For those investors looking for a long-term investment Molycorp (MCP) is the deal for you; however, the esoteric characteristics that encompass this offering, will be a major obstacle for Morgan Stanley to overcome, as the highly technical aspects of this deal can be somewhat difficult to understand.

Given the fragile state of the broader markets, its the deals that are less complex that typically work during this type of cycle. MCP is not that type of offering.

MCP is the only rare earth oxide (REO) producer in the Western hemisphere, as it owns one of the world's largest, most fully developed rare earth projects outside of China -- Mountain Pass. Small-scale production at this mine began in 1952, but closed in 2002 due to the low production costs in China, but more directly because of radioactive leakage in a nearby desert.

In 2008, Chevron ( CVX - Get Report) sold most of these assets to Molycorp Minerals (Molycorp didn't acquire the wastewater pipeline or the evaporation ponds in the transaction, as these assets still remain the responsibility of Chevron), with the primary objective to restore operations at the mine.

For those of you unfamiliar with this portion of the periodic table, rare metals have become a hot commodity, as these components are 'critical inputs' in current and emerging applications including but not limited to hybrid and electric vehicles and wind power turbines, fiber optics lasers defense applications and advanced water treatment technology.

Global demand for rare earth elements (REEs) is expected to rise due to the growth in these aforementioned applications. However, China has dominated the global supply of REOs for the last 10 years, with recent restrictions being implemented in China putting the supply of these elements at risk.
    Molycorp -- MCP
  • Lead Underwriter -- Morgan Stanley
  • 28.125 million shares
  • Current Price Range $15 to $17
  • Deal size to the mid-range -- $450 million
  • Market cap to the mid-range -- $1,300 million
  • Sector -- Metals - Diversified

Of particular note, China has announced export quotas, increased export tariffs and introduced a mining quotas policy that will impose production quotas, while limiting the issuance of new licenses for rare earth exploration. Additionally, the IMCOA issued a plan to reduce the production of separated rare earths by 7% in 2009.

Furthermore, China proposed a ban on 5 of the 17 rare earth elements, but to date this ban has yet to be implemented. To combat this declining supply, several countries are implementing a national stockpile program -- China, South Korea and Japan. Studies being conducted in the U.S. are examining whether or not such actions should be undertaken stateside. A global deficit for REEs is expected to begin in 2011.

MCP estimates that it will cost roughly $511 million to restart mining operations, as well as to modernize, expand, and incorporate rare earth metal and alloy production capabilities to these current operations. The entire proceeds from this offering will cover the majority of these expenses, with the company looking to pursue debt financing or perhaps other public or private equity offerings to cover the balance.

As of 2004 the estimated total proven reserves for Mountain Pass was 88 million pounds of REOs, with the expected mine life in excess of 30 years. Clearly, the global dependence on China for REEs isn't a feasible strategy in today's markets. MCP has positioned itself to meet the growing demands for these elements. In addition to its plans for the modernization of the Mountain Pass, the company is pursuing additional initiatives to secure business.

MCP entered into a non-binding agreement with Neo Material Technologies, in which MCP would be provided with technical assistance and know-how regarding the production of rare earth metals, alloys and metals. MCP has also entered into a contract to purchase a third-party producer of rare earth metals and alloys in the U.S. (this deal remains in negotiations).

Moreover, MCP is pursuing a JV to integrate downstream into NdFeB magnet manufacturing in the U.S. This arrangement would give MCP the access to technology, and the necessary facilities to convert its rare earth materials into the high-performance permanent magnets.

Nevertheless, from a practical standpoint, revenue generation, and thus stable financial results aren't anticipated to surface for quite some time. Currently two customers account for the majority of its revenues (82% for the period ending March 2010).

Furthermore, MCP's contracts with these clients have expired with sales presently conducted on a spot basis. MCP does expect to increase its product offerings, with sales of didymium oxide expected to begin in the third quarter, while efforts to recover cerium, lanthanum, neodymium, praseodymium and samarium/europium/gadolinium concentrate should further expand its offerings and in turn help to diversify its current customer base.

While management notes that it expects a 'dramatic change' in its business and results, once the modernization and expansion initiatives are complete, this entire process isn't anticipated to be finished until 2012. Gradual improvements should begin to surface at the top line, but net losses are anticipated to remain part of the landscape for quite some time.

The question is whether or not you are buying the story or is the financial health of a company a more important component? Despite the longer-term prospects for MCP, this will be a tough sell on Wall Street. A significant amount of capital will be needed to complete the aforementioned enhancements being pursued by the company.

While the federal government may lend a hand in providing loans to MCP, investors will not see a notable shift in its operating results over the next year. This fact alone doesn't make this a must have at the open. Price pullbacks should provide potential investors an attractive entry level.

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