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Ryan Morphin:

Welcome to Non Beta Alpha. I’m Ryan Morphin. On today’s episode, we have Rick Dennen, CEO and founder of Oak Street Funding, talking to us about the RA landscape and how M&A is being financed today. This is Non Beta Alpha.

Speaker 1:

I guess I didn’t know. I guess I didn’t know.

Ryan Morphin:

Rick, welcome to the show. Thank you for joining us, sir.

Rick Dennen:

Good afternoon, Ryan. How are you today?

Ryan Morphin:

Ah, fantastic. Well, I really appreciate you coming on today and talking a little bit about the macro economic backdrop, the credit environment, and what’s going on in the RA landscape. I’ll just kick it off with the first question. What is your perspective? Where are we from a macro economic perspective? You said it in an interesting, see a lot of deals in the wealth management landscape. How is the wealth management industry looking, and how is the macro economic backdrop in your opinion?

Rick Dennen:

A bit of a loaded question. There’s a lot there. I think sitting in the seat we are, there’s a new proposal on a stimulus package here. We went through 710, 720 billion through PPP already. Seeing how that’s going to shake out, I think we’ll have a lot to determine how businesses sustain themselves, what’s going on with the unemployment, how spending continues and what inflationary pressures or inflationary items we might have going forward. From a credit perspective, what we’ve seen is that the stimulus that did come out and the PPP loans impacted a lot of our smaller customers, but the larger customers that we’ve had and some of the larger deals and the M&A has absolutely continued for us.

Ryan Morphin:

From the credit perspective, are you seeing new covenants popup in loan agreements or is the cost of capital changed for risk appetites?

Rick Dennen:

My guess is that there might be, with certain banks, Ryan, I will tell you we haven’t changed our credit standards one bit. I will tell you that we’re looking for some more current information. We’re looking to see how the firms reacted from their highs, of AUMs probably at the end of February, to where they are today to kind of understand the position. We’re also looking at, as I mentioned earlier, the PPP funds that they took. Those government funds will step in line of a first lien lender. There are four, if they don’t get forgiven and in essence convert to like an equity piece, that’s going to be that debt that would stand above ours. We really need to understand how much was taken, how was it utilized and how is it going to be forgiven? We’re kind of tracking that stuff, but as far as leverage covenants, debt service coverage, we’re basically 100% consistent with where we were prior.

Ryan Morphin:

I know the SBA Secretary Carranza’s office hasn’t opened the portal yet, but I’m wondering what your thoughts are. Has the political environment changed the program dramatically and is it creating uncertainty for lenders that have given these loans thinking they were going to get forgiven. Is there any risk into the kind of capital structure of companies that took the notes?

Rick Dennen:

What I would say is I think anytime you’re dealing with the SBA, they always have the potential. I would say historically, consistently change the rules kind of as you go along. I think we’re seeing something similar to that. The SBA would typically put out about $25 billion a year. When you look at and try to segment the PPP loans that were out there, up to $10 million and how they plan to forgive those, the rules are constantly changing and I think still in evolution.

Rick Dennen:

I’m always concerned about that and what the SBA can do there. If they’re not going to be forgiven, what is the risk to the bank? I would say that doing a 1% loan, there’s not a whole lot of margin and those deals that banks did, but I think the banks frankly, did a really nice job propping up a program in about a one to two-week period of time I would say on average, depending on which bank you are, to be able to put a brand new product with new criteria and really undefined criteria through systems, put teams together and get the money out as quickly as they did. Phase one, I think they ran through 350 billion in two and a half to three weeks, and that’s pretty impressive for these large institutions to do.

Ryan Morphin:

Yeah. I really do think Chairman Paul and the treasury department and Secretary Mnuchin, and I think they did a great job. I mean, in March, no one wants, everyone’s got a Monday morning quarterback this, but nobody knew what was going to go down a 32% decrease in about two, three weeks. It gave people the time to right size businesses and charter recovery. I’m wondering though, your view, do you think unemployment on the white collar side is going to pick up dramatically from now until the rest of the year?

Rick Dennen:

Unemployment defined as increasing? I think that, again, depending on the stimulus package and how quickly we can find a cure to COVID, I think will depend on how quickly people can kind of restart their business. I think there’s going to be certain businesses that, some obviously have accelerated like the Amazon, PayPals, things of that nature, but there’s certain businesses that are just going to take a longer time to recover and their industry may even change and evolve as a result of COVID. I just think it’s dependent, but I think from a white collar perspective, I think that there probably will be some tightening that occurs once the PPP funds have been “forgiven” and people try to right size their organization and look for opportunities to be more efficient.

Ryan Morphin:

Yeah. Well, and looking back at the RA industry, the fee for service model has typically predicated, the revenue model’s predicated off of kind of asset valuation levels, where they charge a 1% fee against those assets under management. With the volatility in the asset levels, ie, the indexes as S&P and DOW Jones, how have you guys looked at kind of the earnings profile of RA businesses? Has that changed at all in your opinion?

Rick Dennen:

I will tell you, we’re looking more current on the information. For example, like if we closed a deal the 1st of April, for example, we’ve might’ve just previously used year end numbers. Whereas, if we closed the deal the 1st of April, I mean, we’re going to at least get through February numbers and get updates, understanding as quickly, probably move that forward a couple months when the COVID hit on March 15th. You understand my point with trying to see how businesses have positioned the assets, how have they hedged the assets? If the markets were down 30%, were they down 40 or were they down 10? Frankly, a lot of our customers have done a really nice job with their investment profiles to be 50% of what the losses had been in the S&P and in the DOW.

Rick Dennen:

They’ve done a really nice job. Then now, you can look at it and we’re almost back to those all-time highs of the late February period in both of those. The customer base that we see, people that we see active in the market are not people just sitting on the sidelines doing mutual funds. They’re just going to ride up and down with the S&P. We’ve been very pleasantly surprised with our portfolio and the quality of the management teams and what they’ve been able to do through this.

Ryan Morphin:

Yeah, no, there’s definitely out performance. I think there’s a bull market for good advice today. I look at the underwriting levels of some of these indexes and maybe it’s starting to cause some concern because you’re seeing like the tech darlings, if you will …

PART 1 OF 4 ENDS [00:09:04]

Ryan Morphin:

It’s starting to cause some concern because you’re seeing the tech darlings, if you will, irresistible names like, Google, Facebook, Amazon, they’re becoming a bigger percentage in terms of market cap of the overall index. And I’m just wondering if you guys are starting to think maybe there’s a bit of a tech bubble here because of those five names I just mentioned, the other 495 names are down 5% from the highs, which is not too bad if you look at where we’ve come through, but are you guys worried at all about the kind of the tech industry? Are you guys looking at that as maybe a canary in the coal mine?

Rick Dennen:

I would say, from our business and lending to on cashflow businesses and the RA space, no, I’m not concerned about it. Personally, when you start talking just from stock pickings and things like that, you see Facebook and Amazon and a couple other firms are talking about antitrust and how big can these companies get. But when you think about potential evolution as a result of COVID and where the world might look in the new normal, to me, those businesses are more prevalent then than they even are today. I think they’ve kind of shown that they can be successful in this environment and I think they’ve shown that they’re going to be sustainable. I mean, you could almost look at Amazon and say, I don’t even know what it’s at today, but it’s probably still a good buy, given on where you think the world’s going to go as a result of COVID. But impact to Oak Street, no, not going to have a big impact to Oak Street.

Ryan Morphin:

Well, in your perspective, the macro environment maybe still cloudy, unemployment and inflation, but the Fed’s meeting this week and they’re still doing asset purchases from banks. What is your perspective on negative interest rates and where are we in terms of kind of the banking sector and interest rate environment being so artificially low? Is it hard for banks to make money these days?

Rick Dennen:

Certainly with the declining rates and you see it in the earnings that are being released, last week and this week from all of the banks, certainly they’re down, their margins are down as a result of that. They always do better in a rising interest rate environment. But as for negative interest rates, I’m not really a big believer that that’s going to happen. I think there’s a little bit … I think the economy is strong enough that there might be some inflation in certain areas that will hold rates where they are, and with the stimulus, but I really don’t see them moving much in the next 12 to 18 months.

Ryan Morphin:

I mean, do you think credit spreads can gap out if there’s some distress on kind of delinquencies or defaults?

Rick Dennen:

Yes, I do think credit spreads will widen a bit as well, kind of result of the performance projections, the uncertainty, all those types of things. I think there’ll be some widening spreads. Let me ask you, if you don’t mind me turning it around because I know this is one of your specialties, but what do you think about negative interest rates? I’d love to get your opinion on it.

Ryan Morphin:

Yeah. I think we’re negative real rates when you take the kind of the current yield curve and I think you look at … You take inflation adjustments, I think we have negative real rates here. I think that has tremendous issues for dollar denominated assets, but right now we’re the tallest midget in the world and in a world full of midgets. And so I think in that scenario, as long as we can continue to grow with real numbers and real data, because I don’t think anybody believes the data coming out of China right now, that we’ll be the place that capital continues to flow. What I do worry about though, you brought the point about inflation is, I think we’ve gotten good as a financial architecture to flow capital into certain asset classes and that’s inflating assets.

Ryan Morphin:

There’s a tremendous divergence between the reality of the economy on the ground and main street and the financial markets. It’s kind of like we’re all sitting as a society in the bucket of a hot air balloon and the balloon took off, but we weren’t tethered to the balloon. I think we’re all looking up and realizing, wait a minute, it’s taken off in a different direction and we’re still stuck in reality of the ground. I think there’s going to be some divergence, but a quick convergence and that might mean a normalization of valuation levels across asset classes. But as long as the FED keeps coming out, not during an election season.

Ryan Morphin:

I think it’s going to be a 2021 conversation, no matter who’s elected. It’ll determine how they handle it, if it’s increasing corporate taxes, it’ll happen accelerate faster. If it’s, Hey, let’s borrow more money to invest in infrastructure, maybe that is a productivity enhancement that the market looks favorably over the longterm, but it’s going to depend on how people allocate resources. And if there’s a one party system, run the tables, or if it is a house that is Democrat and a Republican Senate, I mean, that’s probably a good look for the economy and for investors, but yeah. I think there has to be … Yeah. No, that’s right. I hope so.

Ryan Morphin:

Well, and I think that’s the genius, the stimulus does. I mean, we’re going to pay for later for sure. But I think the packages they’ve thrown out are buying people some time to figure out what’s up or down. Well, so as you’re looking at putting new capital to work in this environment, and obviously there’s a secular trend towards independence and to RIAs. In your conversations you’ve had with business owners, how has the perspective changing on valuation? Are valuations going to continue to march upward or do you think we’ve kind of hit a plateau and we’re just going to go sideways or down in the future?

Rick Dennen:

Well, it’s a good question, one we get asked all the time and there’s all kinds of webinars out there on this stuff. We’ve actually had the benefit, Ryan of kind of watching the insurance industry, which is one that we got into back in 2003 and the amount of capital that came into that industry in 2003. We’ve kind of been through a recession with that industry and we saw that we know what happened to capital. In my opinion, we saw tremendous deal flow in the second quarter of this year, but I think that was a result of a couple of larger deals and some efforts made in the fourth quarter. And even the first quarter of this year, it kind of came to fruition.

Rick Dennen:

Because of the amount of capital that does exist, I personally think that the multiples will go a little bit higher than where they are today. On the deals we’ve seen, we’ve seen a little bit of structural change with maybe five or 10% less down that it goes more to an earn out to make sure that the books transfer and kind of see how this COVID plays out, but like you and I have talked earlier, the markers are kind of back to where they were so the revenue streams are about the same. And if that capital is sitting on the sidelines, that’s just going to start reducing the IRRs on these portfolios of the capital provider.

Rick Dennen:

They still have to get their money out. I think the fourth quarter will be strong with a bunch of people trying to sneak some deals in at the end of the quarter. I think 2021 will be a record year for the RIA industry in valuation multiples as well as dollars going out the door. I can also see on these funds is a couple years down the road, as they start looking for additional capital on their next one, there’s going to always be a little asterisk in the corner on what their IRR was that, Hey, here’s what it is calculated, but if you take out that COVID year, it was actually three to 4% larger. You can kind of see that playing out as well, but bottom line is the amount of…

PART 2 OF 4 ENDS [00:18:04]

Rick Dennen:

You can kind of see that playing out as well. But bottom line is the amount of capital that’s here is going to continue to support this industry as it’s kind of proven out. And it’s almost exactly what happened in the insurance industry in the Great Recession.

Ryan Morphin:

Well, this one’s a little different obviously, because it’s forcing everybody to adopt digitization and technology, workflow productivity tools. How has your team dealt with kind of this no touch economy, business development effort? What have you guys changed or how are you handling it?

Rick Dennen:

That’s probably one of the best questions that I’ve heard in a long time. And it’s something we really have to figure out because so much of our businesses are relationship based, right? So how much relationship do you really get from a Zoom call versus two days with the CEO and the management team of a company that you’re going to lend $25 million to? I mean, there’s a big difference. So we’ve tried to continue with the marketing efforts, going more digital with webinars, partnering with people like yourself and even doing some videos and putting them out there. But it’s not the same as going to a conference or going and sitting with some diligence with a potential customer and kind of walking them through the expertise that you have, the structures that you can put together.

Rick Dennen:

It’s just a different feel. So we’ve tried to go more digital, I think, as everyone else has, but we’re also trying to do Zoom calls and WebEx calls like everybody is as well, but it’s just not the same. So probably the greatest concern going forward is how long is this going to last? We’re not getting out of the market, we’re going to continue to lend, but if this is going to occur for the next three years, then I would say that the potential losses in the portfolio might increase if you’re not really careful with your diligence, if you’re not really up to date on the current information and structuring a very aligned deal between a buyer and a seller and a lender there.

Ryan Morphin:

Have you guys been a part of any transactions where buyer and seller never met and they’ve just done due diligence remotely and virtually? Has those going through the pipeline yet?

Rick Dennen:

They are going through the pipeline. I have not seen one close, Ryan, that has been a start to finish diligence. Meeting, deal structure, put together an LOI, do your diligence, legal docs, close without a face to face. It can’t happen in my opinion. So that’s kind of that timing issue I talked about and think it is imperative that there’s a solution here pretty quick. And I suspect there is from what I’m reading, but I’m not a scientist either.

Ryan Morphin:

Right now I think it was five pharma companies in phase 3 FDA process. So 30,000 people are getting the shots for the vaccines. So I’m hoping we’ve got a one in five shot of getting that done, but the problem is going to be the scaling up, right? Of getting access to it at scale because a lot of these, you got to grow the virus and then you have to inhibit it before you can deliver it. So it could be not until… and I’ve told our management team today. I said, this could be one of those situations where we’re working in this kind of hybrid remote posture for the next year.

Rick Dennen:

Yes, I would agree. And I’ve heard different companies. We’ve already kind of put on hold kind of full back to office. I’m back in today and I was in yesterday, but haven’t been in that much. But from our perspective, we’ve got a lot of children, workers with children and things like that and they’ve got to deal with schooling. So we’ve already said, it’s not until at least January of next year. But I agree with you. It could be a whole nother year beyond that.

Ryan Morphin:

It is personal question. I mean, in your leader, you have employees with children. I mean, what are your thoughts? I mean, do you think schools should get opened up or should it all go virtual? I mean, it’s a question we’re dealing with and wrestling with here is, how do we handle and help our employees and their children take the distraction of, the most important thing all parents do, which is educate their kids. I mean, how are you guys handling that is as an employer?

Rick Dennen:

The one thing we immediately put together is we want to make sure that all of our employees’ children have the resources they need to continue the education. What we don’t want is our kids or anybody really in the world to not be able to stay with where they need to be from an education perspective. So we’ve actually put together a group of people to assess that, first, internally with our people, but then to go see what we can do in the community. We actually have an online learning program that we’ve been doing for about three years now, which has really taken off. But for me personally, I would have been an empty nester here come August. My last one is going off to college.

Rick Dennen:

And I frankly think they’re going to go down to school. And there’s a high probability that after 30 days, a lot of these kids will be coming home. There’s a couple of schools in the Midwest that have divided the colleges up to say, only freshmen and sophomores are allowed back in the fall semester. Juniors and seniors can come back the spring, others that have pushed off the start from an August to a September. We’ve got some local grade schools and high schools that started back this week already. And there’s a lot of concerns. So to put an eight year old with a mask and tell them to sit still and they can’t go out and play and be with their friends, I think that’s going to be a little bit of a struggle. But the important thing here is to make sure that no kid gets left behind and they got the resources they need. And that’s the tough question there.

Ryan Morphin:

A lot of kids don’t have laptops or internet at home. That’s like 15 to 20% of the population. So it’s a really important policy question. I commend you guys for making sure that’s a priority. Well, you’re an entrepreneur. You’ve built, sold, rebuilt a business. A lot of our listeners own their own businesses, they’re entrepreneurs, independent minded, financial advisors. What’s some advice you can give them having gone through different cycles about just being an entrepreneur and making lemonade out of lemons?

Rick Dennen:

Remember back in my public accounting days, but I mean, cash is king, right? And we had three different owners, Ryan, kind of as we grew this business until we kind of eventually sold it to a strategic. So three different financial sponsors and one of those sponsors actually struggled. They were supposed to be sponsoring us and committed capital and they struggled much more than we did and got taken over. And so you learn from that to be honest with you, but you really have to watch cash flow. You really have to plan and understand your equity position and how you can grow this business. No one knows, as you and I have talked, no one really knows when this is going to end and what the new norm was going to look like. So being able to preserve that capital, learn and position yourself to come out stronger on the opposite side of this is critical to me for these businesses.

Rick Dennen:

And it’s great discussion to have in a Zoom call with potential customers is just how they’re responding to it, how they plan to come out of it, what changes are they making? I hate to say it, if they’re saying, none, that’s probably a little bit of a red flag. Everybody has opportunities here to learn and grow, as did we, as we came through this process and came through the recession and struggled with some liquidity back in 2007. So everybody can come out stronger. It’s what changes are you listening. Are you making changes and positioning yourself properly?

Ryan Morphin:

That’s good advice. And from a leadership standpoint too, right? You have a lot of employees. How have you been handling the leadership piece? What are your thoughts on that? Any advice for people who have large groups of employees out there?

Rick Dennen:

That’s tough and we’ve been trying different things-

PART 3 OF 4 ENDS [00:27:04]

Rick Dennen:

… That stuff, and we’ve been trying different things, stepping up and propping up a PPP program, like we talked, in a week. I will tell you it was two, sometimes three meetings a day with the team of people that was learning, putting it together, building out the IT, rolling it out, seven days a week, you’re talking 12 to 15 hours a day. I mean, it was a lot there to get that going. Then you get to a point, in my opinion, when those slowed down that was too many Zoom calls a day. And you can live and die when you’ve got a computer in your dining room, that you can never get up and get away from it.

Rick Dennen:

The weather was a little bit colder here. People wanted to be inside, and I think there’s a real balance that you have to get up, get away from your computer, turn it off, get away for a couple hours a day, and find the balance here. So, from a leadership perspective, we’re pushing that. We’re trying to balance too many meetings with not too many meetings, but making sure we can really stay in touch with the business and be super close to our customer. So, now everybody is kind of, as a cascades down to the leadership team, has their different management process that they have. And then, how do we communicate best with our customers? But it’s evolving, no doubt about it, day to day. How’ve you guys been doing with it, Ryan?

Ryan Morphin:

Yeah, and I think it’s about hyper communication. And so, we’re doing a lot of video communication across the organization, and collaboration tools we’ve implemented, that are actually really cheap and affordable, and user experience on those are pretty well thought out. So it’s places like [Basecamp 00:28:44] or Harvest, to try to help people think about how they’re spending their time and their day. And also, because everyone’s remote today, it’s given managers some transparency on what people are actually working on, so that we can help re-allocate or refocus priorities, because God knows the priorities are changing. Every other week we’re having to deal with new ideas or new solutions for our clients. And like you said, generate new IT frameworks, or get new project management up to task.

Ryan Morphin:

So, we’ve been doing a lot of that. From the human element, we did do a kid’s academy this summer. And I think we’re going to probably kick that off again, or get some college students who want to be teachers. We bought a lot of COVID tests, so we’re trying to test our employees and the people coming into the office with children to … There’s just, the data’s there. I mean, there’s no substitute for in-person learning. And so, we think we can augment the virtual teaching between the teacher and the student by having a college age professional in there, to help them stay focused. But yeah, the kids under 10 are not going to wear a mask, or sit in front of computer for six hours a day. It’s just, it’s impossible.

Rick Dennen:

You can say kids or adults. It almost applies to the same thing.

Ryan Morphin:

Yeah, applies to me as well. That’s [crosstalk 00:30:08] right. But, so any silver linings you see for the wealth management industry or the US economy, given the outlook that we have today?

Rick Dennen:

I think memories are short lived. I think people forget about these times quickly, like they did even in the recession of eight, nine and 10, and people get back to it pretty quick. It seems like every time there’s an event like this, we come back pretty strong. And you can look at the markets today, like we’ve talked, and see how quickly they’ve come back since February. There might be another drop at some point in time, but the silver lining is, especially for this industry, is revenue levels are probably back where they are. And like we talked about with the opportunities to clean up and right-size some staffing, I think a lot of these companies are going to come off more profitable and even greater margins.

Ryan Morphin:

Yeah, concur. And over the summer, are there any books you’re reading or places you’re going to for motivation, or thought leadership?

Rick Dennen:

Every day, there’s so much information that’s out there. It’s almost information overload. And I’ve been watching some podcasts. I was thinking about it today, that Peter [Schiff 00:31:34] Discussion on gold and silver stocks, and the impact, and where people shouldn’t be investing there. I was looking at that more from how that might impact the RIE industry, and everybody needs to own some of that, and just how high that is today. So, things like that, but I’m always listening and reading on what people’s perspectives are on the M&A industry. That probably comprises 60 to 80% of our loan growth each and every year. So it’s pretty important for us, and I stay pretty in tune with those readings and webinars.

Ryan Morphin:

Well Rick, thank you for joining us and sharing your thoughts on where we are. And we’d love to have you back on in a few months, and see how the aperture has either tightened or widened on the recovery here. But, we thank you again for your time.

Rick Dennen:

Yeah. Thank you Ryan, certainly enjoy all the podcasts you are doing and all the success you’ve had. Congratulations.

Ryan Morphin:

Well thanks a lot Rick. Have a great day.

Rick Dennen:

You too.

Ryan Morphin:

Thank you for watching NON-BETA ALPHA. And before we go, please remember to like, and subscribe on Apple podcast and our YouTube channel. This is NON-BETA ALPHA, and now you know.

Speaker 2:

All price references and market forecasts correspond to the date of this recording. This podcast should not be copied, distributed, published, or reproduced in whole or in part. The information contained in this podcast does not constitute research or recommendation from NON-BETA ALPHA Inc, Wentworth Management Services LLC, or any of their affiliates to the listener. Neither NON-BETA ALPHA Inc, Wentworth Management Services LLC, nor any of their affiliates make any representation or warranty as to the accuracy or completeness of the statements, or any information contained in this podcast. And any liability, therefore including in respect of direct, indirect or consequential loss or damage is expressly disclaimed.

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The views expressed in this podcast are not necessarily those of NON-BETA ALPHA Inc or Wentworth Management Services LLC. And NON-BETA Alpha Inc, and Wentworth Management Services LLC are not providing any financial, economic, legal accounting, or tax advice, or recommendations in this podcast. In addition, the receipt of this podcast by any listener is not to be taken as constituting the giving of investment advice by NON-BETA ALPHA Inc, or Wentworth Management Services LLC to that listener, nor to constitute such person, a client of any affiliate of NON-BETA ALPHA Inc or Wentworth Management Services LLC.

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PART 4 OF 4 ENDS [00:34:47]

 

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Ryan MorfinPini, Welcome to the show. Thank you for coming on today.

Pini AlthausThank you for having me, Ryan. Good to be here.

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Pini AlthausYeah, I mean, rare earths are an extremely ubiquitous part of all advanced manufacturing or technology manufacturing today's day and age. Several years ago, I had not heard too much about rare earths myself. I was not that familiar with it and being involved in this sector, in this company, for the past few years has given me an education of course. And I mean, I was sad to hear that 50% of all imports into the United States contain are earth elements and it runs the gamut from consumer electronic devices that we use every day. Our cell phones, our laptops, most communication devices, medical equipment. So there's a tie with COVID, which we can touch on at your discretion. Electric vehicles, defense equipment. So pretty much anything or everything high tech today has a rare earth element or critical minerals contained within them.

Ryan MorfinAnd what are some of the names of some of the more important rare earth? I know there's lithium for batteries, but what else is considered in this category, critical?

Pini Althaus: Yeah, so lithium is a separate category to battery material. The rare earths are 17 rare earths. The four, let's call it, key rare earths that we're focused on at our company, the four rare earths that go into the permanent magnets. And these are the magnets that are found, there are a number of them in your back of your cell phone or an iPad. But if you look at an F35 striker jet, you've got about a ton of rare earth magnets in those. And we've got two heavy rare earths and two light rare earths is part of the permanent magnets. You've got dysprosium, ytterbium are the heavies, and then you've got neodymium, praseodymium as the two light rare earths. So those would be key rare earths that are the focus.

Ryan MorfinAnd you use these in, I guess, in military applications as well, but historically, where has the United States sourced the rare earth for supply chain?

Pini AlthausYeah. And that's the shocking part. We've been securing those materials from China. So China controls the rare earth sector and has done so for the past 30 years or so. And it was a significant misstep on the part of the United States, allowing China to have this control. And actually this wasn't a question of China coming in and doing anything nefarious as far as stealing IP or anything. The US government made a conscious decision about 30 years ago to allow China to come to the United States and acquire the processing capabilities for rare earths. So just as part of some background, you've got the rare earth materials containing various mining projects, but once you extract them, you have to then process them and they go through certain phases before they get to the magnet phase. And China, the thought process was let China do the mining, let China do the processing.

Pini AlthausWe don't need to do that here. And we'll buy the materials from China cheaply and the premier of China at the time, Deng Xiaoping made the comment, he said, "The Middle East has oil. China has rare earths." And unfortunately we weren't smart enough to understand what he was saying. And the Chinese understood that the future of manufacturing is going to revolve around control of the rare earth and critical mineral supply chain. So if you think about it today, Ryan, we cannot build... Forget about consumer electronics and medical equipment. We cannot build the equipment that the US Pentagon or the US armed forces require, whether it's F35 fighter jet, Tomahawk cruise missile, communications equipment, without going to China and obtaining those materials. And it's obvious to all that this should be extremely alarming. We've seen China use this as a weapon, if you will, as far as how it interacts with other countries back in 2010, when there was a dispute between China and Japan on the East China Sea.

Pini AlthausSo China cut off rare earth exports from Japan for 40 days. Japan obviously being a significant user of rare earth elements for their high-tech manufacturing sector, that was stopped after 40 days. But in fact, it was President Obama that first made the United States aware of this, formed a division within the Department of Defense to handle this issue, but not much has happened. And we continue to be relying on China for these materials. And what has been made about trade war with China and whether the trade war is really the impetus for China withholding rare earth exports. And that is a huge misnomer. Whilst China had been talking or implying that they would cut off rare earth exports, the truth of the matter is that China, under it's made in China, 2025 mandate, its belt and road initiatives and others. And you seem to control the critical minerals and rare earth supply chain so that it can continue its dominance as a manufacturer or a global supplier of these materials and finished products.

Pini Althaus: It's the backbone of its economy. And in fact, China has become a net importer of rare earths from different countries like Miramar and others. So with that, they are decreasing the exports to countries like the United States, Japan and others.

Ryan Morfin: And was it ever a risk that the Chinese were going to turn off the exports of rare earth to the US during the trade war? How close were we to that? And was that ever some saber rattling that went down during trade negotiations?

Pini AlthausYeah, I think it was saber rattling. I think it would be paramount to an act of war. I can't say with any authority that that would not happen, but it would be probably, aside from war itself, it would be one of the most significant acts of war cutting the United States off from the ability to procure rare earths. But that being said, I mean, if you look at, as an analogy, the oil and gas sector and the reliance of the United States had for many, many years on OPEC countries to supply us with the oil. And we had embargoes and we had price manipulation by OPEC. This is far more significant given the ubiquity of where these rare earths go. And yes, we're always under the threat that China can cut off exports under the guise of a trade war or for any other nefarious reasons.

Pini AlthausBut I think even more importantly, to just as the natural run of the course of things with regards to their business and their desire to maintain themselves as the global leader in manufacturing and exporting of goods, China is in a position now where it actually requires these materials for their own domestic consumption and can legitimately cut off rare earth exports by stating that they need it for manufacturing and that would actually be somewhat correct. So we're in an extremely dangerous position here with this reliance on China. And it wouldn't just be China. If it was another country, it would be similar issues, not to the same extent, but reliance on one country for these materials is dangerous.

Ryan Morfin: And it's been mentioned in the past that in 2010, China flooded the market to really kill all the competitors in the rare earth mining industry. Where was the World Trade Organization during this period? And how did that play out and how does that set the chess board for China to run the tables?

Pini Althaus:

Yeah. So the WTO stepped in when China cut off rare earth exports from Japan, I think it lasted for about 40 days because the US and Japan protested the WTO, and they stepped in and China resumed exports. While I'm not an expert on these trade matters, one thing that I am aware of is that one of the reasons why China had to resume the export of rare earths was it did not legitimately need all the rare earths for domestic consumption. So therefore it was a nefarious act, if you will, to cut off rare earth exports. Now that has changed, which means China have to cut off rare earth exports today, they have a legitimate case to say that they require these materials. There's a shortage of these materials and they require them for their own domestic purposes. It is the backbone of their economy and there's very little we could do about this today, which is why it's becoming an even more urgent issue.

Ryan Morfin:

And the US government started stockpiling some of these after that incident. Can you talk a little bit about what DOD and DOE has done to start making sure that there's not a critical supply shortage going forward, and is it enough?

Pini Althaus:

Yeah, again, there is a national defense stock pile, and there are materials still that the United States needs to procure in order to shore up its stockpile. There are magnets, the finished magnet products as well, the United States government needs to stockpile. Again, there's a limited amount that the United States government has. It requires approval from Congress, whether it's in the NDAA or other approvals from Congress, to allocate monies for the national defense stock pile of these materials. That being said, there's no endless supply of these materials. And unfortunately, the apparatus, the way it's set up right now with the US government, it's going to continue to require having a secure supply chain of those materials for many, many years to come. So it's not a question of stockpiling for 10 or 20 years, and then this complacency and saying, we'll kick the can down the road. But keep in mind as well, Ryan, that US government accounts for low single digits of overall rare earth imports into the United States.

Pini Althaus:

We're talking about defense contractors, we're talking about the manufacturing sector. The direct impact this has on the economy, jobs, the automotive sector, and others is significant. So it's not just limited to the United States government. If you look at over the past couple of weeks, the sanctions that China have put on Raytheon, Boeing, Lockheed, et cetera. I mean, the question is where are they going to get those materials? And if we go beyond that, you need rare earths for the 5G network. Now that Huawei has been banned from installing the network, not only in the US but other countries, we have to have the ability to get a secure supply of these materials as well. Which currently, again, trying to control the hundred percent. So it runs across the board, both for government, defense and manufacturing in this country.

Ryan Morfin:

Well, and so help me paint a picture for our audience. Does China have all the mines for rare earth, or they're the only ones who started mining it? Or are their mines globally dispersed and nobody's been doing the actual infrastructure to do the mining?

Pini Althaus:

Yeah. So finding rare earth projects or rare earth elements is not the difficult part. It's finding them in significant quantities that makes a project economically viable. And part of that consideration are the environmental rigors that companies in the West have to adhere to. And China, even by their own admission, have had a complete disregard for mining these materials and even for processing these materials. And in fact, just the last week or so, the BBC did an expose on this, 60 Minutes has done an expose on this. But the Chinese have not denied this and have talked about cleaning up their act, but it has an effect on the bottom line for what the costs of mining and processing are if you have no environmental standards to adhere to. So China have exploited those rare earth projects they have, primarily in inner Mongolia, and have brought a number of projects online and quite quickly, and in a significant way, with a complete disregard for the environment.

Pini Althaus:

So it was seen as an environmental no-no in the West for many years. Now, what's happened over the past few years is you're starting to see rare earth projects in different parts of the world sprout up. You've got the Mountain World project in Australia owned by Linus, which is a producer of Nd and Pr, neodymium and praseodymium. So two of the light rare earths. They may have some heavy rare earths coming online at some point in time. And you've got Arafura, which is another company in Australia that we're working with to assist them with their processing so they don't have to send the materials to China for processing. But really these are a drop in the bucket for what the requirements are for the United States. And certainly what the requirements are for allied countries, the EU, et cetera. So there is a race, if you will, worldwide to start bringing projects online. The Chinese are very active in trying to secure assets outside of China.

Pini Althaus:

So in Africa. They have ownership of a project in Greenland. So there is somewhat of a race. The Australian government has stepped in and has started limiting the ability for China to own, or have ownership in, or off takes for the Australian rare earth projects. And that's part of the strategic Alliance between Australia and the US. Canada, similar thing as well. There are a number of projects that are looking to come alive, but these projects are, for the most part, will take many, many years to come online. We have to expedite the process. We have to assist with a [inaudible 00:14:41] supply chain and the domestic rare earth sector, because previously investors have been scared off by things like China flooding the market, which is not a possibility at this point in time, given that China can't actually afford to flood the market. They are already very heavily subsidizing their mine to magnet supply chain there.

Pini Althaus:

This is more now a case of being able to get production from non-Chinese sources so that the United States and allies have a viable, secure supply chain of these materials. And it's a concern worldwide. We speak to governments all over the world, and we're all facing the same issue. Some more than others, especially countries like Japan, that don't have their own rare earth projects there and are reliant on Australia where they've made some investments there. And in the United States, they've made an investment recently in Africa. So there is this race, if you will. And I think we've got a five-year window here to at least stand up a few projects worldwide. Otherwise we've lost this race and we will be dependent on China for many, many years to come. And Ryan, it's a bit of a hypocrisy. If you look at it where you've got materials going through clean, green energy applications, like electric vehicles, wind turbines, et cetera.

Pini Althaus:

That we're sourcing these materials from China, where they've, again by their own admission, has been complete environmental devastation to water bodies around these mines and processing facilities, to the communities. People have been getting sick around these projects yet we're putting these materials into our electric vehicles or wind turbines. It makes no sense at all. And people are starting to wake up to this. And that's why the sector is starting to see a lot of support come out of Congress and bi-partisan support. And in fact, it's one of the only bi-partisan issues right now in Washington. And it's good to see that some things decided to move in the right direction.

Ryan Morfin:

And is there a special process? You talk about the expense, is it really difficult to mine these? You have to go through a special chemical process to extract and clean and purify. Is it a lot harder than, say, gold or silver or some of the other, we'll call, more traditional elements?

Pini Althaus:

Yeah. It's all about the processing to some extent. So if you look at MP Materials in California, which used to be Molycorp before they went through their bankruptcy. They are a miner of Cerium and Lanthanum, which are two of the light rare earths, the lower valued light rare earths. Given that they do not currently have processing technology, they are sending those materials to China for processing where China is tariffing those heavily. Linus is also, they're doing their processing work in Malaysia and elsewhere. So it's really about the processing at this stage. One of the things that we've done, after we put out our PDA last year with our upgraded resource, which now includes a significant amount of lithium. We make a decision that, based on the test work that we had done around our processing methodology, that we were not going to send our materials to China. That it's paramount for us to do this work in the United States and in a collaborative effort as well.

Pini Althaus:

We've been asked by some of our investors, "Well, why would you be looking to help other projects with their processing?" And the answer is simple. There's no one project or one company that's going to put China out of business or make a dent, or somehow be able to take care of the overall demand worldwide for rare earths and critical minerals. And it's very important for us to have processing capability in the West. So that was the impetus for us opening up our own rare earth and critical minerals processing facility earlier this year, which we did in Wheatridge, Colorado. And in fact, we've made some significant progress on the method that we're using for this. And we're starting to collaborate with Australian companies, Canadian companies. We're currently talking to a group over in Europe as well, because this has to be a collaborative effort.

Ryan Morfin:

How does Europe solve for these problems? Do they have this better under control than the US?

Pini Althaus:

No, they're in a far worse position than we are. The EU commission recently put out a report, I think, a couple of months ago that the requirement for rare earths is going to increase tenfold within a short period of time. Lithium 18 times. They don't really have rare earth projects. Again, there are the Greenland projects, which people have heard in the news recently. Those need to further development work so they don't have rare earth projects ready to come online there. There are a couple of lithium projects that are spread around Europe, but for the most part, Europe is in an even more precarious position. If you look at Germany with the auto manufacturers, you look at the big companies like ThyssenKrupp and others, all these countries and companies are looking for alternatives to China, because we've already seen in the news about China withholding or reducing exports of some of these rare earths that are required for these industries.

Ryan Morfin:

And you mentioned earlier the regulatory posture of the US makes it difficult to mine. Is it becoming a more bi-partisan issue that we need to maybe relax some regulation around the mining exercise, to incentivize private sector to come in and start producing this? Or is the Republican party versus the Democratic party on two separate pages of music?

Pini Althaus:

Yeah. Good question, Ryan. I mean traditionally the Republican party is obviously being more pro-mining and in favor of less regulation when it comes to these things. With regards to our project, we're on Texas state land. So we don't trigger federal environmental permitting at this point in time. And obviously Texas being Texas, a mining state and oil and gas state, things are a lot easier in Texas than they are on projects on federal land where the Bureau of Land Management controls the environmental process around that. But the thing is here, and I don't want to step into what other companies are doing, et cetera, but we do need to be reasonable about allowing projects to come online if they're adhering to environmental standards that are acceptable worldwide. And what we do know, is that China is destroying the environment and cities and water bodies around their mines and processing facilities.

Pini Althaus:

We have standards here in the United States, and I think what we need to do is make it easier for companies to mine, while at the same time protecting the environment. And there are ways to do that. And we're definitely seeing buy-in from Congress, from both sides, with regards to looking how we can stand up a secure supply chain. And, obviously under the Obama administration, they had very strict regulations when it comes to mining. And that's changed under the Trump administration. Hopefully what we start to see is some normal middle ground that'll allow other projects to come online.

Ryan Morfin:

And typically in these rare earth mines, is it amalgamation of different minerals that are all consolidated together and you have to separate them out? Or do you ever find pure play, Europium, I can't even pronounce some of these. Gadolinium, Cerium. I mean, are they all mixed together and you've got to filter and sift them through, or are they pure play mines?

Pini Althaus:

No, they're generally they have a mix. So they're polymetallic projects. They have a number of different materials. Some projects, you more to what we call the light rare earths like MP in California or Linus in Australia. Our project is actually on the opposite end of the spectrum. We have a very high concentration of heavy rare earths. That being said, we do have to go through a process of separating these materials. But the case of our project where we've got 30 materials. We're not going to produce 30 materials. We're not going to market 30 materials. So what we're doing is we're focusing on the key materials that are marketable, that we need for permanent magnets, lithium as well, and working on the separation and the optimization of those materials in particular. But we're all faced with the same processing challenges and that is something that can't be set.

Pini Althaus:

There's no easy way to do this. There are different technologies that have been used in different parts of the world. So predominantly there's a process called solvent extraction, but it's big, it's bulky, it's not benign. It's a bespoke solution for one particular project. So it doesn't work for feedstock from other projects. What we've done is we're using a processing technology that's actually been around since the 1940s. It was part of the Manhattan Project. It's called continuous ion exchange. In fact, the Chinese use it to increase the purities from 99.99 to four nines, five nines, and even six nines. So for some applications you require higher purity levels. It's a far easier processing method to scale up and to take feedstock from other projects. In fact, we've demonstrated for the Department of Energy that we can take coal waste from Pennsylvania and do high purity separation of rare earths using our processing methods. So it's not a step that can be skipped unless one needs to send it to China for processing, which is not going to help us with our objectives here.

Ryan Morfin:

How many other, we'll call it, going concerns on any other businesses that are doing this, that are trying to, I guess, start the development of these mines. Are you guys one of a few or are you one of many? And is it an international or just a US game? Who's leading the charge at going after this?

Pini Althaus:

Yeah, well, I'd say the Australians are leading it outside of China right now. You've got some really good projects in Australia. Again, more skewed toward the light rare earths. There's one more heavy rare earth project in Australia, which is not yet producing. The United States, you've got MP Materials, you've got Ucore in Alaska, you've got the Bear Lodge project in Wyoming, which is also another light rare earth project. So as far as a heavy rare earth project that looks like it will come online in the near term, that would be our project. In Canada there are a couple of projects there as well, and again, more skewed toward the light rare earths. But we really need to get as many of these projects online as possible. Because again, I don't see it as competition. We all have a problem doing supply agreements or offtake agreements for our materials.

Pini Althaus:

In fact, one of the things that we're going to have to consider is looking at potentially scaling up our production, based on the demand that we're already starting to see. And I think other companies would find that as well. So it's all about the economics of the project. You have projects that were economically viable back in 2012 or rare earth prices with 35% or so higher than they are today, and are not necessarily viable today. So that's the challenge as well, economically viable projects. And we've got to get as many of them online as possible. It takes many, many years. I mean, our project has had over $70 million put into it to get to where we are today, and we're close to getting to the production scenario. It all revolves around processing at this point in time.

Pini Althaus:

We'd be very happy to see another couple of projects come online, because this is extremely important for national security and for the economy as well. I mean, if you think about it, Ryan, if you've got a billion dollars of rare earth materials, that translates into a trillion dollars or I should say trillions of dollars of finished product. So you've got a magnet in your phone there that's worth a couple of dollars and the cell phone's a thousand dollars. And electric vehicles and defense applications even more.

Ryan Morfin:

Yeah, everyone has one of these iPhones now, and there's tremendous amounts of rare earth on the circuit boards here. And I think people take it for granted that that supply chain is not secure right now. So one question for you, there's talk of this maybe medium term to longterm, but there's talk about mining in space. Do you think that's a feasible option in the longterm, medium term? What are your thoughts on that?

Pini Althaus:

No, that's just ridiculous. I mean, we're trying to find ways to make mining on earth economically viable. I think the cost of going up to space would be more than what our capex will be bringing our entire project into production. I mean, we've got about a 350 to $400 million capex to bring 130 year mine life into production. I'm not an aerospace expert, but I think sending a rocket, building a rocket ship and sending it up, I think maybe on the fuel alone, you could bring a couple of projects into production. So unless we have a fortunate situation or an asteroid lands on earth, and fortunate if it lands somewhere where we don't care, I don't see how that happens. And if it's big enough, it's a problem as well. It's nonsense. And even, options aside of the deep sea mining for rare earths, I mean, you've got all sorts of environmental issues around that as well. I think we need to look at projects that we can bring online, that can be done so in an economic way, that can be done so in an environmentally responsible way.

Pini Althaus:

I mean, one of the things that we've done at our project is we've got in excess of 60% of the materials that have come out around top, will have a clean green energy applicability to them. So we're using the benign processing method. We're going to be using renewable energy on site. In fact, we will likely be putting a solar farm on site as well. We've talked to a couple of companies that have approached us about that, and we'll be a net producer of power for the surrounding area. So there are ways to do it which don't affect the environment. Obviously if there's a project that's situated on a sensitive area, that's a unique situation for that specific project. We've seen it with the Pebble project, which is not a rare earth project. The Pebble project in Alaska where their environmental concerns is we've been recognized by both Republicans and Democrats, but we have to be reasonable about the projects that don't have environmental concerns.

Ryan Morfin:

So Pini, in season two, we ask all of our guests a series of six questions. They're usually, yes, no questions, but trying to take a survey of our conversations. And if you want to add a little context to the yes or no, feel free, but here goes the first question. If there was a COVID vaccine available today, would you take it?

Pini Althaus:

Yes.

Ryan Morfin:

Who do you think is going to win the election?

Pini Althaus:

Which election?

Ryan Morfin:

The US election.

Pini Althaus:

Well, I think it looks like Joe Biden's going to win it, but I think what happens, if we go past January six from my understanding is that the house will vote on it and it's one vote per state. But I don't know if I see it getting there at this point in time. I really don't have a crystal ball.

Ryan Morfin:

Third question. What type of economic recovery are we in? What type of shape is it taking? A V-shape, W, U, L?

Pini Althaus:

Yeah, I think 2021 is going to be challenging. I think we've been, and rightly so. I mean, we've had no choice as of almost every other country. We've been printing money for the past year because of COVID. And I think we've got to brace ourselves that, at some point in time, the chickens come home to roost. It was a necessary step. People needed it on an individual level. Businesses needed it as well, but I think we've got to do whatever we can to stimulate the economy, give people confidence to go out and work again, employ people. So I think we've got to watch ourselves, especially in 2021. And I have some concerns, but long-term, I think the approach in the United States is a healthy one.

Ryan Morfin:

During lockdown this summer and quarantine, was there anything in particular that you accomplished that you're particularly proud of?

Pini Althaus:

Yeah. A great amount of family time, which, if you would've asked me a few years ago if I could sit at home and be at home for six months, I would have told you absolutely not. I wouldn't be able to do it for six days, but it has... I'm sure it's done this with a lot of families as well. It's brought families together. We had a baby actually last year on Thanksgiving. So I was doing a lot of travel at the time and thought I wouldn't get to see my daughter in her first year or couple of years too often. And being home with her every day is actually been just the most amazing experience. So thankful at least for some silver lining in COVID.

Ryan Morfin:

Are there any silver linings that you see in the economy going into 2021?

Pini Althaus:

Yeah, I think we've gone through an absolute beating and it looks like we've got the ability to come out of it. And I think that's a testament to how strong the economy was built up in the years preceding COVID. So overall I remain an optimist. I mean, we are a country built on opportunity and going out and making it happen. And we're not a socialist country sitting and waiting for people to send us paychecks or wealth distribution or anything like that. I think the American dream still lives on. I think if you go out and you're willing to work and put your head to it and heart in it, I think we do have the ability to climb out of it. So if we look at what the economy is doing over the past few weeks, it looks like it's starting to rebound. And to me, that's assuring because it could go completely one way as well.

Ryan Morfin:

And the last question is, is there anything that you're watching, or listening to, or reading today that has been impactful on your thinking that you'd like to share with our audience?

Pini Althaus:

Yeah, that's a good question. I think it's been more personal stories. The news, I sort of take that in context or with more than a grain of salt. In some cases stay off the news channels for a number of days at a time, it became quite repetitive. But I think on the personal side, talking to friends, my family's all back home in Australia, they've just come out of 110 day lockdown, which we can't relate to that. It's been very trying on them and seeing the fortitude that they've had to come out of that and stay intact. I think the mental health issues that will come out of COVID are going to have a far longer effect than the economic issues. I think we're going to have to focus on mental health issues in this country for a long time to come.

Pini Althaus:

The impact on kids has been significant with regards to lockdown or remote schooling, et cetera. But to see people come through it. I think it's a testament to people in general and to the country and other countries as well, to see got that fortitude and survival instinct to try to get through whatever adversity we can. So hearing the personal stories, the challenges that people have gone through, I think it's made me a lot more aware of things that I have to be thankful for and where we can help out other people as well. I think we have to be united going forward because there are things...

Pini Althaus:

I think one of the things that COVID has shown us is we can get into this complacency and life goes on and we go one day to the next. And all of a sudden we get hit by something that affects everybody equally. I mean, COVID, whilst there were groups of people, whether it was the elderly or people with underlying health conditions, that got hit the worst. I mean, we all got hit in some form or another. So really, this should be something that unites us, not divides us.

Ryan Morfin:

Well, Pini, I appreciate you coming on today to talk to us a little bit about the supply chain crimp on rare earth and we'll definitely keep an eye on it and would love to have you back in the future.

Pini Althaus:

Thank you, Ryan. Thanks for having me.

Ryan Morfin:

Absolutely. Thank you. Bye-bye. Thanks for watching Non-Beta Alpha. And before we go, please remember to like, and subscribe on Apple podcasts and our YouTube channel. This is Non-Beta Alpha, and now you know.

 

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