As I have reiterated in the past, Molycorp (MCP) is one of my favorite names and investment ideas. For months I have been waiting for an attractive entry point and still have not found it. The company has a strong market position in an industry with high barriers to entry. I have also been impressed with its management team, which has not shied away from making tough decisions for the long-term viability of the company. I pointed this out on September 25th in Molycorp Down Nearly 11% In One Day - What Happened?:
Management's decision to reopen the Mountain Pass mine in 2010 has been a calculated gamble that has paid off for investors, at least initially. Management recently raised approximately $150 million in common stock and $300 million in senior notes. The capital was designated to fund operating expenses, working capital, and capital expenditures for work at its Mountain Pass mine, and other cash requirements. Though management was criticized by some analysts and shareholders for diluting the stock, it showed management's willingness to make hard decisions for the long-term viability of the company. The common equity proceeds will give Molycorp the flexibility to stave off near-term operating losses, if need be.
A few days later one of the commenters on 3 Reasons Why Molycorp Will Not Be Aquired mentioned the dilution caused by the capital raise. Not only did I come to management's defense, but I intimated that more dilution could be on the way:
Commenter: Not one word on the price drop because of the dilution? That is why it dropped 40%.
Shock Exchange: Fair point on the "dilution." However, MCP made the common stock offering because its cash flows were dropping; it wasn't a happenstance. Yet, I give management credit for making an unpopular decision for the long-term viability of the company. Before it's all said and done, management may have to raise additional capital to fund its operations.
Well that "dilutive moment" I alluded to three months ago may finally be here. In its January 10, press release, management intimated that due to weak prices and production delays, Molycorp's 2013 revenue and cash flows would fall short of expectations. The company confirmed it was on track to produce 19,050 metric tons annually at its Mountain Pass mine by June 2013. However, it decided to delay Phase 2 of its $1.25 billion modernization and expansion of Mountain Pass until rare-earth conditions improve. However, what I heard was, "Molycorp is going to use the $450 million in capital it raised in August 2012 to fund future negative cash flows."
Negative Cash Flows
As rare-earth prices have declined, so have Molycorp's revenues and cash flows. For the nine months ended September 30, 2012 Molycorp's cash flows from operations were -41.3 million, i.e. it was a net user of cash. Its run-rate cash flow loss from operations are approximately $50 million - $55 million, and that is before management's press release on its 2013 cash flow miss.
Cash on Hand
According to the company's third quarter 2012 10Q, cash expenditures to complete its Mountain Pass modernization ("Project Phoenix") and other 2012 capital projects were expected to be $170 million for the fourth quarter of 2012, and approximately $305 million for the first half of 2013. Funding for the nearly $475 million in capital projects was to come from ((i)) $436 million in cash on hand, ((ii)) future cash flows from operations, and (((iii))) potential proceeds from revolving credit facilities and equipment financing it was pursuing. How much in capital expenditures the company saved by delaying Project Phoenix Phase 2 is unknown. However, its run-rate negative cash flows of $50 million - $55 million must be funded through cash on hand, by tapping its revolving credit facility or through another capital raise.
Debt Versus Equity
Currently 5.5% Series A Mandatory Convertible Preferred Stock (MCP.PRA) trades at a 69.2% discount to its liquidation preference amount, and yields over 18%. This may serve as a proxy for the interest rate the company would have to pay on any new indebtedness. Additional debt at such "bootstrap" rates would also decrease the company's flexibility as it attempts to wait out the decline in rare-earth prices. The other alternative would be another common stock offering. The August 2012 common equity raise diluted the stock by approximately 15%. Given Molycorp's current market capitalization of about $1.2 billion, a common equity offering of $200 - $300 million could dilute current shareholders by another 15% - 25%.
Molycorp remains a high-beta stock, and is not for the faint of heart. Industry-specific and company-specific events, coupled with the pain ahead for the U.S. economy, equate to a volatile ride for Molycorp. For current shareholders, I suggest they get out "while the getting's good." For those looking to buy into the stock, I suggest you wait for (A) guidance from management on future cash flows or, (B) another dilutive event to create a lower entry point.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.