Due Diligence and Valuation Report Arrowhead Code: 21-01-18 Company: AVALON RARE METALS, INC. Coverage initiated: 25 Aug 2008 This document: 31 August 2012 Ticker: TSX: AVL; AMEX: AVL; FWB:OU5 Fair share value bracket: CA$4.48 to CA$13.44i Headquarters: Toronto, Ontario Share price on date: CA$1.72ii CEO & President: Mr. Don Bubar Analyst team Non-Executive Chairman: Mr. Alan Ferry Vishal Pasari Mohanarangam Purushothaman Website: www.avalonraremetals.com [email protected] [email protected] Part of the ABID TREO. In addition, it bought the one of the two NSR royalties, of 3%, for a cash payment of ESR Index CA$2.0MM. Market Data An update to the PFS, released in 2011, shows 52-Week Range: CA$1.40 – CA$4.25iii the pre-tax internal rate of return (IRR) of 39% Average Daily Volume: 324,760iv and pre-tax NPV of 10% at CA$1.77B. A Market Cap. on date: CA$178.21MM CA$64MM feasibility study (FS) for the project is ongoing and is expected to be completed by 2Q Financial Forecast Data (in CA$) 2013. The production is expected to start in 2016 ‘12E ‘13E ‘14E ‘15E 16E ‘17E ‘18E with its initial sales in 2017, at a total capital High profit/ expenditure of approximately $1.2B, including the (8.0) (10.0) (11.0) (18.2) (44.4) 22.6 124.2 (loss) MM US based separation plant. High EPS (0.1) (0.1) (0.1) (0.1) (0.3) 0.1 0.6 Warren Township is a high potential Calcium CA$ Low profit/ Feldspar Project with high purity anorthosite with (8.0) (10.0) (11.0) (18.2) (44.4) 108.4 246.2 (loss) MM 98% calcium plagioclase feldspar. Separation Low EPS Rapids is host to one of the largest rare metal (0.1) (0.1) (0.1) (0.1) (0.3) 0.6 1.2 CA$ pegmatite deposits, a potential source of lithium minerals, in the world. Spor Mountain and Fiscal Year (FY) September 1st – August 31st Miramichi Project, acquired in 2011, is scheduled Summary for a $1.2MM drilling program in 2012. At Spor Avalon Rare Metals Inc. is a Canadian mineral Mountain, by May 2012, 3 holes totalling exploration and development company with seven ~1,000mof the 3000m was drilled on three of the key projects in the exploration and development seven targets. The program is expected to cost of rare earth elements (REE), rare metals, and $0.6MM. rare minerals. All assets are 100% owned, and In June 2012, Avalon signed an accommodation located in Canada and the US. Avalon had no agreement with the Deninu K'ue First Nation. The assets in production as of July 16, 2012. Agreement is expected to provide business and The company’s focus is on the high-potential employment opportunities at Thor Lake. This is a Nechalacho Deposit Thor Lake REE asset in the very significant milestone for the Project as it Northwest Territories, for which the prefeasibility accommodates the interests of partners in a study (PFS) has been completed. The Thor lake mutually beneficial and respectful way. project is emerging as one of the world’s largest Given due diligence and valuation estimations undeveloped rare earth elements resources and is based on intrinsic revenue capacity of the exceptionally enriched in the more valuable heavy Nechalacho deposit, Arrowhead believes that REE (HREE). In the updated resource estimate Avalon’s fair share value lies in the CA$4.48 to shows 21.7% HREO/TREO in the Measured CA$13.44 v By policy, Avalon complies with category. standards in matters of social and environmental In July 2012, Avalon released an updated responsibility. For interest taken in relationships resource estimate with Measured & Indicated with stakeholders and environmental externalities, Avalon was included in Arrowhead’s Resources at 161.21MMT grading 1.33% TREO vi and Inferred resources at 331.67 grading 1.05% ESR Index on November 7, 2008. Avalon Rare Metals, Inc. – Arrowhead BID 1 TSX: AVL; AMEX: AVL; FWB: OU5 Due Diligence and Valuation Report See important disclosures on page 26 of this report. Table of Contents Company Presentation ...................................................................................................... 3 News ................................................................................................................................. 7 Listing Information ........................................................................................................... 8 Contacts ............................................................................................................................ 8 Major Shareholders ........................................................................................................... 8 Management and Governance ........................................................................................... 9 Assets and Projects ......................................................................................................... 11 Technologies and Markets ............................................................................................... 17 Porter’s Five Force Analysis for the Rare Earth Elements (REE) industry ........................ 21 SWOT Analysis ................................................................................................................ 21 Value ............................................................................................................................... 22 Analyst Certifications and Important Disclosures............................................................ 26 Valuation ......................................................................................................................... 27 Avalon Rare Metals, Inc. – Arrowhead BID 2 TSX: AVL; AMEX: AVL; FWB:OU5 Due Diligence and Valuation Report See important disclosures on page 26 of this report. Company Presentation Avalon Rare Metals Inc. (Avalon), headquartered in Toronto, focuses on the rare metals and minerals, with operations mainly in Canada. Currently, Avalon possesses seven assets; six in Canada and one in the United States. It also has a small Net Smelter Return (NSR) interest in two base and precious metals properties in which the company was formerly involved. All the seven assets in Avalon’s portfolio are either in the development or exploration phases. Avalon’s revenue through 2017 is mainly linked to the entry into production in late 2016 of its Nechalacho deposit and perhaps secondarily of other deposits at Thor Lake. Other projects such as East Kemptville, Warren Township, and Separation Rapids are also at an advanced exploration stage. The company has resumed work on the Warren Township and the Separation Rapids projects, after receiving an expression of interest from an industrial minerals company. The company has signed four MOUs with four Asian industrial companies seeking to participate in the project as strategic investors or technology partners. Three of the MOUs intend for an investment in the project and off take agreements, while the fourth is for the technology support on the separation plant. Avalon looks forward to progress and sign definitive agreements; however, no specific timelines are in place for concluding these negotiations. In June 2012, Avalon signed an accommodation agreement with the Deninu K'ue First Nation. The Agreement is expected to provide business and employment opportunities related to the Avalon’s Nechalacho Deposit. A definitive financial structure for the project has not been finalized, however, as per the agreement, Avalon has agreed to issue to the DKFN an aggregate of 10,000 common shares of the Company, and grant an aggregate of 50,000 non-transferrable common share purchase warrants of the Company. This is a very significant milestone for the Nechalacho Project and it accommodates the interests of partners in a mutually beneficial and respectful way. To first nation it will helps in mitigation of the environmental impacts and provision for environmental monitoring on the land, which is crucial to First Nation members. It also provides business and employment opportunities, along with the education and training provisions, which are essential components of this agreement. Avalon Rare Metals’ Corporate Environmental and Social Responsibility Policies and Inclusion in the ABID ESR Index: For several years, Avalon’s management has focused on developing the company within an environmentally and socially sustainable and responsible framework. In 2010, Avalon won the PDAC Environmental and Social Responsibility Award. In May 2010, Avalon engaged Jantzi-Sustainalytics to assess Avalon’s sustainability performance against a number of benchmarks, including stakeholders’ expectations, competitors’ performance, industry average performance levels, and socially responsible investor expectations. Avalon ranked higher than the average score of 59, with an overall score of 69.2. As of 2008, the focus on corporate environmental and social responsibility (CESR) was translated into a corporate policy based on the principles and guidelines for responsible exploration and the guidelines for environmental excellence in exploration (e3 Plus), both established by the Prospectors and Developers Association of Canadavii (PDAC). To supervise the implementation of these guidelines, Avalon has formed a Sustainability Committee to the Board of Directors on matters relating to corporate environmental and social responsibility such as community relations, environmental practice and health and safety in its projects. The Sustainability Committee has three members with relevant experience and is chaired by Mr. David Connelly, member of the Board of Directors.