Molycorp: Ripe for the Picking?

The markets have been abuzz with rumors that Molycorp’s recent fall below its net asset value is turning the high-potential firm into a prime takeover target.

Earlier this year, the company, which boasts the largest rare earth element (REE) deposit in the western world, increased its proven and probable reserves of rare earth minerals at its Mountain Pass, California facility by 36 percent. The updated estimate expands Molycorp’s reserves to 18.4 million short tons of rare earth ore. An independent verification estimates that the proven and probable component of Mountain Pass’ ore body contains approximately 1.3 million metric tons of contained rare earth oxide equivalent.

However, the company had its fair share of trouble in 2012, including slumping prices, exorbitant costs at its flagship mine and a regulatory probe; it also recorded its lowest ever share price. Those factors ensured that Molycorp’s investors experienced a torrid time in the markets, with circumstances eventually snowballing to the point that the company’s CEO, Mark Smith, resigned in what the board of directors described as “a natural inflection point” as the firm transitions its focus from development to ongoing operations.

Even after rebounding from a record low in November, Molycorp shares are still trading at a 19-percent discount to their book value, according to data compiled by Bloomberg. With the company currently trading well off its one-year high of $35.79 per share, many are of the impression that its currently depressed valuation could jumpstart interest from potential takeover candidates.

Potential candidates

While Molycorp has so far declined to comment on whether there is any truth to the rumors, most investors will be looking to historical market sentiment for guidance.

The company’s current valuation could very well result in manufacturers, such as Nissan putting in a bid, according to a Bloomberg article that cites information from Byron Capital Markets. On a different note, Robert W. Baird & Company’s recent analysis outlines that after expanding its refining and processing operations with the purchase of Neo Material Technologies, Molycorp may even appeal to private-equity firms.

A Roland Berger Strategy Consultants rare earth study, published last year, also supports the idea that a manufacturer may put in a bid. It notes that more and more manufacturing companies are implementing a wider range of measures to counteract volatile REE prices. It adds that while some manufacturers are seeking alternatives, others are going directly to the source; in fact, half of all enterprises surveyed have already set up task forces dedicated to designing strategies aimed at securing supplies of raw materials. This mindset gained even more credibility when Toyotsu Rare Earth Canada, a subsidiary of Toyota Tsusho moved closer to securing its own REE supply by paying Matamec Explorations for an interest in the company’s Kipawa deposit.

Any manufacturer involved in a takeover of this scale would ensure its own REE supply for the foreseeable future and in doing so would give itself a massive boost in relation to its competitors.

However, while a guaranteed supply of raw materials is appealing, another mining company might be better positioned to take over the project.

Luisa Moreno, an analyst at Euro Pacific Capital, told Bloomberg that Molibdenos y Metales, Molycorp’s largest shareholder, and also the world’s largest molybdenum processor, could seek to increase its holding.

However, Michael Gambardella, an analyst at JPMorgan Chase & Company who is also quoted in the Bloomberg article, argues that potential acquirers within the space might hold off because Molycorp’s new plant is employing a refining technique that differs from that of most other mining companies.

One step forward, two steps back

While the company has come up against a number of issues, Molycorp is twice as sophisticated as it was two years ago, when its share price was six times the level it is today.

The company provides a unique buying opportunity in that its shares are currently trading at 0.77 times their actual book value, while one of its largest competitors, Lynas Corporation — which has been involved in a long and drawn out regulatory battle — is trading at a price-book multiple of about 2.1 times.

Despite these factors, the company’s near-term future was once again brought into question last week when its shares plummeted on the back of confirmation that its 2013 revenue will come in lower than previously expected. That’s the result of a drop in selling prices and a delay in achieving full production at its California processing plant.

In a press release, Molycorp noted that all key production components of its new manufacturing complex at the Mountain Pass mine are operational and that the facility has begun ramping up to its full-scale “Phase 1” run rate. However, concerns mounted when it added it will not proceed with the next planned phase of development until it sees an improvement in rare earth demand and prices, in addition to easier access to capital.

As much risk as opportunity

In a market rife with rumors, there will never be a shortage of both bears and bulls, but investors will do well to realize that Molycorp is far from the finished product. It is still developing its mine, has not proven capable of producing heavy rare earths and is still experimenting with a new processing technology. In other words, the stock presents as much risk as it does opportunity.

At the same time, if prices are to rebound, the company remains uniquely poised to ride a wave of opportunity. The fact remains that this project boasts astounding potential, and while investors focused on the short term may be against Molycorp’s decision to hold back on its second phase of development, its willingness to hold out for a more attractive market environment is a plus for long-term investors.

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