Rare Earth Metals

[MWM]

6 Reasons Molycorp Is A Compelling Buy After Thursday's Game Changing Neo Materials Deal
March 12, 2012 by: Ganaxi Small Cap Movers | about: MCP

Colorado-based rare earth resource company Molycorp's (MCP) C$1.3 billion deal announced Thursday to buy Toronto-based rare earth processing and marketing company Neo Material Technologies is a game changer for MCP, moving it closer to the ultimate vision of developing the entire rare earth value chain, from raw material to high-value rare earth magnets. Also, as a bonus, the deal also gives MCP global reach via access and market intelligence for the Chinese rare earth market that currently accounts for 70% of the worldwide rare earths market demand.

We have written extensively before about MCP, including at the end of Q3, arguing mostly on the basis of fundamentals and the supply/demand dynamics. The deal Thursday, however, gives us greater conviction that the MCP story is a story of long-term value and not merely a momentum play that has played out, as many have argued. The following are six good reasons we like MCP here, and why we believe it is going higher:

1. Valuation: MCP is cheap, especially on a P/E relative to growth basis. Even after Friday's steep 19% rally on the deal, its shares still trade at a cheap 7 forward P/E and 2.6 P/B, while earnings are projected to rocket up from $1.27 in 2011 to $4.34 in 2013, at an average annual growth rate of 84.9%. Its North American peers, all Canadian rare earth resource companies, including Rare Element Resources (REE), Avalon Rare Metals Inc. (AVL), Tasman Minerals Ltd. (TAS), and Quest Rare Minerals Ltd. (QRM), are all currently generating losses.

Furthermore, the deal to acquire Neo Materials at 4.7 times EBITDA is the cheapest by a diversified metals producer on record, and at a 40 percent discount to the median 7.8 multiple for acquisitions of at least $500 million made by diversified metals producers, according to data compiled by Bloomberg.

2. Vertical Integration: The deal transforms MCP from mostly a rare earth resource company into a more vertically-integrated rare earth company, by adding Neo Materials' rare earth processing and worldwide marketing capabilities to the company. Thus, after the deal, the combined company will have the processing and marketing capacity to match the expansion in production capacity planned at Mountain Pass, and also with Neo Materials' technology know-how, it will have the ability to produce more types of magnets.

The deal is the third one announced in the past year, but the most significant, as earlier deals to acquire Estonia-based AS Silmet and Arizona-based Santoku America were much smaller. Furthermore, the deal is different and a game changer also in the sense that it gives MCP access to new markets (see below).

3. New Markets: Neo Materials has a global presence, but especially important is its network of R&D centers, sales and administration offices, and rare earths production centers in China. The company derives 38% of its revenues from China and 26% from Japan, thereby giving MCP the ability to compete in the Chinese market that currently accounts for 70% of the worldwide demand for rare earths, and is also the fastest growing market.

This will be particularly beneficial as MCP expands production at it Mountain Pas facility in phase 2 to almost 40,000 tons. Furthermore, MCP gains new bonded magnet powder technology and high purity rare earth processing capabilities, that will help them increase market share.

4. More Extensive Product Portfolio: The deal expands MCP portfolio of rare metals to include gallium, rhenium, and indium, that are used in advanced electronics, photovoltaic, aerospace, catalytic converters, and lighting industries.

5. Synergies: MCP in its presentation after the deal indicated that the deal would be accretive to MCP's 2012 earnings and cash flow, adding $201 million in net income to MCP's projected $118 million in projected net income for 2012 pre-synergies, with the number of shares increasing from 84 million currently to 113 million shares. Furthermore, the two companies have already identified preliminary synergy benefits that they consider low-hanging fruit, that would add $100 million in EBITDA per year starting in 2013, primarily related to MCP's ability to send feedstock to Neo Materials' facilities in Asia.

6. National Stockpile: This maybe a long shot, but on top of MCP's compelling valuation, there is also the possibility that the company could benefit it Washington decides to go ahead with creating a strategic materials stockpile of rare earths for national defense purposes, giving them a large captive customer as well as pushing up demand and prices for rare earths in the worldwide market. We believe that such a move does not appear too much out-of-the-question, especially given China's stranglehold on the market and the geopolitical rivalry emerging between the U.S. and China.

Furthermore, in the aftermath of the deal, speculators also snapped up shares on Friday of MCP's peers, hoping that a deal might lead to further consolidation in the industry; TAS was up the most on Friday, at almost 25%, REE and QRM were both up about 20%, and AVL up over 5%. MCP has engaged in a number of acquisitions over the last couple of years, so that is not completely out of the question, nor is it that at some point MCP itself might look like an attractive acquisition candidate to a larger mining company if it continues to trade at depressed valuations.

Credit: Historical fundamentals including operating metrics and stock ownership information were derived using SEC filings data, Zacks Investment Research, Thomson Reuters and Briefing.com. The information and data is believed to be accurate, but no guarantees or representations are made.

Disclosure: I am long MCP.