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Summary

  • Without a capital raise Molycorp will run out of cash in 1Q 2015.
  • Payments on Molycorp's convertible bonds are projected to end in 1Q 2015.
  • Based on a limited income stream, the convertibles are worth from 3 cents to 5 cents on the dollar.

Given the risk of an imminent capital raise at Molycorp, Inc. (MCP), I think the stock is overvalued. That said, I have decided to look at the company's bonds instead. The following chart illustrates the company's long-term debt, its rating and where it is trading, per FINRA.

(click to enlarge)

  • The principal amount of the company's outstanding convertible notes total $793 million.
  • At June 4, 2014 they traded from 60 cents to 69 cents on the dollar. Yields ranged from 21% to 25%.
  • The bonds are subordinate to the 10% senior notes with a principal amount of $650 million.
  • In 1Q 2014, Molycorp recorded about $35 million in interest expense on all of its non-current debt.
  • Based upon the company's cash outflows, it is possible that Molycorp will run out of cash in 1Q 2015, rendering it unable to pay interest or principal on the debentures.

Molycorp Cash Flows

The following chart displays Molycorp's actual cash outflows for 1Q 2014, and estimates thereafter.

The rationale behind Molycorp's bankruptcy risk from the above chart is as follows:

  • Molycorp generated cash outflows of $78 million in 1Q 2014, leaving the company with cash on hand of $236 million.
  • Cash used from operations includes interest expense of approximately $35 million recorded on long-term debt.
  • Projections assume cash used in operations of $46 million do not improve or worsen.
  • Maintenance capex is $13 million per quarter. Capex for Mountain Pass is $21 million for the rest of 2014, and $0 thereafter.
  • Based on these high level projections, Molycorp will run out of cash in 1Q 2015. The company will not be able to pay interest on its long-term indebtedness, let alone principal.
  • Molycorp will essentially be bankrupt in 1Q 2015 unless it raises capital beforehand. Sans an equity raise, the bonds will most likely go into default this year.

Estimated Payments on Convertible Notes

Below are estimated payments on Molycorp's convertible notes. The chart assumes debt holders receive interest on the debentures through 1Q 2015. That said, I would value the debentures based upon expected payments under the bonds. Anything received after that - interest, principal or equity - would be considered extra.

(click to enlarge)

3.25% Convertible Bonds

  • 3.25% interest on $230 million bonds equates to about $7 million in annual interest income to the bondholder.
  • I assumed one month's worth of interest for June 2014 ($623 thousand) and quarterly interest payments through 1Q 2015. Total interest income of about $6 million equates to a return of about 2.7%.
  • By paying approximately 3 cents on the dollar, an investor would be repaid his upfront investment, and anything after that - principal, interest, equity - would be considered upside.

6.00% Convertible Bonds

  • 6.00% interest on $414 million bonds equates to about $25 million in annual interest income to the bondholder.
  • I assumed one month's worth of interest for June 2014 ($2 million) and quarterly interest payments through 1Q 2015. Total interest income of about $21 million equates to a return of about 5.0%.
  • By paying approximately 5 cents on the dollar, an investor would be repaid his upfront investment, and anything after that - principal, interest, equity - would be considered upside.

5.50% Convertible Bonds

  • 5.50% interest on $150 million bonds equates to about $8 million in annual interest income to the bondholder.
  • I assumed one month's worth of interest for June 2014 ($685 thousand) and quarterly interest payments through 1Q 2015. Total interest income of about $7 million equates to a return of 4.6%.
  • Since Molycorp will most likely run out of cash by then, I assumed no interest or principal payments past 1Q 2015.
  • By paying approximately 5 cents on the dollar, an investor would be repaid his upfront investment, and anything after that - principal, interest or equity in the company - would be upside.

Conclusion

Based on cash outflows, Molycorp will potentially run out of cash in 1Q 2015, leaving investors in its convertible notes with a limited stream of income. That income stream is worth 3 cents to 5 cents on the dollar, yet the bonds trade from 60 cents to 69 cents on the dollar. Molycorp's convertible bonds are a sell.

Disclosure: I am short MCP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I own June puts and September puts on the Molycorp.

Source: Molycorp's Convertible Notes Are Worth From 3 - 5 Cents On The Dollar