China’s control of rare-earth metals is providing Molycorp Inc., owner of the largest U.S. deposit of the minerals, with the most-valuable currency in the industry to pursue acquisitions.
Great Western Minerals Group Ltd. and Ucore Rare Metals Inc. may become targets after shares of Greenwood Village, Colorado-based Molycorp tripled since its U.S. initial public offering in July as China curbed exports, Byron Capital Markets’ Jon Hykawy said. Molycorp is now valued at 117 times earnings before interest, taxes, depreciation and amortization this year, according to data compiled by Bloomberg that includes net debt, the highest of any diversified metals producer.
The surge in Molycorp’s market value to $4 billion makes takeovers cheaper as it tries to compete with Chinese producers that control 95 percent of the world’s supply of elements used to make magnets for Raytheon Co.’s Tomahawk cruise missiles and Toyota Motor Corp.’s Prius sedans. While Molycorp’s mine in the Mojave Desert once met almost all the world’s demand, it has yet to turn a profit and doesn’t have substantial amounts of the “heavy” rare-earth metals that command the highest prices.
“Time is not on their hands,” said Brian Hennessey, a Purchase, New York-based analyst for Alpine Mutual Funds, which oversees $6 billion. “Molycorp would do themselves a service by diversifying into heavy rare earth. There are a number of companies with much lower valuations in the marketplace. They can use their currency to do fairly accretive acquisitions.”
Great Western, which plans to start production at a South African mine in 2013, and Canada’s Quest Rare Minerals Ltd. and Avalon Rare Metals Inc., which control heavy rare-earth deposits, may be possible takeover targets for Molycorp, Hennessey said.
Ucore of Halifax, Nova Scotia, may also attract suitors for its Alaska mine that contains both heavy and light rare-earth materials, according to Byron Capital’s Hykawy and Jack Lifton, an independent commodities consultant and strategic metals expert who has studied mining for almost 50 years.
Ross Bhappu, Molycorp’s chairman, declined to comment about potential acquisitions.
The rare-earth elements are 17 chemically similar metals, such as lanthanum, neodymium and dysprosium. They are used in magnets for everything from cell phones and electric cars to wind turbines, guided missiles and targeting systems for tanks.
BlackBerrys made by Research In Motion Ltd. of Waterloo, Ontario; Cupertino, California-based Apple Inc.’s iPods; General Motors Co. of Detroit’s plug-in Volt; and Toyota City, Japan- based Toyota’s Prius all use rare-earth metals.
While rare-earth materials are relatively abundant in the earth’s crust, finding deposits large enough to mine is less common, the U.S. Geological Survey said. Global demand for the elements may more than double by 2020 from 125,000 metric tons last year, according to Molycorp’s filing last month with the Securities and Exchange Commission.
Rare-earth metals are expensive for producers to extract and are often laced with radioactive elements. China has come to dominate the market because it has been able to produce the metals more cheaply and with fewer environmental restrictions than its competitors.
Prices for rare-earth metals and shares of the companies that produce them have jumped since China said on July 8 that it would reduce export quotas for the second half of 2010 by 72 percent as it attempts to meet domestic needs while closing polluting and inefficient mines.
‘Light’ Versus ‘Heavy’
Prices of many “light” rare-earth elements, including lanthanum and cerium, rose 600 percent to 700 percent on average last year, Matt Gowing, a Toronto-based analyst at Mackie Research Capital Corp., said in a report to clients dated Feb. 8. The price of dysprosium, a “heavy” rare-earth element used in magnets for car motors, almost tripled to $305 a kilogram.
The Bloomberg Rare Earth Mineral Resources Index of 14 companies has surged 273 percent since July 8, seven times more than the 39 percent gain for the MSCI World Materials Index of 161 commodities producers over the same period.
Molycorp, which was formed in 2008, has climbed 252 percent since raising $394 million in its July 29 IPO to start its mine near Mountain Pass, California. The Standard & Poor’s 500 Index has advanced 19 percent in the same period, Bloomberg data show.
The 2,222-acre site, an open-pit mine located 60 miles southwest of Las Vegas, produced a majority of rare-earth materials from 1965 to 1985, a report from the Government Accountability Office in April showed.
While U.S. deposits also exist in several states such as Idaho, Wyoming and Utah, they are still being explored and could take as many as 15 years before becoming fully operational, according the GAO report.
The rally in Molycorp’s shares has left the company a market capitalization of almost $4.1 billion. Molycorp also had $346 million more cash than debt as of Sept. 30, giving it an enterprise value of about $3.71 billion. That’s 117 times its about $32 million in Ebitda that analysts estimate Molycorp will generate this year, higher than the 42 other diversified metal producers globally that are forecast to have earnings this year.
The median multiple is 6.3 times Ebitda, the data show.
Molycorp, which started its Mountain Pass mine in December for the first time since 2002 and has yet to report a profit on a net income basis, also sold $180 million of convertible preferred shares last month as it plans to increase production capacity to 40,000 metric tons a year by the end of 2013.
Cheap or Expensive
“Heavy” rare-earth metals account for only 1 percent of Molycorp’s mine, according to Mackie Research’s Gowing.
“If I were running Molycorp, I would act as quickly as I could to shore up what must be a light rare earth-dominated output from Mountain Pass,” said Toronto-based Byron Capital’s Hykawy, who covers rare-earth mining companies and is the only analyst tracked by Bloomberg with a “sell” rating on Molycorp. “The longer Molycorp management waits, the greater the chance the market switches its attention to some other critical material, and presently overvalued companies like Molycorp drop in value.”
Molycorp’s Bhappu said in an interview on March 5 that the company may still be undervalued. He pointed to estimates that showed analysts project Molycorp’s shares will reach $66.25. That implies a 34 percent gain, data compiled by Bloomberg show.
“Rare earth prices where they are today, you can make a compelling argument for Molycorp being undervalued,” he said.
Great Western, with a market capitalization of C$300 million ($308 million), and Ucore, which has a value of C$157 million, would be likely targets for Molycorp, Hykawy said.
Great Western, which has posted annual losses since at least 1991, specializes in processing rare-earth elements into alloys used to make batteries, magnets and products for the aerospace industry. The producer said on March 2 it increased its stake in a rare-earth exploration company that owns the shuttered Steenkampskraal mine in South Africa to 93 percent.
In January 2009, Great Western said it was working with the mine’s owner to restart the mine, giving it exclusive access to rare-earth metals at the site. The company’s shares have advanced 249 percent in the past year.
“We are not aware of anyone looking at us as a takeover target,” Gary Billingsley, chairman of Saskatoon, Saskatchewan- based Great Western, said in an e-mail. Partly because of the South African mine “we might look attractive to certain groups,” he said.
Ucore operates a former uranium mine at Bokan Mountain in southeastern Alaska. The 19-mile Bokan site is estimated to be one of the largest combined heavy and light rare-earth mineral deposits within the U.S., according to the company’s website. Ucore mines for “heavy’ rare-earth minerals such as dysprosium, which is used to make wind turbines and electric vehicles.
The company met with U.S. lawmakers in February to discuss initiatives that would allow the U.S. to recapture market share in the rare-earth magnet manufacturing industry. Ucore’s CEO Jim McKenzie has said his goal is to become the first company to produce dysprosium for magnets entirely on U.S. soil.
Shares of Ucore have almost tripled in the past year.
“There are players out there right now that I’m sure would be interested in acquiring our deposit at these levels,” McKenzie said in a phone interview. “That doesn’t mean we want to be acquired at these levels.”
Alpine Mutual’s Hennessey favors Quest Rare Minerals and Avalon as takeover targets for Molycorp. The companies hold two of the largest deposits of “heavy” rare-earth elements in the world, according to Mackie Research.
Strange Lake, Nechalacho
A portion of Quest’s Strange Lake project in northern Quebec holds about 1.15 million tons of the metals, according the company’s website. About 43 percent are “heavy” rare-earth elements. Avalon controls the Nechalacho deposit near Thor Lake in the Northwest Territories of Canada, its website said.
The site holds an estimated 1.3 million tons of rare-earth elements, with “heavy” types accounting for about 20 percent, according to Mackie Research.
Avalon is forecast to start producing from Nechalacho in 2015, with Quest’s Strange Lake deposit reaching production a year later. Quest has doubled in value in the past year, while Avalon has almost tripled, data compiled by Bloomberg show. Neither company has any reported revenue, the data show.
The weighted-average price of rare-earth metals at Avalon’s Nechalacho site is estimated to be $94 per kilogram and $120 a kilogram at Quest’s Strange Lake deposit, according to Mackie Research. That’s 45 percent to 85 percent higher than Molycorp’s Mountain Pass mine, which is valued at $65 a kilogram.
“There should be consolidation because of this valuation discrepancy,” said Alpine Mutual’s Hennessey. “It makes a whole lot of sense.”
Peter Cashin, CEO at Montreal-based Quest Rare Minerals, didn’t respond to a phone message outside normal business hours.
“We have no direct knowledge that Avalon is presently a takeover target,” said Donald Bubar, Toronto-based Avalon’s CEO. “We have heard such speculation occasionally, but to my knowledge, there is no substance to it.”
Molycorp’s Bhappu said last month rivals approached it seeking investment in their projects. The companies, which he declined to identify, are “all over the world, from Africa, Australia, Canada, the U.S., South America,” he said. “The real focus for us is, rather than acquiring, better evaluation and expansion of what we have on our own property.”
Companies that rely on rare-earth metals to make their products such as Toyota may also be looking to buy assets or secure supply agreements, according to Lifton. That may hasten consolidation in the industry, he said.
“Our purchasing groups are leading various efforts to mitigate any potential supply disruption and ensure that we have a stable supply for our production needs,” Jeff Makarewicz, vice president of materials engineering at Toyota, said in an e-mail.
Rare-earth mining companies are “already talking to each other and to companies like Molycorp and Toyota,” Lifton said. “Everybody’s looking for heavy rare earths right now.”
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