Molycorp Pays Off for Buyout Believers

GS in Your Value Your Change Short position

But three small investment firms made a bet that a long-closed, and mostly forgotten, mineral mine 60 miles southwest of Las Vegas might have some value.

Today, that mine, chock-full of so-called rare-earth metals, is responsible for one of the fastest windfalls in private-equity history: Turning $200 million into a paper profit of about $2.3 billion in just 30 months, or roughly $2.6 million in profit each day.

In late 2008, an investment group led by two private-equity firms, Resource Capital Funds and Pegasus Capital Advisors, commodities trader Traxys Group and Goldman Sachs paid $80 million to purchase a long-forgotten unit of Chevron called Molycorp. mcp +0.58% Molycorp » mcp in Your Value Your Change Short position

Early last year, Goldman sold its shares to the other investors. Goldman's timing couldn't have been worse. Just four months later, in July of last year, Molycorp went public in what became the most successful initial public offering of 2010. The company's shares soared above $45 Tuesday from $14, valuing Molycorp at nearly $4 billion.

Molycorp shares rose 94 cents, or 2.1%, to close at $45.57 Tuesday after J.P. Morgan Chase JPM in Your Value Your Change Short position raised its rating and price target, citing the company's intention to double rare-earth production by 2014, though Molycorp isn't expected to begin producing until 2012.

The company recently sold $180 million of convertible preferred shares to help finance work on the mine.

Just over a week ago, the three investment firms sold some of their shares through a secondary offering, cashing out $675 million in total; they retain a combined 48% of the company, which boasts the largest rare-earth mine in North America.

At these prices, they are enjoying a paper profit that is nearly 11.5 times their original investment.

"It looks fantastic on paper," said 50-year-old Ross Bhappu, Molycorp's chairman and a partner at Denver-based Resource Capital, who notes that "we still need to realize the investment."

Chevron didn't seem to anticipate any windfall. Molycorp was among a group of nonenergy assets that the oil company was eager to dispose of after its $18 billion acquisition of Union Oil Company of California, or Unocal, in 2005. The mine—perched 4,800 feet above sea level—had its heyday three decades ago, sometimes producing metals such as europium, which provided the red color for color television sets at the time.

Molycorp's fate soured in the 1990s, as Chinese producers flooded the market with cheap rare-earth minerals and a key wastewater pipeline ruptured and hazardous waste seeped into the surrounding desert. Production was halted in 2002.

Molycorp "was not strategic to Chevron's energy/mining portfolio and was slated for divestiture," Chevron said in an emailed response.

Proving that some men's trash can be others' treasure, Mr. Bhappu, and 49-year old Mark Kristoff, chief of New York-based Traxys, separately approached Chevron in 2005 to broach the idea of a purchase.

Resource Capital, which manages $1.9 billion and operates five private-equity funds, had been investing in mining projects since 1998, usually focusing on smaller deals just off investors' radar screens. One company Resource invested in, Eurozinc Mining Corp. LUN.T 0.00% Lundin Mining Corp. Canada: Toronto $4.68 0.00 0.00% Jan. 13, 2014 4:00 pm Volume : 0 P/E Ratio 32.57 Market Cap $2.74 Billion Dividend Yield N/A Rev. per Employee $249,489 More quote details and news » LUN.T in Your Value Your Change Short position , acquired the largest copper mine in Europe and later was sold to a rival miner. Traxys helps metals companies with hedging and marketing, among other things.

The investors were long familiar with the Mountain Pass, Calif., mine, in an arid, desolate area 15 miles from the Nevada state line. Mr. Kristoff's father was a Molycorp executive who gave his son a tour of the mine when he was 12. Mr. Bhappu's father did consulting work for Molycorp.

Some Chevron executives weren't sure which mine Mr. Bhappu and Mr. Kristoff were inquiring about, according to people close to the talks. Molycorp had been an afterthought for Chevron.

Messrs. Bhappu and Kristoff persisted, sending letters, making calls and setting up meetings with Chevron executives. The two were convinced that China, which had crushed the price of rare-earth metals, would curb production. Popularity of wind turbines, hybrid cars and electronics relying on rare-earth metals—a group of 17 elements—also seemed to bode well.

The investors were joined in their quest for Molycorp by Pegasus, which manages $2 billion and was founded by Craig Cogut, a former co-founder of Apollo Management. In May 2007, the group recruited Goldman Sachs's private-equity and trading operations to raise enough cash for the deal.

When Chevron finally conducted a sale, nine bidders indicated interest. Mark Smith, then-president of Chevron Mining, said the Resource group won, in October 2008, because it had the cash in hand and was committed to retaining the mine's 104 employees while returning it to operation. Mr. Smith, who had resigned from Chevron, soon was asked to head Molycorp.

Early on, the investment looked promising as rare-earth prices rose. But when financial markets collapsed in late 2008, an IPO became more doubtful, raising questions about how hundreds of millions of dollars would be raised to return the mine to production. Over the next year, the investors spent $80 million on equipment, to refurbish a processing plant, and post an environmental bond.

"It took guts to write out big checks" throughout 2009, even as the economy was weak and markets shaky, said Alan Docter, Traxys chairman. "The financial world was coming to an end."

In early 2010, Goldman said it wanted out, eventually agreeing to an undisclosed price estimated at around $40 million. Someone close to the deal said Goldman was happy to cash out with a strong return on an investment. "We said 'yes' very quickly," recalled Mr. Docter. A Goldman spokesman wouldn't comment.

A few weeks before Molycorp went public, a contact in China emailed news that the Chinese government would reduce its export quota for rare-earth metals by 72% for the second half of that year. Since China supplies about 95% of these metals, the billions of pounds of reserves buried underground at Molycorp's mine suddenly became more valuable.

Prices of rare-earth metals have been soaring. Cerium oxide, a rare-earth produced by Molycorp, is quoted at $71,000 per ton, up from $6,500 in mid-July, while lanthanum oxide is at $73,000, up from $8,400, according to Metal Pages Ltd.