RTK - Rentech Inc

[KJP]

 

Corporate overhead although reduced will still remain. Most of the G&A expenses at the sub level are rolled into corporate overhead and reported separately. This is an opaque structure and if you go through the previous CC's you would notice the analysts demanding that overheads be reported at the  sub level. My guess is that the overheads will be in the range of $7-8 minus industrials.

 

Right now there is only one board member from activist investor ,Ariel investments but if the Raging capital can get the board seats, then there is some hope that those overheads will be reduced.

 

I'm not sure what you mean by "most of the G&A expenses at the sub level are rolled into corporate overhead and reported separately."  There is detailed segment level-reporting in the K's and Q's.  Are you saying that a buyer of one of the segments, e.g., Fulghum, would have to take on a significant amount of SG&A that is currently classified as "corporate/unallocated" in the segment reporting?  (My assumption is that essentially all of what is classified as "corporate/unallocated" could be eliminated by the buyer(s) of the operating assets.) 

 

Or are you suggesting that some of the current run rate of around $12 million corporate/unallocated relates to costs that could be eliminated with the sale of the Industrial wood pellet business? If that's what you mean, I'm sure that's right.  But when goblue referred to selling assets for 7x EBITDA [i think this is too high for Fulghum], I assumed he was referring to Fulghum or NEWP, not industrials. 

 

Also, if one of Fulghum or NEWP is sold, then it would make even more sense to go ahead and sell the other as well, rather than keep the now unnecessary and overly expensive layers of corporate execs that aren't needed. 

 

Of course, management here owns essentially no stock, so they might need a hard push to take that road.  I hope the plan isn't to wait around and  pray that fertilizer prices recover so they can get bailed out by selling the UAN stock at a big premium to the GSO debt.

 

 

[KJP]

KJP,

 

What is their total current NOL?  After the impairment of Wawa plant shutdown, they probably will add another $100M to it. Putting a 35% tax rate, that is like $35MM+ of cash value. I don't know but are such kind of NOLs considered sort of like an "assets" when selling a company?

 

At this point, with all of the moving parts and all of the losses that are going to show up over the next few quarters, I'm not at all sure what the NOLs will be, or whether they'll ultimately need to use some of them to shield any gains from asset sales.  Moreover, a change of control can impose significant limits on the use of NOLs, so I wouldn't assign much, if any, value to them.  [see http://scholarship.law.wm.edu/cgi/viewcontent.cgi?article=1005&context=tax] 

 

[Picasso]

These guys are across the street from me, I should probably meet with them and get a feel for the situation.

[KJP]

These guys are across the street from me, I should probably meet with them and get a feel for the situation.

 

Are you in LA or DC?  They supposedly moved to DC 6 months ago, but it wouldn't shock me if they decided to winter in the old offices.

[valcont]

 

I'm not sure what you mean by "most of the G&A expenses at the sub level are rolled into corporate overhead and reported separately."  There is detailed segment level-reporting in the K's and Q's.  Are you saying that a buyer of one of the segments, e.g., Fulghum, would have to take on a significant amount of SG&A that is currently classified as "corporate/unallocated" in the segment reporting?  (My assumption is that essentially all of what is classified as "corporate/unallocated" could be eliminated by the buyer(s) of the operating assets.) 

 

 

Sorry I was typing on my mobile. What I meant was that the corporate expenses are material SG&A expenses in valuing the subs. When I start valuing Rentech , I made the same assumption that if they can just cut corporate overheads ,these subs are way more than the market is valuing them. But its not that simple. Corporate expense have to be capitalized with the same multiple that you are assigning to Fulghum and NEWP since they are not reporting ALL SG&A at the sub level. Here is the exchange about the expenses:

 

Brent Rystrom

 

It directionally helps. So in the latest quarter SG&A was about 77 and segment level SG&A was about $3 million, how are those two kind of look say over the next year and a half. Do you have a plan to put all the SG&A eventually down with the units since you're no longer primarily a wood fiber business now or will SG&A always have a corporate component?

 

Jeffrey Spain

 

Brent. It’s Jeff. That first question I’ll address. We guided to off of a $44 million total SG&A number several quarters ago that are cost savings of 10 to 12 would be off of that $44 million. We're now seeing 12 to 15 off of that $44 million. That's total SG&A ex- RNF, so all the business units plus corporate and including non-cash comp. So that's a fully gross number.

 

With respect to the second part of your question. It is too early to be definitive, but I anticipate that there will be some layer of corporate SG&A as we consolidate the business unit financials have reporting - public reporting obligations, so some centralized support and activity for accounting and reporting. So some component of corporate SG&A rather than all being pushed down. And I think next quarter we’ll be able to - be a little more transparent on where the SG&A fits at the units as well as corporate of that refined savings off of $44 million right.

 

So when we talk about having pushed the back office accounting to Jaffrey, if that still a corporate venture function that just been shifted there, those people that are bifurcated to some extent working on new things. But really there we have a good team in place there. There is cost advantages and the like.

[KJP]

 

Sorry I was typing on my mobile. What I meant was that the corporate expenses are material SG&A expenses in valuing the subs. When I start valuing Rentech , I made the same assumption that if they can just cut corporate overheads ,these subs are way more than the market is valuing them. But its not that simple. Corporate expense have to be capitalized with the same multiple that you are assigning to Fulghum and NEWP since they are not reporting ALL SG&A at the sub level.

 

When you say all "corporate/unallocated" expense has to be capitalized, are you talking about valuing Rentech as a going concern or trying to determine what one or more of the pieces would fetch in a sale?

 

If Rentech is going to continue as a going concern, then I get that they'd need a corporate-level CEO, CFO, board, a unified reporting and control system, etc. and incur various other public company costs.  But a buyer of some or all of the assets wouldn't need any of that.  So, if you're trying to see what the company could get by selling Fulghum and NEWP (essentially a liquidation), I don't think it makes sense to burden those subs with all of the corporate SG&A when evaluating how much they would sell for. 

 

There is also some support in Fulghum's pre-Rentech financials for the belief that the reported segment-level SG&A is all a buyer would need (and a strategic buyer might be able to cut some of that as well).  Specifically, for the fiscal years ended March 31, 2012 and 2013, Fulghum's total annual G&A expense was $4.3 million.  In 2015, Fulghum's reported segment-level SG&A was $5 million, and they're running at about that rate again this year.  The business is essentially the same size now as it was when Rentech bought it, so it's hard to see why a buyer today would need more than the reported segment-level SG&A.

[valcont]

 

If Rentech is going to continue as a going concern, then I get that they'd need a corporate-level CEO, CFO, board, a unified reporting and control system, etc. and incur various other public company costs.  But a buyer of some or all of the assets wouldn't need any of that.  So, if you're trying to see what the company could get by selling Fulghum and NEWP (essentially a liquidation), I don't think it makes sense to burden those subs with all of the corporate SG&A when evaluating how much they would sell for. 

 

 

I disagree. These expenses are incurred to run these subs and have to be allocated accordingly for the valuation no matter if its a going concern or a liquidation. The "synergies" that you are referring to are not discounted. You can make the case that a lot of these expenses are unnecessary and can be cut but so far it hasn't been done and the company will be priced as such.

 

I do agree that this company was badly mismanaged before the new CEO came along . Their whole business is in NE and Canada and their corporate headquarter was in LA!! Keith finally moved them to DC but I bet there is a lot of deadweight hanging around. That is why you need a board who can prioritize these expenses.

[KJP]

 

I disagree. These expenses are incurred to run these subs and have to be allocated accordingly for the valuation no matter if its a going concern or a liquidation. The "synergies" that you are referring to are not discounted. You can make the case that a lot of these expenses are unnecessary and can be cut but so far it hasn't been done and the company will be priced as such.

 

 

In 2015, Fulghum's reported segment-level EBITDA was $22 million and it's EBITA was $13 million.  With the loss of three mills, those numbers going forward may be something like $20-21 million and $11-12 million.  I'm suggesting a buyer of Fulghum's assets is going to look at those numbers and pay a multiple of them. 

 

My understanding is that the "corporate/unallocated" SG&A includes, for example, the $1 million in compensation that Forman received last year.  According to the proxy, the CFO, General Counsel, and SVP of Human Resources get $400,000 - $500,000 each per year.  The non-employee directors received about $600,000 collectively.  The company also paid $3 million in audit fees.  Those are just some examples of what's in "corporate" SG&A.  Adding up these examples gets you $6 million in costs in 2015.  If I'm understanding you correctly, you're saying that any buyer of the Fulghum's assets is going to impute some (half?) of those costs to Fulghum to cut EBITDA/EBITA to $17-18 million/$8-10 million, and base their multiple on that. 

 

Why would a buyer of Fulghum's assets do that?  Why would a buyer of Fulghum's assets care or take into account the compensation paid to Forman, Rentech's board or Rentech's auditor?

 

Or, to use your phrase, why is the compensation paid to, for example, Rentech's board or Forman "incurred to run" the Fulghum assets themselves (and thus would also be incurred by any buyer of those specific assets), as opposed to being incurred to run the corporate apparatus that has been placed on top of those assets (among others) and which would not stay with those assets if they were sold?

[valcont]

 

In 2015, Fulghum's reported segment-level EBITDA was $22 million and it's EBITA was $13 million.  With the loss of three mills, those numbers going forward may be something like $20-21 million and $11-12 million.  I'm suggesting a buyer of Fulghum's assets is going to look at those numbers and pay a multiple of them. 

 

My understanding is that the "corporate/unallocated" SG&A includes, for example, the $1 million in compensation that Forman received last year.  According to the proxy, the CFO, General Counsel, and SVP of Human Resources get $400,000 - $500,000 each per year.  The non-employee directors received about $600,000 collectively.  The company also paid $3 million in audit fees.  Those are just some examples of what's in "corporate" SG&A.  Adding up these examples gets you $6 million in costs in 2015.  If I'm understanding you correctly, you're saying that any buyer of the Fulghum's assets is going to impute some (half?) of those costs to Fulghum to cut EBITDA/EBITA to $17-18 million/$8-10 million, and base their multiple on that. 

 

Why would a buyer of Fulghum's assets do that?  Why would a buyer of Fulghum's assets care or take into account the compensation paid to Forman, Rentech's board or Rentech's auditor?

 

Or, to use your phrase, why is the compensation paid to, for example, Rentech's board or Forman "incurred to run" the Fulghum assets themselves (and thus would also be incurred by any buyer of those specific assets), as opposed to being incurred to run the corporate apparatus that has been placed on top of those assets (among others) and which would not stay with those assets if they were sold?

 

Ok assume that the CEO,CFO spends a day managing Fulghum operations. If another company buys it, who is going to take that added responsibility? Probably the new CEO who will hire a direct report for Fulghum. Lets say PWE does the audit work for this company. Will they agree to take more work for free?

 

Lets say a company has two subs , RipOff and FreeLoader with EBITDA of $10m each and multiple of 5x with the corporate overhead of $5m. The combined EBITDA will be $15m.  So if the company sells Freeloader it should get $50m vs if the company puts itself for sale it will get $75m. That means RipOff got exactly half of what it should have since the Freeloader didn't assume any unallocated expense. 

 

Just because a cost can not be assigned directly to a segment doesn't mean it can be ignored.

[KJP]

 

Ok assume that the CEO,CFO spends a day managing Fulghum operations. If another company buys it, who is going to take that added responsibility? Probably the new CEO who will hire a direct report for Fulghum. Lets say PWE does the audit work for this company. Will they agree to take more work for free?

 

Lets say a company has two subs , RipOff and FreeLoader with EBITDA of $10m each and multiple of 5x with the corporate overhead of $5m. The combined EBITDA will be $15m.  So if the company sells Freeloader it should get $50m vs if the company puts itself for sale it will get $75m. That means RipOff got exactly half of what it should have since the Freeloader didn't assume any unallocated expense. 

 

Just because a cost can not be assigned directly to a segment doesn't mean it can be ignored.

 

Thanks for the response.  I respectfully disagree.  For example, a buyer of Fulghum or NEWP wouldn't need to hire a new direct report to oversee those businesses; the direct reports already exist at the segment level in Kevin Cain (Fulghum) and Mark Wilson (NEWP), who aren't among the Rentech corporate C-Level execs whose comp I assume is reported in "corporate/unallocated".  (See  http://www.rentechinc.com/management.php)

 

At the end of the day we disagree on this point, but it's something for anyone looking at this to consider.  If there is in fact another $8-10 million of costs that need to be pushed down to the Fulghum and NEWP level, then the equity may indeed be a zero if there end up being significant recourse Industrial liabilities that are not satisfied by the Canadian assets.

[awindenberger]

These guys are across the street from me, I should probably meet with them and get a feel for the situation.

 

Are you in LA or DC?  They supposedly moved to DC 6 months ago, but it wouldn't shock me if they decided to winter in the old offices.

 

Set up that meeting Picasso, I for one would love to hear what you learn.

[Picasso]

These guys are across the street from me, I should probably meet with them and get a feel for the situation.

 

Are you in LA or DC?  They supposedly moved to DC 6 months ago, but it wouldn't shock me if they decided to winter in the old offices.

 

Set up that meeting Picasso, I for one would love to hear what you learn.

 

Unfortunately I'm in LA.  I mistakenly saw their old corporate address. 

[valcont]

Thanks for the response.  I respectfully disagree.  For example, a buyer of Fulghum or NEWP wouldn't need to hire a new direct report to oversee those businesses; the direct reports already exist at the segment level in Kevin Cain (Fulghum) and Mark Wilson (NEWP), who aren't among the Rentech corporate C-Level execs whose comp I assume is reported in "corporate/unallocated".  (See  http://www.rentechinc.com/management.php)

 

At the end of the day we disagree on this point, but it's something for anyone looking at this to consider.  If there is in fact another $8-10 million of costs that need to be pushed down to the Fulghum and NEWP level, then the equity may indeed be a zero if there end up being significant recourse Industrial liabilities that are not satisfied by the Canadian assets.

 

Yeah no point in arguing about that. Lets address it from a valuation stand point. They have until end of this year before the wawa liabilities are claimed. Even if you assume that they are not negotiated and are paid in full, here is what I have as the most pessimistic scenario:

 

Debt :

 

LT

Drax - $20m

QSL - $14m

CN -  $36m  ($3.6m for 10 years? Not sure where I read it but shouldn't it be same time length as Drax contract of 7-8 years ?)

GSO - $55m

 

Current:

GSO interest - $3.5m

corporate - $12m

wawa - $2m

Enviva,NEWP,Fulghum - 0

 

= $125m + $17.5 = $143m

 

Assets

 

Fulghum - $10-11m FCF at 10x  = $100-110m

NEWP -  $4-5m FCF at 10x = $40-55m ( They bought it for $45m in 2014 )

UAN 7m @$5.32  -  37m

 

Current - 

Fulghum - $10m

NEWP -    $2.5m

Cash -    $20m

Fulghum unit sale - $5m

 

= $177m + $37m = $214m

 

So you get ~$71m equity, capitalize corporate expense of ~$7-8m for NEWP and Fulghum and you are left with nothing. This is what market is pricing it at.

 

My bullish scenario has Fulghum at $16-$17m FCF and NEWP at $6-8m . At 10x they are $240m . I am also not considering UAN distributions and potential price appreciation.

 

What do you think? Did I miss anything?

 

[KJP]

Thanks for the response.  I respectfully disagree.  For example, a buyer of Fulghum or NEWP wouldn't need to hire a new direct report to oversee those businesses; the direct reports already exist at the segment level in Kevin Cain (Fulghum) and Mark Wilson (NEWP), who aren't among the Rentech corporate C-Level execs whose comp I assume is reported in "corporate/unallocated".  (See  http://www.rentechinc.com/management.php)

 

At the end of the day we disagree on this point, but it's something for anyone looking at this to consider.  If there is in fact another $8-10 million of costs that need to be pushed down to the Fulghum and NEWP level, then the equity may indeed be a zero if there end up being significant recourse Industrial liabilities that are not satisfied by the Canadian assets.

 

Yeah no point in arguing about that. Lets address it from a valuation stand point. They have until end of this year before the wawa liabilities are claimed. Even if you assume that they are not negotiated and are paid in full, here is what I have as the most pessimistic scenario:

 

Debt :

 

LT

Drax - $20m

QSL - $14m

CN -  $36m  ($3.6m for 10 years? Not sure where I read it but shouldn't it be same time length as Drax contract of 7-8 years ?)

GSO - $55m

 

Current:

GSO interest - $3.5m

corporate - $12m

wawa - $2m

Enviva,NEWP,Fulghum - 0

 

= $125m + $17.5 = $143m

 

Assets

 

Fulghum - $10-11m FCF at 10x  = $100-110m

NEWP -  $4-5m FCF at 10x = $40-55m ( They bought it for $45m in 2014 )

UAN 7m @$5.32  -  37m

 

Current - 

Fulghum - $10m

NEWP -    $2.5m

Cash -    $20m

Fulghum unit sale - $5m

 

= $177m + $37m = $214m

 

So you get ~$71m equity, capitalize corporate expense of ~$7-8m for NEWP and Fulghum and you are left with nothing. This is what market is pricing it at.

 

My bullish scenario has Fulghum at $16-$17m FCF and NEWP at $6-8m . At 10x they are $240m . I am also not considering UAN distributions and potential price appreciation.

 

What do you think? Did I miss anything?

 

There is ~$37 million of segment-level debt at Fulghum and ~$17 million at NEWP.  I don't see where you accounted for those debts.  Also, as I think you noted earlier, the CN Rail take-or-pay very likely will be negotiated down.  I think $20 or $25 million is a conservative number for that, though we technically don't know the length of the contract.

 

$110  million enterprise value for Fulghum sounds about right to me.  After the recent mill losses, I think its annual normalized unlevered free cash flow is about $11 million.  I don't see Fulghum generating $16-$17 million in FCF in the typical year unless they secure several new contracts, which they haven't been able to do since they bought it.

 

NEWP has been hit so bad by warm weather and low propane/heating oil prices that it's hard to say what somebody would pay now for it, given the volatility it's proven to have.  Including the earn-out and the purchase of Allegheny, Rentech actually paid $58 million for it, so your range seems reasonable to me, and might even be a bit low if you were looking at it during an average-to-cold winter in New England. 

 

Atikokan should also be worth something.  If it's cash flow breakeven at 45k tons/year, it would produce real cash flow if Rentech or someone else can find a home for the other 45-55k tons/year capacity.

 

[heth247]

It seems to me that the main wildcard  here is how do they address the fallout from the Industrial e.g. Drax+QSL+CN = $20MM + $14 + $20MM = $54MM.

 

They spent $145MM for developing Atikokan + Wawa. If they can sell both together for an amount >= $54MM then we should get a double/triple from here. If they cannot, then the stock price will be very sensitive to the shortfall, since the market cap is only $25MM now. It is unclear to me how much time they have, and will they have enough liquidity to address the fall out in time.

 

Do they have access to any credit facility like a revolver at the corporate level? I couldn't find it from the recent 10Q. The only revolver I found is at NEWP for $6MM. Then I dig into their 2015 10K and found that they used to have a credit agreement with GSO for up to $50MM (trench A) +$45M (trench B) = $95MM. Now since they have paid it down to $52MM (mostly trench A loans) for now . Will they still be able to access the $45MM "Trench B loan" facility (L+9%) should they have any liquidity issue? 

 

[Patmo]

One thing to also consider is whether "exploring strategic alternatives" meant they gave up or whether they actually hope to keep going. There's always a Chinese buyer for a failing business at a small premium to share price. In that event, valuing the business is a futile exercise because the offer will be based on share price, not business value.

 

Actually meeting mgmt to get a pulse for the size of their balls would be a pretty big boon if you think this is worth a multiple of share price, although I wonder why the mgmt team would waste time doing that in this current situation. Get to work ya lazy bums!

[valcont]

KJP,

  You are right, I missed the segment level debt. I thought the GSO debt was allocated to the segments since both are ~$54m.

 

Fulghum generated $21.6m EBITDA in 2015( '15 10K on p83) so they are capable of $15-16m FCF.

 

Heth,

  The liability from Industrial would be $20m+$14m+$3.6m = $37.6m.Even if its not negotiated down, they have $20m cash. I doubt if anyone would buy Industrial so if they can sell Fulghum, they'll end up with $60m cash and wait it out for UAN to appreciate. I am not sure if they can access Trench B since that was opened against RNF. That is why the UAN stake is collateral against the GSO loan.   

 

The key here will be corporate expenses.That needs to be cut in half to about $7-8m. The activist's involvement here gives me a lot of comfort. I am sure Raging capital must be pissed off having just bought their stake at $2.60 a share.

 

Either way I just don't see a path to restructuring here. Good luck getting a bankruptcy judge to approve a voluntary restructuring. Who will force them into it?

[heth247]

KJP,

  You are right, I missed the segment level debt. I thought the GSO debt was allocated to the segments since both are ~$54m.

 

Fulghum generated $21.6m EBITDA in 2015( '15 10K on p83) so they are capable of $15-16m FCF.

 

Heth,

  The liability from Industrial would be $20m+$14m+$3.6m = $37.6m.Even if its not negotiated down, they have $20m cash. I doubt if anyone would buy Industrial so if they can sell Fulghum, they'll end up with $60m cash and wait it out for UAN to appreciate. I am not sure if they can access Trench B since that was opened against RNF. That is why the UAN stake is collateral against the GSO loan.   

 

The key here will be corporate expenses.That needs to be cut in half to about $7-8m. The activist's involvement here gives me a lot of comfort. I am sure Raging capital must be pissed off having just bought their stake at $2.60 a share.

 

Either way I just don't see a path to restructuring here. Good luck getting a bankruptcy judge to approve a voluntary restructuring. Who will force them into it?

 

Valcont, why do you think nobody will buy the Industrial? I think the key is how much more money needs to be put in.  Keep in mind that based on their original goal, they just need to spend $75MM to generate 15% ROI. So if a buyer can buy the Industrial for $50MM and put in another $25MM to make it work, then it is still a good deal.  But again, I don't know how much more money is needed.

 

Fulghum is the most valuable part of their business at this point. If they sell it, then there is really not much point to remain as a public company. I think the unallocated corporate expense can easily be cut more than in half. For example, from 2015 10-K, non-cash equity-based compensation alone contributes $3~4MM of that.

 

I agree with you that if they can wait it out, time is on their side. My only concern is, if they can find a buyer (either for Industrial or for Fulghum) in time, that's why I was trying to see if they have access to extra liquidity in short time.

[heth247]

One thing to also consider is whether "exploring strategic alternatives" meant they gave up or whether they actually hope to keep going. There's always a Chinese buyer for a failing business at a small premium to share price. In that event, valuing the business is a futile exercise because the offer will be based on share price, not business value.

 

Actually meeting mgmt to get a pulse for the size of their balls would be a pretty big boon if you think this is worth a multiple of share price, although I wonder why the mgmt team would waste time doing that in this current situation. Get to work ya lazy bums!

 

I disagree. First, the company as a whole is not a failing business. They have valuable (UAN stake) assets and profitable business (Fulghum+NEWP).  Second, valuing the business is still a good exercise since it helps you to know the downside.

[igor]

Either way I just don't see a path to restructuring here. Good luck getting a bankruptcy judge to approve a voluntary restructuring. Who will force them into it?

Valcont, do you think they are not going to able to place the Canadian subsidiary into bankruptcy? I'm not as familiar with practicalities of bankruptcies. What are the criteria that are not satisfied?

 

  The liability from Industrial would be $20m+$14m+$3.6m = $37.6m.

I think it is 3.6m per year for the duration of the railroad contract rather than 3.6m total. One would hope the duration matches Drax contract. The Quebec Stevedoring contract was for 15 years.

 

Keep in mind that based on their original goal, they just need to spend $75MM to generate 15% ROI. So if a buyer can buy the Industrial for $50MM and put in another $25MM to make it work, then it is still a good deal.  But again, I don't know how much more money is needed.

Shouldn't the same logic work for the current owner as well? If the required investment to make it work passes the hurdle rate of the buyer, why wouldn't it pass the hurdle rate of the current owner (assuming similar hurdle rates)?

 

Sunk costs should not affect the rational decision-maker's best choice. It seems safer to conclude that the required investment doesn't pass a typical hurdle rate.

[valcont]

Heth,

  One of the natural buyer is Enviva and if you hear their conference call from last week, they seem to be pretty picky. I am not ruling it out but its far easier to sell a cash flow positive business than a distressed one and timing is the key here.Even if someone buys both plants and assume liabilities , it is still a good sell.

 

Igor,

They can place the subs in bankruptcies but the liabilities are recourse to Rentech so it wouldn't matter.

 

Yes the liabilities are $3.6m/year for 7 years. I was trying to estimate their liability this year.

 

I don't think management has a handle on Wawa's issues so you have to assume the worst and so will the buyers.

[heth247]

Heth,

  One of the natural buyer is Enviva and if you hear their conference call from last week, they seem to be pretty picky. I am not ruling it out but its far easier to sell a cash flow positive business than a distressed one and timing is the key here.Even if someone buys both plants and assume liabilities , it is still a good sell.

 

Valcont, I was not aware that there was a conference call last week. I only read their press release on Feb 16th. Where can I listen to the conference call on Feb 16? I couldn't find it on their website. thanks.

[KJP]

Heth,

  One of the natural buyer is Enviva and if you hear their conference call from last week, they seem to be pretty picky. I am not ruling it out but its far easier to sell a cash flow positive business than a distressed one and timing is the key here.Even if someone buys both plants and assume liabilities , it is still a good sell.

 

Valcont, I was not aware that there was a conference call last week. I only read their press release on Feb 16th. Where can I listen to the conference call on Feb 16? I couldn't find it on their website. thanks.

 

Heth,

I assume Valcont was talking about Enviva's call, during which they said this, among other things:  "In concert with our sponsor and its joint venture with John Hancock, to continue to consider opportunistic third-party acquisitions when they arise. On that point, several of our investors have inquired about our interest in a few of the distressed assets on the market. And while we maintain an open mind on opportunities, given our operating excellence and proven capabilities, to date, much of what we have seen contained inherent fatal flaws as if they remain unremediated limit our enthusiasm."

 

Valcont,

I hope you're right that Fulghum can generate $15-$16 million in annual FCF, but I think 2015 doesn't represent normalized earnings going forward for two reasons. 

 

First, Fulghum is now owning/operating three fewer mills.  We don't know which mills were lost, but we're probably looking at $1 - $1.5 million less in gross profit from no longer having those mills. 

 

Second, I think 2015 benefited from abnormally low maintenance and repair expenses.  In 2014, they had a lot of downtime and performed extra maintenance.  That (along with various plant outages and the fire in Maine) resulted in very poor 2014 results (only about $13.5 million in EBITDA).  I think 2015 benefited from that extra 2014 maintenance as some of the cost that ordinarily would have been incurred in 2015 was incurred in 2014.  Two data points in support of my belief are (i) the amount recorded in COGS for maintenance and repairs declined from ~$23 million in 2014 to ~$18 million in 2015 (I acknowledge that management attributed the decline to tight cost control, but I'm skeptical of that assertion); and (ii) EBITDA margins in 2016 appear to have declined fairly significantly from 2015 (part of the decline, however, relates to outages at two customers caused by flooding and the higher amount of lower gross margin biomass sales).  The segment-level information for 2016 should shed some light on whether 2015's costs are sustainable. 

 

After accounting for those two factors, I think Fulghum's normalized, annual unlevered free cash flow is $11 - $12 million, built up as follows:

 

US GMT processed:  11-11.5 million

US gross profit/ton:  $1.12

US gross profit:  $12.3 - $12.9 million

 

S.A. GMT processed:  1.85 million

S.A. gross profit/ton:  $1.12

S.A. processing gross profit:  $2.1 million

 

S.A. biomass sales gross profit:  $1.5 - $2 million

 

Total gross profit:  $16-$17 million

SG&A: $5 million

EBITA/unlevered, pre-tax FCF:  $11 - $12 million

 

This analysis uses depreciation as a proxy for normalized maintenance CapEx.  I don't know of any reason to think that, over time, depreciation materially overstates normalized CapEx, though actual annual CapEx may be lumpy. 

 

 

 

 

[valcont]

 

Valcont,

I hope you're right that Fulghum can generate $15-$16 million in annual FCF, but I think 2015 doesn't represent normalized earnings going forward for two reasons. 

 

First, Fulghum is now owning/operating three fewer mills.  We don't know which mills were lost, but we're probably looking at $1 - $1.5 million less in gross profit from no longer having those mills. 

 

Second, I think 2015 benefited from abnormally low maintenance and repair expenses.  In 2014, they had a lot of downtime and performed extra maintenance.  That (along with various plant outages and the fire in Maine) resulted in very poor 2014 results (only about $13.5 million in EBITDA).  I think 2015 benefited from that extra 2014 maintenance as some of the cost that ordinarily would have been incurred in 2015 was incurred in 2014.  Two data points in support of my belief are (i) the amount recorded in COGS for maintenance and repairs declined from ~$23 million in 2014 to ~$18 million in 2015 (I acknowledge that management attributed the decline to tight cost control, but I'm skeptical of that assertion); and (ii) EBITDA margins in 2016 appear to have declined fairly significantly from 2015 (part of the decline, however, relates to outages at two customers caused by flooding and the higher amount of lower gross margin biomass sales).  The segment-level information for 2016 should shed some light on whether 2015's costs are sustainable. 

 

After accounting for those two factors, I think Fulghum's normalized, annual unlevered free cash flow is $11 - $12 million, built up as follows:

 

US GMT processed:  11-11.5 million

US gross profit/ton:  $1.12

US gross profit:  $12.3 - $12.9 million

 

S.A. GMT processed:  1.85 million

S.A. gross profit/ton:  $1.12

S.A. processing gross profit:  $2.1 million

 

S.A. biomass sales gross profit:  $1.5 - $2 million

 

Total gross profit:  $16-$17 million

SG&A: $5 million

EBITA/unlevered, pre-tax FCF:  $11 - $12 million

 

This analysis uses depreciation as a proxy for normalized maintenance CapEx.  I don't know of any reason to think that, over time, depreciation materially overstates normalized CapEx, though actual annual CapEx may be lumpy.

 

Makes sense. I have to look back some of the transcripts but I remember management saying that the US market should pick up in coming years. I assumed  maintenance capex for these as between $1-2m based on this exchange in Q2'14

 

Operator

 

The next question comes from Lucas Pipes with Brean Capital.

 

Lucas Pipes - Brean Capital LLC, Research Division

 

My first question is on your previous stated goals of that roughly $55 million EBITDA run rate in the fourth quarter next year, again, on an annualized basis. But could you maybe breakdown in terms of what you're targeting from your various segments to contribute to that run rate in the wood fiber business?

 

Dan J. Cohrs

 

Yes. Lucas, what we have there was -- this is the guidance that we put out in terms of what we see the run rate for the fiber business later this year as the Atikokan and Wawa projects are fully operating. Actually, I should say next year it's they're fully operating really once they're fully ramped up. We had approximately $20 million for Fulghum Fibres. And of course, we just talked about the fact that we're trying to recover from a little bit of increased expenses there. But at the time we issued that guidance of $55 million, we had $20 million for Fulghum Fibres. We had approximately $18 million for the Canadian projects in U.S. dollars, and then we would have our guidance of about $7.5 million for New England Wood Pellet. And then the balance would be made up by an additional project that we've not yet announced.

 

Lucas Pipes - Brean Capital LLC, Research Division

 

That's helpful. And in terms of the sustaining capital that it would have to be a fight against that level of EBITDA, could you maybe also provide a similar breakdown?

 

Dan J. Cohrs

 

I'm sorry, you were really breaking up. You're asking about how much capital?

 

Lucas Pipes - Brean Capital LLC, Research Division

 

Yes. What would be the sustaining capital for these various units that you just walked me through?

 

Dan J. Cohrs

 

You mean ongoing maintenance capital?

 

Lucas Pipes - Brean Capital LLC, Research Division

 

That's correct.

 

Dan J. Cohrs

 

Yes, it's very low. These businesses tend to operate with very low maintenance CapEx. Most of the maintenance runs through the P&L. And so for typically these things -- I mean, we're not going to put out a precise forecast, but you can think of a number like $1 million or $2 million for most of those major categories that I just gave you.

 

Lucas Pipes - Brean Capital LLC, Research Division

 

So essentially, $1 million to $2 million per segment?

Dan J. Cohrs

 

Yes.

[heth247]

Heth,

I assume Valcont was talking about Enviva's call, during which they said this, among other things:  "In concert with our sponsor and its joint venture with John Hancock, to continue to consider opportunistic third-party acquisitions when they arise. On that point, several of our investors have inquired about our interest in a few of the distressed assets on the market. And while we maintain an open mind on opportunities, given our operating excellence and proven capabilities, to date, much of what we have seen contained inherent fatal flaws as if they remain unremediated limit our enthusiasm."

 

Thanks, KJP, for the pointer. I went and read the CC transcripts of EVA. It was interesting that later on the call an analyst specifically asked what they are looking for among those distressed assets (he even mentioned Rentech's name). And the CEO made the following comments:

 

"Sure. Again, if you really look at the most broadly defined market for wood pellets, you could probably say that there are hundreds of plants in the United States that -- and abroad -- that constitute a wood pellet plant. I think from our perspective, you'd be focused on the large-scale industrial plants that can achieve scale based on a solid build, a good location, and a relatively good operating profile. And what I would tell you is those are rare. We acquired the Cottondale facility several years ago because it was a great plant. It was a great set of operations, and it had a great opportunity for improvement.

 

The fatal flaws aren't always just build limitations. They aren't always just logistics limitations. It could be in the wrong spot. It can have the wrong contract profile against it. It can have other encumbrances that you really need to understand what it means from a long-term basis to try and operate in what is inherently a logistics business, these midstream assets, where the lowest cost position is essential to your long-term success. And much of what we have seen just doesn't meet any of those characteristics."

 

So in your opinion, what are the options RTK have here and what are the main risks left for RTK?  On last week's press release, they specifically mentioned that they expects NEWP and Fulghum to generate positive cash flow and be self-sufficient from a liquidity perspective in 2017.  Thanks.