RTK - Rentech

[KJP]

Rentech, Inc. (RTK) is a wood processing company that also owns a roughly $65 million stake in a nitrogen fertilizer MLP.  There are a lot of moving parts to the valuation, the market cap is only $60 million and one of the company’s wood processing segments has been a disaster.  For all those reasons, I think there’s a potential opportunity here.   

 

This post is long enough as it is, so I won’t take up your time with a discussion of the company’s history and how it got to where it is.  If you’re interested in that, there’s an April 2015 writeup on VIC and a bunch of old presentations on the company’s website.  As of today, the company consists of the following five parts:  (i) a wood chipping business called Fulghum Fibers; (ii) a retail wood pellet business called New England Wood Pellets; (iii) a sputtering industrial wood pellet business based in Canada; (iv) 7.18 million units of the nitrogen fertilizer MLP CVR Partners (UAN); and (v) corporate overhead. 

 

In this post I’m going to give an overview of the various parts and some back-of-the-envelope valuation so others can determine whether they’re interested in looking further at this. 

 

Fulghum Fibres

Fulghum Fibres processes trees into wood chips on a contract basis (with minimum volume commitments) for big lumber and paper companies.  It has a large share of the outsourced wood chipping business, but only about 5-10% of wood chipping is currently outsourced. 

 

The business is MLP-eligible.  Rentech acquired it in 2013 for $112 million (including assumed debt), or 5.5-6x EBITDA.  The theory was that Fulghum is a stable business that has high customer retention and opportunities to grow from increased outsourcing and could be dropped into an MLP at a significantly higher multiple than 6x.  A May 2013 presentation related to the transaction is available here:  http://phx.corporate-ir.net/phoenix.zhtml?c=66629&p=irol-presentations

 

While the MLP plans have been shelved for the time being, the business is performing as expected, with about $20 million annual EBITDA and $10 million annual EBIT.  The “A” in the EBITDA includes about $4-5 million a year related to amortization of wood chipping agreements in place at the time of purchase, and the company pays no taxes for reasons explained below.  So, I believe Fulghum produces a steady $14-15 million a year in cash flow before interest.  At 10x, this segment would have an enterprise value of $150 million.  Fulghum has $47 million of debt at 5.9%, so I estimate this segment has a net value of about $100 million.

 

New England Wood Pellets (“NEWP”)

Much of New England too rural and sparsely populated to build out natural gas infrastructure.  So, they typically get heat from something else, like heating oil.  Wood pellets have historically been a cheaper heating option that has lower price volatility.  As a result, consumption of wood pellets for heating purposes has been growing.

 

NEWP makes these wood pellets.  Rentech bought the business in 2014 for $50 million, including assumed debt, or about 6-6.5x EBITDA.  A presentation on the transaction is also available at the link above (the earnout referred to in the presentation was paid, bringing the purchase price to $50 million).

 

From what I have read, NEWP appears to have some scale advantages, which have led to good relationships with big retail outlets like Home Depot, Tractor Supply, etc. and local retailers.  But NEWP still only has a relatively small percentage of the market, so there is room to grow, and Rentech has already made one bolt-on acquisition (Allegheny).

 

Until this winter, the business had done quite well.  For example, in 2013, it generated $44 million revenue/$7.4 million EBITDA.  In 2015, those numbers increased to $54 million revenue/12.4 million EBITDA.  In addition Q4 2015 was depressed due to the beginning of the very warm winter that New England had last year. 

 

That warm winter continued into Q1 2016, which was a dreadful quarter for the company.  But El Nino’s don’t last forever, and this looks like solid business with room to grow.  NEWP has historically generated 22% gross margins.  If you assume normalized sales of $60 million (this may be low), that’s $13.2 million in gross margin.  Subtract about $4 million in SG&A + D and that gets you to $9.2 million in EBIT.  At 10x, that’s $92 million.  NEWP has $16 million in debt at 4.1%.  So, subtracting the debt gives this segment an enterprise value of about $75 million, with no credit for what appear to be accretive acquisition opportunities. 

 

Industrial Wood Chips

At the same time it purchased Fulghum Fibres, Rentech also bought two decommissioned fibre board facilities in order to convert them into wood pellet plants with the capacity to product 485k tons of wood pellets annually.  Most of these pellets would be sold to Ontario Power and Drax (a European utility) under take or pay contracts.  Rentech also signed contracts with CN for rail transport and built out significant capacity at the Port of Quebec. 

 

At the time, management estimated that the total cost to convert the plants and get them commissioned would be about $75 million and, once running near capacity, they would generate about $15 million annually in EBITDA.

 

Things have not worked out as management intended.  These have been substantial delays in the commissioning of both plants, and substantial parts of both have had to be rebuilt.  The smaller plant (Atikokan) is now running at 80-90% of capacity, but the bigger plant (Wawa) is only running at 20-30%.  During the last conference call, management – which is new as of 2015 -- stated that it doesn’t think the problems at Wawa are due to additional uncorrected design flaws, but rather management’s inexperience with these types of assets.  In addition, management recently estimated that, if they can get the plants stabilized, they should generate about CAD $13-16 million annually in EBITDA. 

 

There is about $20 million in debt related to this segment arising from construction of the port facilities, and it continues to be cash flow negative.  I don’t yet have a good handle on the production levels at which these facilities would be cash flow breakeven.  But I think it’s fair to say the knowledge likely exists somewhere in the world to get these plants operating properly, and Rentech will likely eventually either obtain that knowledge itself through experience or hire people who have it.  Nevertheless, I’ll value this segment at zero and treat it as a somewhat free option (it’s only somewhat free because you need to fund any ongoing negative cash flow).

 

UAN Stake

Rentech used to own a controlling stake in Rentech Nitrogen Partners, L.P., which recently merged with CVR Partners, another nitrogen fertilizer MLP.  Rentech received cash and units in CVR.  Rentech used most of the cash and units to retire debt, but still has 7.18 million units.  CVR’s current unit price is $9.15, so Rentech’s stake is currently worth about $65 million at market prices.

 

Corporate, Debt & NOLs

 

Rentech currently has $86 million in cash, but about $30 million of that will go to taxes on the CVR transaction (~$10 million) and CapEx to (hopefully) complete the industrial wood pellet facilities (~$20 million).  So, I’ll use $55 million in cash for my valuation.

 

Rentech is currently run-rating at about $20 million per year in corporate overhead.  But new management is cutting this by eliminating unnecessary personnel, moving headquarters, etc.  I assume that this number can be cut down to about $15 million per year.  Capitalized at eight times, this is a negative $120 million.

 

The company also has $53 million in corporate level debt at L + 700, secured by the CVR units.  At CVR’s current distribution levels, the distributions on the units would exceed the interest on this debt by about $3 million per year. 

 

Finally, the company has a bunch of NOLs, so it likely won’t be paying significant taxes for awhile.

 

Adding it all up

Here are two back-of-the-envelope sum of the parts valuation:

 

CVR at market, no value for Industrial wood pellets, NOLs or growth

Cash:  $55 million

Fulghum:  $100 million

NEWP:  $75 million

CVR stake:  $65 million

Industrial wood pellets:  $0

NOLs:  $0

Growth at Fulghum and NEWP:  $0

Corporate:  ($120 million)

Corporate Debt:  ($53 million)

Industrial Wood Pellet debt:  ($20 million)

Total:  $102 million 

 

Capitalize CVR distributions less interest on debt, Industrial at 5x EBITDA, nothing for NOLs or growth

Cash:  $55 million

Fulghum:  $100 million

NEWP:  $75 million

CVR less debt ($3 million at 10x):  $30 million

Industrial wood pellets:  $50 million

Corporate ($120 million)

Industrial Wood Pellet debt:  ($20 million)

Total:  $170 million

 

The first valuation would be about a 65% gain.  The second valuation would be a triple. 

 

If there’s any interest, I’ll explore the CVR stake further in a separate post, because it may be quite undervalued in its own right.   

 

 

 

[dwy000]

Interesting idea KJP - thanks for posting.

 

Do you know if the remaining GSO debt is recourse back to Rentech or does it just have recourse to the UAN shares that secure it?  Wondering to count that as only upside above the debt amount or downside risk if the stock price drops.

 

 

[KJP]

 

Do you know if the remaining GSO debt is recourse back to Rentech or does it just have recourse to the UAN shares that secure it?  Wondering to count that as only upside above the debt amount or downside risk if the stock price drops.

 

I believe the GSO debt is recourse to Rentech.  My belief is based on the following excerpt from page 19 of the latest 10Q (emphasis mine):

 

The GSO Credit Agreement currently consists of a $53,250,000 term loan facility, which matures on April 9, 2019.

The current loans are part of a single tranche of term loans made up of (i) $45 million of tranche B loans borrowed under the prior credit agreement with the GSO Funds and maintained and continued under the GSO Credit Agreement and (ii) $8.25 million of tranche A loans borrowed under the prior credit agreement with the GSO Funds and rolled over into the tranche B loans at the closing of the GSO Credit Agreement (collectively, the “Loans”). The Loans under the GSO Credit Agreement bear interest at a rate equal to the greater of (i) LIBOR plus 7.00% and (ii) 8.00% per annum.

 

RNHI’s obligations under the GSO Credit Agreement are guaranteed by the Company and the Company’s direct and indirect subsidiaries other than certain excluded subsidiaries (such subsidiaries guaranteeing obligations under the GSO Credit Agreement, the “Subsidiary Guarantors,” and together with the Company and RNHI, the “Loan Parties”). On April 1, 2016, the Company and the Subsidiary Guarantors entered into a Second Amended and Restated Guaranty Agreement (the “Guaranty Agreement”) in favor of the Agent. The Guaranty Agreement contains customary affirmative and negative covenants for the Company, the Subsidiary Guarantors and their respective subsidiaries, including, among others, certain reporting requirements to the Agent, payment of material obligations, compliance with laws, use of proceeds and limitations on the incurrence of indebtedness and liens, the sale of assets and the making of restricted payments by the Company and the Subsidiary Guarantors. Furthermore, the obligations under the GSO Credit Agreement and the guarantees are secured by a lien on substantially all of the Loan Parties’ tangible and intangible property, and by a pledge of all of the shares of stock and limited liability company interests owned by the Loan Parties, of which the Loan Parties now own or later acquire more than a 50% interest, subject to certain exceptions. The GSO Credit Agreement contains customary affirmative and negative covenants and events of default relating to the Loan Parties. The covenants

and events of default include, among other things, a provision with respect to a change of control and limitations on the incurrence of indebtedness and liens, the sale of assets, and the making of restricted payments by the Loan Parties. In addition, upon the occurrence of an initial public offering of the wood pellets or wood fibre operations of the Company, the Company must make an offer to prepay the entire outstanding principal amount of the facility.

 

The obligations of RNHI under the GSO Credit Agreement are also secured by 7,179,996 CVR Common Units owned by RNHI.

[Deepdive]

I've heard that the management team got lucky with their fertilizer plant and that they aren't good at capital allocation. Any investment in Rentech definitely requires an honest assessment of the management team.

[KJP]

I've heard that the management team got lucky with their fertilizer plant and that they aren't good at capital allocation. Any investment in Rentech definitely requires an honest assessment of the management team.

 

By "got lucky with their fertilizer plaint" I assume you mean Rentech got a windfall from falling natural gas prices.  I suspect you're right. 

 

But the management that made the decision to buy the fertilizer plant and invest in the industrial wood pellet business is gone.  As of December 2014, the Company has a new CEO and in mid-2015 reorganized the management of its various businesses, including getting rid of the guy who was running the industrial wood pellet business. 

 

Does your comment that management isn't good a capital allocation relate to the old management team or the new one?  I haven't yet seen bad capital allocation from the new team during its limited tenure at Rentech, but I'd be interested to hear any insights you have.   

[dwy000]

KJP - I've been digging a bit deeper and wanted to get your thoughts on a couple of questions:

 

- where did you get your $85M cash figure?  The pro forma in the 10Q (which was pro forma for the fertilizer transaction closing on Apr 1st) shows cash of $65M. 

- They mentioned that the CVR shares are held with a cost basis of $0.  Are you netting off any tax required on the gains when the sell these (or just in the valuation)?  I know they have NOL's but given they are already paying $5-15M in taxes due to the transaction as it has occurred to date, it would seem to imply the shares are not eligible for the NOL's.  That could be another $10M negative on the value at a 20% tax rate for gains.

- curious as to why you capitalized the cash flows from the businesses at 10x but the corporate overhead at 8x.  Shouldn't you use the same multiple.

 

It's an interesting opportunity no doubt.  It seems to hinge on the ability to get those Canadian plants up to capacity because not only is it lost opportunity but they are paying stiff penalties to CNR (and possibly to Drax if prices go up).

 

[KJP]

KJP - I've been digging a bit deeper and wanted to get your thoughts on a couple of questions:

 

- where did you get your $85M cash figure?  The pro forma in the 10Q (which was pro forma for the fertilizer transaction closing on Apr 1st) shows cash of $65M. 

- They mentioned that the CVR shares are held with a cost basis of $0.  Are you netting off any tax required on the gains when the sell these (or just in the valuation)?  I know they have NOL's but given they are already paying $5-15M in taxes due to the transaction as it has occurred to date, it would seem to imply the shares are not eligible for the NOL's.  That could be another $10M negative on the value at a 20% tax rate for gains.

- curious as to why you capitalized the cash flows from the businesses at 10x but the corporate overhead at 8x.  Shouldn't you use the same multiple.

 

It's an interesting opportunity no doubt.  It seems to hinge on the ability to get those Canadian plants up to capacity because not only is it lost opportunity but they are paying stiff penalties to CNR (and possibly to Drax if prices go up).

 

dwy, thanks for looking at this and for the questions.

 

1.  You're right that pro forma cash should be $65 million, not $85 million.

 

2.  I agree it's unclear what the tax liability, if any, is going to be on the CVR units.  Given the CVR is an MLP, some of the distributions may be classified as a return of capital, so the ultimate tax rate on a sale could be higher than the typical cap gains rate.  On the other hand, the NOLs may apply or there may be other methods to reduce the tax liability upon a sale.  The next 10-Q and conference call may shed some light on this. 

 

3.  How to think about the current corporate overhead is one of the trickiest parts of this investment, I think.  As I explained in my initial post, I think there's going to be significant cutting of corporate SG&A, and then going forward corporate SG&A should grow much more slowly than the operating businesses.  That's why I gave it a lower multiple.  But I can see the argument for giving it the same multiple as the operating businesses. 

 

I was initially attracted to the idea because I think Fulghum + NEWP + CVR units are currently worth significantly more than the market price.  I think management's desired path is also fairly clear.  The current CEO is an MLP guy. He likely wants to use the excess cash plus the capital locked up in the CVR stake to grow the wood chipping and pellet businesses through acquisitions and then drop them into an MLP.  If the typical MLP math still applies, that could be very lucrative for RTK shareholders.  The main risks, I think, are (i) bad acquisitions, and (ii) as you mentioned, the Canadian facilities becoming black holes that have significant negative value beyond the $20 million in CapEx that I discussed in my initial post.

 

What's your view on the various parts of the business? 

[dwy000]

Thanks for the reply KJP (and the idea).  I would tend to agree with all your responses.

 

After an initial look, there are a number of things that look good and a number of things that I worry about.

 

On Fulghum - this appears to be a bond-like business that churns out EBITDA without much upside potential other than the South America assets.  In the US, volumes and prices are flat and really can't increase without buying new relationships or having other mills outsource their chipping to Fulghum.  They talk about the growth of this business and outsourcing opportunities but it worries me that 2 of the plant are being bought back by the mills from them.  One they will remain an operator but the other is going in house.  That seems to be the opposite of the trend they are playing.

 

The other thing I'm trying to figure out on Fulghum is the capex.  Right now capex appears to equal dep'n.  But I'm not sure if that's just maintenance and then every 10 years you have a big purchase requirement to replace the machinery or that number is a good, steady assumption for the longer term.  Otherwise this is just a good steady cash churner with no commodity price risk.  I think you're right to put a 10x on the cash flow.

 

NEWP - this could be an interesting rollup story if managed correctly.  The downside is that it's not a business with a ton of barriers to entry so you are a commodity player unless you can leverage the volume for cheaper input and better distribution.  I like this side of the business and am hoping the really warm winter is providing opportunities to buy out some of the competition on the cheap.

 

Industrial - this is the somewhat free option.  I have little concern that they can get up to volumes required to service the contracts but I suspect the play for them here was that those contracts would provide an "okay" ROI on the $145M build cost but that selling the excess capacity in the spot market was the equity play.  It worries me if they take the Wawa capacity down to 400,000 because that's basically just servicing the Drax contract with no excess.  Also it's a question of how much time it takes to get there because it's expensive in the meantime - cost of capital, contract costs, operating losses etc.

 

There was also some comment by the CEO about additional capacity coming online.  I haven't researched it but that could impact pricing outside the contracted volumes and if they sell any of that volume in the US or retail market it could impact NEWP.

 

Finally, were you able to figure out the QS Construction Debt?  It's reported at $21.6M but they claim they only owe $15.  How's that work?

 

thanks again.

 

[KJP]

Your points above are all good ones.

 

At the time of purchase, Fulghum was certainly pitched as a growth business, but that hasn't been the case.  It's not clear to me what is driving the in-sourcing versus out-sourcing decisions, but I suspect the thought was that an MLP with a very lost cost of capital would be in a good position to pick up contracts from companies with higher costs of capital.   

 

As for NEWP, wood pellets are certainly a commodity.  Based on management disclosures/commentary, they have suggested that their scale gives them a distribution advantage, particularly at big retailers.  But it's hard to confirm that.  I also hoped that the warm winter would create good acquisition opportunities, but nothing has happened yet.  To be fair, though, I suspect a lot of management time in recent months has been devoted to the Rentech Nitrogen transaction and Wawa/Atikokan, rather than potential NEWP transactions. 

 

Regarding Canadian industrial, the plan was $15 million EBITDA on $75 million construction costs, with upside coming from spot market sales.  The doubling of construction costs means that overall ROI is very likely going to be poor, but that's also a sunk cost at this point.  The bright side here is that you really don't need upside from this asset -- you just need it to stabilize.   

 

Finally, on the QS construction facility debt, there's a description of it on page 130-31 of the last 10-K.  Based on that, it appears that GAAP deems RTK to be the "owner" of the port facilities and thus it must book the full amount of the outstanding construction loan, but by contract it is only required to pay QSL the lesser amount.  This is all quite opaque, but shouldn't ultimately make much difference to the valuation.

 

 

[KJP]

Q2 press release out today (10-Q delayed to address tax allocations between continuing and discontinued operations):  http://phx.corporate-ir.net/phoenix.zhtml?c=66629&p=irol-newsArticle&ID=2194569

 

There is encouraging commentary about the Canadian plants, particularly Wawa.  They're also making good progress on cutting corporate costs. 

[KJP]

This went to zero in 2017.  Time for a post-mortem.  I highlight below a few of the analytical mistakes and issues in my original post from May 2016.  I'm sure there are more.  Hopefully some of you will find this useful.

 

Rentech, Inc. (RTK) is a wood processing company that also owns a roughly $65 million stake in a nitrogen fertilizer MLP.  There are a lot of moving parts to the valuation, the market cap is only $60 million and one of the company’s wood processing segments has been a disaster.  For all those reasons, I think there’s a potential opportunity here.   

 

This post is long enough as it is, so I won’t take up your time with a discussion of the company’s history and how it got to where it is.  If you’re interested in that, there’s an April 2015 writeup on VIC and a bunch of old presentations on the company’s website.  As of today, the company consists of the following five parts:  (i) a wood chipping business called Fulghum Fibers; (ii) a retail wood pellet business called New England Wood Pellets; (iii) a sputtering industrial wood pellet business based in Canada; (iv) 7.18 million units of the nitrogen fertilizer MLP CVR Partners (UAN); and (v) corporate overhead.

 

So the company is small, yet it has four distinct businesses.  That disparate mishmash may be a caution flag in its own right.  But it also presents another problem for someone with a day job:  You have to be prepared to take the time to learn about and understand four different businesses.  That's alot of effort and time commitment to sign up for at the outset.  You run the risk of gaining only a thin understanding of each business and potentially overlooking issues and donning rose-colored glasses to justify all the time you're going to have to spend.  I did both. 

 

Fulghum Fibres

Fulghum Fibres processes trees into wood chips on a contract basis (with minimum volume commitments) for big lumber and paper companies.  It has a large share of the outsourced wood chipping business, but only about 5-10% of wood chipping is currently outsourced. 

 

The business is MLP-eligible.  Rentech acquired it in 2013 for $112 million (including assumed debt), or 5.5-6x EBITDA.  The theory was that Fulghum is a stable business that has high customer retention and opportunities to grow from increased outsourcing and could be dropped into an MLP at a significantly higher multiple than 6x.  A May 2013 presentation related to the transaction is available here:  http://phx.corporate-ir.net/phoenix.zhtml?c=66629&p=irol-presentations

 

While the MLP plans have been shelved for the time being, the business is performing as expected, with about $20 million annual EBITDA and $10 million annual EBIT.  The “A” in the EBITDA includes about $4-5 million a year related to amortization of wood chipping agreements in place at the time of purchase, and the company pays no taxes for reasons explained below.  So, I believe Fulghum produces a steady $14-15 million a year in cash flow before interest.  At 10x, this segment would have an enterprise value of $150 million.  Fulghum has $47 million of debt at 5.9%, so I estimate this segment has a net value of about $100 million.

 

In short, the claim was that this was a steady business.  In fact, it collapsed in short order as mill owners bought back the mills, which had never happened before in significant numbers.  Perhaps that would be hard to anticipate as an outsider, but there's at least one thing missing from the analysis above:  Why does this business even exist?  Mill owners can do their own chipping and, in fact, most chipping is done by them.  So, why is a small portion of it outsourced to companies like Fulghum?  Labor arbitrage?  A desire to use Fulghum's balance sheet to house assets?  I don't actually know the answer, and if you don't know why a company exists, that's a problem.  In this case, it also prevented me from making an real assessment or analysis of whether mill owners would choose to buy back the mills, or the circumstances that would justify doing so.

 

New England Wood Pellets (“NEWP”)

Much of New England too rural and sparsely populated to build out natural gas infrastructure.  So, they typically get heat from something else, like heating oil.  Wood pellets have historically been a cheaper heating option that has lower price volatility.  As a result, consumption of wood pellets for heating purposes has been growing.

 

NEWP makes these wood pellets.  Rentech bought the business in 2014 for $50 million, including assumed debt, or about 6-6.5x EBITDA.  A presentation on the transaction is also available at the link above (the earnout referred to in the presentation was paid, bringing the purchase price to $50 million).

 

From what I have read, NEWP appears to have some scale advantages, which have led to good relationships with big retail outlets like Home Depot, Tractor Supply, etc. and local retailers.  But NEWP still only has a relatively small percentage of the market, so there is room to grow, and Rentech has already made one bolt-on acquisition (Allegheny).

 

Until this winter, the business had done quite well.  For example, in 2013, it generated $44 million revenue/$7.4 million EBITDA.  In 2015, those numbers increased to $54 million revenue/12.4 million EBITDA.  In addition Q4 2015 was depressed due to the beginning of the very warm winter that New England had last year. 

 

That warm winter continued into Q1 2016, which was a dreadful quarter for the company.  But El Nino’s don’t last forever, and this looks like solid business with room to grow.  NEWP has historically generated 22% gross margins.  If you assume normalized sales of $60 million (this may be low), that’s $13.2 million in gross margin.  Subtract about $4 million in SG&A + D and that gets you to $9.2 million in EBIT.  At 10x, that’s $92 million.  NEWP has $16 million in debt at 4.1%.  So, subtracting the debt gives this segment an enterprise value of about $75 million, with no credit for what appear to be accretive acquisition opportunities. 

 

Winter 2016-17 was another warm one.  That's bad luck (but lack of liquidity exposes you to the risk!).  But also missing here is any analysis of the actual heating alternatives, which are heating oil and propane.  The price charts of those point to another potentially short-term issue that I overlooked.

 

 

Industrial Wood Chips

At the same time it purchased Fulghum Fibres, Rentech also bought two decommissioned fibre board facilities in order to convert them into wood pellet plants with the capacity to product 485k tons of wood pellets annually.  Most of these pellets would be sold to Ontario Power and Drax (a European utility) under take or pay contracts.  Rentech also signed contracts with CN for rail transport and built out significant capacity at the Port of Quebec. 

 

At the time, management estimated that the total cost to convert the plants and get them commissioned would be about $75 million and, once running near capacity, they would generate about $15 million annually in EBITDA.

 

Things have not worked out as management intended.  These have been substantial delays in the commissioning of both plants, and substantial parts of both have had to be rebuilt.  The smaller plant (Atikokan) is now running at 80-90% of capacity, but the bigger plant (Wawa) is only running at 20-30%.  During the last conference call, management – which is new as of 2015 -- stated that it doesn’t think the problems at Wawa are due to additional uncorrected design flaws, but rather management’s inexperience with these types of assets.  In addition, management recently estimated that, if they can get the plants stabilized, they should generate about CAD $13-16 million annually in EBITDA. 

 

There is about $20 million in debt related to this segment arising from construction of the port facilities, and it continues to be cash flow negative.  I don’t yet have a good handle on the production levels at which these facilities would be cash flow breakeven.  But I think it’s fair to say the knowledge likely exists somewhere in the world to get these plants operating properly, and Rentech will likely eventually either obtain that knowledge itself through experience or hire people who have it.  Nevertheless, I’ll value this segment at zero and treat it as a somewhat free option (it’s only somewhat free because you need to fund any ongoing negative cash flow).

 

Geez -- I really blew this by lack of imagination on the downside.  This business completed imploded because they could never get Wawa running properly.  Contrary to its prior statements, management ultimately admitted that the planning, logistics and location of the plant were fundamentally flawed.  So, rather than being a "free option," this business had substantial negative value once all of the contingent, off-balance sheet liabilities like take-or-pay rail contracts came due.  I didn't discuss any of those risks or contemplate the real chance that this business was worth less than zero. 

 

UAN Stake

Rentech used to own a controlling stake in Rentech Nitrogen Partners, L.P., which recently merged with CVR Partners, another nitrogen fertilizer MLP.  Rentech received cash and units in CVR.  Rentech used most of the cash and units to retire debt, but still has 7.18 million units.  CVR’s current unit price is $9.15, so Rentech’s stake is currently worth about $65 million at market prices.

 

UAN is now at $3.50/unit.  That's the risk of relying on market price for a security on the balance sheet rather than evaluating the business for yourself and deciding whether you want exposure to it.  I suspect that I did this partly because I didn't want to spend the time to fully analyze the nitrogen fertilizer business, which would be a big undertaking in its own right.  I obviously paid for that laziness.

 

Corporate, Debt & NOLs

 

Rentech currently has $86 million in cash, but about $30 million of that will go to taxes on the CVR transaction (~$10 million) and CapEx to (hopefully) complete the industrial wood pellet facilities (~$20 million).  So, I’ll use $55 million in cash for my valuation.

 

Rentech is currently run-rating at about $20 million per year in corporate overhead.  But new management is cutting this by eliminating unnecessary personnel, moving headquarters, etc.  I assume that this number can be cut down to about $15 million per year.  Capitalized at eight times, this is a negative $120 million.

 

The company also has $53 million in corporate level debt at L + 700, secured by the CVR units.  At CVR’s current distribution levels, the distributions on the units would exceed the interest on this debt by about $3 million per year. 

 

Finally, the company has a bunch of NOLs, so it likely won’t be paying significant taxes for awhile.

 

Adding it all up

Here are two back-of-the-envelope sum of the parts valuation:

 

CVR at market, no value for Industrial wood pellets, NOLs or growth

Cash:  $55 million

Fulghum:  $100 million

NEWP:  $75 million

CVR stake:  $65 million

Industrial wood pellets:  $0

NOLs:  $0

Growth at Fulghum and NEWP:  $0

Corporate:  ($120 million)

Corporate Debt:  ($53 million)

Industrial Wood Pellet debt:  ($20 million)

Total:  $102 million 

 

Capitalize CVR distributions less interest on debt, Industrial at 5x EBITDA, nothing for NOLs or growth

Cash:  $55 million

Fulghum:  $100 million

NEWP:  $75 million

CVR less debt ($3 million at 10x):  $30 million

Industrial wood pellets:  $50 million

Corporate ($120 million)

Industrial Wood Pellet debt:  ($20 million)

Total:  $170 million

 

The first valuation would be about a 65% gain.  The second valuation would be a triple. 

 

If there’s any interest, I’ll explore the CVR stake further in a separate post, because it may be quite undervalued in its own right. 

 

Management did cut overhead below $15 million, but that didn't matter in light of all of problems with the operating businesses, and UAN eliminated its dividend, taking away another source of cash.

 

Overall, you have a series of analytical errors largely driven by a failure to understand the true risks of the business.  I suspect part of those failures were caused by the fact that I really wasn't interested enough in the various businesses to really understand them.  Instead, I relied on a thin understanding of each one and wrapped them up in a sum-of-the-parts that was wildly optimistic.

 

Also, the various parts are largely mediocre or commodity businesses.  Time or business quality may bail you out when you misunderstand the risks of those types of businesses.

[snow pea]

Thank you for the thoughtful post. 

[Picasso]

+1

[awindenberger]

+1

+2

 

I looked at this one in early 2017 after it had already seriously started falling apart. Got a bit interested but luckily didn't have any positions I wanted to sell.

[LightWhale]

+1

 

+3

Also held this one. Some lessons for me:

 

1. The situation combined a turnaround attempt, mediocre management, commodity products, and overleverage. Each factor on its own can be ok, but together they are deadly. Growing debt levels and declining EBITDA is a race against time, and so against odds. 

 

2. After the Wawa announcement, with the stock diving 50%, I did not have the integrity to (a) acknowledge the thesis was broken and (b) get the hell out at a loss.

 

3. Director resignation, for reasons other than health, is an under-appreciated sign of a sinking ship. Directors rarely quit (it’s an easy and well paid job) unless they fear B/R will spoil their reputation. Even then, they leave quietly and are reluctant to appear rebellious, since it would lower chances of getting unto other boards.  Here we had all the ingredients in place when Williams left (Feb 2017) "due to strategic disagreement".

 

4. Company culture: no history of generating FCF or even operating profit in the company’s entire existence. Management can easily fall into a state of mind where losing cash seems normal and is taken for granted.

 

 

[SnarkyPuppy]

+1.  Thanks.

[KJP]

 

2. After the Wawa announcement, with the stock diving 50%, I did not have the integrity to (a) acknowledge the thesis was broken and (b) get the hell out at a loss.

 

 

I agree that, at a a minimum, this event should have forced a thorough reexamination of Wawa/Atitokan downside.  Unfortunately the share price collapsed before I got around to seriously rethinking these issues.

 

Also, after my writeup, RTK reached ~$3.90 per share while UAN sank in value.  At that point, the RTK reached (and likely exceeded) my "conservative" sum-of-the-parts value, yet I did not sell, even though I considered doing so.  That was another big mistake, because I never thought this was a great business with great management, so I shouldn't have had any strong desire to hold past a conservative fair value.