TEXT-S&P rates Molycorp 'B' rating
Overview -- Molycorp Inc., a U.S.-based miner and processor of rare earth elements, has issued $650 million in senior secured notes to fund a portion of its acquisition of Neo Materials Technologies Inc. -- We have assigned a 'B' corporate credit rating to the company and a 'B' issue-level rating and '3' recovery rating to Molycorp's notes. -- The stable outlook reflects our expectation that demand and pricing for rare earth elements will remain high enough to allow the company to complete the build out of its mine and that it will complete the Neo Material acquisition with proceeds from the offering and existing cash resources. Rating Action On July 5, 2012, Standard & Poor's Ratings Services assigned its 'B' corporate credit rating to Colorado-based Molycorp Inc. The rating outlook is stable. At the same time, we assigned a 'B' issue-level rating (the same as the corporate credit rating) to the company's $650 million senior secured notes due 2020. The recovery rating on these notes is '3', indicating our expectation that lenders can expect average (50% to 70%) recovery in the event of a payment default. The notes have been sold pursuant to Rule 144A with registration rights. Molycorp will use proceeds from the notes to finance a portion of the acquisition of Neo Materials Inc. (not rated), a Toronto-based producer and processor of permanent magnet powders, rare earths and other metals, and for general corporate purposes. Pending the completion of the Neo Materials acquisition, the proceeds will be deposited into an escrow account. Rationale Molycorp is a miner, processor, and producer of rare earth elements, which are a group of 17 elements generally found together in the earth's crust that are used in a variety of high tech applications. The rating and outlook reflect what we consider to be the combination if its "vulnerable" business risk profile and "aggressive" financial risk profile. In our view, the company's vulnerable business risk profile stems from exposure to volatile pricing, the pricing and supply uncertainties resulting from China's control of the supply of global rare earth elements, the execution risks inherent in starting up a mining operation and integrating the Neo Materials acquisition, and reliance on a single mine to drive future performance. Our view of the business risk also takes into consideration the company's relatively large reserve base and the growing demand for certain of these elements, which the risk of new entrants and the potential reengineering of products to lower dependence on rare earth elements somewhat offset. In our view, the aggressive financial risk profile reflects the company's lack of operating history, high capital spending needs, what we would consider relatively high debt levels (considering the start up and integration risks facing its business), and, in our assessment, the company's "less than adequate" liquidity, which could cause the company to slow its mine development plans, resulting in lower-than-expected cash flow. Molycorp is aggressively pursuing a strategy to become one of the world's most integrated producers of rare earth products, including oxides, metals, alloys, and magnets used in high tech, defense, clean energy, and water treatment technology. It is reopening the Mountain Pass mine, which had been inactive for a decade, although the company continued to process ore from existing stockpiles. This site has a significant reserve base (more than 20 years at full production) and the potential to expand reserves on the current site. The mine is slated to resume production by the end of 2012 at an expected rate of 20,000 metric tons per year of rare earth oxides (REO) and up to 40,000 metric tons per year in 2013 when we expect it to complete the second phase of its expansion. We estimate that the combined company's capital expenditures will total about $700 million in 2012, including spending to complete both phases of this project. The company has the majority of its 2012 output contracted at market-based prices with average terms of three to five years. In addition to reopening the mine, the company has made a number of acquisitions in the past year or so to expand its processing capabilities, including operations in Estonia and the U.S., and has recently announced it is acquiring Toronto-based Neo Materials, producer and processor of permanent magnet powders, rare earths, and other metals. The Neo Materials acquisition expands Molycorp's direct exposure to China, the largest rare earth-consuming nation. The transaction expands production capabilities to include Neo Materials' magnet powder portfolio used to produce neodymium-iron-boron bonded rare earth magnets, which are in high demand for use in a variety of applications including hard disk drives, wind turbines, and drive motors for electric vehicles. It also expands Molycorp's rare metals portfolio to include gallium, rhenium, and indium, which are used in advanced electronics, photovoltaic, aerospace, catalytic converters, and lighting. In our view, integrating this acquisition--a company that is larger than Molycorp and whose major operations are in China--could pose major challenges for management, particularly as it is simultaneously ramping up the Mountain Pass operation. China controls the supply of rare earths. It produces about 95% and consumes about 70% of rare earths used globally. Beginning in 2010, China began to severely limit exports, partially reflecting depleting supply and environmental concerns as well as putting further pressure on users of rare earths to site their operations in China. These restrictions resulted in skyrocketing prices in 2011, creating a market characterized by speculation and users of rare earths scrambling to ensure supply. Although prices have since moderated, they seem to have stabilized at levels significantly higher than historical levels. However, in our view, China's control of supply creates pricing risk, since it could release supply under political duress (the U.S. filed a recent World Trade Organization case), lowering speculative demand and easing supply shortages. Moreover, over the longer term, high prices could encourage new entrants or cause end users to reengineer products, thus creating oversupply. However, based on Molycorp's assessment, only one other new entrant has a mine that is close to production. In our view, developing, permitting, and financing a new mine could take several years, and for some applications, there are no suitable substitutes. As a result, we anticipate that pricing will be volatile, based on perceptions of China's policies, but should on average be high enough for the company to generate free cash flow once the mine is complete. Both Molycorp and Neo Materials lack a history of strong operating results. The Mountain Pass mine has only recently resumed production and has been processing ore from prior mining activities. Given strong prices in 2011, Molycorp posted about $182 million in EBITDA, which was in stark contrast with EBITDA losses from 2008 through 2010. Neo Materials' results also improved in 2011, with EBITDA increasing to about $299 million compared with an average of about $65 million per year during the prior five years. In light of this lack of operating history, we feel that the total debt level contemplated, totaling about $865 million, is somewhat aggressive. In addition, the proposed financing increases fixed cash outflows in a period of heavy capital spending and operating challenges. We expect the combined company to generate between $350 million and $400 million of EBITDA in 2012, which would result in debt to EBITDA between 2x and 3x, and funds from operations (FFO) to total debt between 25% and 30%, which we would consider strong for the rating. However, in our view, delays and cost overruns related to the completion of the Mountain Pass mine or higher-than-expected costs, lower prices, or difficulties in integrating Neo Materials could dramatically weaken these ratios. Liquidity We view the company's liquidity position as less than adequate. Key aspects of our liquidity assessment reflect the following expectations: -- We estimate that by year-end 2012 liquidity will likely fall below $100 million; -- Liquidity sources will exceed uses by less than 1.2x in 2012; -- In our view, because of the importance of completion of the mine to future performance, the company is unlikely to materially scale back its capital program in the coming year or so, even if industry conditions show signs of weakening, and, therefore, the company would be unlikely to absorb low-probability adversities; and -- The company has limited bank relationships and would likely have to rely on share issuance, which may not be available if market conditions weaken, to fund cash shortfalls. The company is relying on external financing as it builds out its business. We expect combined cash flow from operations to be between $225 million and $300 million in 2012. We expect capital spending to be about $700 million and the Neo Materials acquisition and associated costs to approximate $1.2 billion (net of equity consideration). To fund the capital and acquisition spending, the company is planning to use balance sheet cash (including the proceeds from an already completed privately placed equity offering) and proceeds from the bond issuance. This leaves minimal cash cushion to finance a cash shortfall, in our view. Recovery analysis For the complete recovery analysis, see our recovery report on Molycorp, published May 16, 2012, on RatingsDirect. Outlook The outlook is stable. Although market conditions for the company's products remain relatively strong, which should allow the company to complete the reopening of its mine and begin to generate cash flow in 2013, the company is subject to commodity price fluctuations, execution risks and operating risks inherent in reopening the mine, and integration risks associated with the Neo Materials acquisition. We could raise the ratings if the company completed its growth platform and gained sufficient operating traction to improve liquidity and demonstrate the sustainability of its business, without operating significant leverage to do so. We could lower the ratings if the company ran into delays, cost overruns, or operating difficulties in opening and operating the Mountain Pass operation, leading to weak liquidity and deterioration in credit metrics. Related Criteria And Research -- Issuer Ranking: North American Metals And Mining Companies, Strongest To Weakest, April 13, 2012 -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Key Credit Factors: Methodology And Assumptions On Risks In The Metals Industry, June 22, 2009 -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List New Rating; Outlook Action Molycorp Inc. Corporate Credit Rating B/Stable/-- New Rating Molycorp Inc. Senior Secured $650 mil nts due 2020 B Recovery Rating 3 Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.
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