What does Liontown's funding deal tell us about the lithium sector?

Lithium hopeful Liontown Resources (ASX: LTR) has pivoted away from major banks, replacing a previous $550 million debt facility with a strategic partnership with foundational partner, LG Energy Solution.

The deal includes five-year US$250 million (A$379 million) convertible notes, a 10-year offtake extension and downstream collaboration agreement to explore the feasibility of establishing an Inflation Reduction Act (IRA) compliant refinery.

But beyond the deal itself, it says a lot of about the lithium industry. We'll explore some of the more subtle takeaway below.

Funding secured

The $379 million convertible notes issued to Liontown will carry a five-year term with interest pegged to the Secured Overnight Financing Rate, currently around 5.3%. LG Energy has the option to convert this debt into Liontown shares at $1.80 each. If they did this today, they'd own approximately 8% of the company.

However, with Liontown's shares trading around $1.00, immediate conversion is unlikely. This arrangement offers LG Energy the dual benefit of earning interest while retaining the potential for equity upside if Liontown performs well.

This Convertible Note replaces a $550 million debt facility previously arranged with a syndicate including Commonwealth Bank, National Australia Bank, and Société Générale. The former facility's interest was based on the Bank Bill Swap Rate (currently 4.8%) plus a variable margin capped at 4%.

Additionally, Liontown extended its offtake agreement with LG Energy by 10 years, maintaining the original five-year terms and conditions.

What does this tell us about the lithium sector?

LG Energy is confident in the long-term: Despite current market challenges, LG Energy has demonstrated strong faith in the lithium industry's future by investing $379 million to support Liontown's production ramp-up to 3Mtpa. This strategic move comes at a time when lithium prices have plummeted to three-year lows. For context, Chinese lithium carbonate prices have completed a dramatic cycle — from 90,000 yuan per tonne in mid-2021, skyrocketing to 600,000 yuan in late 2022, only to return to 90,000 yuan.

The industry's response to these price fluctuations has been cautious. Many lithium companies have delayed expansions and development activities, with Core Lithium even placing its Finniss Project into care and maintenance. However, LG Energy appears willing to weather the short-term turbulence, focusing instead on long-term potential.

I mean, why else would they front up $379 million if they think Liontown is just going to end up like Core Lithium?

But then again ... did LG Energy step up or did the banks exit: Is the lithium sector too risky for traditional banks? Does this flag distress in the sector and/or project economics?

Securing long-term supply: LG Energy has extended its offtake deal to:

• Year 1: 100,000 tonnes per annum (tpa)

• Years 2-5: 150,000 tpa

• Years 6-10: 160,000 tpa

• Years 11-15: 140,000 tpa

The extended deal reflects LG Energy's optimism about future demand and the need to secure a quality source of lithium. This is despite recent setbacks in EV sales momentum. For instance, the European Automobile Manufacturers Association reported a 7.9% quarter-on-quarter decline in EV market penetration for Q1 2024. The IEA also expects EV sales growth to ease from 35% in 2023 to just shy of 25% in 2024.

Lithium stocks get a kick

Liontown finished the session on Tuesday 7.3% higher, down from session highs of 17.4%. This performance is particularly noteworthy given the company's position as the third most shorted stock in the market, carrying an 11.36% short interest.

Today's price action can be attributed to a combination of factors:

• Short covering: Short sellers may have closed their positions in response to the strategic partnership and improved funding arrangement, driving the stock higher

• Shorters reloading: The pullback from session highs could indicate short sellers re-entering positions at higher levels as the lithium narrative remains bearish

• Improved funding terms: The secured funding is at a lower interest rate plus an extended offtake agreement

• Lithium prices remain low: Despite the above, lithium remain near three-year lows. In the end of the day, any re-rate for the lithium sector is dependent on higher prices

Liontown's announcement had a positive ripple effect across the lithium sector. Several other lithium stocks benefited from the news, rallying off session lows. But still, a bellwether name like Pilbara Minerals (ASX: PLS) finished the session down 3.6% or the lowest level since August 2022.

Arcadium Lithium (red), Mineral Resources (green) and Pilbara Minerals (blue) intraday performance on Tuesday, 2 July | Source: TradingView