ZINC - Horsehead Holding Corp

[Homestead31]

there is certainly a risky case where you lose.  they are clearly having trouble with the new plant - if they get it fixed by the end of the year, you're fine.  if they have to do an equity raise to get it done, there will be alot of short term pain to come.  if they do an equity raise and still can't get it fixed, there could be future equity raises and BK to come, although i think that is extremely unlikely due to the value of the other businesses which could be sold off if necessary.

 

that being said, i am of the view that they will get it figured out... eventually.  i am not an engineer, nor have i been to the plant.  i'm just an optimist with faith in man's ingenuity. 

 

if figuring it out involves an equity raise, there is still likely 100% upside from here, although in the interim the stock will get crushed.  If it doesn't involve an equity raise, there could be 300 or 400% upside from here.  There is likely further upside in both scenarios b/c the engineers who have made the mistakes likely have some liability.

 

like alot of Pabrai's investments, the X factor is the ability to take short term and even medium term pain.  His ability is off the charts.  Mine is higher than most.  If you care about quarterly or even annual results, this probably isn't for you.  If you can look out ~3 years, I think the upside is substantial.

[ERICOPOLY]

if figuring it out involves an equity raise, there is still likely 100% upside from here, although in the interim the stock will get crushed.

 

What's the method of determining the price at which an equity raise would occur?  It would permanently devastate the current price if it happened at $1 per share, but I'm just pulling a scary number out of the sky in order to demonstrate a point. 

 

What is the rational method of determining what the price will be when/if the shares are diluted?

 

I find it pretty frightening when intrinsic value estimates are given in a situation where there is a real risk of a significant dilutive equity raise, because how do you know at what price that will happen and isn't that the primary driving force of the future intrinsic value per share?  It's very maddening to try to predict a future price of an equity raise that would be struck during perhaps maximum pessimism fear. 

 

It seems like IV calculations get relatively far more precise if you can get the risk of dilutive equity raises out of the equation.  Value investors who are facing a real chance of equity dilution are no longer able to simply discount cash flows into the future -- they have to also pinpoint the price at which dilutive equity raises occur.  Gets much harder because you have to rely on the prices that Mr. Market will pay in the dilution..

 

That all being said, why is the current price the right price for estimates of dilution?  Why not the price of a few months ago, or $3, or $2, etc...???  Any reasonably informed guesses? 

 

Sorry, I suppose I'm dissing too much on the ability to estimate IV when you have to also deal with an elevated risk of dilution at a price you don't know.

[cayale]

 

What's the method of determining the price at which an equity raise would occur?  It would permanently devastate the current price if it happened at $1 per share, but I'm just pulling a scary number out of the sky in order to demonstrate a point. 

 

What is the rational method of determining what the price will be when/if the shares are diluted?

 

I find it pretty frightening when intrinsic value estimates are given in a situation where there is a real risk of a significant dilutive equity raise, because how do you know at what price that will happen and isn't that the primary driving force of the future intrinsic value per share?  It's very maddening to try to predict a future price of an equity raise that would be struck during perhaps maximum pessimism fear. 

 

It seems like IV calculations get relatively far more precise if you can get the risk of dilutive equity raises out of the equation.  Value investors who are facing a real chance of equity dilution are no longer able to simply discount cash flows into the future -- they have to also pinpoint the price at which dilutive equity raises occur.  Gets much harder because you have to rely on the prices that Mr. Market will pay in the dilution..

 

That all being said, why is the current price the right price for estimates of dilution?  Why not the price of a few months ago, or $3, or $2, etc...???  Any reasonably informed guesses? 

 

Sorry, I suppose I'm dissing too much on the ability to estimate IV when you have to also deal with an elevated risk of dilution at a price you don't know.

 

Exactly.  And it seems managements always wait too long to pull the rip cord, thereby ensuring even greater dilution.

[prevalou]

dilution doesn't matter if you can put the cash for the capital increase. In 2008/2009, I didn't invest in Wells fargo because I was afraid of TARP dilution...

[ERICOPOLY]

dilution doesn't matter if you can put the cash for the capital increase. In 2008/2009, I didn't invest in Wells fargo because I was afraid of TARP dilution...

 

This is a fair point, however it still does matter a little bit.  You have to inject cash perhaps in order for the company to pay down debt, and you likely aren't getting a great return on that portion of the investment. 

 

So if you initially invested $10,000 at $10 per share thinking you had a 20% FCF yield, and then you had to invest another $5,000 at $5 per share in the dilutive equity raise that doubles the share count, you aren't getting 20% FCF yield on those extra shares -- you're just getting whatever they plow that cash into, like perhaps meeting a 7% coupon debt maturity obligation if they can't refinance existing debt. 

 

However you're right that it isn't anywhere near as damaging as having no cash left to invest in it and not being able to participate in the dilution.

 

It becomes perhaps 15.67% FCF yield on the entire $15,000 invested.  That's not as good as the initial 20% FCF you thought you had.

 

It declines to 14.96% FCF yield on the entire $15,000 invested if you apply a 30% tax rate to the 7% coupon bond.

 

EDIT:  Or you could restate it as the initial investment really happened at a roughly 10% FCF yield (whatever it really is after adjusting for the lower amount of debt) and the new investment happens at roughly 20% (again, after adjusting for the lower amount of debt).  I think the diluted FCF yield on the entire $15,000 remains the same.  I was phrasing it in a awkward way because I was thinking about where the new cash injected winds up -- this led me to explain it a bit funny.  Or perhaps this extra paragraph is wrong (or both) and I should just shut up  :)

[prevalou]

Thanks. There is an opportunity cost too, the cash could be spent for a better investment

[rishig]

there is certainly a risky case where you lose.  they are clearly having trouble with the new plant - if they get it fixed by the end of the year, you're fine.  if they have to do an equity raise to get it done, there will be alot of short term pain to come.  if they do an equity raise and still can't get it fixed, there could be future equity raises and BK to come, although i think that is extremely unlikely due to the value of the other businesses which could be sold off if necessary.

 

that being said, i am of the view that they will get it figured out... eventually.  i am not an engineer, nor have i been to the plant.  i'm just an optimist with faith in man's ingenuity. 

 

if figuring it out involves an equity raise, there is still likely 100% upside from here, although in the interim the stock will get crushed.  If it doesn't involve an equity raise, there could be 300 or 400% upside from here.  There is likely further upside in both scenarios b/c the engineers who have made the mistakes likely have some liability.

 

like alot of Pabrai's investments, the X factor is the ability to take short term and even medium term pain.  His ability is off the charts.  Mine is higher than most.  If you care about quarterly or even annual results, this probably isn't for you.  If you can look out ~3 years, I think the upside is substantial.

 

I think one must distinguish what a majority shareholder like Mr. Pabrai can make with his huge bankroll from what minority shareholders like you and me can make.

 

In case of distress, management may offer Mr. Pabrai a sweet deal (as preferred or some other security higher in the capital structure) in return for injecting liquidity at a much needed time. For minority shareholders investing today, in absence of ability to participate in the same securities, the current equity invested may get highly diluted.

 

In my opinion, the fairest way to raise equity is to do a rights offering, so any current minority shareholder also can buy into the dilutive shares. One must separate the moat of the business from the capital structure in my opinion. If I am an investor today, one has to confident that management is going to treat the minority shareholders fairly.

[cmlber]

there is certainly a risky case where you lose.  they are clearly having trouble with the new plant - if they get it fixed by the end of the year, you're fine.  if they have to do an equity raise to get it done, there will be alot of short term pain to come.  if they do an equity raise and still can't get it fixed, there could be future equity raises and BK to come, although i think that is extremely unlikely due to the value of the other businesses which could be sold off if necessary.

 

that being said, i am of the view that they will get it figured out... eventually.  i am not an engineer, nor have i been to the plant.  i'm just an optimist with faith in man's ingenuity. 

 

if figuring it out involves an equity raise, there is still likely 100% upside from here, although in the interim the stock will get crushed.  If it doesn't involve an equity raise, there could be 300 or 400% upside from here.  There is likely further upside in both scenarios b/c the engineers who have made the mistakes likely have some liability.

 

like alot of Pabrai's investments, the X factor is the ability to take short term and even medium term pain.  His ability is off the charts.  Mine is higher than most.  If you care about quarterly or even annual results, this probably isn't for you.  If you can look out ~3 years, I think the upside is substantial.

 

I think one must distinguish what a majority shareholder like Mr. Pabrai can make with his huge bankroll from what minority shareholders like you and me can make.

 

In case of distress, management may offer Mr. Pabrai a sweet deal (as preferred or some other security higher in the capital structure) in return for injecting liquidity at a much needed time. For minority shareholders investing today, in absence of ability to participate in the same securities, the current equity invested may get highly diluted.

 

In my opinion, the fairest way to raise equity is to do a rights offering, so any current minority shareholder also can buy into the dilutive shares. One must separate the moat of the business from the capital structure in my opinion. If I am an investor today, one has to confident that management is going to treat the minority shareholders fairly.

 

One thing I think a lot of investors on this board are overlooking is the value of the "Old Horsehead" assets.  The company considered just becoming a recycler and calcine producer as an alternative to building Mooresboro before moving forward with the project.  "Old Horsehead" is a real business generating real cash flow today that is being consumed by Mooresboro. If the company went bankrupt, the secured creditors could just get rid of Mooresboro for nothing or pennies on the dollar and would have the EAF recycling facilities and contracts which are very valuable and easily sellable assets.  Replacement cost for those is probably $275mm and the contracts are probably worth another $75mm.  Then INMETCO is easily worth $100mm, Zochem is easily worth $100mm, and the calcine kiln in Palmerton must be worth something... So you get maybe $550mm in asset value counting Mooresboro as nothing securing ~$250mm in debt.

 

Therefore, I think the debt is very secure and it should not be difficult to push out maturities if necessary for secured debt with a 10-12% coupon even if there is no progress in the ramp.  If it actually traded and wasn't a private placement, I'd love to own debt yielding 12% secured by a business with a very wide moat that I'd love to own and think is worth at least $550mm. 

 

So unless Mooresboro is still losing money in 2017 or zinc prices fall of a cliff (from this already low level) in 2016, an equity raise doesn’t seem likely given that the CFO has said they have the ability to borrow an additional $50mm for short term liquidity needs. 

 

[cayale]

dilution doesn't matter if you can put the cash for the capital increase. In 2008/2009, I didn't invest in Wells fargo because I was afraid of TARP dilution...

 

Wells Fargo didn't need the cash.  They were forced to take it.

[supertutti]

Continuing its steady decline and setting new lows. I think every day zinc prices stay at these levels, the future prospects of the company decline as well. They are burning through cash with no end in site for getting this plant working properly. I'm continuing to sit on the sideline until there is some indication they have gotten this figured out.

[stahleyp]

dilution doesn't matter if you can put the cash for the capital increase. In 2008/2009, I didn't invest in Wells fargo because I was afraid of TARP dilution...

 

Wells Fargo didn't need the cash.  They were forced to take it.

 

Did you (or anyone else outside of insiders) know that at the time?

[moody202]

Down another 10% today..couldn't find any news that would cause this new decline...anybody has insight?

[buylowersellhigh]

Down another 10% today..couldn't find any news that would cause this new decline...anybody has insight?

 

I think it is due to concerns of Glencore selling inventories to pay down debt, thus further reducing prices for zinc.

[BG2008]

Zinc now trades at 75 cents.  The 60 day price chart is not pretty

 

http://www.kitcometals.com/charts/Zinc.html

 

http://www.kitcometals.com/charts/zinc_historical.html

 

Long term, the value of ZINC is tied to the long term price of zinc metal which can vary greatly.  But if price do stay here, the economic of owning ZINC is quite different. 

[undervalued]

Zinc now trades at 75 cents.  The 60 day price chart is not pretty

 

http://www.kitcometals.com/charts/Zinc.html

 

http://www.kitcometals.com/charts/zinc_historical.html

 

Long term, the value of ZINC is tied to the long term price of zinc metal which can vary greatly.  But if price do stay here, the economic of owning ZINC is quite different. 

 

Why does the 60 days LME chart vs spot vary so much? One is trending up and the other is trending down.

 

Ah n/m just realized that's LME Warehouse stock chart. So inventory is increasing and price is decreasing.

 

 

Link to the article about Glencore selling zinc http://www.reuters.com/article/2015/09/18/zinc-glencore-inventories-idUSL5N11O1AV20150918

 

The heavy flow of inventories is dampening the impact of the closure of big mines this year, which had been expected to tighten the supply balance and create a deficit.

 

This year, China-owned MMG is closing its Century Mine in Australia while Vedanta Resources is shutting down its Lisheen Mine in Ireland.

[RadMan24]

You and the herd alike.

[supertutti]

The freefall continues. At this point, I have no idea how to even value the company. Anyone have any ideas? Or is it just trying to catch a falling knife now?

 

I have also not seen any news or purchases/sales, or any word from Pabrai or the company. To me, the silence is deafening.

[TREVNI]

The company posted on its website a presentation from September 17.  Here's an interesting bullet:

 

"If zinc prices continue at current levels into 2016 and Mooresboro continues to ramp up slowly, we would need to add more liquidity"

 

Link to the presentation: http://horsehead.net/corporate_information.php

[KCLarkin]

At this point, I have no idea how to even value the company.

 

This is an interesting case study in "reflexivity". As ZINC drops, the dilution from the inevitable equity raise increases. Further reducing the value of ZINC.

[Picasso]

Mohnish is adding some ZINC to his portfolio:

http://www.dataroma.com/m/holdings.php?m=PI

 

Brave man, doesn't look like he's coat tailing anyone…

 

Long-term owner and more than doubling the position, so maybe he sees a catalyst:

http://www.dataroma.com/m/hist/hist.php?f=PI&s=ZINC

 

"Dan Moore on Why Horsehead Holding (ZINC) Represents a Compelling Investment Opportunity":

 

My messy notes from the video:

- $15 price target

- very well-run company

- major competitive advantages

- wide moat

- off the radar screen

- not well understood by institutional investors

- most see ZINC as a commodities producer

- we see it as a leading environmental services company that provides critical value-added services to its customers

- extremely difficult to displace

- double or triple EBITDA in 12-18 months based on Zinc prices

- business is a bit complicated

- James Hensler and CFO are aggressive, opportunistic, conservative

- long-term contracts

- strong environmental track record

- significant cost advantages

- closed-loop business

- long-term trends favorable for zinc prices

- serving minimill customers in a growing market

- $350+ million investment in a new Zinc refinery

- $50-70 million EBITDA now. $150-200 million by 2014. Doesn't include Zinc price inflation. Would be trading at 2.5 EBITDA.

- highly levered towards inflation

- net-net Zinc is paid for removing EAF-dust, but in some cases they pay for EAF-dust.

- net cash position ($180 million)

- constructing new Zinc plant in NC

 

Looking back at the original thesis, seems like it somewhat played out and he should have cashed in and walked away.

 

Now there is no net cash but instead a lot of stock dilution, price of zinc going down the toilet, no EBITDA, depending on the capital raise it's probably trading for 4x the $150-200mm estimate, and most importantly EBITDA did not double or triple in 12-18 months. 

 

This is a completely different stock now.  You really have to throw everything you thought you knew out the window and look at it from a fresh set of eyes.  Only two years went by but wow did a lot of things change.

[TREVNI]

My analysis of the situation is as follows:

 

What I think we have here is a confluence of negative factors weighing very heavily on the stock price.

 

1. General stock market uneasiness - Who cares? Macro forecasting is not my bailiwick. 

 

2. General commodity market weakness - Oil, metals, other commodity weakness is a negative sentiment in the market that cannot be denied.  How much use is it to investors, I'm not sure and I don't really care.

 

3. Zinc-specific weakness - The announcement that a major supplier can/will be dumping inventory is obviously relevant.  However, what is the long-term impact of this?  Well, it will temporarily increase zinc stocks.  It will also cause a longer-term decrease in available stock if an ongoing deficit persists.  The company also states that it has hedged its output through 2H 2015.  (Full or partial I'm not sure.)  They have puts north of $1.00 which will obviously temper the decline in spot prices.  This can only go on so long, however.

 

4. Company (read: ZINC) specific operating issues - The Mooresboro plant.  Can they / will they get the plant operational?  This I'm fairly optimistic on this point as its simply a matter of engineering out the problems.  This is a newer technology, but it's not brand new.  The timing of the ramp to full capacity could take more time than people think.

 

5. ZINC capitalization structure issues - The company has taken on debt to fund the new plant, and because of ramp-up issues has had to dilute equity to raise additional funds.  This is a real risk that cannot be discounted.  Especially seeing as the company has said in its presentation that it could face liquidity issues.

 

6. ZINC shareholder weariness - We know that the buy-on-weakness-because-it's-what-value-investors-do crowd has its limits.  People eventually capitulate, especially those who haven't done their own or thorough due diligence.  This could and probably is exacerbating the above factors. 

 

Bottom line: Is the current market cap of +/-$250 million a steep enough discount to warrant a rational risk / return tradeoff?

 

[TREVNI]

I thought I'd post this separately. In my last post I posed the question: "Bottom line: Is the current market cap of +/-$250 million a steep enough discount to warrant a rational risk / return tradeoff?"

 

Today you're paying $4.50/share in the market for a company that has 56.6 million shares.  That equals $254.7 --> $250 million market cap.  Add +/- $400 million in debt and you have an enterprise value of somewhere around $650 million.  Let's assume that the company needs to issue additional shares.  For simplicity sake let's assume they issue 43.4 million shares, bringing the total to 100 million shares.  We'll also assume that they issue them at $2.50/share and that that $108.5 million (43.4 x $2.50) goes right out the window in operating losses and interest carry.  How much are you really paying today, assuming the dilution occurs? [Putting on the owner's cap] You had owned 100% of a $250 million company; now you own 56.6/100 or 56.6% of a $250 million company; that's $141.5 million, a decrease of 43.4%.  That means you paid a 250/141.5 = 76.7% premium by buying at $250 million with full knowledge of dilution.  So you really valued the company at $250 million x 1.767 (+76.7%) = $441.75 million.  Add in the $400 million debt and that's around $850 million in enterprise value. 

 

So if you were thinking of buying the shares at $7.80/share (market cap of equity of $441.75 million on 56.6 million shares) you should be indifferent to a purchase price of $4.50/share assuming a dilutive raise to 100 million shares is going to happen. 

 

This is a smart board, and I'm an error-making human being, what have I missed here?

[valueyoda]

I already said it months ago that the halo effect is so strong with ZINC because of Pabrai's involvement. Now the stock has decreased from $12 to $4, and it is still hard to make a strong bull case, even though it is probably a lot closer to a bottom. One could argue that Posco and Freeport McMoran are both value traps with a big hallo effect on top of it. Investors underestimate the cumulative force that China had on the capacity build out of most commodity and steel producers in the last 15 years, and the reverse effect that China's down turn will have in the next 5 years.

[undervalued]

The fact that the low cost producer always wins over time in commodities b/c the best cure for low prices is...  low prices.

 

Low cost producer always wins provided it has the balance sheet to withstand the pain of low prices in the interim. Otherwise, the business survives like you said but not with the same owners. The debt owners become the new owners of the business in the meantime.

 

 

you are of course correct. 

 

however, once again putting myself in Pabrai's head, there are some pattern recognition bells going off in my head.  In Dhando Investor Pabria briefly talks about Tesoro, and if you dig around a bit on the web you can find the full story.  The short version is that Pabrai bought TSO around $7-8 per share because the market was fixated on the company's problems with debt.  The stock traded down to $1 as the market harped on bankruptcy risk due to the debt.  Pabrai held firm however b/c he believed that management could easily sell off assets such as a non core refinery if they needed cash to cover the debt.  Eventually the stock rallied as oil stabilized and the bankruptcy fears passed.  Pabrai sold out a year later for a 100% gain.

 

with that story in mind, i suggest re-reading the post on this thread on July 11th by AlexBossert in which he details the value of  Inmetco - a non core business that could be easily sold by ZINC if they had real problems with their debt.  I agree with Alex's position that Inmetco alone is likely worth $200 + million, which goes along way toward reducing the risk around the debt in an emergency situation.

 

however, it should of course be noted that Pabrai has proved several times that he is not afraid to ride his ideas to $0, so nothing here is certain.  From my vantage point however, the risk reward for an investment in ZINC is favorable.

 

Homestead you bring up a valuable point. While many investors are lamenting management over the current situation, let's look at a piece of their track-record. Specifically, they bought Inmetco for $34 million in 2009. It earned $14 million pretax in 2014 and about $10 million in 2013, $13 million in 2012, excluding insurance benefits. Capex requirements $1-3 million, depending on expansion plans. $1 million high end of maintenance capex. I'd say that is a fairly strong return on capital, wouldn't you?

 

Zochem, including initial purchase price and investments to date, have totaled $32 million. The segment produced pretax income of  $13.5, $8, $3.5 million in 2014, 2013, 2012, respectively. Again, pretty good returns if you ask me, purchase was made in 2011.

 

Pretax income from these two segments is down about $3-4 million pretax thus far in 2015.

 

Let's say Horsehead gets in a bind, they can easily fetch $140 million for Inmetco (other estimates do reach $200 million). Worse case, Inmetco is sold and used to pay down/refinance secured loan and other outstanding debt in 2017. Worse case--as in you really want he company to keep this business, but to save your investment you don't mind seeing it go. 

 

By and large, if this plant isn't up and running by 2017 I would be disappointed. But the risk/reward is well worth it.

 

Anyone adding more or did everyone sell out? MoS has increase because of lower price, no? Averaging down?

[500pages]

So if you were thinking of buying the shares at $7.80/share (market cap of equity of $441.75 million on 56.6 million shares) you should be indifferent to a purchase price of $4.50/share assuming a dilutive raise to 100 million shares is going to happen. 

 

So if you were thinking of buying the shares at $7.80/share (market cap of equity of $441.75 million on 56.6 million shares) you should be indifferent to a purchase price of $4.50/share assuming a dilutive raise to 100 million shares is going to happen. 

 

Assuming the non-core Inmetco and Zochem businesses can indeed be sold for 140m + 100m, getting within ballpark of fair price (of however good they are) seems like much better capital management than near-confiscatory dilution scenario of raising ~$100m at $2.50. After all, equity issue as outlined above is similar to selling a share of the entire business, getting ~100m for roughly half of Inmetco, Zochem, and the core business.

My impression is that mgmt would issue equity, even on very bad terms, but only if more attractive options (junk debt, and maybe non-core asset sale) were not available.

 

As others have noted, I also fail to see how Glencore zinc dump is negative long-term news. Current zinc prices render an awful lot of zinc production uneconomical, and presumably put a solid damper on any investments on future supply increase -- would you, currently, fund a mine expansion to get more zinc out out the ground?

Negative short-term news which is neutral to positive longer term is alright with me.

 

So what are the new wrinkles, given the new price and new developments?

- Realistically, when a stock gets this cheap relative to its earning power, there's a danger of some sort of going-private or takeover transaction, where OPMI get a premium on current price, but do not experience full upside.

- Issue of the kind of convertible debt (coupon + warrant) that Buffett likes to get would be dilutive, but would only dampen, not eliminate upside

- Is there really some dramatic secular slowdown of zinc consumption by China? Combined with production increase, for maximum pain. This is pure and fuzzy speculation, but it seems like stimulating slowing economy in China might actually prop up zinc consumption. It would indeed be odd to prop up China's expensive and presumably polluting production given the low world prices. Going back to the cost curve, the way the numbers stack up, it seems difficult (to me) to lose money on ZINC without a lot of miners (and maybe smelters) going out of business first.

 

Disclosure: very long ZINC, thanks to buying more at 6, 5, 4/sh...