Through keen asset management and various accretive acquisitions, Globe Specialty Metals (GSM) has transformed itself into the world's lowest cost producer of silicon metal. We initially submitted the idea in 2008 as we recognized the market failed to appreciate the industry's high barriers to entry and GSM's top-tier cost structure in the context of strong underlying end-market fundamentals. GSM had and still has long-term low cost electricity, close proximity to primary raw materials quartz, woodchips, and coal, and the most efficient facilities that competitors can only replicate with material capital costs and up to five years of permitting and construction. While market valuation has improved since our initial write-up, we believe GSM's value proposition has significantly improved and is not adequately reflected in the stock price. Upcoming catalysts include further expected increases in product pricing, profitability improvement from recently acquired coal operations, and expected contribution from the company's silicon metal facility in Iceland.

Supply continues to tighten as demand improves for silicon metal and silicon based alloys. For the past fiscal year, facilities ran at over 90% utilization. Demand should continue to recover from growth in use of silicones in its core chemicals markets, cyclical recovery in steel, foundry, and aluminum end markets, and continued capacity growth in polysilicon solar facilities. Various acquisitions over the past year have taken merchant supply offline, further supporting GSM's competitive positioning. Trade barriers in the U.S. and E.U. have kept excess supply from China competing with GSM's products, and within the U.S. various strategic players have acquired entire silicon metal facilities to ensure supply sustainability which has also improved GSM's pricing power.

The company is led by Alan Kestenbaum, a proven dealmaker and the company's biggest shareholder. Kestenbaum has built GSM through highly accretive acquisitions and selective divestitures; GSM now owns four of the five lowest cost facilities in the Western World (which excludes China, Russia and former republics' capacity) and has a 62% share of U.S. silicon market and 100% of the merchant market. GSM is the sole supplier for many of its silicon alloy customers and has a 50% market share of capacity for other alloys. Importantly, GSM's position on the cost curve allows it to maintain market share and generate profits during difficult pricing environments. In periods of strengthening pricing, GSM will generate significant earnings leverage. GSM is the key supplier of silicon based alloys for both steel producers and foundries. GSM has improved its positioning through a higher level of vertical integration with its recently acquired metallurgical coal assets, favorable electricity contracts and growth projects including its planned silicon metal production facility in Iceland. The timeline below illustrates the key acquisitions that have transformed GSM since 2007.

Coupled with expected improvement in pricing trends (the company guides every $0.01 increase in silicon metal/alloy pricing equates to an increase in $4.4mm in EBITDA), earnings should significantly improve over the next two years surpassing our past and the market's current expectations.

Trading Update, Valuation Refresh

GSM has entered into various transactions to expand capacity, complete its vertical integration, and create shareholder value, all while maintaining a net cash position of $118mm as of June 30. While the stock reached a 52-week high this summer, it has since traded down with most metals producers, though its growth prospects and earnings visibility differ greatly from other standard metals players.

GSM reported in late August its fourth fiscal quarter results, which were in line with market expectations. While production was below full capacity due to planned outages and a tornado outage in April, average product pricing came in higher than expected due to improved product mix and strong marketing. Costs were slightly higher than expected, but we attribute this variance primarily to transactional due diligence and planned outages, both of which are in the long-term interest of the company and its shareholders. While rising macroeconomic outlook uncertainty has forced investors to heavily discount future earnings, GSM remains poised to build shareholder value over the next few years through a number of key transactions the market has overlooked.

In February 2011, GSM announced it will build a 40,000MT silicon metal plant in Iceland. GSM has guided this facility is expected to be up and running by mid-2013 and will be among the lowest cost in the Western world and the lowest cost plant in Europe. Similar to its US plants, the facility has long-term low cost power contracts in place, and proximity of the plant to the harbor greatly reduces shipping costs, and GSM will not face a duty exporting to the EU. Notably, this build represents the first Greenfield silicon metal plant to be built in the Western world in the last 15 years. GSM will own 85% of the facility, contribute $152mm in capital (balance sheet cash and limited recourse debt), and when fully operational the facility should contribute approximately $65mm in EBITDA based on expected 2013 silicon metal pricing.

In August 2011, GSM acquired a coal miner Alden Resources and coal processor Gatliff Services for $73.2M with an optional contingent payment of up to $6.8M based on future performance. GSM notes Alden is North America's leading specialty metallurgical coal producer for the silicon industry; this vertical integration will guarantee GSM supply of coal in the future and allow GSM to avoid using more costly charcoal as a potential substitute. Alden's Kentucky and Tennessee mines hold 21M tons of met coal reserves and supply 600,000 tons per year to silicon producers. 

GSM currently finds itself in an industry operating at peak utilization rates amid a pause in the macro-economic recovery, and GSM expects a very strong calendar 2012. In this context, GSM believes it is in its best interest to accelerate planned outages for maintenance by the end of calendar 2011. Not only does the company believe this will enable it to realize higher production and higher sales prices in 2012, but GSM will recognize a 100% depreciation bonus tax benefit for assets placed in service by year-end 2011. As a result of this maintenance acceleration, GSM guided the EBITDA to decrease 10% for the last two quarters of calendar 2011.

We take a longer-term view of GSM and recognize 2012 and future years will be stronger for the company and its shareholders, albeit at the expense of 2H 2011 earnings. Market estimates still ignore the income contribution from GSM's Iceland expansion and the cost savings from its acquisition of coal resources earlier this year. The company is now a fully integrated specialty steel producer with top-tier assets, significant pricing power, and a strong management team. Heading into the last few months of 2011 and into 2012, we believe analyst estimates will be revised to properly reflect GSM's improved cost structure and competitive positioning.

We expect GSM to earn approximately $200mm in EBITDA for the fiscal year ending June 2012 and see upside to the current $250mm consensus estimates for 2013 given analysts' exclusion of cost savings and expansion initiatives. Based on a current stock price of $15, GSM trades at 5.1x EV / FY 2012 EBITDA and 4.0x EV / FY 2013 EBITDA. As the company continues to execute according to plan and prove its earnings sustainability, we expect GSM's valuation multiple to expand. The table below illustrates our view on GSM's fair value; we believe a 12x EV / EBITDA - Maintenance CapEx multiple is fair for next twelve months of earnings given earnings will likely be below "cross-cycle earnings" as the global economy recovers and GSM benefits from its coal acquisition, Iceland expansion, and other initiatives will not be reflected in earnings until the second half of 2012 and thereafter.  Considering GSM's position at the very bottom of the silicon cost curve, industry supply/demand dynamics, excellent management with skin in the game, and its continued success in finding new opportunities we believe a 10x  EBITDA - Maintenance CapEx multiple is appropriate. 

As a reminder GSM ends its fiscal year on June 30th.