seth klarman photoOnly one thing pertaining to The Highland Companies’ Ontario mega-quarry is

gaining notable momentum.  Unfortunately for Seth Klarman’s Baupost Group, it is serious opposition—not progress—for which the proposed facility has become known.  The Boston-based hedge fund owns a rumored 16% stake in the project, which has more than $40B in gross revenue potential.  Yet, the effort has been a non-starter, with stormy skies looming grayer than before.

 

If executed, the project would be the second-largest mega-quarry in the history of North America (a “mega-quarry” characterized as one with mineral deposits of 150 million tons or more).  The project in question would produce 1 billion tons of aggregate, the name for the spectrum of building materials that can be fashioned from the underlying limestone.  It has been estimated that each acre of quarry would yield $18M in revenue at current market prices.  Yet, the project has seen unexpected obstacles at every turn.

 

Bad PR for Highland = Bad News for Baupost

Perhaps it was bad foresight on the part of Highland, which showed signs of mismanagement since the beginning, if not from a project viability perspective, certainly with respect to PR.  For at least three years, it hid its land use agenda, having its purchaser claim that the small farms it ate up would be used for the legacy industry, potato farming (a claim that turned out to be patently false).  Numerous missteps in the wake of the proposal filing in the Spring of 2011 prompted Highland to fire spokesman Michael Daniher, replacing him with Lindsay Broadhead of PR firm, Hill & Knowlton.

 

Yet, Broadhead may not be faring much better in light of a new set of inflammatory claims, having asserted that the project “simply can’t have a negative environmental impact” according to internal research findings.  (If this statement were true, would Highland be doing everything in its power to uphold the precedent that quarry projects not be subject to conditional public environmental review?)

 

A quick glance at Highland’s own web site continues in the same ingratiating vein: “We are creating diversified portfolio of sustainable local businesses,” it reads, “…creating local jobs and improving the life of the communities in which we operate.”  It touts its standings as Melancthon’s largest employer (not mentioning that the rural Township was home to fewer than 2,700 people as recently as 2006).  It emphasizes its commitment to the region’s legacy potato farming businesses, glossing over the fact that, if the mega-quarry is approved, those farms will be closed to make way.

 

This hubris is problematic not least of all for stretching what most people would consider reasonable truth, but also for its tonal discord with the sentiment of the community.  Its most egregious offenses have been myriad “no environmental impact” statements that few logical people would believe are true.  Per Canadian Geographic, the facility would drill 57 meters underground (a depth surpassing Horseshoe Falls at Niagara), run 365 days a year, 7 days a week, see 150 trucks coming and going every hour, and compromise the water table, requiring some 600 million liters be pumped out of the facility each day.

 

The stark contrast between what Highland is saying and what myriad local, regional, and environmental groups contest has subjected the application to extraordinary scrutiny.  It has already cost Highland time.  It will certainly cost more money.  And if it costs Highland the project, it will cost Baupost its return.

 

 

Project Rejection = Revenue Potential Plummet to ~13.5% Level

So, what would the land’s revenue potential be if the mega-quarry were nixed?  According to Canada’s official Potato Production Report (July 2011), not very much by comparison.  The entire state of Ontario saw only $117M worth of potatoes sold in 2008 and $99M in 2009.  If we assume the life of Highland’s mega-quarry to be the standard 50 years, the result would be $800M in annual revenues from the Highland facility alone.

 

From this, we can conclude the following: potato farm revenues max out at only 13.5% of what is possible were the same land used for quarry.  Though operating costs and profits remain unknown (and different for each industry), the order of magnitude makes the value potential (or lack thereof) clear.  Rumor has it that Highland bought out local farmers by offering only $8,000 per acre over market value.  Yet, failure to launch the quarry project, given interim costs and despite future revenues, would result in a multi-year loss.

 

 

The Likelihood That This All Goes Away = None

So, what would be the best-case scenario for investors like Baupost?  The most favorable outcome would be a cutting of regulatory red tape.  Also needed is the propensity to work through other government bureaucracy while simultaneously winning the hearts of myriad local opponents.  Yet, such an outcome is highly unlikely given Highland’s refusal to stop acting in ways that inflame detractors.

 

And that’s not just speculation.  Consider the fact that the response period granted to the local community was extended from 45 to 120 days, a strong signal that Highland does not have local officials in pocket, and that opposing arguments are being taken into serious consideration.  It’s a virtuous cycle for adversaries: the delay will give them more time to join forces and build a case against the project.  A delayed project start means delayed, and diminished, revenues.

 

A final factor stripping investor value away from the project is the domino effect of negative buzz, made highly visible by the grassroots efforts of social media savvy opponents.  One Facebook group, aptly named “Stop The Quarry!,” has upwards of 5,000 followers, and has done a better job of besmirching the project’s image than has official spokesperson Lindsay Broadhead of bolstering it.

 

The most likely scenario is that community opposition combined with the record magnitude of the project will prompt the environmental audit Highland is trying to avoid.  Even if the findings are benign, the exercise alone would delay approval, dashing hopes for a near-term project start.  In the (more likely) event that environmental impacts are found, it will spell more bad news for Highland.  If the stakes are too high, the project may be rejected, leaving Baupost and other large investors to suffer a loss.  Even if the project moves forward, any environmental citations will be costly, reducing net profits and limiting Baupost’s overall return.

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