Summary of findings

• American Resources’ (“AREC”) CEO Mark Jensen and president Thomas Sauve were sued in the past for mismanaging investment funds, negligence, and failing to follow through on debt guarantees. Similar things are happening at AREC. Around $2m was looted from the company’s coffers after delinquent loans were bought from related parties between 2017 and 2021. They are all completely worthless at this point.

• The metallurgical coal miner grossly underestimates its operating costs. Structural issues have seen AREC burn over $80m cash since 2017, even in the first half of 2022, when coal prices were at record highs. AREC’s mines have high development costs. The company has also continuously failed to reach its production objectives. 

• Coal property Deane Mining was leased to third-party Bluegrass Resources in April this year. Bluegrass is managed by men involved in a long-running bankruptcy case in which they have been accused of fraudulent asset transfers. 

• AREC chases fads and has built a hodgepodge of unrelated businesses: crypto, a SPAC, and rare earth recycling. None of them have been successful.

• The company is dangerously close to running out of money. As of 30 September 2022, AREC had only $4.9m cash, and a burn rate of $23.5m over the last twelve months. Just last week, AREC filed an amended 10-K for the 2021 financial year, and in its liquidity disclosure, said that the company needs money to settle ‘payables and debt that are in default of their original agreements’. Adding to this headache is a recent lawsuit filed by Lexon Insurance, seeking to recover $25m, after AREC defaulted on $547,000 of surety bond premiums. The $25m represents 67% of AREC’s total asset position as of end-September.

Presentation of AREC

American Resources Corporation (AREC) describes itself as a ‘next generation and socially responsible supplier of rare earth and critical elements, carbon and advanced carbon materials to the new infrastructure and electrification marketplace’. The reality is more prosaic. The Fishers, Indiana-headquartered company operates coal mines in Eastern Kentucky and West Virginia. Its main assets are McCoy Elkhorn, which produces “high-vol B” metallurgical coal, and Perry County Resources which produces pulverized coal for injection (PCI), another type of met coal. These mines sold ~87,000 tonnes of coal in 2021: 79,547 tonness of PCI and 7,890 tonnes of high-vol “B”.

The Nasdaq-listed miner believes it stands to benefit from high met coal prices. Its confidence comes from the ~$28m spent over the period 2015-2019, to acquire developed assets out of bankruptcy, or when coal prices were depressed. These mines had retirement liabilities of ~$20.0m at the end of September 2022. AREC’s coal sales were $34.4m in 9M22. Yet, AREC still lost $10.5m, and the book value of its equity was negative $9.1m. 

AREC is actively promoting its rare earth recycling startup. This business commenced on 8 June 2020 and claims to be ‘the first and most efficient commercial producer of separated and purified rare earth elements’ in the US. The company plans to process rare earth element concentrate in the future using its met coal mines. The sell-side believes that rare earth recycling could bring in up to $270m of revenue per year based on potential capacity of three million kilograms of critical and rare earth elements.

The company’s market cap was $113m as of 29 November 2022.

AREC’s management was accused of mismanaging investment funds, negligence, and failing to follow through on debt guarantees

AREC CEO and chairman Mark Jensen co-runs investment firm T Squared Capital LLC with Thomas Sauve, president. The lead investor (Hull Capital) for one of its funds (T Squared Investments LLC) sued the firm in 2014 for failing to meet a $4m withdrawal request. The complaint filed with the New York Supreme Court shows the fund suffered huge losses because of factors such as:

• Three stock investments that turned out to be frauds (L&L Energy, Dolphin Digital Media, China For-Gen). Hull Capital accused the firm of failing to perform ‘minimally competent due diligence’. The largest holding in the fund was in China For-Gen, where Jensen also served on the board.
• Charging excessive management fees based on inflated asset valuations.
• Without permission, transferring the fund’s most valuable assets to a new one, and leaving the old fund with the burden of its liabilities.

Both parties settled on 24 January 2022. 

Similar patterns of self-dealing have emerged at AREC. About $2m of secured loans were acquired from related parties between 2017 and 2021, only to be entirely impaired, due to ‘collectability uncertainty’ (Pg F-19 of the 10-K for 2021). This behaviour amounts to looting of company assets as some loans were overdue by four to five years at the time of purchase.

In October 2020, another lawsuit hit Sauve and Jensen who were president and CEO/chairman, respectively, at coal miner Quest Energy Corporation (now known as Samuel Coal Holding). Six investors had put $400,000 into secured promissory notes issued by Quest Energy in 2013. The investors were supposed to receive monthly payments: comprising the coupon on the notes and certain royalties based on gross coal sales. Sauve and Jensen personally guaranteed those obligations. Quest payments were sporadic and stopped completely after September 2014. Jensen placed all of his assets in a trust to escape personal liability. He told investors, “You guys [the Investors] can go after me in court if you want but it will take two years and you’ll get nothing because I’ve put everything into trust.” Quest and the noteholders settled in October 2021.

Structural issues mean AREC coal mines are unlikely to generate cash flow

From 2016 to 2021, AREC lost a total of $161m, while its operating cash flow was minus $77m. This loss-making continued in 9M22 despite the higher price of met coal. Still, the company is confident that its Perry County and McCoy Elkhorn complexes, as well as a recently completed lease on its Deane Mining complex, will turn the cash flow tide. AREC believes it can raise production output at lower than average cash costs. This optimism is misplaced.

• Cash costs are much higher than what AREC claims: Back in 2020, AREC boasted it had the lowest production costs ($50-$60 per tonne) among mining peers, including giants Rio Tinto and BHP. 

Source: AREC investor presentation, Pg 19

This presentation was at the very least highly misleading. AREC’s actual cash costs, defined as the cost of coal sales and processing plus production taxes and royalties, divided by total production during the year, were $70-$362 per tonne from 2018-2021. On top of that, missing from these costs are perennially high development expenses, which totaled $62.0m (~74% of operating cash outflow) over the 2017-9M22 period. These were ‘incurred to prepare future sites for mining’ and AREC spent $30.1m in the last twelve months alone. By adding these development expenses, AREC’s cash costs go up by an average of 65% from 2018-2021, as shown below. This places AREC way above its peers on the production cost curve.

We believe these development expenses are hidden operating costs. AREC does not give a breakdown but two things stand out. One, they were recognised as expenditures instead of being capitalized. And two, the fact that these costs happen every year belie AREC’s assertions that they are one-time in nature. 

• AREC generally sells coal with specs far lower than its peers: In 2021, AREC sold ~87,000 tonnes of met coal at an average price of $88, which was ~31% less than peers who sold for around $128/tonne.

About 90% or 79,547 tonnes of these sales were industrial stoker and PCI — met coal of the poorest quality — from AREC’s E4-2 mine. As a result, along with AREC’s high production costs, the miner has incurred losses on every tonne of coal sold. It is noteworthy that AREC remains in the red even when development expenses are excluded from cash costs.

AREC’s average sales improved to $250/tonne in 3Q22. But this was because its most productive mine (Perry County), which sells low quality coal, was closed for almost the whole quarter. AREC however still posted losses of $5.3m and operating cash flow of negative $3.9m for the quarter.

We don’t expect the situation to improve in the later part of 2022. Australian Premium Coking Coal Futures (FOB), which reflect much higher specs than AREC’s production, have dropped 58% from their peak of $635 in March 2022 to $268/tonne as of 29 November. Most of AREC’s coal is sold on the spot market.

• Management has consistently failed to deliver on production promises: In late 2018, AREC predicted that its mining assets would produce as much as 3.5 million tonnes of coal the next year.

Source: AREC investor presentation in 2018

Note: Prediction of total 2019 production based on McCoy Elkhorn + Knott County + Deane Mining

AREC has never achieved a fraction of this estimate. Its 2019 production ended up 90% lower, as shown below, mostly because only five mines were operating that year compared to the stated 13 in AREC’s forecast. Its Carnegie 1 mine was supposed to contribute 32,000 to 42,000 tonnes per month in the fall of 2019. The mine ended up producing 10,652 tonnes for that year according to Mine Safety and Health Administration (MSHA) data — far below historical production levels. AREC produced just 87,436 tonnes in 2021.

Any production guidance from AREC should therefore be viewed with skepticism. Furthermore, the company does not have any proven or probable reserves certified by a third-party. 

The lease to Bluegrass looks like a non-starter

On 29 April 2022, AREC leased its non-core Deane Mining thermal coal asset to Bluegrass Resources, for ~$5/tonne of coal produced or 5% of gross sales from the complex. The asset comprises two mines that have not been producing since 3Q19: Access Energy is listed as temporarily idle while Razorblade Surface’s status is non-producing but active, based on MSHA info as of 15 November 2022.

Sell-side cheerleader Roth Capital valued the five-year lease at $50m on the assumption that Bluegrass would produce at least 1 million tonnes each year. That represents ~45% of AREC’s current market cap. CEO Mark Jensen said in a press release at the time. “We have known the owners of Bluegrass Resources for a number of years and have confidence in their ability to execute and create value for our shareholders and theirs.”

The only website we could find for Bluegrass is basic, and was created on 7 April 2022, around three weeks before the lease announcement. 

Source: ViewDNS.info website

Bluegrass is managed by father and son team Kenneth McCoy and Jason McCoy, according to the MSHA website. 

Source: Mine Safety and Health Administration website

Both are involved in a long-running bankruptcy case in which they have been accused of fraudulent asset transfers. The McCoys were majority shareholders in Mission Coal Company LLC with a 57.5% stake. By October 2018, only nine months after its creation, Mission Coal filed for bankruptcy with unfunded debt of $175m. At the heart of the bankruptcy was its subsidiary Seneca Coal Resources. In 2015, Seneca bought mining assets from NYSE-listed Cleveland-Cliffs (fka Cliffs Natural Resources) for $268m and had to pay another $32m in costs related to the deal. Seneca did not meet its obligations. Instead, the McCoys and other executives allegedly diverted millions out of Seneca’s bank account to their own coffers, fabricated management fees, and sold coal to affiliates at below-market prices to avoid paying tonnage fees. Cliffs took Seneca to court but the action ended in October 2019 with Seneca filing for chapter 11, which resulted in its bankruptcy discharge. However, on 19 July 2022, Mission Coal’s liquidator sued Kenneth for illegally transferring $918k to his wife from the sale of a Florida condo to escape creditor claims. The case remains open.

The accusations of self-dealing leveled against the McCoys lead us to believe the Deane Mining lease has no value.

Moving from one hype to another

AREC has spent the last two years expanding into fields that have nothing to do with coal mining. Examples include rare earth element (REE) recycling, crypto investing, and sponsoring a SPAC, all in an effort to generate buzz.

1. Crypto zero

AREC holds two million crypto tokens that were issued by related party Land Better Exchange (LBX) in 2021. While the capital invested is not disclosed, these have zero value as there is no market for these tokens, according to AREC’s 3Q22 filings.

2. The zero-sales rare earth business

AREC wants to recycle REE materials. The business started in 2020 and is largely driven by ligand-assisted displacement (LAD) chromatography technology that was developed by Linda Wang from Purdue University and licensed from Hasler Ventures LLC in February last year. It is supposed to separate and clean rare earth elements (REE), using feedstock such as discarded lithium-ion batteries and magnets. As per AREC, the costs of this tech will be much lower than the traditional solvent extraction method, both economically and environmentally. The REE business has no revenue. Yet recently, in an attempt to generate hype, AREC announced plans to spin-off its REE business into a standalone public company.

 Source: Investor presentation, Page 11 (Link)

We found that only one other company has shown interest in this technology. Medallion Resources is listed on the TSX with a $3.4m market cap. It struck a license deal for the same technology last year. However, Medallion has done nothing to advance this tech, and generates no revenue of its own. 

3. Taking part in the SPAC-mania

AREC jumped on the SPAC bandwagon after raising over $100m from the IPO of American Acquisition Opportunity (AAO) in March last year. AAO has been a letdown. Its initial promise to complete a merger by 22 March 2022 never happened. That deadline has been pushed back twice, the first to 22 September 2022, and then to 22 March 2023. 

The SPAC’s cash dropped from $106m at the end of 2021 to $7.5m as of 30 September 2022 because of these failures:

• Shareholders redeemed 8,943,317 shares worth ~$90.3m in March 2022, after the first extension.

• Another $8.3m (820,377 shares) left the trust account after the second extension.

AAO is now in the process of merging with a company managed by… AREC’s management. The deal with Royalty Management Corp (RMC) was announced on 28 June 2022, and according to Jensen, came after evaluating more than 50 acquisition targets. Sauve (AREC president) and Mark LaVerghetta (VP of corporate finance & communications) are key RMC executives, as shown below.

 Source: Royalty Management Corp website (Link)

RMC is a young company that was formed over a year ago. The Indiana-incorporated entity describes itself as a royalty company focused on ‘acquiring and structuring cash flow streams related to land, water, and mineral rights, patents, and intellectual property’, among other things. No financials are available.

Cash crunch and lawsuit for the failure to pay performance bond premium 

AREC is facing a liquidity crisis. It spent $23.5m of cash over the last twelve months, even with coal prices having edged up recently, and had a little over two months of cash based on its $4.9m balance as of end-September. 

Legal risks could worsen the situation. On 18 November 2022, AREC filed an amended 10-K for the 2021 financial year, and in its liquidity disclosure, added that the company needs money to settle ‘payables and debt that are in default of their original agreements’.

 Source: AREC filings

No context was given but AREC may be talking about an ongoing legal matter with Lexon Insurance. AREC was taken to court by the insurer on 12 July 2022 in the Southern district of New York for a total of around $25m. As per the complaint, AREC had not paid $547,000 of insurance premiums on surety bonds — under a general indemnity agreement signed in 2020 — to Lexon who issued these bonds to the State of Kentucky. These bonds are required before mining operations can begin to ensure proper reclamation of the land. Lexon also sued AREC for not meeting its collateral requirement after it stopped paying $1 per ton of extracted coal every month from April 2022. These monthly payments were part of the collateral agreement signed in 2021 but the complaint does not indicate which assets they support. 

AREC’s situation looks dire. Its cash is likely to run out by the end of this year. Combined with its high burn rate and potential legal liability, means the company has to tap dilutive sources of financing, very soon. 

Conclusion: 

There is little hope that AREC will be managed in a way that benefits shareholders, in light of management’s track record. We believe the company is a fatal combination of a low-quality mining business, with a weak balance sheet, and poor corporate governance. 

All attempts to diversify into the latest fads — crypto, SPACs, and rare earth — have failed.

AREC’s liquidity situation is likely to get worse and shareholders would ultimately see significant dilution of their equity interests. We expect the company to suffer more losses, and see its negative equity position widen, as the cost of running its mines stays high. 

We are short AREC.

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