There's been a tsunami of reporting on Molycorp (NYSE: MCP) lately as the stock has taken yet another leg down. From a 52-week high of about $8, the stock closed at $1.92 on July 21, down 76%. It appears that bankruptcy fears and the possible need for an equity raise are main drivers of the recent plunge.
In fact, the recent high close on the stock of $2.94 on June 19 happened to be the exact day that Moody's Investors Service downgraded the debt of Molycorp to Caa2 -- Moody's bond ratings range from C to AAA. Any rating below BBB is considered speculative grade, and bonds with ratings that aren't investment grade are known as "high yield" or "junk" bonds. At Caa2, Molycorp is way, way down into the junk bond realm! This is important to understand, because when the bonds of a company become deeply distressed, an entirely new set of very sophisticated, professional investors enter the scene. It's vitally important that retail investors understand that the game has changed. It's no longer only about production rates, costs and realized prices -- it's now a detailed game of chess with a number of expert players.
Of course, this game of chess didn't just begin last month, Molycorp has been a financial mess for years. However, a July 9 Bloomberg article pointed out that Apollo Global Management LLC added to its holdings of Molycorp convertible bonds due in 2016. According to the article, "The New York-based firm is betting holders of the convertible notes won't receive a full recovery in a default, putting those lenders in control of a restructuring and in line to take over the company's equity."
Anyone following the financials knows that Molycorp is in big trouble. Moody's reported that the company roughly $1.5 billion on the Mountain Pass project compared to an original estimate of only $800 million. Cost overruns and delays are the death of many mining projects. Moody's reported that for the 12 months ending March 31, 2014, earnings before interest, taxes, depreciation, and amortization, or EBITDA, was a negative $140 million, and operating cash flow was a negative $240 million over that same period. With debt at over $1 billion and interest expense of more than $100 million, this obviously can't continue. Make no mistake, some aspects of the story are improving. Capital expenditures going forward will be far lower, and the company's production rate has been increasing. The question is, will Molycorp be a day late and a dollar short?
Not worth much in a bankruptcy...
Yes, the game has changed and lawyers, financial firms, and vulture investors are perhaps best suited to play. Retail investors need to understand that they are up against people and firms with large checkbooks and in some cases even larger egos. In the vast majority of cases, a company's stock is wiped out in bankruptcy. This is just a fact -- it has nothing to do with Molycorp in particular. Holders of the company's debt, (secured bonds, unsecured bonds, convertible bonds) and trade creditors/vendors all have claims on the assets of the defaulted company. Even some classes of bondholders might not recover 100% of their claims if the assets don't cover all the debt.
Coal companies offer prime examples of bankruptcy risks
Debt is what ultimately brings a company to its knees. We saw this with both James River Coal and Patriot Coal. Stockholders of those two companies will receive zero, or very close to zero. James River put up quite a fight, skirting bankruptcy for quite some time, but in the end the company's East Coast assets could not service the debt. Patriot Coal suffered the same end game with bondholders fighting over the assets of the company.
Some investors believe that Arch Coal (NYSE: ACI) is at risk of bankruptcy due to its debt burden. Arch acquired Massey Energy at the peak of the coal market in 2011. Finally, Walter Energy (WLTGQ) is certainly at risk with a crushing debt balance. Walter acquired Canadian-based Western Coal in 2011. Arch and Walter have bought themselves some time by refinancing near-term debt maturities and getting debt covenant relief. To be clear, I'm not predicting that either Arch or Walter will file bankruptcy. However, if coal prices remain deeply depressed for the next few years, Arch and Walter will be in big trouble.
Importantly, sophisticated investors, lawyers, and restructuring teams are getting involved, representing each class of claims. The secured bond holders may be represented by different experts than the unsecured bondholders. Each class is competing for a larger slice of a fixed asset pie. Again, this is a highly complex game of chess that begins well before a bankruptcy filing as players jockey for position. By no means am I saying that I think Molycorp will file for bankruptcy, but there are clear signs that some think it's increasingly possible.
All eyes on second quarter earnings
It appears that many investors are eagerly awaiting the release of second quarter earnings in a few weeks. Some hope that earnings will be strong and that the stock price will rebound. I am skeptical that the Molycorp mess will be straightened out by second quarter earnings. Even if the earnings are strong, that may simply enable the company to issue a large slug of new equity. There's no easy way out for Molycorp. The stock will remain extremely volatile as sophisticated and retail investors buy and short the stock based on factors perhaps unrelated to underlying commodity prices, costs, or production rates. This is truly a dangerous stock for retail investors to invest in. I fully recognize that it's tempting to "double-down" or to buy these big dips. But, buyers be warned, we are all swimming with the sharks now.
