ZINC - Horsehead Holding Corp

[supertutti]

My issue isn't as much with the market and long term pricing as it is with the cash position and the failure to continually fall short of expectations when it comes to the new plant. I understand falling short 1-2 quarters, but we are now at 6 or so of saying they will ramp up and fall short. Until they prove they are capable of getting the plant working as planned, I just can't commit to these guys. I was very lucky to buy at 7.50 and sell out at the last spoke at 9.50, but now even at 4ish I'm hesitant to get back in because nothing fundamentally has changed.

[cmlber]

Why is everyone assuming they need to raise equity?  Selling Zochem is much better for shareholders and easy to do.  At these prices, I would hope management is smart enough to sell a non-core asset rather than issue equity.  I asked the CFO how easy it would be to sell non-core assets in a worst case scenario earlier in the year and he said they could probably sell Zochem "in a quarter or two."  He even said to me they've always viewed Zochem as non-core (as opposed to Inmetco) because it isn't in the business of recycling waste.  Zochem EBITDA was $17.9mm in 2014.  At 5x EBITDA (a ridiculously low multiple given that there is almost no capex, hence EBITDA is pretty much pre-tax free cash flow) that would raise $90mm, plenty to get them through 2016 and early 2017, especially if they add $50mm in unsecured debt. 

 

According to analysts, CFO said a couple weeks ago that liquidity will be roughly unchanged through year end due to zinc hedges.  So at year end Horsehead will have $80m in liquidity. 

 

Let’s assume Horsehead gets to 70-75% by year-end, which I think is a fair base case.  Based on the CFO’s recent comments, they will be EBITDA break-even.  Cash burn if they stay at that level and zinc prices stay at this level all year would therefore be $35mm in interest plus lets say $45mm in capex for the year.  If they borrow another $50mm unsecured even at 20% interest (probably more like mid teens), that would result in cash burn in 2016 of $90mm (assuming 70-75% utilization and unchanged zinc prices through the year), leaving Horsehead with $40mm in liquidity at the end of 2016.  I think it’s highly likely that the plant is close to 100% and zinc prices are close to $1 by year end 2016.  If by the end of 2016, the market is valuing Horsehead based on fully operational FCF at $1 zinc, there would be ~$160mm EBITDA and ~$83mm in FCF, at 10x FCF that would be 3.5x this price. And that FCF is fully taxed, they probably won't pay taxes for a few years do to NOLs.

 

And if by the end of 2016 they still aren't at 100% or zinc prices are still this low, they at least should be in a position where they aren't burning cash and still have the Zochem option. 

 

[matts]

I asked the CFO how easy it would be to sell non-core assets in a worst case scenario earlier in the year and he said they could probably sell Zochem "in a quarter or two."   

 

Is that the same cfo that said the plant would be running at capacity six quarters ago? It amazes me that you would still put so much credibility into a statement by this management.

[cmlber]

I asked the CFO how easy it would be to sell non-core assets in a worst case scenario earlier in the year and he said they could probably sell Zochem "in a quarter or two."   

 

Is that the same cfo that said the plant would be running at capacity six quarters ago? It amazes me that you would still put so much credibility into a statement by this management.

 

First, what do you think is easier to predict, 1) how quickly you can sell a good business at a fair (or discount) price or 2) how quickly you can ramp a custom built $525mm metallurgical project?

 

Second, gut check that with logic, and does it seem right?  It's a very simple business to understand (buy zinc, process it, sell zinc oxide) that is not really effected by commodity prices because it's a spread business.  The due diligence and closing would be very quick, all that would take time is finding the right buyer. 

[RadMan24]

Again, you are more than compensated at this price for ramp up delays and zinc prices. Yes, production has to he north of 75% capacity to be profitable or breakeven I should say, but is that really a bad thing? Think about it. It's been a year and a half, by 2 years things will be getting better. If not, There will have been 6 monthly updates to explain why.

[BG2008]

Why is everyone assuming they need to raise equity?  Selling Zochem is much better for shareholders and easy to do.  At these prices, I would hope management is smart enough to sell a non-core asset rather than issue equity.  I asked the CFO how easy it would be to sell non-core assets in a worst case scenario earlier in the year and he said they could probably sell Zochem "in a quarter or two."  He even said to me they've always viewed Zochem as non-core (as opposed to Inmetco) because it isn't in the business of recycling waste.  Zochem EBITDA was $17.9mm in 2014.  At 5x EBITDA (a ridiculously low multiple given that there is almost no capex, hence EBITDA is pretty much pre-tax free cash flow) that would raise $90mm, plenty to get them through 2016 and early 2017, especially if they add $50mm in unsecured debt. 

 

According to analysts, CFO said a couple weeks ago that liquidity will be roughly unchanged through year end due to zinc hedges.  So at year end Horsehead will have $80m in liquidity. 

 

Let’s assume Horsehead gets to 70-75% by year-end, which I think is a fair base case.  Based on the CFO’s recent comments, they will be EBITDA break-even.  Cash burn if they stay at that level and zinc prices stay at this level all year would therefore be $35mm in interest plus lets say $45mm in capex for the year.  If they borrow another $50mm unsecured even at 20% interest (probably more like mid teens), that would result in cash burn in 2016 of $90mm (assuming 70-75% utilization and unchanged zinc prices through the year), leaving Horsehead with $40mm in liquidity at the end of 2016.  I think it’s highly likely that the plant is close to 100% and zinc prices are close to $1 by year end 2016.  If by the end of 2016, the market is valuing Horsehead based on fully operational FCF at $1 zinc, there would be ~$160mm EBITDA and ~$83mm in FCF, at 10x FCF that would be 3.5x this price. And that FCF is fully taxed, they probably won't pay taxes for a few years do to NOLs.

 

And if by the end of 2016 they still aren't at 100% or zinc prices are still this low, they at least should be in a position where they aren't burning cash and still have the Zochem option.

 

Full disclosure - I own married puts that expire in December.  My next trade is to either exercise the position and just get out of the trade or sell the puts and leave the longs on.  Slightly different dynamic for me than others who's in this from the teens.  Luckily for me, the ride down is not as painful and I'd like to think that I can be objective here.  In value investing, downside protection is very important and I often play out "Murphy's Law" in my head prior to taking a position.  It was that exercise that lead me to structure the trade with married puts rather than an outright long.  I asked myself "if the price went down, would I want to buy more."  Clearly the answer was "it depends."  That lead me to structure my trade the way that I did.   

 

I have provided my disclosure above to provided context and hopefully convince others that I'm being objective.  If "Murphy's Law" were to occur, I would say that selling non-core assets in this commodity sh*t storm may not be as easy as one thinks.  Yes, that was one of my exercises prior to putting the trade on.  When investing in commodities, one just have to accept the fact that crazy things can happen and we are witnessing "anything that can go wrong will go wrong" playing out right in front of our eyes.  I really do think that the "liquidity provider" in a massive market selloff is one who may get to buy Inmetco at 3x EBITDA.  The S&P has actually held up quite well despite the carnage in energy/commodities.  Imagine if the S&P were to sell off 20% from here and liquidity in general dries up.  I'll bet that the non-core assets' cash generation abilities are now stale and you have to add in multiple compression.  I don't think neither is easy when fear pervades the market, selling one of the ZINC's non-core assets or raising equity capital into an unforgiving market.  From my banking days, it takes at least 3-6 months (this is assuming you have a banker already and are actively soliciting buyers) to execute a sale of an asset.  If ZINC is not out there marketing the non-core assets as of 9/22/2015, cash may run out before then.  Hence, the liquidity issues maybe forcing their hands to raise equity.   

 

One bright spot is that ZINC did hedge 50% of its expected 2H production at $1.07.  At 30,000 hedged ton for the 2nd half, that could be about $13.2mm of cash profit assuming $0.85 per pound of zinc. 

   

Am I a buyer or seller at these prices (taking off the puts or exercising the puts), I'm neither.  If ZINC trades down to $2, I'll probably just sell my puts and leave the position on.  I would rather own ZINC at higher prices when they announce reaching 75% production rate. 

 

Good luck everyone. 

 

[cmakam]

I think at this point the best Horsehead can do is ramp up and pray that prices recover or at worst atleast hover around where they are.

 

If the ramp is delayed beyond December or if prices deteriorate sub 70-75 cents am not sure there is any breathing room absent a massive dilution.

 

The prices thrown around for Inmetco and Zochem assume the commodities are in demand, wouldn't the commodity carnage affect their earning power as well?

 

If Glencore is dumping a massive amount of Zn and there are sufficient paste tailing at other to be shutdown mines where marginal cost is very low,not sure what the demand driver might be to take prices up again.One way to think about it is Glencore supply from 2016 and beyond is dumped right now.It does seem like the market might have to feel a supply deficit before prices go up again.

 

Does anybody know the cost of production per lb for all the major producers?

 

-cmakam

[cmlber]

I think at this point the best Horsehead can do is ramp up and pray that prices recover or at worst atleast hover around where they are.

 

If the ramp is delayed beyond December or if prices deteriorate sub 70-75 cents am not sure there is any breathing room absent a massive dilution.

 

The prices thrown around for Inmetco and Zochem assume the commodities are in demand, wouldn't the commodity carnage affect their earning power as well?

 

If Glencore is dumping a massive amount of Zn and there are sufficient paste tailing at other to be shutdown mines where marginal cost is very low,not sure what the demand driver might be to take prices up again.One way to think about it is Glencore supply from 2016 and beyond is dumped right now.It does seem like the market might have to feel a supply deficit before prices go up again.

 

Does anybody know the cost of production per lb for all the major producers?

 

-cmakam

 

Zochem is barely affected by zinc prices.  It is a spread business!  There is zero commodity risk.  Zinc oxide is used primarily in tires.  Has anyone looked at US SAAR lately?  Zochem buys zinc at lme and sells zinc oxide at lme plus a premium.  That premium is affected by end market demand/supply for zinc oxide, not by supply/demand of zinc.  They are making roughly the same amount of money now as they were at $1.10 zinc prices.  With interest rates at 0% and steady free cash flow generation, it's an easy asset to sell.

[moody202]

Here's the response from Investor relations to a question I emailed them

 

********************************************************

I can assure you that we share your frustration and are working diligently to address the operational issues that have impeded the ramp up at Mooresboro.  We have identified a variety of projects designed to mitigate or eliminate the various bottlenecks identified, including the shortfall in capacity in the bleed treatment portion of the plant.  While some of the drop in stock price may be attributed to the delays in achieving meaningful progress on the ramp up, much likely can be attributed to the drop in zinc price over the past several weeks.  As you know, our stock price tends to follow the LME zinc price.  With respect to updates, we have been issuing updates on a monthly basis and will continue that practice by placing the updates on our web site beginning with the October update.

*********************************************************

 

My read -- clearly more blame on Zinc prices rather than taking accountability for the issues!

[nikhil25]

Here's the response from Investor relations to a question I emailed them

 

********************************************************

I can assure you that we share your frustration and are working diligently to address the operational issues that have impeded the ramp up at Mooresboro.  We have identified a variety of projects designed to mitigate or eliminate the various bottlenecks identified, including the shortfall in capacity in the bleed treatment portion of the plant.  While some of the drop in stock price may be attributed to the delays in achieving meaningful progress on the ramp up, much likely can be attributed to the drop in zinc price over the past several weeks.  As you know, our stock price tends to follow the LME zinc price.  With respect to updates, we have been issuing updates on a monthly basis and will continue that practice by placing the updates on our web site beginning with the October update.

*********************************************************

 

My read -- clearly more blame on Zinc prices rather than taking accountability for the issues!

 

I asked them a few questions as well and got the same exact response for the most part --- with this minor addition:

"Regarding liquidity, we have ~$50 million of unsecured debt capacity that we can try to issue if additional liquidity is necessary. Generally speaking, if liquidity beyond that must be considered, all options will be reviewed."

[beaufort]

Re sale of Zochem.

 

Immetco, Zochem, Horsehead and generally all assets are secured by a general security agreement, with cross guarantees.  The bond holders would have to agree to a sale of an asset in order for it to be effected.  Given that the bonds become less secure as a result of a losing a valuable asset, I would think that this would be a further wrinkle to raising cash from a Zochem sale.  This of course assumes that the Zochem cash raised would go to operating capital instead of debt repayment.  If there was a combination of debt repayment and operating capital usage, perhaps bond holders would be amenable to that scenario. 

 

In my discussion with the CFO at Pabrai's California meeting, he said that he expected he could get anywhere from 5-7 times earnings.  When we further discussed specific numbers, the CFO said Zochem could go for approximately 75-100 million.  This is not what would happen first in the event of a material drop in operating capital.  The first step would be to raise the 50 million in available debt.

 

 

[RadMan24]

Not too many people on here are optimistic. Doesn't that provide another layer of margin of safety?

[AzCactus]

Not too many people on here are optimistic. Doesn't that provide another layer of margin of safety?

 

I feel like much the same thing was said at $7-$8/share and since than investors have seen ~40-50% loss on paper. 

[JEast]

Well that escalated quickly.  I assume most now see this more binary than they did before.  Irrespective, it is getting closer to decision time where you make your money (initial investment/double down), or lose a lot.

 

Long-term favorable viewpoints:

 

• wide moat with long-term contracts on dust collection,

• leading environmental services company with new entry getting tougher,

• very difficult to replicate or displace existing footprint,

• probable significant cost advantages,

• long-term trends favorable for zinc prices,

• some even toss out the word compounder.

 

Skeptic viewpoints:

 

• minimills have been growing for some time, so how many more minimills can be placed in the southeast? Is this still a growth sector?

• most see ZINC as a commodities producer  -- well, because they are.  The service fees earned for dust removal are really just low cost feedstock versus mining the ore.

• does (or will) ZINC really have a major cost competitive advantages?  Glencore indicates their cash cost will be 43¢/lb in a year or two, so not that much different from the most optimal conditions at the new plant.  Estimate transportation cost advantage of an importer is maybe 2¢.

• for this new environmental company, why are two (2) plants in violation of environmental restrictions (maybe minor issues, but no reports to substantiate one way or the other), but not exactly where you want to be for the marketing program.

• oh, and then there is the debt – looks like more is coming, or equity raise, due to required cap ex for the redesigns and EPA remedies at other plants.

 

[mvalue]

Not too many people on here are optimistic. Doesn't that provide another layer of margin of safety?

 

 

ZINC has no margin of safety because there is a decent chance of the equity value being zero. Unfortunately they have a very inappropriate capital structure given the company characteristics, namely the combination of high sensitivity to a commodity price and a bet-the-farm project.

 

It could be a multi-bagger if it survives, but it's just as likely headed for bankruptcy. Others with deeper insight might be able to parse out the risk-reward and find it worth owning, but there isn't any margin of safety.

 

In the 08-09 pain ZINC and a few others were very appealing because they had high levels of net cash to ensure a long runway of survival in various scenarios and were priced far below the value of assets if they did survive to see a cyclical recovery. These kinds of stories and/or sum-of-the-parts theses mixed with leverage are often disastrous. Seahawk comes to mind.

 

If things get worse both creditors and management have as much incentive to go into bankruptcy as they do to allow/facilitate asset sales.

[finetrader]

This story seems to look similar to what happened to Fortress Paper.

[RadMan24]

Only if you think engineers can't fix the plant and creditors will want to sink the company and the assets of old are garbage. But to say the least, I disagree.

[undervalued]

Only if you think engineers can't fix the plant and creditors will want to sink the company and the assets of old are garbage. But to say the least, I disagree.

 

Thanks for summarizing that. I am only on page 32.

[cmlber]

Re sale of Zochem.

 

Immetco, Zochem, Horsehead and generally all assets are secured by a general security agreement, with cross guarantees.  The bond holders would have to agree to a sale of an asset in order for it to be effected.  Given that the bonds become less secure as a result of a losing a valuable asset, I would think that this would be a further wrinkle to raising cash from a Zochem sale.  This of course assumes that the Zochem cash raised would go to operating capital instead of debt repayment.  If there was a combination of debt repayment and operating capital usage, perhaps bond holders would be amenable to that scenario. 

 

In my discussion with the CFO at Pabrai's California meeting, he said that he expected he could get anywhere from 5-7 times earnings.  When we further discussed specific numbers, the CFO said Zochem could go for approximately 75-100 million.  This is not what would happen first in the event of a material drop in operating capital.  The first step would be to raise the 50 million in available debt.

 

If my reading of Section 4.11 Page 73 of the Senior Secured Indenture (pasted below) is correct (I'm not an expert, so if anyone disagrees please correct me), ZINC could sell Zochem without approval of the debt holders so long as it uses the proceeds for "a capital expenditure" and uses any excess proceeds to pay down debt.  Thus, I believe they could sell Zochem, use $45mm to pay for capex to support the ramp, and use the remainder to pay down debt, which should provide more room to issue more debt if necessary in the future as there will still be probably $450mm in asset value between the EAF recycling facilities and Inmetco (valuing Mooresboro at $0).  I agree though that this is 2nd to borrowing an additional $50mm in debt.  The point I was making is simply that this is far more likely to be Step 2, with an equity raise being Step 3.

 

4.11 Limitation on Sales of Assets and Subsidiary Stock.

 

(a) The Issuer shall not, and shall not permit any Restricted Subsidiary to, directly or indirectly, consummate any Asset Disposition unless:

 

(1) the Issuer or such Restricted Subsidiary receives consideration at least equal to the fair market value (such fair market value to be determined on the date of contractually agreeing to such Asset Disposition in good faith by an Officer of the Issuer or of such Restricted Subsidiary with responsibility for such transaction, or the Board of Directors if the Asset Disposition exceeds $20.0 million, which determination shall be conclusive evidence of compliance with this provision), of the equity and assets subject to such Asset Disposition;

 

(2) at least 75% of the consideration received by the Issuer or such Restricted Subsidiary is in the form of cash or Temporary Cash Investments, Additional Assets or any combination thereof (collectively, the “Cash Consideration”); and

 

(3) an amount equal to 100% of the Net Available Cash from such Asset Disposition is applied by the Issuer (or such Restricted Subsidiary, as the case may be), at its option:

 

(i) to the extent the property that is subject to such Asset Disposition constitutes ABL Facility Priority Shared Collateral, to repay or prepay Indebtedness under the ABL Credit Agreement within 365 days from the later of the date of such Asset Disposition or the receipt of such Net Available Cash, provided such prepayment or repayment permanently retires, or reduces the related loan commitment for, such Indebtedness in an amount equal to the principal amount so prepaid or repaid;

 

(ii) to the extent the property that is subject to such Asset Disposition constitutes INMETCO Collateral, to repay or prepay Indebtedness under the INMETCO Facility within 365 days from the later of the date of such Asset Disposition or the receipt of such Net Available Cash, provided such prepayment or repayment permanently retires, or reduces the related loan commitment for, such Indebtedness in an amount equal to the principal amount so prepaid or repaid;

 

(iii) to the extent the Issuer elects, to acquire Additional Assets in a Permitted Business within 365 days from the later of the date of such Asset Disposition or the receipt of such Net Available Cash;

 

(iv) to make a capital expenditure;

 

(v) to the extent the property that is subject to such Asset Disposition does not constitute Collateral, to repay Indebtedness and other Obligations of a Restricted Subsidiary of the Issuer that is not a Subsidiary Guarantor (other than Indebtedness owed to the Issuer or a Restricted Subsidiary of the Issuer);

 

(vi) to the extent the property that is subject to such Asset Disposition does not constitute Collateral, to repay (i) Indebtedness or other Obligations of the Issuer that rank pari passu with the Notes or (ii) Indebtedness and other Obligations of a Subsidiary Guarantor that rank pari passu with such Subsidiary Guarantor’s Subsidiary Guarantee (other than Indebtedness owed to the Issuer or a Restricted Subsidiary of the Issuer); provided that the Issuer shall equally and ratably redeem or repurchase the Notes pursuant to Section 3.01 hereof or by making an offer (in accordance with the procedures set forth in Section 4.11(b) hereof for an Asset Disposition Offer) to all holders to purchase the Notes at 100% of the principal amount thereof, plus accrued and unpaid interest, if any, to but not including the date of repayment; or

 

(vii) to make a combination of repayments and investments permitted by the foregoing clauses (i) through (vi).

 

Pending application of Net Available Cash pursuant to this Section 4.11(a)(3), such Net Available Cash may be invested in Temporary Cash Investments or applied to temporarily reduce revolving credit Indebtedness.

[abitofvalue]

Somewhat related to their debt - one thing that concerns me is their revolving debt is with Macquarie.  While Macquarie may be well respected in Asia, having some experience with US middle market debt my impression has been that MacQ is pretty much a joke in the US. You don't go to them unless you can't raise the funds with the big boys or with a specialized firm.  Also doesn't have the reputation for being client friendly so wouldn't count on them being willing to amend contracts without getting more than a pound of flesh. On the other hand, ZINC did manage to increase their borrowing base...

 

 

 

 

[abitofvalue]

Here's the response from Investor relations to a question I emailed them

 

********************************************************

I can assure you that we share your frustration and are working diligently to address the operational issues that have impeded the ramp up at Mooresboro.  We have identified a variety of projects designed to mitigate or eliminate the various bottlenecks identified, including the shortfall in capacity in the bleed treatment portion of the plant.  While some of the drop in stock price may be attributed to the delays in achieving meaningful progress on the ramp up, much likely can be attributed to the drop in zinc price over the past several weeks.  As you know, our stock price tends to follow the LME zinc price.  With respect to updates, we have been issuing updates on a monthly basis and will continue that practice by placing the updates on our web site beginning with the October update.

*********************************************************

 

My read -- clearly more blame on Zinc prices rather than taking accountability for the issues!

 

Not surprising; Management is going to quickly squander what little credibility it has. The monthly updates sound great in theory but they always seem to have identified new bottlenecks and projects to resolve them. At this point till they don't actually show some real increase in volume produced, I don't see how the stock recovers. In some ways if they can get issues resolved this year and volume up by Q1'16, the zinc price decline and selling of excess inventory may be a blessing in disguise - at least the zinc price is low while they aren't producing much and have hedges in place...  not really but just looking for the silver lining here.

 

Re: Pabrai - At this point if you were him, it almost makes more sense to wait for the equity raise or capital need arises at ZINC and get some kind of "Buffett" preferred investment return deal to be the liquidity provider. 

[NoCalledStrikes]

This story seems to look similar to what happened to Fortress Paper.

 

+1

 

Bingo! Market prices for the commodity changed while the plant was getting fixed. Double whammy. 

 

 

 

[tombgrt]

This story seems to look similar to what happened to Fortress Paper.

 

+1

 

Bingo! Market prices for the commodity changed while the plant was getting fixed. Double whammy. 

 

 

 

 

Basically what Liberty and I were alluding to on July 6th when the stock was more than double the current price....

[Green King]

This story seems to look similar to what happened to Fortress Paper.

 

+1

 

Bingo! Market prices for the commodity changed while the plant was getting fixed. Double whammy. 

 

 

 

 

Basically what Liberty and I were alluding to on July 6th when the stock was more than double the current price....

 

Did you buy out of the money puts ? something i wished i did if i had more experience with these things.

[tombgrt]

No I didn't and I'm in no way trying to say that I knew the stock was going to do what it did. I just recognized how similar the situations are before it lost even more of it's value. If commodity prices shot up they might have had more luck.