General Moly: A Case Study of Probability, Not Hope

| About: General Moly, (GMO)

When trading stocks it is of paramount importance to remove phrases like “I hope, I wish, if only" from your vocabulary. Instead I deal with stocks in probabilities. What is the probability of profiting from this stock if x equals 1 and y equals 2. By calculating probabilities two things happen. All emotion is removed from trading and a dispassionate approach to trading can take place and we can better assess the risk to reward ratio and determine if this is a trade that we want to undertake. In trading, emotion is the bullet that will kill you. Stick with probabilities.

I own a sizable stake in a company called General Moly (NYSEMKT:GMO) which I will use as a proxy for my thesis. When I first learned of it I studied the project and determined that it owned the rights to the Mt. Hope project which is the company's flagship project. I learned that when it received the permit to begin building the infrastructure for the mine that it would be sitting on the world’s largest deposit of molybdenum. I also learned that it owned a site called the Liberty project that it would deal with at a later date, but from the preliminary analysis it had done the company is sure that this project will also produce a windfall amount of molybdenum.

So what’s so great about molybdenum? Molybdenum is an alloy that is a byproduct of mining copper. When molybdenum is mixed with iron ore one can create lightweight, incredibly strong stainless steel that is impervious to high degrees of temperature and pressure. I concluded that this would make it an essential ingredient for building oil rigs and nuclear reactors as well as basic infrastructure. I also learned that while China exported 97% of the world’s rare earth elements (that has subsequently changed) the country actually was a net importer of molybdenum.

My next step was to learn about the management team. I read everything I could find on the management of this company and was very pleased to learn that CEO Bruce Hansen had amassed an amazing team that was not looking to be acquired but instead looking to take this company into the arena of being the suppliers of molybdenum to the world.

What did the balance sheet look like? The company had received a loan from one of the largest producers of steel in the world, a South Korean company called Posco. It had also received financing from a Japanese company called Sojitz and finally it had received a bridge loan from a Chinese company called Hanlong for the amount of $50 million with the promise that when permitted it would receive an additional $665 million loan to fast track the project into production. Make no mistake; the South Koreans, the Japanese and the Chinese were not being benevolent. They do not want the loans paid back in dollars. They want the loans paid back in molybdenum.

So everything was going as scripted when a “Black Swan” appeared out of nowhere and in December of 2010 with the stock trading at around $7.00 an issue came up regarding water rights. To the credit of General Moly it has from the beginning of the project dealt with every problem with complete transparency. It has followed the law “chapter and verse” and there have been no mistakes made. This was no different. This did, however, slow the process down and the stock immediately became the backyard of the short sellers who used this as an opportunity to further drive the price down.

We will fast forward to last week when the state engineer granted the water rights to General Moly. I expected the stock to bounce to its previous level before the water rights problem but that did not happen. What had changed fundamentally? I got out my pencil and sharpened it. To use the latest balance sheet figures I could find, I determined that if I used a proxy price of $15.00 a lb for molybdenum then the company should have a net present value (NPR) of $1.2 billion or a 66% increase over where the stock is presently trading as far as market capitalization. Given the discount to the NPV, does this imply that the market believes that there is a 66% chance that this project will not go into production? I conclude that this is simply not the case.

Let’s honestly look at the risks at this point. Let’s assume the worst case scenario, China doesn’t come through with the expected financing or the Record of Decision (ROD) comes back negative or the Molybdenum concentrations are significantly less than expected or finally management cannot perform adequately enough to get this through to production. China is contractually obligated to provide financing once permitted and moreover it needs the molybdenum. There have been extensive exploratory bore holes done and everyone knows what is under the ground. The management team has performed spectacularly at every turn and I see no evidence of that changing. The X factor as I see it is the ROD and every due diligence has been taken. I see this as a probability of 80% to 90% that the ROD will come back positively. So other than the ROD, how can this kind of discount to the NPV be justified?

I conclude that the stock based on the fundamental analysis should be trading at the $10 to $12.00 range. Indeed the previously mentioned price of molybdenum that my analysis was based on was $15.00 a pound and as I write this, Freeport Mac Moran (NYSE:FCX), one of the largest copper producers in the world, reported that it had sold the molybdenum (which I said was a byproduct of copper mining) at a price of $18.00 per pound. I believe this is hedge funds continuing to try and drive the price down and judging by what I see on the tape they are beginning to run out of gas. Yesterday the stock closed at $4.78 but I do not see it trading there for much longer. So I would encourage anyone who is interested in making a profit to take a look at this project and if you like what you see stake your claim at a very discounted price.

I have learned through bitter experience to “never say never." But as I have previously stated I see the probability of this project coming to fruition at 80% to 90%. Surely somebody in Nevada wants a billion dollar mine to operate there. Consider the tax revenues generated for the state and the town of Eureka and the thousands of good paying jobs this project will create.

Disclosure: I am long GMO.

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