get an ESG real- obviously you built in something for the IRA, but you haven't factored in, they get a real ESG multiple. That's the type of thing that could get really sexy. I don't know how to frame what they make, but what are they going to do with licensing off their EV patents? I guess this would also take us to the battery play if that ever played out as well.
Kyle: Yeah, let me frame it out and then have Mike give you a more detailed answer. So silicon, in terms of being a material in the battery, silicon, if the anode of a lithium battery was allowed to use all silicon from a physics, now we're talking physics, it would charge 10 times as fast and take 10 times as much power. But the problem is silicon metal expands and it cracks, and so these batteries crack and they wear out, they don't work, right? So right now there are many, many companies all around the world from the biggest names to startups all working on how to get more silicon metal in the batteries and if and when that does happen, that's a boon for the entire industry including Feral Globe as a producer. But Mike, do you want to answer more or help expand on that and then answer the more specific question on the patents?
Mike: Yeah, sure. So when you look at batteries today, silicon metal replaces typically three to 10% of graphite and that technology works. So when you just think of batteries as a demand driver, the more batteries we create that's going to be more silicon metal demand. Like Kyle mentioned, all these battery producers, when you think about batteries, the two of the biggest issues are reducing the charge time and increasing the capability of holding the power, silicon metal solves both of those. So, battery producers throughout the world are making big investments to increase that silicon metal content replacing graphite. We aren't making a big bet on this. It's above our pay grade in terms of technology, but we wouldn't be surprised to continue to see that percentage increase over time.
The other key point of this is this is one of the products that require a very specific quality quartz to meet what these battery producers need. So, Feral Globe being vertically integrated into that high-quality quartz is one of the few players that can meet these tons. So they're partnering with a lot of battery producers, they are shipping some volumes into these projects today. When you think about that markets, they've kind of outlined, 200,000 ish tons in the coming years of silicon metal demand that could come from that and then more over time as that percentage of graphite is replaced by silicon metals. So it's another super interesting in our opinion call option that's not being priced in whatsoever to the stock. We'll see how it plays out, but they're pretty excited about it as well.
Andrew: Why do you think maintenance CapEx is here?
Mike: Around 75 million we think would be plenty to sustain the asset base and in terms of growth CapEx, we think they could expand silicon metal capacity by 50%, with only $80 to $100-ish million dollars. So when you think about the cash generation, they can grow and return a lot of capital with no issues there.
Andrew: But if I just take your $75 million in maintenance CapEx, the low end of EBITDA guide is $275 for this, it's $270, but let's call it $275 for this year, that's $200 million in unlevered cash flow. Obviously, there's some interest expense, there's some tax expense, but again, it's a billion-dollar company, so you're talking about a 20% unlevered free cash flow number and that takes us nicely and we haven't given credit for any of the growth option or anything, but that does take us nicely into- I just want to end by talking about the 2024 outlook because it struck me on the Qtwo call. Here's two quotes, market's extremely challenging at the moment, we expect to see better conditions next year. Optimism for 2024. Excess inventory depleted, supply-demand balance for our products are improving. Obviously, the full IRA won't have flown through there, but just if people are pod shop through the world, 2024 is going to be what's on most people's minds when they look at this and if we don't go into a huge recession- if we the plane doesn't crash, how are you guys thinking about 2024 earnings when people are kind of thinking about a 12 or 18 month outlook?
Kyle: Mike, do you want to start, or me?
Mike: Yeah, I can go. So, when we think about part of the step up to our 2024 number is just these Spanish assets coming online and these power contracts coming through and so just based on that, which we kind of consider a mid-cycle earnings number, we think the company can do $375 million of EBITDA. Over time we think that goes up but barring any material recession we think that's a very doable number. Based on the cost reductions and kind of what they've shown this year. Even if the economy gets far worse, we still think they're going to be a cash generator, obviously not to the level of what we're currently expecting. But yeah, you've seen kind of the Chinese silicon metal prices bottom out and start to uptick. Europe kind of tracks typically those Chinese prices. So you are seeing some kind of normalization in demand and end markets and if the economy holds in, we think there'll be a nice step up.
Andrew: Did you want to add anything to that, Kyle?
Kyle: No, look, EBITDA, so we're bracketed, there's two cell side shops, BRiley and Seaport. The Seaport analyst used to be at Jefferies. We're bracketed, we're right in the middle of their 24 numbers. We think it's just that the street is not paying attention to this company yet and then on 25, our numbers go far higher as you really get that solar pull-through. So that free cash flow just goes along with it. So it's a very interesting and catalytic six to nine months here.
Andrew: Actually, I have one last question, if that's okay, and what Mike said and what Kyle you just said actually goes really well into it. I had in my notes on their 2000, I can't remember, was their 22 call, if it was their 22 investor day or if it was on their last call, but they said, Hey, we think the new floor EBITDA number for our business is higher than historical averages. Right. And this is a common thing that I've had. I mentioned the Bob robotic thing earlier. When a lot of supply has come offline, the new floor is just higher because think about your economic supply demand curve, supplies come offline, new floor pricing is higher. Mike, you mentioned $375 million EBITDA for 2024, and I think you were kind of saying, Hey, that's around a mid-cycle number when things aren't too hot or too cold, $375. I think the pushback would be, I'm looking at their 2022 investor deck right now. Right? The highest EBITDA they'd earned since the merger was 2018, where they did $230 million in EBITDA. They will break that this year, but cool. They broke for the first time in almost 10 years, they did $275, and Mike's out here telling me $375 is kind of the new normal mid-cycle. So how do you bridge those two gaps?
Kyle: Yeah, let me take a crack and just be really blunt, there was $200 million of some of the worst managed costs we'd ever seen prior to Marco Levy joining, right? They had no centralized procurement, they were focusing on volume at the facility level. They were sending stuff all over the globe rather than producing in the right geographies, producing locally, and delivering those products. When we went through and our deep dive channel checks, some of the comments were like, wow, you'd write a business school case study about what Marco and his team have come in and cleaned up and that was just a culture clash. It was European American merger, right? You can write another business school case study about that too, right?
And a lot of that's, it's just very simple. It's just cleaned up. And quite frankly, Andrew, we didn't really believe the magnitude of it until this last, this Q two call, right? Where the price of silicon metal is given the China weakness European weakness here, we thought they were going to cut numbers and they didn't. So that was just another proof point that we weren't fully ready to underwrite in terms of how real those cost cuts were. So you take $150 and you add $200 and you're pretty darn close to that $375. So...
Andrew: I'm going to butcher it. I was trying to find it, but there was this really interesting line in the, again, the two intro Geo Analysts day where they were like, look, one of the things we had to do was we had to go out and teach our salespeople to be business people and understand how what they did impacted the PNL and l and everything and you could just tell the underlying thing behind it was like, Hey, we had salespeople and they were just like, go make sales. Doesn't matter. It doesn't matter if we're selling negative margin business. Doesn't matter if you ship something from Cleveland, Ohio to South Africa when we've got a South Africa plant. Like you could just tell there were things and as you said to bring it back to the real world instead of me misremembering an anecdote, like, go look at the cost they've taken out. I love what you said of, hey, the Q two thing kind of bore out because people are going to look and say, oh, it's up a little bit in a few months, but hey, when you start getting these proof points, those are huge inflection points. I don't know, Mike, do you want to add anything to kind of what I said or what Kyle said?
Mike: Yeah, I think last year and this year are real proof points about the earnings power of this business going forward. The CEO Marco has said repeatedly throughout this year that they believe their guide this year is a trough number. We thought trough would be far lower and if it certainly plays out that's a huge advantage, but when you think about the macro environment, 50% roughly of their silicon metal production is in Europe and when you think about what's happened in the Europe industrial economy, a lot of their customers shut down and still haven't come back or are still running at utilization rates far below normal. So when you think about a recession lot of their customers are already in a recession and they're still going to be generating a lot of cashflow this year. So yeah, we were really excited about maintaining that guide and we think it's a real proof point of how the structural profitability of these assets is far above what it was historically.
Andrew: Just one other thing on that, one thing that they've highlighted is, hey, this business was running 30% working capital to sales, and they brought it down to about 20% and I think that might inflate a little bit in the short term, but well managed working capital is one of those interesting things. You don't really think about it. I can't tell you how many times, it's very small on the podcast time to talk about it, but well-run companies, guess what? They run with lower working capital and I'm not saying you need to go hugely negative, but 30% to 20%. They had $100 million for cashflow release this year from Better Working Capital Management and that's just another sign the business was- it was just mismanaged before. And that's you get good management in there and it improves. Guys, we've almost gone an hour. We have a lot to talk about. I'm looking through all of my notes and stuff. I think we hit everything I had, but I want to turn it over to you. Anything, you guys have done a lot more work on this than me. Anything we didn't talk about that we should be thinking about or people should hit harder, Mike?
Mike: Yeah, I think people should just spend a lot of time kind of looking at the supply-demand picture and getting comfortable with that and once you really see the outcomes here McKinsey just came out with a study this year about an estimate for silicon metal demand to grow 21% CAGR through 2032. Those are very real numbers, and when you look how difficult it is to bring on supply, you can really see the opportunity they have in front of them. I think take the time to talk to the company and get to know management and really understand the changes they've made and we think you'll come away really impressed and give a lot more credit to the transformation that they've done over the past few years even in a difficult macro environment.
Andrew: I will tag Coves Select on Twitter. So, people who are interested in getting in touch with you guys- I know one of the reasons you come on is you want smart people to come on and buy the stock and see what you guys see. I'll tag Coves Select so people can hit you up there. People can go listen to the first podcast to hear a little bit more about Coves Select, but yeah, I don't know. Kyle, did you want to end with anything on Coves Select or anything?
Kyle: So people, we're fairly well known in the small-cap community, at least in industrials and materials for sure. We got a 150-page deck. We're happy to communicate with folks. If folks are digging in doing real work. Hit us up, Mike or me, email or on the Twitter machine and we can get in touch. Yeah. Coves we run a small-cap platform that's designed to help smaller managers get their names in front of institutional investors. It's going well. We have paid managers cash and continue to look for ideas that we're trying to help guys grow their businesses, guys, and girls grow their businesses. So yeah, I appreciated talking to a lot of guys folks on that front too.
Andrew: Again, you know how I know you guys are covering industrials too much, you said you paid managers cash. You got to pay them that non-cash stock so you can get the free ads back. Who cares about it? Well, Kyle, Mike this has been absolutely great, this is a fascinating idea. I love buying- Kyle and I have talked all the time, but I love buying assets at a discount to replacement the value, and here you got the great thing. You've got a good management team coming in and replacing the business and you've got the [inaudible] coming in for replacement value where I think a lot of the things Kyle and I talk about are the things where you might have the tail wins but you might not have as good of management team kind of [inaudible] in it and getting where it's written on the cash list. So, people can go check out Kovaslak [?] including [inaudible] note and we'll go from there. Thanks guys.
Kyle: Thanks, Andrew.
Mike: Thanks, Andrew.