The Many Lessons of Molycorp

by James Brumley | August 21, 2012 7:00 am

The Many Lessons of Molycorp

What’s the fastest way to knock 12% off your company’s stock value? The answer : Announce a secondary fundraising offering. That’s what  Molycorp (NYSE:MCP[1]) achieved on Friday, when it confirmed it would be hitting up the market for more money to keep its rare earth mining efforts going.

Here’s the more amazing part: That 12% plunge was nothing compared to the 25% whack shares suffered back on Aug 3 after Molycorp reported disappointing Q2 results.

All told, MCP shares have fallen 87% off their May 2011 peak of $79.16 to around $10. They reached not just new 52-week lows last week, but new all-time lows — for a stock that went public in July of 2010 at $14. Needless to say, it’s a far cry from the results investors were expecting a couple of years ago when prices for cerium, neodymium, and other rare earth minerals were soaring.

These minerals are used in a variety of clean energy technologies like wind turbines and electric cars, and because the rise of those technologies was inevitable — around 2008 anyway — the price for the requisite materials to make those technologies ballooned. Problem is, the actual demand for the materials didn’t balloon… just the prices.

The whole reason Molycorp got back into the rare earth business and reopened its Mountain Pass mine in California was the doubling of cerium oxide prices, exceeding $4 a pound by 2007. Neodymium prices more than quadrupled during the same period, along with lanthanides.

After peaking in June 2011, prices for cerium and neodymium have been more than cut in half. And Molycorp is having a rough time selling its rare earths for more than they cost to produce. To buy more time, the company’s going back to the market to ask for more money … $480 million to be precise.

This rags-to-riches-to-rags story has plenty of lessons, but investors really need to learn two big ones, plus another — about Molycorp’s future.

1. What’s a Secondary Offering?

When a company first becomes a publicly traded entity, it does so by issuing stock in exchange for money. Those funds are either used to start or expand that company’s business operation. That’s called an initial public offering, or IPO.

Facebook (NASDAQ:FB[2]) is the most high-profile recent example. To raise money to fund its business, it issued 421 million shares in May, raising $16 billion in the process. That $16 billion is “working capital” that will (hopefully) be used to make Facebook significantly more profitable.

What if a company that’s already publicly traded wants more money to expand its existing business? It can issue more shares in a secondary offering, like Molycorp is doing.

In general, investors lament secondary offerings because they’re dilutive to current shareholders in that they divvy the same underlying earnings among a larger number of shares, thereby decreasing each individual share’s value. It’s not inherently a setback for current owners, though: The money raised in the secondary offer can be used can help the company become more profitable than it would have been otherwise.

And that’s the big question: Will the company be better off with the funds raised in a secondary offer, or is that money just going to be wasted?

2. Trend or Hype?

The other big lesson some Molycorp shareholders have learned the hard way is that hype can hurt.

Think back to 2010. Rare earth prices were on a tear, as production of electric cars, smartphones, wind turbines, aircraft, LED screens and more climbed rapidly, all of which need these elements to operate. At the same time, China (the world’s top supplier) was threatening to cut its rare earth exports to supply its own demand. These forces pushed rare earths to become almost debilitatingly expensive.

For Molycorp, they meant it could profitably get back into the rare earth business after shutting down the Mountain Pass mine in 2002 because of — you guessed it — excessively low rare earth prices.

To help make that expansion happen, Molycorp went public in 2010. Given the hype surrounding rare earths and the “obvious” profits they’d generate, it wasn’t tough to find investors. However, the company doesn’t look nearly as compelling now that rare earth prices have significantly weakened — and now that we’ve seen two quarters’ worth of losses.

What happened? Hype happened.

The entire reason Molycorp got into the rare element business (again) was predicated on permanently high cerium and neodymium prices. Not enough investors asked the critical question: “What if the rare earth prices don’t stay firm enough to keep Molycorp profitable?”

Add this to the list of investment ideas that looked great when they became wildly popular, but weren’t that great later on. That list includes Crocs, Palm Pilots, a ton of dot-coms, McMansions and more.

Now What for Molycorp?

What really matters for shareholders now is whether the worst is over for the stock. How much more bad news could possibly be priced in?

In the company’s defense, it has been profitable before, and may be profitable again. For that to happen though, rare earth metal prices have to rebound considerably.

At $1.25 per pound, Molycorp’s costs are among the world’s lowest, but still not necessarily low enough to make the operation viable. Broadly speaking, current prices for most rare earths are right at Molycorp’s profit/no-profit tipping point. Throwing more money at the problem won’t change the dynamic between mining costs and selling prices.

Won’t future demand eventually reinflate rare element prices? Maybe, but even if consumption grows as quickly as forecast, the math still doesn’t paint a great picture.

Back in 2008 when the world used 124,000 tonnes of rare earth minerals, it was anticipated that we’d use 200,000 tonnes of it by 2015. In 2011 the world used 158,000 tonnes, so we’re on pace to use a huge amount of the stuff to be sure. But the dollar size of the market is still relatively small at $2 billion annually … and that’s in a good year!

Compare that to Molycorp’s current market cap of just a tad under $1 billion, which doesn’t include the upcoming half-billion dollar dilution, and last year’s revenue of just under $400 million. Could there be enough profit worth spreading around to shareholders?

We know Molycorp won’t capture the whole rare earth market. China will remain top dog, and new mines are being set up all over the world. Lynas (PINK:LYSCF[3]) in Australia and Canda’s Avalon Rare Metals () are just two of dozens of newcomers that will compete with Molycorp. Even if Molycorp could capture half the world’s annual rare earth spend, that’s still only about a billion in sales per year, and that’s if it can crank up its output from last year’s 4,000 tons to the potential 40,000 tons it’s been talking about for three years. [Remember, capacity and production are two different things.]

Bottom line? The two-year rare earth saga has been fun to watch, but “fun” doesn’t equal “profitable.” That’s not to say Molycorp can’t be profitable, but when you crunch the numbers, it would take a Herculean effort and a lot of luck for MCP to reach the potential being batted around in 2010.

Feel free to pony up your part of the $480 million the company’s looking for now, but given how it hit a wall this year on the rare earth price front, I’m not seeing how putting more cash in Molycorp’s coffers is going to solve the bigger problem.

Endnotes:
  1. MCP: http://studio-5.financialcontent.com/investplace/quote?Symbol=MCP
  2. FB: http://studio-5.financialcontent.com/investplace/quote?Symbol=FB
  3. LYSCF: http://studio-5.financialcontent.com/investplace/quote?Symbol=LYSCF

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