Lodbrok Publishes Letter to REC Silicon’s Board of Directors

Lodbrok Capital LLP, in its capacity as one of the largest shareholders in REC Silicon ASA, recently sent the letter below to the company’s Board:

REC Silicon ASA (“REC”)
Fornebuveien 84
PO Box 63
1324 Lysaker
Norway

Attn: The Directors of the Board

GOVERNANCE CONCERNS RELATED TO REC SILICON

10 October 2022

Dear directors,

Certain funds and accounts managed or advised by Lodbrok Capital LLP (“Lodbrok”) own 5.2 million shares in REC (OSE:RECSI), making Lodbrok one of the largest shareholders in the company, and hold close to 20% of the 2023 senior secured bond. Lodbrok has been invested in REC continuously since our inception in 2017, and we have supported the company through difficult times, including by anchoring the bond refinancing in 2018 and by supporting the equity raise in 2019.

Lodbrok believes REC is significantly undervalued considering its two highly strategic assets in rapidly expanding industries, which benefit from political tailwinds and potentially strong profitability outlook, and we would recommend that:

1. REC immediately postpones its EGM scheduled for 21 October 2022 and seeks to identify and consider additional board candidates, with the aim of having a board with a majority of directors being unrelated to Hanwha;
2. Hanwha either accepts having a minority of the directors and appropriate oversight for any contract negotiations or increases its equity stake in REC;
3. Absent an ownership increase by Hanwha, an independent board hires advisors to explore and evaluate strategic and commercial interests in REC, in light of recent positive market developments, to ensure any large contracts signed with Hanwha are balanced against alternative opportunities from the perspective of all stakeholders; and
4. The board of directors observes the Norwegian statutory rules prescribed for transactions with related parties, including the approval of any off-take agreement with Hanwha at a validly constituted shareholder meeting.

In the absence of appropriate responses to the recommended actions set out above, Lodbrok will vote to reject all proposals on the EGM scheduled for 21 October 2022.

Value potential

We have been believers in the potential of REC for more than half a decade, and we are highly encouraged by recent developments in both the political and the industrial landscape. In our opinion, REC has an exceptional platform from which to capitalise on the accelerated push towards sustainable energy and the electrification of the auto industry.

The Butte plant is the world’s largest supplier of silane gas, with a very substantial market share, meaningful barriers to entry, and a fairly stable level of profitability, which we believe could easily attract strategic interest in a valuation range of $300-400 million. On current share prices, we estimate this would imply a $320-420 million valuation of Moses Lake, which corresponds to 19-25% of the reported c. $1.7 billion invested in the plant – all the while REC is negotiating offtake contracts with Hanwha Corporation and Hanwha Solutions (“Hanwha”) for 100% of the plant’s capacity, with potential for additional demand from battery anode producers going forward.

With polysilicon spot prices close to $40 per kg, we estimate that Moses Lake, with its 18,000MT capacity, alone could generate close to half a billion dollars in annual EBITDA if it could sell 100% of its capacity in the open market. When factoring in the required reactivation capex, we estimate this would imply a <2x EV/EBITDA on the current market value of REC. Even in a scenario where polysilicon prices were to drop as much as 40%, to around $22 per kg, by our estimates, REC could still generate more than $200 million in annual EBITDA, which would imply around 4x EV/EBITDA on the current market valuation (incl. required capex). Alternatively, if Butte could be sold for $300-400 million, and the Moses Lake plant could sell 100% of its volume at a price that is 40% below current spot prices, the current valuation of REC would imply that Moses Lake would be valued at around 3x EV/EBITDA. For a business with strategic products for the US solar industry and the lithium-ion battery markets, and the know-how and experience to consider avenues for deeper expansion into these rapidly growing industries, we believe REC could have potential to command much higher EBITDA multiples.

While we recognise the expected supply growth from Chinese producers in the coming years and its potential impact on polysilicon prices, we believe that the energy markets in general – and the solar market in particular – will become increasingly bifurcated between Western and Eastern producers, from which REC should stand to benefit. We believe the incumbent US producers in the solar value chain, such as REC, will continue to enjoy political support for the development of a domestic value chain and be able to command a materially higher margin than what a global supply curve would suggest. A range of new government initiatives from the last year should drive investments in US based solar and battery supply chains, increase demand for semiconductor grade polysilicon and silicon gases, and more broadly drive adoption of clean energy technologies.

Moreover, Lodbrok has spent a significant amount of resources on other investment opportunities in the battery industry, and from our considerable time spent with experts on the benefits of distributing silicon on anodes by way of silane gas, as well as analysing the potential cost efficiencies for the battery producers and car manufacturers, we believe REC has the potential to command a very large premium on selling silane gas to anode producers rather than current end markets. From the recent investment behaviour of several anode producers, we consider it obvious how strategically important REC’s silane gas is, but we believe the market may underestimate the ability REC could have to extract premium pricing on its product. While we appreciate that the adoption of silane gas in anode production could be a slow process, we have been a patient investor to date, and we are encouraged by the pace of recent developments.

Finally, over the last 18 months we have submitted a proposal to anchor a refinancing of the expensive bonds and continuously displayed a willingness to be part of a refinancing solution for the very expensive senior secured bond. We are hopeful that the company’s lack of engagement on this reflects confidence in being able to source attractive bank financing that can minimize any potential future equity raise required to ramp up Moses Lake, and the positive developments in recent quarters have given us greater confidence that this should be attainable.

In short, we believe REC is uniquely positioned with two highly strategic assets in rapidly expanding industries that should benefit from lasting political tailwinds, strong profitability outlook and attractive funding opportunities.

Governance concerns

Despite what we consider very important positive developments and an attractive long-term outlook, the share price has largely gone sideways during the last 18 months. We believe part of this share price development is potentially attributable to concerns around poor corporate governance protocols, as recently illustrated by the very negative market reaction to the replacement of the interim CEO during a crucial time for the company.

In the last year, Hanwha has replaced Aker Horizon as the leading shareholder and acquired 1/3 of REC’s shares. During that period, the company has witnessed the departure of its long-serving CEO, Tore Torvund, and now recently the departure of its interim CEO and long-serving CFO, James May. Meanwhile the new board of directors saw the sudden and unexplained departure of one of its two independent directors, Heike Heiligtag, which left Hanwha with two out of three remaining board seats, with the top two executives at REC having been replaced.

Against this backdrop, REC has reported that it has executed an MOU with Hanwha Solutions for polysilicon, with negotiations underway to complete the supply contract and Hanwha having proposed an offtake contract for 100% of the production at Moses Lake. Furthermore, REC has reported that discussions are ongoing with Hanwha Corporation for REC’s silane gas, which we believe will be a highly strategic product for anode manufacturers going forward.

While we welcome and understand Hanwha’s interest in REC’s products, we believe the situation potentially gives rise to material conflicts of interests. Lodbrok has repeatedly flagged concerns directly to the REC management team about the importance of arm’s length negotiations between REC and Hanwha. We are deeply troubled by the departure and replacement of REC’s two leading executives during this crucial time, coupled with the sudden departure of one of two independent board members, leaving the board now controlled by a shareholder that holds a minority of the equity, at a time when that shareholder is potentially looking to acquire the vast majority of the company’s future production. Having been invested in REC for more than half a decade, we are highly concerned that a new executive team, which we have never had an opportunity to meet and which has effectively been selected by a Hanwha-controlled board, will lead the company through the finalisation of a potentially company-defining contract with Hanwha.

We believe any offtake contract directly entered into between Hanwha and REC will be a related party agreement under the Norwegian Public Limited Liability Companies Act, rendering adoption by a shareholder meeting required, at which Hanwha should be excluded from voting. Moreover, we believe Hanwha board representatives should be disqualified from participating in the board considerations of any agreements or corporate reorganization related to a Hanwha entity or contract, and we do not believe that the remaining two board members – as implied under the currently proposed board composition – constitute an appropriate quorum for such considerations.

We also note with concern that the nomination committee, made up by Junghey Chae (chair and employee of Hanwha), Sungchoon Kang and Jieun Lee, have found it reasonable in its EGM proposal to let Hanwha obtain half of the board seats, including the chair and deputy chair, despite Hanwha only holding 1/3 of the shares and being in negotiations with REC for very large contracts.

We want to ensure that non-Hanwha shareholders in REC – who hold the majority of the shares – are given due consideration as governed by Oslo Stock Exchange regulations and the Norwegian Securities Trading Act regarding equal treatment of shareholders, and in our opinion a minority shareholder should at best have minority representation on the board. Under the proposed corporate governance model, Lodbrok will push for a full independent investigation of any potential offtake contracts signed between REC and Hanwha.

Lodbrok intends to reject the current proposals on the EGM scheduled for 21 October 2022.

Recommended actions

Lodbrok believes REC should immediately postpone its EGM scheduled for 21 October to provide more time for additional board candidates to be identified and considered. We believe appropriate governance would dictate that any minority shareholder should only have minority representation at the board. Moreover, given the negotiations with Hanwha, we think REC could benefit from a non-Hanwha shareholder being represented on the board.

If Hanwha wants to effectively control the board, while potentially signing offtake agreements for the majority of REC’s production, we believe Hanwha must increase its equity stake in the company. If Hanwha intends to put in place large offtake contracts at prices consistent with arm’s length negotiations, we believe substantial and attractively priced debt should be available for REC, which could finance a substantial portion of an acquisition of the remaining 2/3 of the equity (and refinancing of the $12m of net debt). Any potential divestment of Butte could further contribute to minimize the required funding for Hanwha to implement such a transaction.

Absent such an ownership increase, it is our opinion that the board, made up by a majority of directors unrelated to Hanwha, should hire an M&A advisor to evaluate strategic interest in REC and a commercial advisor that ensures all other potential counterparties are given fair consideration to maximise value for all stakeholders in REC. While such a process may have been pursued while Aker Horizon was the largest shareholder, we believe the landscape for energy security has dramatically changed since that time, and there is now much greater certainty on the political dynamics related to the US solar and battery value chains. We believe these forces leave REC with substantially improved prospects of attracting acquisition interest and commercial relationships.

In summary, Lodbrok believes REC is significantly undervalued considering its two highly strategic assets in rapidly expanding industries, which benefit from political tailwinds and potentially strong profitability outlook, and we would recommend that:

1. REC immediately postpones its EGM scheduled for 21 October 2022 and seeks to identify and consider additional board candidates, with the aim of having a board with a majority of directors being unrelated to Hanwha;
2. Hanwha either accepts having a minority of the directors and appropriate oversight for any contract negotiations or increases its equity stake in REC;
3. Absent an ownership increase by Hanwha, an independent board hires advisors to explore and evaluate strategic and commercial interests in REC, in light of recent positive market developments, to ensure any large contracts signed with Hanwha are balanced against alternative opportunities from the perspective of all stakeholders; and
4. The board of directors observes the Norwegian statutory rules prescribed for transactions with related parties, including the approval of any off-take agreement with Hanwha at a validly constituted shareholder meeting.

Hanwha has the potential to be a great strategic shareholder for REC, but if Hanwha will remain a 1/3 shareholder with contracts for the majority of REC’s production, it is essential that the company maintains the right governance model and independent management team to ensure all other shareholders will be able to participate fairly in the great value potential we see for the business.

Sincerely,

Mikael Brantberg
Chief Investment Officer
Lodbrok Capital LLP

Joachim Bale
Partner
Lodbrok Capital LLP

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Contact information

Lodbrok Media Contacts
Nepean
nepeanlodbrokteam@nepean.co.uk