Best stock to invest in – Molycorp: Holding a Stinky Bag

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by Debra Fiakas CFA
Last week news agencies reported plans by Molycorp (MCPIQ:  NYSE) to
move forward with plans to sell major assets as part of a plan to
emerge from bankruptcy.  Molycorp was the single largest
producer of rare earths in the U.S. until it discontinued product at
its Mountain Pass mine in Colorado.  Molycorp filed for
bankruptcy protection in June 2015 after it became apparent that it
could no longer support the debt on its balance sheet on
historically low selling prices for its rare earth materials.

The turn of the tide for Molycorp and its rare earth business plan
surprised few who follow the mining industry.  The U.S. had led
the way in the rare earths arena.  The Mountain Pass mine had
been the world’s leading producer  of these unusual metals in
the 1960s when new color television designs escalated demand for
europium.  It took a while for the Chinese to catch up, but by
the 1990s producers there had increased production to rival that of
Mountain Pass.  What is more, strategists in China had also
figured out how to use low prices to force competitors out of
business.  The machinery came to a stop at Mountain Pass. 
Other mines in Japan and elsewhere followed suit, leaving China with
as much as 95% of the market for rare earth materials.

Then the Chinese decided to curtail exports of rare earths. 
Sensing an opportunity to grab customers from the Chinese and
sufficiently high selling prices to justify investment, Molycorp
management decided the time was ripe to return Mountain Pass to its
previous glory.  Why anyone would invest billions on the
vagaries of Chinese business and political strategies seemed a bit
ludicrous to me, but it passed the tests of lenders who extended
over $1.7 billion in loans to Molycorp.  

Of course, about the time that Molycorp and its lenders became fully
committed to the Mountain Pass plan, Chinese rare earths producers
were treated to a reversal in policy by government officials. 
In an attempt at compliance with World Trade Organization rules,
China resumed rare earth exports and the world prices plummeted.
Molycorp’s business model at Mountain Pass was no longer viable at
the new, lower prices.  Production at Mountain Pass was
confined to the ‘light’ rare earths, europium oxide, dysprosium,
lanthanum oxide and cerium oxide, which commanded the lowest prices
of all.  Furthermore, Molycorp management had experienced
problems in coming to market in the first place.  There were
impurities in initial rare earths production and low-quality
construction of tanks at one of its plants ended up increasing costs
and delaying achievement of target production.

To make matters worse, all the while that the Chinese were holding
back exports of rare earths and Molycorp was gearing up production
at Mountain Pass, manufacturers of magnets, batteries, electronics
devices and other items requiring rare earths got busy figuring out
ways to get along with lower amounts of rare earths.  As a
consequence demand for rare earths has diminished.

By the time Molycorp finally got to the rare earth materials market
its production cost was as much as $20 per kilogram.  
With the Chinese now back at the sales block and customers reluctant
to pay top dollar, the rare earth portfolio is selling for around
$10 per kilogram.

The creditors of Molycorp are now left holding the bag and it is
apparently a stinky one.  Certain of Molycorp’s junior lenders
have been at odds with one of the more significant creditors,
Oaktree Capital Management.  There is good reason to
argue.  Initial bids for the company’s assets, which will go to
the auction block on the first week in March 2016 and are valued at
$2.5 billion on the company’s balance sheet, have risen from a
nickel on the dollar to more than a dime on the dollar.  That
means there will be more money available to repay creditors.

Shares of Molycorp closed last week at $0.05 per share, suggesting
that after debt the value of the company is $14 million.  It
appears shareholders and traders have some optimism that Molycorp
can emerge from bankruptcy with some sort of business intact. 
The company’s mine operation is a money loser, but its downstream
processing facility in   China is turning a profit. 
Can this management team be trusted to craft a viable business with
whatever assets are left after the March auction?  So far their
business strategies have been wrong and execution weak at
best.  The March asset auction might be worth watching to see
what sort of asset base is left over and whether the current
management team survives the battle that is unfolding as the date
draws near.
Debra Fiakas is the Managing Director of
Crystal Equity
, an alternative
research resource on small capitalization companies in selected

Neither the author of the Small Cap
web log,
Crystal Equity Research nor its affiliates have a beneficial
interest in the companies mentioned herein.

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