Tuesday, February 14, 2012

Does Dacha Deserve To Be Your Valentine?

Rare earth metals are used in all sorts of applications from lightbulbs to hybrid cars. Their prices are rather volatile, and have swung dramatically in recent quarters on supply/demand issues and export restriction news out of China. Value investors may not be interested in buying rare earth metals at market prices...but what if they could be purchased at a major discount?

That's the opportunity that's potentially available through the purchase of the stock of Dacha Strategic Metals (DSM). Dacha trades for $40 million, but has rare earth inventories valued at $100 million against very little in balance sheet liabilities. The investor is thus given the opportunity to buy rare earth metals at a considerable discount.

Management appears to be trying to do something about the discount, as it purchased 10% of the company's float in the last 8 months. It will be eligible to buy back more shares in June, which could help close the discount. Unlike most companies, Dacha reports on the market value of its inventory position weekly, so your not stuck sitting on a company with stale three-month-old financials.

But there are a few risks that could result in losses despite such an apparently large margin of safety. First, the prices of these metals are volatile. As such, they could fall abruptly, destroying any margin of safety in the process.

Further complicating the matter is that some estimates have to be made in order to determine the market value of the company's inventory. The bulk of this inventory is not sold frequently, reducing the transparency of the "market value" of these elements.

Finally, there are some options outstanding which will likely reduce the potential upside. There are 20 million options outstanding (compared to just 75 million shares), the vast majority of which have exercise prices lower than the current share price.

Nevertheless, some value investors who are not terribly bearish on rare earths may find Dacha to be of compelling value.

Disclosure: No position

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