The Commodity Investor: Molycorp Takeover Will Trigger Other Deals

Includes: AVL, MCPIQ, QRM, REE
by: Hard Assets Investor

Rare Element Resources, Avalon Rare Metals and Quest Rare Minerals could be the next acquisition targets in the space.

Last week I highlighted Molycorp Inc. (NYSE:MCP) as a company that offers a discounted entry point into the rare earth element (REE) sector. This is a unique subsector in the commodities complex because it tends to move independently of other commodities and offers high-value-added services to many key industries.

I particularly like the REE sector at the moment because prices look very reasonable; prices for many key REE metals such as cerium and neodymium are trading at historic lows following frenzied speculation a few years ago that saw prices rise by 300 to 400 percent. As I analyzed in my previous column, China dominates the REE sector by producing 97 percent of the world’s REE metals.

This market structure means that companies outside of China are in a race to consolidate in order to try and counteract the country’s dominance in the market. And this is where Molycorp’s bid for Toronto-based Neo Material Technologies comes into play. Last week (literally two days after I highlighted Molycorp in this column), Molycorp announced a bid of $1.3 billion to acquire Neo Material Technologies. The market applauded Molycorp’s action and the stock price jumped almost 25 percent the week after the announcement.

The competitive landscape in the REE sector has become much tougher, especially when you combine China’s dominance in the sector and lower prices for these metals, which is forcing weaker players into the arms of stronger rivals. The industry has now entered a decisive wave of consolidation and don’t be surprised to see even more mergers and acquisitions announced this year.

Molycorp’s bid for Neo Material Technologies is an acquisition that makes a lot of sense for both parties and to the market in general. Molycorp’s biggest asset is its ownership of a 2,222-acre site in Nevada that contains the largest-known reserves of rare earth deposits outside of China. As the prices of rare earth metals plummeted in the last year or so, so has the value of Molycorp’s reserves, which has meant a lower stock price.

Molycorp, with this acquisition, has decided to enter into the downstream processing space of the business. Prior to this acquisition, Molycorp was known for its upstream assets and its large reserves. Post-acquisition, Molycorp will be one step closer to controlling many critical links in the REE supply chain, including extraction, transformation and distribution.

In a certain sense, Molycorp’s acquisition gives it more exposure to the Chinese market since NMT owns and operates several world-class processing facilities in the country. In fact, many U.S. lawmakers have expressed concern over the deal based on national security grounds because Molycorp will be shipping its rare earth deposits in Nevada to China for processing in NMT’s facilities there. However, it is unlikely that lawmakers will derail this acquisition based on those concerns.

With this timely and strategic target, Molycorp has moved up the food chain in its industry by adding processing and downstream capabilities in its portfolio, which will give it a decisive competitive advantage over some of its rivals. While most REE stocks rose last week following the announcement, I believe that this event is going to trigger further M&A activity in the space.

I’m going to keep an eye on some of Molycorp’s smaller competitors, especially Rare Element Resources (NYSE: REE), which saw prices jump 20 percent last week following the announcement. Another company I’m monitoring is Avalon Rare Metals (NYSE: AVL), a Canadian-based mining company focusing on rare earth metals for clean energy technology. Avalon owns a major deposit of REEs in Thor Lake, located in Canada’s Northwest Territories. With Molycorp’s latest action, Avalon will be forced to scale-up its operations if it seeks to remain an independent company; otherwise, it may become a takeover target.

Finally, another company to keep on your radar screen is Quest Rare Minerals (NYSE: QRM). Quest, also based in Canada, owns and operates the Strange Lake Rare Earth Project in Quebec, with an area that covers more than 54,000 hectares of exploration land. Quest’s performance depends almost entirely on its ability to identify and develop these rare earth deposits. If it’s able to make a significant discovery, it could end up being a bigger rival to Molycorp; however, if it’s unable to make these discoveries, it will most likely become an acquisition target.

The rare earth element industry is very vibrant at the moment, with lots of activity, and this should provide a good investment opportunity for the discerning investor.

Disclosure: The author doesn’t have any positions in the stocks mentioned.