Yesterday Molycorp (MCP) declined $0.81 (10.28%) to $7.07/share - the third largest percentage decline on the New York Stock Exchange. Several shareholders attributed the sharp decline to an article from Shock Exchange which hit the Internet just before the market opened. The article, "Are Molycorp's $1 Billion Intangible Assets Impaired," questioned whether the $978 million in intangibles and goodwill attributed to Neo Material Technologies, renamed "Molycorp Canada," have been impaired since its $1.2 billion acquisition in March 2012. Given the fact that the unit reported an operating loss through nine months ended September 30, 2012, a potential write-down of a portion of its intangible assets is a real risk. Coupled with the fact that the intangibles represent over 60% of Molycorp's $1.6 billion book value, an asset impairment has wider implications for the company's market capitalization and pending $300 million capital raise:
Neo's potential, and Molycorp's for that matter, has been a consistent theme. However, the Neo acquisition was made when rare-earth prices were more buoyant than they are today, it created a higher expense burden at Molycorp, and it created nearly $1 billion in intangible assets, including over $500 million in goodwill. That said, given that the company's operating losses may not abate any time soon, a portion of those intangible assets may be impaired.
The following table illustrates Molycorp's total intangible assets and goodwill. At September 30, 2012, intangible assets and goodwill pursuant to the Molycorp Canada transaction were $476.4 million and $501.6 million, respectively.
Molycorp Canada's Deteriorating Revenue
Molycorp Canada possesses processing technologies in powders used in sophisticated high-performance bonded magnets. Its operations are included in the operating segment known as "Magnetic Materials and Alloys." The following table illustrates the financial performance of Molycorp's four operating units - Resources, Chemicals & Oxides, Magnetic Materials, and Rare Metals - for the third quarter of 2012.
- Molycorp's Magnetic Materials and Alloys unit which reflects Molycorp Canada's financial results, experienced a pretax loss (prior to corporate costs) of $2.4 million for the nine months ended September 30, 2012. The price of neodymium is the primary determinant of Neo Powders, which accounts for the lion's share of the segment's volume; neodymium prices fell approximately 11% during the third quarter of 2012.
- The above table reflects pretax income (prior to corporate costs) for the three months ended September 30, 2012. How corporate and other costs are allocated by segment is unknown. Magnetic Materials represented approximately 36% of total segment revenue; an allocation of a mere 7.0% of Molycorp's $17.2 million (1.2%) of corporate costs would leave the unit at breakeven on a pretax basis.
- For the three months ended December 31, 2012, volume and price/kilogram declined across all segments. Volume, prices, and ultimately revenue, for the fourth quarter of 2012 were derived from management estimates provided in Molycorp's January 23, 2013 8-K pursuant to its common stock offering.
- I took the mid-point of management estimates for (i) volume and (ii) price to derive revenue per segment. No estimates for inter-company eliminations, corporate costs or pretax income were given.
- Global economic weakness and the continued erosion of rare earth prices negatively affected the fourth quarter. A case could be made that diminution in Molycorp Canada's value has occurred.
Intangible Impairment Impact
The following table displays the impact of a write-down of Molycorp's intangible assets.
- Prior to the announcement of capital raise, Molycorp's stock was around $8.84/share. Its market capitalization was $1.2 billion or a 25% discount to its $1.6 billion book value. Given the deterioration in Molycorp's revenue and earnings, this is where the market thinks the stock should trade.
- Under a "base case" scenario, the company writes off the entire $502 million in goodwill associated with Molycorp Canada. I assumed the deferred taxes (tax shield) created by the goodwill write-down was not admitted since the company needs to earn future profits in order to utilize the deferred taxes.
- At 75% of its pro forma book value of $1.2 billion, Molycorp's market capitalization would be $840 million, or $6.09/share.
- In the "downside case" all of Molycorp's goodwill and intangibles of $978 million are written off. At 75% of its pro forma book value of $643 million, its market capitalization would be approximately $484 million or $3.51/share.
The potential for an intangible asset impairment is real. Either management can tell shareholders prior to the capital raise or afterwards, but the issue still remains. That said, I recommend investors hold off on buying the stock until management addresses the issue. However, if Molycorp drops to $3.50/share which has a "downside case" scenario built in, I would buy and hold on for the long-term.