By Amine Bouchentouf
These are tough days for one of the world's largest miners of rare-earth minerals and strategic metals, but unlike other commodity-related companies struggling because of macro issues and a global economic slowdown, Colorado-based Molycorp's problems are largely self-inflicted.
And make no mistake about it, the injury to the company from management missteps could prove fatal for this once-thriving company.
Molycorp (NYSE:MCP) is the largest holder of rare-earth deposits outside of China. It's a leading producer of highly sought-after metals such as niobium and tantalum. Although these metals are not known by the general public, they are essential building blocks in many key industries such as defense and aerospace. Specifically, metals such as niobium are used to develop superconducting magnets that have applications in highly specialized devices such as particle accelerators and even thermonuclear reactors.
Since MCP is a leading producer and distributor of these key metals, and because of the high demand and exclusive supply of the products it commercializes, it has a high economic moat and a defensible business model. In other words, demand for MCP's products is highly inelastic, which provides it with a strong and defensible business model.
That said, prices of MCP have plummeted during the summer. Indeed, prices dropped from $22 per share in the middle of June to $9.90 in the middle of August. All in all, the stock is down 48 percent over the last month, 54 percent over the last three months and a whopping 58 percent year-to-date. In fact, the stock price is 83 percent off its 52-week high, a stunning drawback for this once-high-flying stock.
Why has the market seemingly lost confidence in MCP, and what can we expect from the company going forward?
Can Confidence Be Restored?
Molycorp seemed to start the year on a positive note with a solid balance sheet, stable rare-earth prices and a generally benign market outlook. As the year progressed, MCP got caught up in what seems to be an avalanche of bad news. First, as the eurozone crisis raged on, it began having an effect on global economic output, which pushed down prices of niobium, tantalum and other key metals that make up the core product base of Molycorp.
Second, MCP embarked on an expensive acquisition in Canada in a new company renamed Molycorp Canada. This acquisition saddled the company with heavy debts, and it was also burdened with legacy debts that were on the balance sheet of its newly acquired company; namely, $230 million in convertible notes.
Third, the company embarked on an aggressive capital expenditure program to develop its mine and trophy asset located in Mountain Pass, Calif. The capital-expenditure costs weighed heavily on the company's balance sheet, which required it to go to the market to raise capital. The revamping of operations in Mountain Pass is estimated to cost $900 million, a huge number for a company with less than $400 million in total revenues (2011 figures).
As a result, MCP went to the market for a financing package worth almost $500 million. The big problem here, though, is that this round of financing turned out to be extremely dilutive for existing shareholders.
Specifically, the financing round included $120 million in straight equity priced at $10 per share, and senior convertible bonds with a $12 conversion price due in 2017 with a 6 percent clip. Sensing that MCP bit off more than it could chew, investors headed for the exits, which precipitated the stock price drop (more than 50 percent in three months).
What is clear is that MCP made a series of strategic mistakes, and its shareholders and management are paying dearly for those mistakes.
First, it appears to have grossly overpaid for its Canadian acquisition because of the legacy costs involved. Second, the infrastructure redevelopment and revamp at Mountain Pass are-at best-ill-timed. As any mining company executive will tell you, raising equity for development projects is extremely tight right now. Banks are not lending, and alternative sources of funding (such as hedge funds, private equity firms and SPVs) are demanding egregious terms.
The 6 percent coupon the company will be paying out to its convertible bondholders is extremely high for a company with limited revenues and earnings visibility. It is no wonder the market lost confidence in MCP and its management so quickly and abruptly.
The events of the last three months don't instill confidence in MCP or its management team's ability in terms of good corporate governance, business acumen, negotiating ability or strategic vision. It's the view of The Commodity Investor that MCP is skating on a razor-sharp knife and that one false move could cause it to go belly up. Yes, declaring bankruptcy protection is a very real possibility here.
If prices for rare-earth metals don't rebound significantly, then MCP will be facing decreasing revenues and weakening earnings. If construction and capex costs don't adhere to strict and conservative budget parameters, then MCP will be struggling to pay down its large amounts of debt. And if MCP isn't able to generate the synergies it claims to be able to achieve from its recent acquisitions, it won't be able to generate any shareholder value from these recent moves.
All in all, the outlook is extremely bleak for Molycorp. The company is lost at sea in the middle of a storm, with no help in sight. Unless a white knight emerges-such as a diversified mining company looking to expand into the rare-earth space-it will be extremely difficult for the company to survive on its own. At this juncture, one wonders whether the 58 percent drop in stock price is enough. There is certainly room for the stock to go down further. I wouldn't recommend buying shares of MCP until management is able to restore confidence in the company and its growth prospects.
Disclosure: The author doesn't have any positions in the stocks mentioned.