Gentek is a post-reorganization equity that trades at roughly 3.5-4x free cashflow. It exists in a self-imposed information vacuum that will be removed in the first quarter of 2006 during its first analyst day as a recapitalized company.
Gentek is a manufacturing and chemical company that emerged from bankruptcy in late 2003. It sold its communications division in May of 2004 and paid out the proceeds in a $7 dividend. It then retained Goldman to explore strategic alternatives in November of 2004, and decided to re-lever the balance sheet and pay out a $31 special dividend in March of 2005.
The stock traded at $48 before the dividend was paid, dropping to $18 when it went ex-dividend. It then proceeded to drift downwards to the $10 level as a new CEO was appointed in May. Evidently, investors were holding the stock to participate in the dividend, and were not convinced of the continuing merits of the investment after they had received their cash. They also did not appreciate the value-enhancing effects of the appropriate amount of leverage. The stock rebounded after a robust second quarter, where savvy investors, including Jeff Gendell, bought shares.
The company currently has two lines of business. The manufacturing division makes engineered components and wire harnesses for appliance, automotive, and industrial end markets. It consists of Balcrank (lubrication equipment for automotive dealerships), Defiance (specialty bearings and components for engines), Noma (wire and harnesses for automotive and appliances), and Toledo (precision components). The automotive end market has been somewhat soft, and it is reasonable to expect further softening. It is important to note though that recent appliance manufacturers have reported healthy volumes despite weakening margins, and that should the Whirlpool/Maytag deal go through, Gentek would be a beneficiary. Overall, this division was tepid end markets but substantial room for cost cutting and manufacturing efficiencies.
The chemical division (mostly the old General Chemical) serves the personal care, environmental, and semiconductor end markets. The largest business is sulphur services for refineries, where they are paid on a volumetric basis to regenerate the suphuric acid that is contaminated during the refining process. This business is stable and/or growing, as most refineries are running as full and as sour as they can. The next largest business is water treatment chemicals. As water purity is increasingly scrutinized, and as competing synthetic chemicals for water purification are petroleum derived (and thus more expensive), this business also has a bright future. The third main business is ultra-high purity sulfuric acid for etching silicon wafers. From my channel checks, they have an excellent reputation in this area, which should grow with the economy. The remaining business are ingredients for deodorants and antacids, preservatives for hot dogs, and poultry sanitation chemicals, all of which seem like pretty stable businesses to me. The manufacturing footprint has been largely rationalized over the last few years and the remaining plants are not in any danger of obsolescence.
Run-rate EBITDA is roughly $100m. The manufacturing division provides roughly 40% of the EBITDA, with automotive being under half of this. The company is relatively highly leveraged, though I would argue that the leverage is appropriate. It carries $360m of net debt, including its underfunded pension (which does not require cash contributions until 2008), pro forma for a small real estate sale and all warrant proceeds. However, EBITDA/interest is very manageable at 4.5x.
The opportunity here lies in aggressive, financially-motivated management. Bill Redmond started as CEO in May of 2005 and immediately started sending out pink sheets and closing redundant facilities. He accelerated the process of moving manufacturing from Canada to Mexico and is ramping up a facility in India. I estimate that these actions will contribute $8m to ebitda on a run-rate basis ($2m from facility closures, $3m from salary, and $3m from production efficiencies), with more to come. I believe his employment contract only runs through 2006, so he will likely demonstrate results sooner rather than later. Redmond seemed pretty confident on the second quarter call (transcript available on the website):
Question: OK. And I know that there are initiatives that you laid out in terms of projects with large potential savings, and you spoke about that on the call. Today it might be early, but where are you relative to what you expected to save (or) those initiatives? Do you feel you're on target?
William Redmond: Ahead of target.
Question: You're ahead of target by – in a material way or just ahead of target and – because you're conservative in developing your target?
William Redmond: Ahead of target and I think a lot more good news to come.
Insider buying has been widespread, as Redmond forced the top 34 executives to purchase stock on the open market in order to qualify for the restricted share portion of their incentive plans (on a share for share basis). I would consider this buying to be a generally positive sign in that management’s incentives are aligned, but it is obviously heavily subsidized.
Gentek has generated $22m in free cash in the last 6 months. It may be unrealistic to expect this rate to be sustained, though one could make the argument that the cost-cutting measures have just started to take effect and this number is actually understated. I assume the current EBITDA run-rate plus modest and identified cost savings in the following analysis:
Without warrants With warrants
EBITDA 110 m 110 m
Interest 26 m 20 m
Tax 14 m 17 m
Maintenance Capex 30 m 30 m
Free Cashflow 40 m 43 m
Equity Market Cap 141 m 184 m
FCF yield 28 % 23 %
As the company has paid down its term loan by $3m in each of the last 3 months, these estimates are certainly feasible. In addition, all recent data points that I have been able to gather have shown positive business momentum, though admittedly there is not much information available.
There are roughly 3m warrants outstanding, with strike prices of $20 and $22. Recently, Abrams Capital tendered for all of them at $4.25-4.75, which seemed to rekindle some interest in the stock. I believe Abrams Capital is a high-quality investor and these warrants will prove to be better investments than the common stock, though the liquidity is more limited. Obviously, they believe the shares are worth more than $27, as this is their breakeven point.
Disclaimer: I own shares of GETI. I may buy or sell these shares at any time without notice. The information contained in this write-up is believed to be correct, but I undertake no obligation to update the write-up if new information arises at a future date.
3Q05 earnings in the second week of November
Analyst day in March, 2006
Continuing paydown of term loan on a monthly basis