Mason Graphite: Graphene Revolution, Lithium-Ion Battery Growth, And China Supply Woes Offer A Compelling Opportunity

Investment Thesis Summary

Mason Graphite (OTCQX:MGPHF) is a Québec-based mining company that is developing the graphite resources of its Lac Guéret property in northeastern Canada. Technical reports and preliminary assessments show this property is rich in high-grade, high-purity flake graphite, which is the primary manufacturing component in lithium-ion batteries. As the rapid growth in lithium-ion batteries accelerates in the short term, a revolutionary new material called graphene offers the potential to change our lives through a vast array of commercial products that were previously only dreamed about in the realm of science fiction. Isolated in a laboratory in 2004 by two scientists who were later awarded the Nobel Prize for Physics, graphene is a two-dimensional, one-atom thick material that is the essential building block of graphite. As thin as a piece of Saran Wrap, graphene is 200 times stronger than steel and conducts electricity 1000 times better than copper.⁴ Major companies and university scientists around the world have filed more than 9,000 patents for products containing graphene in the last several years.³ While the material is already available in consumer products such as tennis racquets, as you will read later in this report, graphene is poised to become a multi-billion dollar industry by 2023. Unlike many other natural resources, graphite is not traded on commodities markets and its price is determined by contracts between individual suppliers and end-users. With technical reports showing the Lac Guéret site containing some of the highest carbon content grades and purity levels on recovery of any flake graphite mine in the world, Mason Graphite is a strong pure-play on graphite prices as the accelerating growth of lithium-ion batteries continues and graphene rises to its fullest potential in commercial markets.

As the growth in graphene and lithium-ion batteries fuels the demand-side of markets for flake graphite, a confluence of several important variables has combined to suppress the supply-side of the market for this resource. China produces over 70 percent of the world's natural graphite as a result of flooding the market with excess supply in the 1990s. This had the effect of driving nearly all of the graphite mines in North America out of production and grinding further exploration to a halt until supply disruptions in 2008 in Inner Mongolia were followed by a doubling of flake graphite prices by 2011. Adding to supply woes, China's mines are becoming old and national production is in decline. In mid-December 2013, China completely closed down 55 mines in the nation's second-largest graphite producing region of Shandong province due to widespread environmental problems, which indicates the need for modernization of the country's graphite industry. Meanwhile, all-time high prices for flake graphite in 2011 led to renewed exploration and discoveries of higher quality flake graphite deposits in Canada during the last two years. This opportunity exists due to the unique sequence of events for the economics of the flake graphite industry in coming years, which are reaching a tipping point with China supply slowing simultaneously as demand increases for lithium-ion battery production and graphene's commercial potential becomes unleashed across a wide range of markets. With a 22-year estimated production life at 50,000 tons per year and relatively modest corporate tax rates in Canada, even with graphite prices for the next two decades averaging around $1,500 per ton, a valuation of the Lac Guéret project reveals that Mason Graphite is worth 500 percent more than its current share price. As a pure-play on graphite prices and the growth of this resource as a manufacturing input in coming years, Mason Graphite offers an excellent opportunity to reward investors with triple digit gains in the next three years as the market comes to realize the quality of the company's flake graphite deposits, China supply issues, and the potential of graphene.

Graphene "Wonder Material" Overview

In their revolutionary journal publication "Electric Field Effect in Atomically Thin Carbon Films" in October 2004, University of Manchester scientists Andre Geim and Konstantin Novoselov - along with a team of six academic peers - demonstrated that single layers of carbon could be isolated with the carbon atoms arranged into tightly bound hexagons just one atom thick. The result is graphene, which is a material that was only calculated in theory in a May 1947 science journal by Canadian theoretical physicist Philip Russell Wallace titled "The Band Theory of Graphite." Wallace lived long enough to see his theory proven by Novoselov and Geim in 2004 before he passed away in 2006. In 2010, the Nobel Prize for Physics was awarded to Andre Geim and Konstantin Novoselov for their achievement in developing Wallace's theory on graphite structure into graphene, which is a two-dimensional material with profound potential to reshape technology with both industrial and commercial applications that previously only existed in science fiction films.

Since Novoselov and Geim won the Nobel Prize in 2010, companies have responded in what the Wall Street Journal calls a "Patent Land Rush," noting that "There were 9,218 published graphene patents and patent applications filed cumulatively as of May around the world, up 19 percent from a year earlier, says Cambridge Intellectual. Over the past five years, it says, the cumulative number of graphene patent filings has more than quintupled."³ The UK Daily Mail newspaper describes graphene's potential by declaring, "Some researchers claim it's the most important substance to be created since the first synthetic plastic more than 100 years ago."⁴

The unique characteristics of this revolutionary two-dimensional material make it one of the most potentially profitable new substances to emerge in decades, with applications across a multitude of different industries. Graphene is only one atom thick, yet is 200 times stronger than steel, conducts 1000 times more electricity than copper, and is capable of making semiconductors 50 to 100 times faster. Furthermore, it emits and absorbs light in addition to being a superb conductor of heat, which offers opportunities to make solar power 50 to 100 times more efficient. Due to its ultra-thin form, the eminently flexible material can be rolled-up like a thin sheet of paper for tablet style mobile devices and its light weight combined with its phenomenal strength could make aircraft 70 percent lighter. The Daily Mail notes, "A sheet of graphene as thin as cling-film could hold the weight of an elephant. In fact, according to one calculation, an elephant would need to balance precariously on the end of a pencil to break through that same sheet."⁴

To more fully comprehend this remarkable material's potential impact, consider the following facts about graphene and some of its potential applications for technology and industrial products:

• One millimeter of thickness takes a stack of 3 million sheets of graphene


• Ultra-small transistors for electronics products


• Flexible touchscreens that can be rolled 360 degrees around users in capsule form


• Tablets and mobile devices that can be rolled up like a daily newspaper


• Seawater filters made of graphene were patented by Lockheed Martin (LMT)³


• Bullet and explosive-proof armor for military applications


• Coated sleeves for oil and gas well production devices using graphene sheets was filed with USPTO by Exxon Mobil (XOM)


• Graphene credit cards with data storage equal to current computers⁴


• Wide variety of applications in the field of medical technology


• Graphene heat drain patent for mobile devices was filed with USPTO by Apple (AAPL)³


• Numerous applications for wearable electronics


• Touch screen displays using nanostructure films from graphene flakes patent was filed with USPTO by Samsung (OTC:SSNLF)


• Electric car battery capable of powering an EV over 600 miles on a charge⁶


• Protective skin layer for robotics that also acts as a sensor and conducts power


• By 2020, 10 nanometer chips using graphene transistors that can make CPUs process 100 times faster is in development by Samsung


• Graphene inks for smartcards and RFID devices


• Graphene heat circuits patents for airplane deicing were filed for by Saab (OTC:SAABF)³


• Daily Mail claims, "The electronics industry is convinced graphene will lead to gadgets that make the iPhone and Kindle seem like toys from the age of steam trains."⁴

University of Manchester Professor Novoselov, one of the two scientists awarded with the 2010 Nobel Prize, believes touchscreens are one of the top areas for commercial product advancement with graphene within the next two years, quoted by RedOrbit in an article as saying, "Another possible prototype application that should be available by 2015 is rollable e-paper. Graphene's flexibility proves ideal for fold-up electronic sheets, which could revolutionize electronics."

Graphene's seemingly limitless potential is succinctly summed up by the other Nobel Prize recipient that isolated the material when University of Manchester Professor Andre Geim told BBC News, "Graphene does not just have one application. It is not even one material. It is a huge range of materials. A good comparison would be to how plastics are used."²

While some of the more than 9,000 patents filed for graphene innovations may never manifest in the form of identifiable commercial products, the reputations of companies such as Samsung, IBM (IBM), Lockheed Martin, and Apple combine with the novel uses for this material to suggest that there is an intention to actually develop products rather than simply mine intellectual property.³ Whether through licensing rights for these patents or actual production, there is every reason to believe that a substantial number of products containing, or entirely composed of, graphene will be in market within the next two to five years.

Sporting goods manufacturer Head NV (OTC:HEDYY) is one of the well-known global companies that already is producing products that are marketed specifically by extolling the wonders of this material to consumers with a trademarked line of graphene tennis racquets. A report by Future Markets titled "Graphene: The Global Market to 2020" published in September 2012 claimed that in the previous 18 months prior to publication demand for materials used to produce graphene increased 4,000 percent. The surge was led mostly by tech companies such as Intel (INTC), Nokia (NOK), and Texas Instruments (TXN), which infers that the initial wave of products using graphene may be mostly concentrated in high-tech products and consumer electronics devices. Samsung is a dominant player in leading graphene research and development through a partnership with Sungkyunkwan University in South Korea. Flexible graphene touchscreens were demonstrated by Samsung at the 2013 CES and YouTube videos showing possible future products with similar technology offer a glimpse of its potential. Graphene's pioneer, Nobel Prize Professor Andre Geim, told BBC News that Samsung has its "own roadmap where they believe there will be a dozen products using graphene in the next five years."²

A report by BCC Research titled "Graphene: Technologies, Applications and Markets" estimates that the market for graphene products will be around $195 million by 2018. While that milestone is only 48 months away, the report goes on to forecast remarkable growth at a 47 percent CAGR for the size of the graphene products market to $1.3 billion by 2023. Clearly, the burgeoning market for graphene products is only surpassed by its seemingly limitless potential for innovation and new applications using the "wonder material."

For those interested in learning more or seeing what graphene actually looks like, an excellent in-depth television report titled "Graphene Revolution" about the phenomenal products that are planned with the material aired on BBC World News. Another video resource for those interested in its scientific properties is this demonstration of graphene and its physical attributes courtesy of Yale University.

Lithium-Ion Battery Growth

The proliferation of lithium-ion batteries in mobile devices, tablets, iPod-type media players, hybrid and electric vehicles, power tools, and laptop computers is another key driver of the growth for the flake graphite market. Each lithium-ion battery contains 10 times more graphite than lithium and, as a result of waste during manufacturing processes; it takes 30 to 40 times more graphite to produce a battery than ends up in the final product. Importantly, graphite is the non-substitutable primary host material, the anode, in lithium-ion batteries and only high-grade spheroid flake graphite or high purity synthetic graphite can be used in their manufacture.⁸ Graphite demand for lithium-ion battery manufacturing in 2010 was estimated at 125,000 tons and is forecast to rise to at least 320,000 in 2020.⁶

In order for high-grade natural flake graphite to be equivalent to synthetic graphite for lithium-ion battery manufacturing and graphene production, it must have a purity level of 99.9 percent. Notably, synthetic graphite is made by a petroleum coking process that makes it much more expensive to produce these 99.9 percent purity levels. The important factor about lithium-ion battery production is that these high purity levels can be obtained by manufacturers with high-purity natural flake graphite at a fraction of the cost of synthetic graphite.

China Supply Decline

China is by far the leading global supplier of graphite and currently mines around 70 percent of the world's annual supply. This remarkably large market share was a result of China dumping graphite on the world market in the 1990s, which drove prices down to the $750 per ton range from around $1,300 per ton in the late 1980s. This had the effect of driving most of the graphite mines in other parts of the world out of business and disincentivized new exploration.

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In the chart above, you can see that 55 percent of the world's graphite production comes from amorphous graphite and only 45 percent from flake graphite. Not included in this chart is the third variety, which is vein - also known as lump - graphite, which accounts for less than 1 percent of production. As we will detail later in this report, although amorphous graphite constitutes over half of global production, it only sells for around half of the price of flake graphite. This disparity in quality and prices for the two different types of graphite is an important distinction to understand in order to distinguish between the more common amorphous form and the higher quality, higher carbon content, of flake graphite that is required for graphene production and lithium-ion battery manufacturing.

On December 16, Industrial Minerals Data reported that the government of China halted all production activities in Shandong province, which is the nation's second largest flake graphite mining region.⁸ Specifically, in the town of Pingdu, China's oldest flake graphite mining region, as many as 55 graphite producers were ordered to stop production on environmental grounds as a result of widespread complaints filed by residents over alleged gas emissions, dust, and wastewater violations.⁸

The cessation of graphite production in Shandong province takes 100,000 tons of capacity offline, which equals 20 percent of China's national production and 10 percent of the world's flake graphite supply.⁸ The earliest time frame expected for the companies to restart production is June 2014.⁸ In a passage that provides color regarding the state of China's flake graphite industry, a key observation from the report states, "The regions known flake graphite resources have been dwindling for some time however and this could be the first step in closing mining in the region for good. Graphite grades in the ground are lower than 5 percent carbon content and miners are having to spend more money and dig deeper for less graphite."⁸

An important consideration regarding the Pingdu closures is that a situation resembling the recently announced actions occurred in late 2008 and the first half of 2009 in Inner Mongolia that was shortly followed by a graphite price spike.⁸ Importantly, Inner Mongolia produces only half the graphite that Pingdu does, yet global graphite prices soared 55 percent within the first year after production in the region was halted.⁸ The Industrial Minerals Data report cites the Inner Mongolia mine closures as the start of the price volatility for graphite that followed in subsequent years.⁸

Graphite Prices

Since mid-2007, flake graphite prices have remained well above $1,000 per ton with the exception of a brief dip in the second half of 2008 during the financial crisis. This decline reversed quickly and the price of graphite was back above $1,000 per ton in December 2008. Notably, the price has not gone below $1,300 per ton since surpassing that level in Q4 2009 before making its most recent all-time high of just over $3,000 per ton in late 2011.

Graphite is sold in one-year supply contracts, which translates into price volatility occurring in sequential years and the necessity of analysts to evaluate prices on a longer-term trend line. Due to the lack of a futures market, companies that buy large amounts of graphite each year must stay in constant contact with mining companies to maintain supplies and guidance on pricing terms. Additionally, graphite is not sold uniformly at one unified price, which makes for even greater variation in pricing the resource. In addition to the previously mentioned distinctions between flake and amorphous graphite, within the scope of flake graphite prices there are several more variables that are considered when valuing the price per ton.

There are three vital components that are evaluated when determining flake graphite prices:

• Size of the flake: Small, Medium, Large, and Jumbo


• Grade: The carbon content of the graphite flake


• Purity: The purity of the graphite flake on recovery, 99.9 percent purity is desirable for lithium-ion battery and graphene production and is the purity level of synthetic graphite, which is very expensive compared to natural flake graphite.

Specifically, there are designations for the size of each graphite flake:

• Small: -150 mesh


• Medium: +150 mesh


• Large: +80 mesh


• Jumbo: +50 mesh

Essentially, the primary determinant for natural flake graphite prices is based on the size of the flake. From that starting point, more refined criteria such as grade and purity are applied to determine minimum standards for the end-user when contracts are negotiated. Supply contracts are one year in duration and establish flake graphite specifications, price, delivery dates, and quantity in tons. The grade of the carbon content is important to suppliers due to a higher grade making overall mining costs lower on the production end. Higher recovery purity similarly can lead to lower production costs and also carries with it the aspect of marketability as a result of its desirability for manufacturing processes such as lithium-ion battery production.

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In the chart above, you can see a distribution of prices for different forms of natural graphite in August 2013. Amorphous graphite, which constitutes 55 percent of global graphite production, is worth around half of even the lowest flake graphite at $525 per ton.⁷ At the low-end of the scale, small flake graphite sold for $1,050 per ton as of August prices, more than double the price for amorphous. From there, flake graphite prices increase around $150 per ton as the size of the flake increases from -150 mesh to large flake graphite at +80 mesh. Medium flake was priced at around $1,200 per ton and large flake was $1,350 per ton as of August.⁷ Although it is not shown on this chart, jumbo flake graphite, with +50 mesh designation, typically sells for around a $1,500 to $2,000 per ton premium over most large flake graphite prices, contingent on the unique set of terms contained in each individual contract. The important factor to consider in graphite prices is that amorphous sells for one half to a third of the price of the various sizes of flake graphite, while flake graphite prices increase around $150 to $250 per ton based on the size of the flake.

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As you can see in the chart above, the company's forecasts suggest that the prices for both medium and large flake graphite are expected to rise in coming years as demand from end-users ramps up for these resources. In particular, large flake, +80 mesh, graphite is projected to increase 85 percent in coming years as a result of lithium-ion battery production and the cost-efficiency of using natural large flake as an alternative to the much more expensive synthetic graphite.⁷

These estimates are supported by recent interviews with industry analysts such as Simon Moores of Industrial Minerals Data, which is a London-based publication that maintains a price database and market information for the mining and minerals industry. In a July 2013 interview, Simon Moores offered his analysis of current market conditions and forecast for graphite prices by saying, "Flake graphite supply is delicately balanced with little margin for error. China dominates global production with a 73 percent market share in 2012 according to our new statistics. Limited supply elsewhere together with unpredictable demand has resulted in the volatile prices seen over the last five years. We don't see this situation changing any time soon."

Mining and metals consultant Jack Lifton, who is a Senior Fellow at the Institute for the Analysis of Global Security, incisively described the fundamentals of the graphite market and its importance in world markets by commenting, "Traditional demand for graphite in the steel and automotive industries is growing 5 percent annually, and graphite prices have tripled. New applications such as heat sinks in computers, lithium-ion batteries, fuel cells, and nuclear and solar power are all big users of graphite. These consumers are beginning to place substantial demands on existing production and over 70 percent of that production is from China, which is no longer selling this resource cheaply to the rest of the world as the country's easy-to-mine, near-surface deposits are becoming exhausted."⁵

Lifton continues by describing the impact on prices and clarifying the balance between production and global demand for graphite by saying, "Production has now held steady for several years at approximately 1.1 million tons as China appears to have reached the limit of its productive capacity and the commodity super cycle has soaked up excess supply. Since 2005 prices have basically tripled, and supply is tight."⁵ Finally, Lifton characterizes the vital importance of graphite to the advanced economies of the world by stating, "Graphite's criticality and potential scarcity has been recognized by both the United States and the European Union, which have each declared graphite a supply-critical mineral. Recently, the British Geological Survey ranked graphite right behind the rare earths and substantially ahead of lithium in terms of supply criticality. Clearly, there is much more to graphite than pencils."⁵

Lac Guéret Mine Overview

The site Mason Graphite will be mining is known as Lac Guéret and the property is located in Côte-Nord-Nouveau-Québec. This region of northeastern Québec is among the friendliest jurisdictions in the world to mining interests and the Lac Guéret property is in the Government of Québec's "Plan Nord" economic development zone that was launched in 2011 to advance new mining projects in the area. Lac Guéret spans 11,630 hectacres, includes 215 mining claims, is in close proximity to mining industry service centers in Baie-Comeau, has plenty of qualified labor available nearby, and has all-season infrastructure with easy access to highway 389 through key logging roads. The property Mason Graphite will be mining contains the highest grade flake graphite in the world, which was succinctly described by Global Metal News CEO Guy Bennett in a November 2011 article appearing on WSJ Marketwatch as, "The Lac Guéret deposit is a freak of nature, a high grade, large flake asset with mineralization close to surface. It is a one-off geological anomaly that will allow the mine to be built cheaply and operated with high margins."⁹

Among the most important factors for companies purchasing flake graphite, high-purity values are sought in addition to grading. This is particularly important for both lithium-ion battery and graphene production, which require high-grade and the highest possible purity levels. The highest purity levels are found in synthetic graphite, yet this form is extraordinarily expensive and is cost-prohibitive for many companies to use as a manufacturing input. At 99.9 percent purity, natural flake graphite is at the same purity level as synthetic graphite.⁶ Mason Graphite recently proved that they can achieve 99.9 percent purity through a purification process that only costs 25 percent of the price of creating synthetic graphite.⁶ This important development will give Mason Graphite a key competitive advantage over other graphite mines in both grade and purity, while offering a significantly lower price than synthetic graphite producers.

When the company reported the impressive results of the caustic bake process trial that achieved these remarkable purity levels, Mason Graphite President and CEO Benoît Gascon declared, "Having reached 99.9 percent Cg from the very first run of testing, without any optimization, reaffirms our belief in the exceptional quality of the graphite hosted on our property. These high purity levels are required in many industrial applications including electrochemical applications like lithium-ion batteries which are used in electric vehicles, portable electronics and cordless power tools, which represent a significant and growing market."

The Lac Guéret project's technical report, performed by Québec-based firm Roche Consulting, provides granular details regarding the technical aspects of the property and its resource deposits. The highlights that pertain to our analysis and other important considerations for valuing Mason Graphite are as follows:

• Investment of direct capital to begin operations was $90 million


• 22-year estimated life of mine for high-grade flake graphite deposits


• 27.4 percent grade of flake graphite for 22-year production estimate


• Finished product production costs of $390 per ton


• Relatively low Canadian corporate tax rate

Company Leadership

Due to the manner in which flake graphite is sold to corporations all across the world, the quality of the leadership team at Mason Graphite is a matter of particular importance to shareholders. Unlike many other natural resources where prices are discovered through financial markets by transactions between hedgers and speculators, graphite is not traded on any commodities exchange. This requires management to establish special relationships with direct buyers and understand the unique characteristics that each client is seeking when they agree to a contract to purchase large quantities of flake graphite. This means that a strong team of knowledgeable executives is required to identify opportunities with prospective customers worldwide and successfully negotiate contracts with the most favorable price terms. Mason Graphite has just this sort of executive with CEO Benoit Gascon, who brings a wealth of experience leading one of the few graphite mining companies operating in North America before joining the company.

CEO Benoit Gascon successfully ran TimCal Graphite and Carbon, which is one of the only consistently operating graphite mines in North America over the last two decades.⁶ Gascon worked for 20 years at TimCal, formerly known as Stratmin, during which time he spent the last six as the company's chief executive officer.⁶ As TimCal CEO, Benoit Gascon turned the company around and improved its fortunes during the era of low prices resulting from Chinese mines dumping graphite on the world market.⁶ Gascon traveled the globe building relationships with clients and expanding TimCal's production processes to diversify into 50 different types of graphite to accommodate buyers and increase sales.⁶ Gascon actually shepherded the deal for one of the world's largest graphite producers, Paris-based multinational mining company Imerys SA (OTC:IMYSY), to acquire StratMin, which was the origin of the formation of TimCal Graphite and Carbon.⁶ In addition to his network of end-user companies and wealth of graphite industry contacts, Benoit Gascon also brought several top executives from TimCal with him in the spring of 2012 when Mason Graphite acquired the Lac Guéret property.⁷ This team includes CFO Luc Veilleus and Vice President of Process Development Jean L'Heureux, both of whom played vital roles in Gascon's success at TimCal.⁷ These two executives similarly bring veteran graphite industry experience to Mason Graphite, with Veilleus serving eight years and L'Heureux over 20 years as TimCal executives.⁷

The effectiveness of this management team is best summed up by CEO Benoit Gascon when he described the market opportunity available to the company as, "All batteries need graphite and applications are very diversified - going from steel making to autoparts and electronics - so it is a material that we use every day but don't see. There is only one graphite mine currently operating in Canada, the Stratmin mine. I was the CEO of that operation for many years. The Stratmin mine was profitable at $600 a ton, the current prices are around $1,400 a ton."⁹

Mason Graphite Valuation

By assembling all of the aforementioned information regarding the Lac Guéret project, we are ready to calculate a valuation for Mason Graphite shares.

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As you can see in Figure 1 above, by applying an 8 percent discount rate we obtain valuations of Mason Graphite ranging from $1.10 to $7.80 per share based on a range of flake graphite prices spanning $1,000 to $3,000 per ton. It is important to point out that these valuations are based on fully diluted shares if all currently issued options and warrants are exercised. Since it is impossible to determine if and when further dilution could occur in the event the company needs to raise additional capital, these amounts are the current best representation of the company's equity on a fully diluted basis. Conversely, if share prices do not reach or exceed the exercise prices for the warrants and options by the various dates of expiration, dilution could be significantly less. The price range of $1,000 to $3,000 per ton is a reasonable distribution to estimate the company's valuation and represents the highest likelihood that average prices over the 22-year life of the project will fall within one standard deviation of recent historical prices. This price range also estimates the top of the range at $3,000 per ton, which is the current all-time high that was reached in 2011 and Q1 2012. If average prices exceed $3,000 per ton over the time period, potentially as a consequence of graphene and lithium-ion production demands, the valuation of Mason Graphite share prices are likely to be correspondingly higher.

Importantly, this estimate calculates the valuation of Mason Graphite based on a 27 percent corporate tax rate for the Canadian company. Currently, that tax rate is likely to be closer to the national average of 25 percent, which allows for possible changes in tax rates at either the federal or provincial level over the life of the project. The estimates also are using nominal values to provide us with a forecast and do not include the effects of inflation on production costs or graphite prices. The estimates in the chart above are calculated based on an 8 percent discount rate, which would be the low-end of the range. To gain additional insight into the valuation of Mason Graphite for the specified range of average graphite prices, we must look at these estimates with a discount rate that is much higher to provide contrast and greater clarity.

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As you can see in the figure above, the same range of average graphite prices reveals shares' values that are correspondingly lower with a range of 81 cents at $1,000 per ton and a high of only $6.58 per share with an average of $3,000 per ton. Similar to Figure 1, these values reflect Mason Graphite's shares on a fully diluted basis with all warrants and options currently issued being exercised before expiration dates.

To gain the best estimate of Mason Graphite's share value, we will take the average between the two previous rates and calculate a valuation based on a 9 percent discount rate. This will represent our best estimate of Mason Graphite shares for the range of average flake graphite prices for the projected lifetime of the Lac Guéret project.

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As you can see in the figure above, by applying a 9 percent discount rate to Mason Graphite shares on a fully diluted basis, we discover a range of 95 cents at an average price of $1,000 per ton to the high of $7.15 per share with an average flake graphite price of $3,000 per ton. These prices represent a 90 percent increase in Mason Graphite shares at the lowest of the graphite price range and a 1,430 percent gain to $7.15 per share at the $3,000 per ton average price. Importantly, current prices for high-grade large flake graphite imply a value of around a $2.50 per fully diluted share for Mason Graphite, which is a 500 percent increase over the current share price of 50 cents per share.

By way of comparison, at the current share price and range of flake graphite prices per ton, Mason Graphite is being valued at a 20 percent discount rate. If we apply a 10 percent discount rate to Mason Graphite's current share price, we find that the market is valuing its high-grade flake graphite deposits at only $890 per ton, which is substantially lower than current prices and would be the lowest price since the depths of the 2008 financial crisis. Clearly, with a high-end of the range of $7.80 per share, which is a 1,560 percent gain from current share prices, and a low-end of the range 62 percent higher than current prices at 81 cents, Mason Graphite shares look significantly under-valued. Applying the best estimate of $2.50 per fully diluted share at a 9 percent discount rate implies a 500 percent gain from current prices for the valuation Mason Graphite shares.

Risks: The Bear Case

• Possible dilutive effects if approximately 9.1 million warrants are exercised by June 2015


• Unforeseen regulatory obstacles in advancement of mining permits


• Operations risks involved with launch of the mine


• Graphite market extreme price volatility


• Labor problems, possible mining strikes, or sudden wage inflation in Québec


• Departure of key executives


• Execution errors in contract negotiations with end-users


• Global spike in interest rates


• New disruptive technology displacing lithium-ion battery growth


• Failure of graphene to gain traction as a material in commercial products

What the Market is Missing

The market is currently under-pricing Mason Graphite shares for several key reasons that relate mostly to the lack of widespread knowledge about the high-grade flake graphite market and its remarkable potential in coming years. The central source of the mispriced share value is a result of being a micro-cap stock that only began trading as a public company on the Toronto TSX Venture Exchange on October 30, 2012. For U.S. investors, the introduction of Mason Graphite shares was even more recent with shares debuting in the OTCQX market on November 12, 2013. The markets simply have not had enough time to fully evaluate the company and perform a detailed financial analysis of the Lac Guéret project. Although the company will commence operations in Q4 2015, the value of the company can be calculated easily based on information provided by Mason Graphite and the independent firms providing PEAs about the Lac Guéret property. This translates into no current earnings or history of operating results in financial reports, which is an indication of the speculative nature of this investment opportunity.

The core of the investment thesis presented in this report centers around two distinct drivers of growth from the demand side and two factors limiting graphite production from the supply side. On the demand side, high-grade, high-purity flake graphite is set to benefit from the transformative potential of graphene in a vast array of revolutionary commercial products. Graphene has yet to catch on in the financial markets as a revolutionary innovation that could change the way we live. The tipping point is approaching rapidly, however mainstream acknowledgement by investors of graphene's potential could take a few more years to develop. Think of internet-related stocks in 1994 as a comparable possibility. The anticipation surrounding graphene advancement is likely to build substantially on the strong momentum in the growth of demand for flake graphite for use in lithium-ion battery production.

These dual circumstances combine with existing supply issues such as declining flake graphite production in China, increased export restrictions, higher duties, and government shutdowns of entire mining regions in the country. Additionally, the long-term effect of China dumping massive supplies of graphite on the world market in the 1990s was to discourage exploration and reduce the number of mines in operation in North America, which resulted in resources that suddenly became more valuable remaining idle in the ground for roughly two decades. Since graphite is not priced like other commodities on liquid financial exchanges, the time-lag in price discovery led to discontinuity in the timing of launching new mining projects in graphite-rich regions of Canada. That trend changed in the years since the 2008 financial crisis when graphite prices soared to $3,000 a ton. The lack of North American graphite producers made finding a pure-play on skyrocketing graphite prices hard to identify for many investors.

With the all-time high prices and acknowledgment that China's supply is rapidly depleting, graphite mining suddenly looks extraordinarily profitable and projects are rapidly moving toward operational launch stages in Canada. The market is only starting to become conscious of the ways in which this unique confluence of events is creating major imbalances between the forces of supply and demand that will drive prices in coming years as the promise of graphene in commercial markets ramps up throughout the course of this decade.

Finally, the market is missing the critically important elements of the percentage of carbon content in the graphite, its recovery purity, and the flake size distribution of high-grade flake graphite and the role these factors play in pricing. In order to get top pricing, graphite must be recovered with at least 94 percent purity or higher and the largest possible flake size. This is where Mason Graphite's Lac Guéret project offers the most potential from a financial perspective. The initial PEA released on April 22, 2013 reports 22 years worth of market-ready flake graphite at 50,000 tons per year. Additionally, the 99.9 percent purity levels of flake graphite from Lac Guéret achieved during purification trials last summer indicate that Mason Graphite will be capable of bringing product to market that rivals the purity of the most expensive synthetic graphite, with price ranges of $7,000 to $20,000 per ton, at a fraction of the cost. This development demonstrates that the quality of the flake graphite offered by Mason Graphite will be among the most valuable available on the world market in terms of all the key pricing factors. When the markets realize this vital fact, shares will be priced higher according to the new projections of annual cash flows reflecting higher prices per ton of Mason Graphite's high-grade flake graphite.

Catalysts for Share Appreciation

• SEDAR filing of Mason Graphite's updated National Instrument 43-101 technical report, in mid-January 2014 detailing specifics of the Lac Guéret project


• Press releases regarding Mason Graphite securing new permits


• Final Fauna and Flora Inventory Report by Roche Consulting by Q1 2014⁷


• Completion of Impact and Benefits Agreement by Q1 2014⁷


• Release of updated feasibility study for Lac Guéret by Met-Chem Canada Inc.


• Press releases detailing larger high-grade flake graphite deposits at Lac Guéret than previous estimates


• Completion of Environmental Social Impact Assessment by Q2 2014⁷


• Completion of Certificate of Authorization by Q1 2015⁷


• Completion of Lac Guéret site mill construction


• Launch of mining operations at Lac Guéret in Q4 2015⁷


• Heightened interest by hedge funds in natural resource companies


• Sharp rise in flake graphite prices


• Continued closures and suspensions of graphite mines in China


• Increased export restrictions, duties, and tariffs on graphite imposed by China


• Explosive growth in electric vehicle sales in coming years


• Mainstream media feature stories about graphene and its potential in commerce


• News reports of groundbreaking patent filing regarding new disruptive technology discovery for use of graphene


• Introduction of popular commercial products composed of graphene

Conclusion

In his famous economics lesson building off a Leonard Read essay, the late Nobel Prize economist Milton Friedman artfully conveyed the power of markets through the simple example of the creation of a pencil. While illustrating the ways in which people and firms from all over the world voluntarily cooperate for the benefit of themselves and others in the manufacture of a pencil, Milton Friedman pointed out that the "lead" in the pencil was actually graphite, yet, like its other components, he said he did not know for sure where it came from. The economics lesson demonstrated ways in which resources we often do not think much about such as wood, rubber, and graphite can be brought together by the "magic of prices" and the free market to produce items like pencils that offer great utility to our lives. Everyone sees the final product, yet so few of us closely examine the origins of the inputs used to produce it. Similarly, the graphite used to make lithium-ion batteries is not often considered by those purchasing mobile devices, portable media players, tablets, laptops, and electric vehicles. With the burgeoning market for products manufactured with graphene already ramping up, the more than 9,000 new patent filings indicate exceptionally strong demand for graphite in the years ahead.³ Due to its ability to match the 99.9 percent purity level of synthetic graphite required for graphene production and lithium-ion battery manufacturing, Mason Graphite is uniquely poised to experience the benefits of increased demand for high-grade flake graphite. The quality of its executive team provides investors with confidence that Mason Graphite will establish itself as a beneficiary of higher flake graphite prices as both quality and supply from China continues to decline. By calculating a valuation for the company, with a 9 percent discount rate and flake graphite prices only averaging $1,500 per ton over the next 22 years, Mason Graphite shares are 500 percent undervalued at current levels on a fully diluted basis. As the market becomes aware of catalysts such as the extraordinary potential of graphene to revolutionize our lives, production timetables for development of the Lac Guéret mine are met, and further China supply issues arise, Mason Graphite shares will rise to this valuation in the years ahead. The etymology of the word graphite is very interesting in the context of the breakthrough by Andre Geim and Konstantin Novoselov. In 1789, geologist Abraham Gottlob Werner named the substance after the Greek word "graphein." Due to its use in pencils, as previously described by Milton Friedman, Werner chose the word graphein because it means "to write" or "to draw." With the exciting potential of this phenomenal new material, graphene offers the opportunity to write a whole new chapter in commercial products and industrial applications.

Source Attribution Key

¹ Mason Graphite August 2013 Fact Sheet

² BBC News, "Is graphene a miracle material?" article, published May 21, 2011

³ Wall Street Journal, "Wonder Material Ignites Scientific Gold Rush," published August 24, 2013

⁴ UK Daily Mail, "The wonder stuff that could change the world: Graphene is so strong a sheet of it as thin as clingfilm could support an elephant" article, published October 7, 2011

⁵ International Business Times on Nasdaq.com, "Graphite and rare earth metals for the 21st Century" interview with Senior Fellow Jack Lifton from the Institute for the Analysis of Global Security

⁶ Wall Street Journal MarketWatch, "Mason Graphite Making Case for Being World's Lowest Cost Graphite Producer" article, published November 19, 2013

⁷ Mason Graphite October 2013 Investor Presentation

⁸ Industrial Minerals Data, "Shandong, China ordered to halt flake graphite production" article, published December 16, 2013

⁹ Wall Street Journal MarketWatch, "Mason Graphite Develops a 'Freak Of Nature'" article, published November 21, 2013

Source: Mason Graphite: Graphene Revolution, Lithium-Ion Battery Growth, And China Supply Woes Offer A Compelling Opportunity

Disclosure: I am long OTCQX:MGPHF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)

Additional disclosure: Author's Note: I own Mason Graphite shares as a long-term investment in accordance with the investment thesis set forth in this report. As my investment in Mason Graphite is long-term and not a trade, I do not intend to sell any MGPHT shares until at least 2023 when the full potential of graphene will be better understood as new products are developed. Although, I do intend to add shares on an opportunistic basis as events regarding Mason Graphite and the graphite industry unfold in coming years.

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