Rare Element Resources: A Secondary Stock Offering and the Volatility Issue

Between November 18 and December 22, 2010, Rare Element Resources (REE) announced and closed on a secondary-stock offering of 6.4 million shares that effectively diluted shareholder ownership by approximately 25 percent. The secondary-stock offering was not reflected in the stock price of Rare Element Resources because it was exclusive to the Toronto Stock Exchange (TSX Ticker RES) and it was not registered with the SEC or communicated to the United States Press. The press release submitted to the Canadian Security Administrators on December 22, 2010, specifically states: “Not for distribution to United States newswire services or for dissemination in the United States.” Adjusting for the increase in shares outstanding would result in a stock price of 10.32 compared with a closing stock price of 13.72 on Friday.

Background

Investors in the Rare Earth Element stocks have become accustomed to a high degree of volatility within the sector. Whether there is news of further tightening of Rare Earth Element exports by China or an announcement of a secondary stock offering by an Rare Earth company, it is not uncommon for these stocks to move between five and 10 percent per day and several times that amount in a given month. For example, on January 5, 2011, Molycorp (MCP) traded at an intraday high of 62.80 and over the subsequent 12 trading days, the stock decreased by over one-third in anticipation of the January 25th, 2010, lock-up expiration. On Friday, the stock fell 6.61% to settle at 47.77 after announcing a secondary offering of 13.5 million shares at a market price of $50 (article). Interestingly, the increased volatility in Molycorp’s share price following these announcements has not been shared by similar announcements by Rare Element Resources. I attribute the discrepancy in volatility to the type of secondary stock offering chosen by Rare Element Resources, and I recommend that investors pay close attention to the pending lock-up expiration of REE’s secondary stock offering on March 22, 2011.

Analysis

An investor in the United States researching the number of shares outstanding for Rare Element Resources would find a consensus view of approximately 35 million shares outstanding (Yahoo-Key Statistics). However, an investor who retrieved REE’s quarterly filings with the Toronto Stock Exchange (Filings) would learn that on December 22, 2010, Rare Element Resources closed on a 6,394,000 secondary share offering priced at $9.00 Canadian. Because this increase in shares was exclusive to the TSX, the dilution of share ownership of approximately 25% was not reflected in the shares outstanding in the United States nor was it reflected in the share price of REE upon the share offering announcement and subsequent pricing and closure of the placing (Figure 1).

Figure 1

News Event	Date	Share Price (CAD)	Share Price (USD)	Control (REMX)
Share offering announced	11/17	10.10	9.86	19.35
	11/18	10.10	9.98	19.94
	11/19	10.00	9.94	20.97
Pricing Date	12/10	9.89	9.82	20.55
	12/13	9.89	9.70	21.01
	12/14	9.26	9.21	20.88
Closing Date	12/21	10.66	10.28	21.33
	12/22	10.32	10.17	21.32
	12/23	10.32	10.16	21.42

*Impact of currency fluctuations is minimal due to comparable exchange rates

If investors were aware of the share offering, an investor would anticipate that the stock price would decrease equal to the extent of the dilution and that the stock would trade close to the share-offering price of $9.00 Canadian. As exhibited above, there was no statistically significant change in the share price of REE when these details were announced. One possible explanation for the lack of stock volatility (reflected by minimal change in closing price) could be because shares of REE are overwhelmingly traded in the United States and without full disclosure of the secondary stock-offering, US investors failed to react to the news. The news release specifically states “Not for distribution to United States newswire services or for dissemination in the United States” (SEDAR News Release, December 22, 2010).

Because Rare Element Resources is not required to register the share placement with the SEC, investors in the United States were unaware of materially important information that effectively diluted their share ownership in the company. The imprudence of this action is further exacerbated by the fact that majority of shares in REE (94%) are traded in the United States. There are 5,000,000 shares of REE traded per day on average in the United States compared with 315,000 share of RES.V traded per day on average in Canada (daily volume reflects 3-month daily average).

According to management’s latest discussion in their quarterly report ending December 31, 2010, “there were 43,170,423 common shares issued and outstanding and 46,508,463 common shares outstanding on a diluted basis” (MD&A Filing Pg. 27, Section 6(e)-Disclosure of Outstanding Share Data). This reflects a 25% increase in the number of shares outstanding on June 30, 2010.

Conclusion

On March 22, 2010, the lock-up period for the Canadian share offering expires. Applying the effective dilution of shareholder equity from the Canadian offering to the price of REE at the close on Friday of 13.72, the stock should be trading at 10.32 (25% discount to Friday’s closing price).

Because Rare Element Resources continues to increase the number of shares outstanding without providing specific disclosure for the use of the additional raised capital, I recommend reducing exposure to REE. This recommendation is further supported by the increase in short interest that has been building in the stock over the past several months (Figure 2).

Figure 2

Settlement Date	Short Interest
1/31/11	4,006,817
1/14/11	3,753,568
12/31/10	2,714,491
12/15/10	1,948,748
11/30/10	2,035,011
11/15/10	2,301,425
10/29/10	1,798,340
10/15/10	573,838
9/30/10	302,763
9/15/10	169,732
8/31/10	5,195

(Nasdaq Short Interest)

Disclosure: I am short REE.