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Molycorp as a Buyout Target? Don’t Laugh.

It could happen, but that doesn't mean investors should pile in


When a Bloomberg article posed rare earth provider Molycorp (NYSE:MCP) as a potential takeover target last week, a few eyebrows perked up. After all, rare earth prices have plunged — with no end to the weakness in sight — pushing Molycorp back into the red for the past couple quarters despite rising sales.

And when that same Bloomberg article suggested an automotive company like Nissan Motor (PINK:NSANY) or Hyundai could be interested … well, those raised eyebrows likely tuned into scoffs and snickers.

Oh, the superficial logic is there: Molycorp has a huge stash of rare earth metals, which have a variety of uses, including being one of the core components of electric vehicles. But there are plenty of other sources of rare earth elements, and these REEs are hardly overpriced or difficult to come by right now. Why would Nissan or Hyandai — or any other name, for that matter — shell out $1.5 billion to buy Molycorp forever when those manufacturers can simply buy rare earth metals as needed?

Well, the idea of owning a supplier isn’t as crazy — or uncommon — as it might seem.

Not So Far Off the Beaten Path

Granted, an acquisition of Molycorp would be one of the biggest and most extreme cases of vertical integration we’ve ever seen, but plenty of deals designed to ensure a supply of materials have panned out.

Take Apple (NASDAQ:AAPL) for instance. Last year it threw what some believe to be a couple of billion dollars at display panel maker Sharp (PINK:SHCAF). Sharp had little investment value then, and doesn’t have much more now. But the company’s existence is critical to Apple, and rather than lose the supply source altogether and hope another lands in its lap, AAPL decided to bite the bullet and shell out the cash … and in doing so, prevented someone else from taking over Sharp and perhaps redirecting those panels toward Apple’s competition.

It’s not just the tech and industrial sectors that are doling out major acquisitions of suppliers. We’re seeing them more and more in the energy sector, too. India’s Tata Power Company purchased a little more than a quarter of Indonesian coal mining company PT Baramulti Sukses Sarana just to make sure it has the coal it needs when it finishes building its newest power plants. China Guangdong Nuclear Power Group acquired a controlling interest in Namibia’s Husab uranium project early last year, primarily to ensure a supply of uranium for the 27 nuclear power plants that were under construction in China at the time; more plants are in the lineup.

The most relevant vertical integration effort for fans of a Nissan/Molycorp union has to be last year’s acquisition of a stake in Argentina’s Salar de Olaroz lithium and potassium project from none other than — surprise — Toyota Motor (NYSE:TM). The reason? To ensure Toyota’s supply of lithium, which is the other key component of electric vehicles. Toyota only owns about a quarter of the mine, but that’s enough to supply Toyota with lithium (used in EV batteries) for more than a decade.

Point being, while an outright purchase of a materials supplier is still a rarity, it has become pretty clear that most companies are starting to demand a controlling interest.

But Molycorp?

It might be cliché, but it’s true: Never own a buyout target you’d regret owning if an acquisition is never made, because the odds are that company won’t be bought.

That’s the question investors must ask themselves today. Is MCP really a buyout candidate — and barring that, would it still make for a great investment?

The answer to that question is a resounding “probably.”

The Bloomberg commentary quotes Oracle Investment Research’s Laurence Balter as saying:

“If Molycorp was ever going to be taken out, it would have to be right now and not when the stock price is three times higher than it is now and the outlook is rosy… A buyer would have to act when the stock is weak, value has been destroyed, management is in a shuffle and they are about to turn a corner. It is the time for someone to come write a big check.”

Or, as Baron Rothschild said it, “Buy when there’s blood in the streets.”

And to be fair, Molycorp really is beaten down right now. The rare earth price pendulum is poised to swing in a bullish direction again soon, too. It might well prompt a partial purchase of the company sometime within the next few months.

However, if an investor is looking for a big acquisition premium stemming from a buyout of the entire company, that might not be the best bet at this point.

Remember, companies like Apple and Toyota don’t really need Sharp or Salar de Olaroz to be profitable. Toyota and Apple just need a controlling interest in those companies to ensure supply is routed in the right direction. Investors, however, actually need their stocks’ underlying companies to be profitable on the off chance there is no buyout, and Molycorp hasn’t demonstrated it’s all that reliable on that front yet.

Tread lightly.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media, http://investorplace.com/2013/01/molycorp-as-a-buyout-target-dont-laugh/.

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