Molycorp bankruptcy looms, but debt haircut “could give a longer lease of life”

By James Sean Dickson
Published: Friday, 05 June 2015

Chapter 11 bankruptcy arrangements could be on the cards for Molycorp, the sole US producer of rare earths. However, the company may see its fortunes improve should its highly-leveraged debt structure be reorganised and operational improvements continue.

US-based rare earths miner Molycorp Inc.’s shares were worth $74.22 each on 15 April 2011. On Monday this week, its shares closed at $0.42. The company invoked a grace period for a $32.5m debt interest payment and is looking increasingly likely to default.

In recognition of Molycorp’s difficulties, ratings agency Moody’s downgraded the corporate family rating of the company to Ca from Caa2, increased its probability for company to default on its remaining payments, lowered the rating on senior secured debt to Caa3 from B3 and set its outlook to negative.

 Chlor-Alkali facility_Molycorp
Operational difficulties at Molycorp's Mountain Pass chlor-alkali facility have set back the company's incomes. Source: Molycorp.
"It is pretty clear that existing stock will be cancelled and bankruptcy proceedings will begin before the end of June," Kevin Starke, an analyst at CRT Capital told IM.

"Unsecured debt will be wiped out, maybe with a recovery rate of 2-3%. Unsecured debt holders are likely to initiate conflict over unencumbered assets. They will see a haircut of about 98% at a guess."

"Oaktree Capital Management’s debt will be left untouched – its facility structured in a way that will give it priority over the 10% senior notes following bankruptcy proceedings," he added.

Molycorp arranged a $400m financing deal with Oaktree in September 2014, described as "critical" by the company’s CEO, Geoffrey Bedford.

Moody’s said that its downgrade reflected "continued pressure on the company's credit profile" and a capital structure that has become "untenable".

"The ratings also reflect the expected recovery in the event of bankruptcy," Moody’s added.

Molycorp has struggled in the difficult rare earths pricing environment since it started producing rare earths from its Mountain Pass mine in California in 2012. A number of operational setbacks have dented the company’s expected earnings and the pricing bubble that popped for the group of energy minerals in 2011 has left the company in an over-leveraged position.

Mountain Pass_Molycorp
Mountain Pass was once the largest source of rare earths globally. Today, China dominates the market. Source: Molycorp.

A JP Morgan research report authored by analyst Michael Gambardella agreed that Molycorp is likely to enter bankruptcy proceedings soon. A note released last week said that the bank expects an "expensive restructuring" of the company’s capital structure in the near term.

"Normally, a restructuring of this type would look at the priority of claims in the capital structure and equity holders would be at the bottom of the list, while secured creditors would likely become the new majority equity holders."

"We continue to (…) recommend clients to avoid the stock," the report added.

An earlier note by JP Morgan listed Chinese supply discipline, the ramp up at Mountain Pass, the ability to secure extra capital and reach targeted operating cost levels, and demand growth from key end markets as key risks to the bank’s rating.

 "A longer lease of life"

Despite downgrading Molycorp, Moody’s noted that its ratings continue to be supported by a good resource base, potential for a competitive cost structure once production at capacity levels is achieved and substantially reduced capex costs going forward.

"Non-corporate finance and debt market specialists will assume bankruptcy is the end – it’s not that simple. Bankruptcy could give a longer lease of life to Mountain Pass," Starke told IM.

Molycorp_Molycorp
Molycorp's production base at Mountain Pass, southeastern California. Source: Molycorp.
At the centre of Molycorps’ problems are Mountain Pass’ profitability and the company’s debt structure, he said. "Molycorp’s downstream businesses based in Asia will be fine – liquidation is not on the table. Even after bankruptcy restructuring, making Mountain Pass profitable will be difficult. Its outlook is fairly uncertain."

However, Starke told IM that: "There is a continued risk of oversupply in rare earths. Before Molycorp and Lynas, the rare earths market was broadly balanced – but their entrance changed that. Look at oil – it does not take much oversupply to have a big impact on a market."

Molycorp has seen positive news on the demand side recently – the company signed a supply contract with German engineering conglomerate Siemens AG in April for the supply of materials for high efficiency, direct drive wind turbine electricity generators.

Aside from the green energy market, supply security is also often spoke of as a positive factor in Molycorp’s ability to continue as a viable company.

Following the airing of Lesley Stahl’s "60 Minutes" documentary on the CBS channel in the US in March, rumours had circulated that the federal government may wish to protect Molycorp owing to the role of rare earths in high-tech military equipment.

Starke told IM that he was sceptical that the federal government would intervene in a case that is not a matter of financial security to the entire US, such as was seen at the height of the banking crisis in 2008.

"The owners of the 10% senior notes are likely to have had concerns over rare earths supply security," Starke said.

He noted that as a producer outside of China, Molycorp is also being held to higher environmental standards that are likely to come at a greater cost than for Chinese producers.

"California’s environmental laws are strong. They have to make rare earths production work in a way that nobody else has achieved. Oaktree must have seen the venture as possible to invest at the time, but they accepted the risk of industry pricing and a very complex chemical process," Starke told IM.



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