Molycorp: Underdog or Just a Dog?

Short-sellers and hedge funds may be shadowy, but sometimes they are the smartest guys in the room. They've done their homework, and they're willing to bet their capital against the crowd -- an investing strategy that can be as lucrative as it is contrarian.

On Motley Fool CAPS, the 180,000-member-driven investor community where informed opinion is translated into stock ratings of one to five stars, we also have investors who find the chinks in a company's armor and correctly call its fall. We call them "Underdogs" if they've earned 100 or more CAPS points by correctly predicting that one or more stocks would underperform the market.

Today I'm looking at rare-earth minerals miner Molycorp (NYSE: MCP), which has lost three-quarters of its value, is under SEC investigation for its public disclosures, and just blindsided investors with reduced guidance on production delays. Having had its CEO suddenly jump ship unannounced last month, there's little doubt as to why the miner carries a two-star CAPS rating.

It's been a long ride down for investors, so if there are any who've scored big by correctly predicting which stocks will fail, it may be worth our while to check out those they think will ultimately succeed. And CAPS All-Star TomFoolNC is one who's earned the underdog moniker and recently predicted that Molycorp would rout the shorts.

Molycorp snapshot

Source: FinViz.com. N/A = not applicable; Molycorp doesn't pay a dividend.

Of course, not every short sale goes as planned, which makes shorting a risky proposition. Stock prices can be irrational longer than you have money to stay in the game. And you don't want to end up with fleas by lying down with dogs until you do your homework.

A scary opportunity
It was just this past November I warned investors not only to avoid this stock, but to run far away from it as well. A company that would go to such great lengths to hide from investors the fact that it had been under a full-blown SEC investigation for months and only respond to the situation after it had been uncovered -- and then do so late at night on a Friday -- is not a stock you want to put your money in.

Now, the rare-earth minerals miner does trade higher than where it did when I issued my caution, but that's only because of a pie-in-the-sky article by Reuters suggesting that Nissan (NSANY -1.31%) or Siemens (SIEGY 1.81%) might make a bid for it. But there are a lot of problems with that scenario, including its changing its focus from being a strict miner into one that will also process and refine the mineral. On top of that, it'll be using a process that hasn't been commercially tested.

The string of events that followed my article shows it hasn't done anything to warrant a change of heart. This week's implosion on slashed 2013 revenue expectations and delayed production from its Mountain Pass mine in California only serves to underscore my warning.

A smaller piece of the pie
Worse, it's probably thinking about diluting current shareholders again after having done so last year, a capital raising effort that was supposed to have carried it through the mine's development. Apparently it's burning up that cash hand over fist and may need to dip into the equity markets once again. Whatever advantages Molycorp had over other rare-earth miners such as Avalon Rare Metals (AVLNF -0.68%) and Rare Element Resources (NYSEMKT: REE) have long since evaporated.

Demand for rare-earth minerals has fallen substantially as the global economy has remained weak. Moreover, alternatives are starting to emerge. While there may be 40 pounds' worth of rare-earth magnets in a hybrid vehicle, Toyota (TM -0.54%) is starting to make electric vehicles without the minerals using an induction motor instead, and Renault is producing cars with electric motors that don't need permanent magnets at all. General Electric (GE -0.60%) is also reducing its reliance on REs in the manufacturer of its wind turbines.

Apple (AAPL -2.19%), Research In Motion (BB -9.51%), and other smartphone makers rely upon RE minerals to light up their handsets' displays, and while there's not always an easy replacement for a mineral, companies will work to reduce the dependence on them.

For me, a company that has governance issues, plays hide-and-seek with material investor information, and is pursuing a market that may suffer from even further reduced demand is not one whose valuation, even at depressed levels, will hold up very long.

I think Molycorp is a real dog, but let me know in the comments section below whether you think it can still dig its way out of the hole it finds itself in.