Baupost Might Lose Money on Mega-quarry Investment

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The economics of The Baupost Group’s Ontario mega-quarry investment continue to unfold strangely, with new statements made in a January 12th Town Hall Meeting between Highland Companies executives and local parties adding clarification.


Back-of-the-envelope math once told a story that estimated $43B profits for the mega-quarry project.  This was based on the assumption that most or all acreage named in the proposal (2,316 of Highland’s 9,000+ acre holdings) would be used for the extraction of aggregate, and would yield an estimated $18M revenue per acre.  Yet, pointed questions around the specific use of the land told a different financial story.


Most notable are extraction volume projections that fall far below early estimates, a useful life operating period that doubles the benchmarked average, a reinforced commitment to limit the market to Ontario Province, and cost concessions that will further erode profits.  Messrs. John Lowndes (a co-owner), John Scherer and Joseph Izhakoff, all principals of the Highland Companies supplied the referenced clarifications at the meeting.


Extraction Volume: Acreage Caps and Operational Levels

Though the proposal references 2,316 acres in mega-quarry land, Highland clarified that operations would ramp-up slowly.  Further, maximum extraction would take place only on 300 acres at a time and extraction would take place only 270 days a year.  Messages underscoring gradual installation and smaller-scale operations were mentioned to mollify local opponents.  Yet, downsized production may be of little appeal to investors.


For one, investors want returns to arrive as robustly, and as early, as possible.  A slow ramp-up means delayed revenues, and a 300-acre limit means less inventory to supply market demand; and Highland executives indicated that the largest opportunities are short-term.  Referencing the “State of the Aggregate Resource in Ontario Study”, conducted in 2010 with the participation of “the Ministry of Natural Resources, the Niagara Escarpment Commission, Gravel Watch Ontario, and members of the scientific and planning communities,” demand will increase by 13% between 2011 and 2030.  That doesn’t give Highland much time to get a mega-quarry project approved, built, ramped-up, and operating at full steam.


Useful Life:  From 50 to 100 Years

Also of note was the statement that the quarry was expected to be in operation for between 50 and 100 years.  In alignment with University of Indiana’s geological survey aggregate industry benchmarks, ValueWalk estimates assumed that the quarry would see a 50-year (the industry average) useful life.  Yet, an expected life that could double that does two things: for one, it stretches out total profits over a longer return period; second, it calls into question long-term supply and demand alignment.  How can Highland guarantee that it will sell aggregate only in Ontario over such an extended period of time?


Reinforced Commitment to Sell Only in Ontario

If there is one message Highland has touted consistently, it is the company’s commitment to making business decisions that support local communities.  During the 1/12 session, Highland executives said over and again that the aggregate was to be sold only in Ontario to support regional growth.  Yet, Ontario aggregate demand has only been projected out 20 years, and stiff competition from other (smaller) quarry project proposals wishing to take advantage of this short-term demand increase may find the year 2030 full of aggregate suppliers in Ontario without a market to sustain them.


Other Profit-Jeopardizing Developments

In addition to clarifications that gave a better sense for the timing and scale of revenues, answers to other questions revealed cost structure implications.  For one, Highland admits that it does not ultimately know its cost obligation in an area that has been a huge issue for opponents: roads.  “We have never published any numbers regarding the specific numbers of trucks expected from our facility, which is directly related to market demand,” executives said at the meeting.   Though the company’s traffic consultant (Morrison Hershfield Limited) has said that Country Route 124 should have adequate capacity, Highland acknowledged “any required road improvements will be paid for by us.”


Highland is also on the hook to be accountable for more than 3,700 project concerns submitted by concerned groups and citizens and forwarded by the Ministry of Natural Resources from the Environmental Bill of Rights, the remediation of which will take time and will likely also cost them money.


Finally, problems have now reached beyond Melancthon, as a wider group of opponents in Southern Ontario has organized to fight an accelerating influx of quarry project proposals.  According to the Globe and Mail, the province’s ten top aggregate-producing municipalities have formed a coalition that has proposed legislation to demand higher royalties for road repair, improved land rehabilitation oversight, and greater stringency with respect to environmental analysis.  The coalition has recommended particularly restrictive rules for quarries proposing to operate below the water table, as the Highland Companies’ project does.


The New Math

So, what does all this tell us?  The production volume is so much smaller than anticipated and road for the Highland quarry is becoming so long that the numerator (annual revenues from aggregate production) will be smaller, the divisor(the revenue-earning/payback period) larger and the quotient (annual revenues), therefore, much smaller.  This means a longer overall investment payback period, and does not accurately predict whether the project will be able to go online with timing advantageous to the Ontario aggregate industry growth window.


When questioned in December about whether investors would be open to a smaller scale excavation plan, Mr. Izakhoff told the Globe and Mail that it was “too soon to tell” but underscored that it was not the company’s first choice to disaggregate the application into smaller projects.  He also commended Highland for its transparent approach, saying, “Our view was that this was a very responsible way to do it.  Put all our cards on the table.”

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