Topic 7 molycorp case instruction

FIN 633 Final Group Project Instruction
Molycorp, the western hemisphere’s only producer of rare earth minerals, was in the middle of
a $1 billion capital expenditure project (known as Project Phoenix) as part of its strategy to become
a low cost, vertically integrated supplier of rare earth minerals, oxides, and metals. Yet prices for
rare earth minerals had plummeted in 2011, causing Molycorp’s revenues, earnings, and cash flow
to fall dramatically. When the firm announced its second quarter results for 2012, its stock price
fell by almost 30% to close at $11.49 per share, far below its recent high of $77 per share.
This sequence of events created a number of challenges for Molycorp’s management team
including a serious funding shortfall. They needed additional cash to finish Project Phoenix (the
renovation of its Mountain Pass mining facilities) and to repay debt obligations that were coming
due. To address the funding shortfall, management had to develop a financing strategy that
answered three questions: how much capital to raise; what kind or kinds of capital to raise; and
when to raise it. These decisions would determine not only Molycorp’s capital structure, at least
in the short term, but also its ability to implement its business strategy and, ultimately, its value.
Suppose you are the financial manager of Molycorp. You need to write a report to the executive
team, addressing the aforementioned issues. Your report should include at least four parts. In the
first part, you need to briefly discuss the key elements of Molycorp’s business plan and the critical
risks facing the firm. The purpose of the first part discussion is to quickly develop a common
understanding of Molycorp’s business strategy and to identify Molycorp’s funding shortfall as a
serious concern.
In the second part, you need to determine the magnitude of Molycorp's immediate funding need
for the rest of 2012 (and possibly for 2013), discuss the available financing alternatives, identify
the factors that Molycorp should consider, and formulate a financing plan. Specifically, an
appropriate financing plan should take into consideration the relative costs of the various funding
alternatives, including potential mispricing of the securities to be issued, changes in leverage (and
the increased likelihood of financial distress), and signaling effects.
In the third part, you need to focus on the potential mispricing of Molycorp’s securities. Given its
high current leverage, Molycorp must seriously consider selling additional equity. The
attractiveness of this option depends in part on whether the market is correctly valuing Molycorp's
stock particularly after the recent decline associated with the second quarter earnings
announcement. As part of this analysis, you must review Molycorp’s financial projections and

conduct a DCF valuation of the company to determine a theoretical share price. Molycorp is also
considering issuing convertible debt. You need to determine whether the terms being offered are
fair and, if not, the extent of the possible mispricing. As part of this analysis, you need to value the
convertible bond by replicating its payoffs as a straight bond plus collection of call options, and
valuing the two components using bond math and Black-Scholes option pricing techniques.
In the fourth part, you need to develop a specific financing proposal incorporating the insights
from the preceding discussions and analyses. You must develop and defend proposals that not only
satisfy Molycorp's aggregate funding need, but also take into consideration the relative costs of
the various financing alternatives and the key business risks.


Questions:
1. Would you like to buy Molycorp’s stock at $11.49 per share in August 2012? Why or why
not?
2. What are the key risks for Molycorp?
3. What is Molycorp’s current capital structure?
4. How much capital does Molycorp need to raise for the remaining of 2012? Analyze the
uses and sources of the fund.
5. What are the possible financing strategies and how will different financing strategies affect
Molycorp’s capital structure?
6. Use the free cash flow method to calculate Molycorp’s firm value and fair share price. Is
Molycorp’s common stock overvalued or undervalued?
7. Calculate the fair value of the convertible bond.
8. Now you can develop the financing strategy. What are the advantages of disadvantages of
the various financing alternatives? What is the best financing strategy based on your
opinion?