Blue Orca Report – Blue+Orca+Short+Li-Cycle+Corp+(NYSE+LICY).pdf (squarespace.com)
Li-Cycle recognizes revenues using an Enron-like mark-to-model accounting gimmick. Li-Cycle recognizes revenues months prior to the actual sales of its recycled black mass, based on its own provisional estimate of the future value of the product. This accounting treatment is plainly vulnerable to abuse, giving Li-Cycle discretion over its reported revenues. We suspect that under this framework, Li-Cycle marks up the value of its receivables on unsold products and runs the gains through its revenue line. In the most recent quarter, we calculate that 45% of Li-Cycle’s revenues were derived from simply marking up receivables on products that had not been sold.
We suspect that such questionable accounting could explain why Li-Cycle’s CFO and auditor resigned in January 2022, mere months after the Company went public. Li-Cycle is a governance nightmare. Its founder is a serial penny stock promoter recently sanctioned by Canadian authorities and its management team diverted half a million in shareholder money to enrich their entourage with wasteful spending, including tens of thousands of dollars on leather goods purchased from the CEO’s family.
Li-Cycle’s cash burn is so severe and far above previous guidance that analysts have already downgraded the stock and told the market to expect Li-Cycle to raise at least $1 billion through debt and dilutive equity issuances. By our calculation, Li-Cycle’s stated capital investments will require the Company to raise at least $1 billion – 102% of its current enterprise value – in large part by massively diluting current shareholders. We think Li-Cycle, which currently trades at 96.8x LTM revenues.
Chairman a Serial Penny Stock Promoter Recently Sanctioned by Canadian Regulators. Li-Cycle’s co-founder and chairman, Tim Johnston, is a serial penny stock promotor who was recently banned by the TSX Venture exchange from acting as a director or officer of any TSXV-listed company without prior approval due to misconduct as president and CEO of Desert Lion Energy (DLI.CN). Johnston was sanctioned for failing to disclose key terms of a discounted financing he arranged for the junior miner. The British Columbia Securities Commission recently upheld the punishment. Undeterred, Johnston listed another lithium hype story on a junior Canadian exchange, which is down 62% from its highs and already admitted to overstating its cash balance.
Half a Million in Investor Money Diverted to Family Entourage. Despite a business that is hemorrhaging cash, and which will require multiple near-term cash infusions, Li-Cycle diverted $529,902 in investor capital to the family entourage of its founders through a series of highly questionable related party payments. These payments include, $85,824 to a leather goods maker owned by the CEO’s family which makes wallets, toiletry bags and beer holsters. Li-Cycle also paid C$4,500 per month to lease part of a C$312,000 office from the CEO’s family, paid hundreds of thousands of dollars to a corporate video production company owned by the chairman’s brother and paid over $170,000 to a family owned “technology service” with three employees in India.
Li-Cycle’s Revenues are based on Enron-esque Mark-to-Model Accounting. Li-Cycle claims to sell 100% of its recycled black mass to an investor, Traxys, and recognizes revenues immediately upon delivery. But Traxys is not really a customer, it is merely a broker providing working capital financing to Li-Cycle while Traxys attempts to sell Li-Cycle’s black mass to end buyers. Traxys is not the end customer, it bears no commodity price risk, and charges Li-Cycle interest on any cash to the Company prior to final sale to the end buyer. Yet Li-Cycle somehow recognizes revenue immediately upon delivery to its brokers, months before any sale occurs. Li-Cycle’s revenues are based on its own provisional estimate of the value of its unsold recycled product. In our opinion, Li-Cycle’s accounting is reminiscent of Enron – as the Company’s revenues are not derived from bona fide sales of recycled product to end customers, but rather Li-Cycle’s estimates of the future value of such products. Li-Cycle in effect uses markto-model accounting, pulling sales forward from future periods and recognizing revenues based on its self-serving estimates of recycled product shipped to its brokers. Under this framework, Li-Cycle also bolsters reported revenues by marking up the value of receivables for black mass which sits at its brokers and has yet to be sold. In the most recent quarter, we calculate that 45% of Li-Cycle’s revenues were derived from simply marking up receivables on products that had not been sold. We question whether this highly aggressive accounting treatment caused Li-Cycle’s auditor and CFO to resign, both of whom abruptly left the Company following the end of the last fiscal year.
Li-Cycle Requires $1 Billion in Near Term Capital. Li-Cycle’s costs and anticipated capital expenditures have ballooned. Morgan Stanley estimated in a recent note downgrading the stock that cost and capital expense overruns increased its estimate of Li-Cycle’s free cash flow burn (2022-2026) from $643 million to ~$1.85 billion, a 3x increase. Analysts estimate that Li-Cycle burns cash so much more rapidly than it initially told investors, that the Company will need to raise $1 billion in additional capital through debt and dilutive equity issuances. We agree. By our calculation, Li-Cycle’s proposed capital investments will require the Company to raise at least $1 billion – 102% of its current enterprise value – in part by diluting existing shareholders. This is fatal to the bull case for the stock: even if investors ignore Li-Cycle’s nightmarish corporate governance, questionable accounting, and negative margins, they will likely be so badly diluted that even if they win, they lose.
Hiding Negative Gross Margins. Notably for a self-styled ‘urban miner,’ Li-Cycle does not disclose gross margins on its income statement, instead reporting nebulous expense categories which on the surface, seem to imply an impressive 83% gross margin in the latest quarter. We think this is highly misleading, as the footnotes to the financial statements reveal that LiCycle’s aggregate inventory costs exceeded its aggregate revenues since inception. This suggests that Li-Cycle likely has negative gross margins, indicating that its recycling business is neither scalable nor economically viable. Rising commodity prices are unlikely to help, as the cost of Li-Cycle’s inputs will simply rise along with commodity prices.
Blood Diamonds and ESG. Li-Cycle’s purported commitment to ESG is central to its narrative, a commitment which we believe is more of a marketing ploy than a guiding tenet. Li-Cycle’s advisor, major shareholder and company consultant owned a Tanzanian diamond mine which has been accused of appalling human rights abuses. We question how ESG investors will feel about the ESG credentials of a company with close ties to a group accused of profiting from blood diamonds.
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