Description

Kaiser Group Holdings, Inc. (OTC BB: KGHI; recent share price $19.00) is a post bankruptcy liquidation play that should have a cash value of around $35 per share at the end of 2006. Catalysts exist that could drive this value to $40 to $45 per share.

Background and Description of Assets

KGHI used to be a moderately sized construction/industrial concern that filed Chapter 11 in early 2000. The company emerged in late 2000 and has been undergoing a slow process involving the sale of assets and the (continuing) resolution of bankruptcy claims. While KGHI’s most recent 10-K and 10-Q give a detailed description of the company’s remaining activities, I have provided a brief summary. KGHI’s activities consist of:

1. The ownership of a 50% interest in Kaiser-Hill Company (Kaiser-Hill), which serves as the general contractor at the U.S. Department of Energy’s Rocky Flats Environmental Technology Site near Denver, Colorado, for the closure of the site which formerly was used to produce nuclear weapons. The operating partner (and other 50% owner) of Kaiser-Hill is CH2M Hill, a 10,000 employee, private company based in Colorado. Check out www.rfets.gov for more information on this project.

Kaiser-Hill earns a fee for its performance under the contract, the size of which is driven by the overall cost to complete the contract and the time taken to do so. The fee is currently estimated by Kaiser-Hill to be $424 million, payable at the end of 2006. The maximum fee payable is $463 million. KGHI is entitled to 50% of the fee, which is its most significant asset. Important factors regarding the fee are:

a. The contract provides that Kaiser-Hill absorb certain non-reimbursable costs before distributions of the fee are made to KGHI. These costs are estimated to be 15% to 20% of the fee. At present, Kaiser-Hill receives quarterly distributions relating to the fee of $7.1 million. Non-reimbursable expenses are currently being deducted at a rate of 15.5% such that about $3 million (50% of the net) is remitted to KGHI.

b. 50% of the fee is payable upon completion of the contract. Net of the non-reimbursable expenses, I estimate this amount to be about $102 million for KGHI.

2. The closeout and resolution of a completed contract for the engineering and construction of a steel mini-mill for Nova Hut in the Czech Republic for which KGHI anticipates receiving $6 million within the next year or so (Nova Hut Claim).

3. The holding of an interest-bearing promissory note due in 2006 of $6.4 million from IFC Consulting Group, a division that the pre-bankruptcy KGHI sold in 1999 (IFC Note).

4. A wholly owned captive insurance company that is no longer issuing new policies and is simply involved in resolving remaining claims (Insurance Claims).

5. An ongoing obligation of about $7 million to fund a capped, post-employment medical benefit plans for a fixed group of retirees (OPEB Liability).

Capitalization Profile

KGHI has two publicly traded securities: KGHI’s common stock offers potential IRRs of over 20% from current levels while its preferred stock (which trades under the symbol KGHIP) offers returns of 8% to 10% for the more risk averse, although this return could increase should the preferred stock be redeemed prior to its stated redemption date, which is likely (at least, in part).

Recent common stock price $19.00
52 week range $2.00 to $21.50
Shares outstanding 1.6 million

Recent preferred stock price $50.00 (per $55 face amount)
52 week range $34.00 to $52.50
Shares outstanding 0.6 million (after recent redemption)

Significant (top 5) common owners (with estimated ownership positions)
Michael Tennenbaum (47%; also owns 6% of the preferred), James Bennett/Bennett Restructuring (14%; 17% of the preferred), John Hancock (5%), Pacholder (4%), Prudential (3%)
Management ownership NM

Equity market capitalization $30 million
Preferred stock $32 million
Debt $0 million
Cash and cash equivalents $18 million (estimated after preferred redemption)

Valuation Analysis

I believe the best way to analyze the value of KGHI is to perform a discounted cash flow analysis of the company’s assets and liabilities. The key elements of the analysis are:

1. One-time items - there are two significant payments to which KGHI is entitled:

a. The first is the final payment of the fee for the Department of Energy contract. Per the 10-Q, the total fee payable to Kaiser-Hill is anticipated to be $424 million payable at the end of 2006. After adjusting for non-reimbursable costs of 15.5% of the fee, payments to KGHI’s joint venture partner, and components of the fee that have been paid or will be paid prior to the final payment, I estimate that KGHI will receive a pretax payment of $102 million.

Given that this payment is KGHI’s most significant asset, I have assumed the company will be liquidated when the payment is received. Thus, by the end of 2006 the following transactions would take place:

i. KGHI’s share of the Kaiser-Hill final payment would be received.

ii. Taxes on this income would be paid.

iii. The OPEB Liability would be liquidated at its future value.

iv. All remaining bankruptcy claims would be settled for an amount equal to 25% of the amount of cash reserved for these claims per the most recent 10-K (this is consistent with the way such claims have been settled in the past).

v. All Insurance Claims would be settled for an amount equal to 50% of the amount of cash reserved for these claims per the most recent 10-K (also consistent with past performance).

vi. The company would collect on the IFC Note.

vii. All other working capital items, excluding cash, would be eliminated at their most recent 10-Q amounts.

Going through this process yields the receipt of approximately $56 million (after taxes) by KGHI at the end of 2006.

b. The second significant one-time item is the receipt of the Nova Hut Claim at its book value of $6 million, which I have assumed takes place at the end of 2004. Pursuant to the terms of KGHI’s preferred stock, I have assumed these proceeds are used to redeem a portion of this preferred stock.

2. KGHI also has recurring income and expense items as follows: The company receives quarterly distributions from Kaiser-Hill, interest on the IFC Note and interest on its cash balances. I estimate these add up to over $12 million per year. From these receipts, KGHI makes payments related to the OPEB Liability of about $1 million per year, operating expenses (I have assumed $3 million for the last half of 2003, $3 million in 2004 and $1.5 million in each of 2005 and 2006), taxes and dividends on the preferred stock. Adding the net cash flow from these items to KGHI’s existing cash balance yields a cash balance at the end of 2006 of about $29 million prior to the receipt of the $56 million from the one-time items above.

Adding these two items and subtracting about $29 million for redemption of KGHI’s remaining preferred stock (after the redemption from the Nova Hut Claim payment at the end of 2004) yields a cash value for KGHI’s equity at the end of 2006 of about $56 million or $35 per share. This represents an IRR of 21% assuming a purchase at $19 today.

Sensitivities

The following drive meaningful changes in value:

1. The size of the fee payable to Kaiser-Hill. For example, if you change the fee from $424 million to $463 million, the theoretical maximum, KGHI’s future value goes to $41 per share. Of course, any reduction in the fee also has an impact. However, I feel comfortable that KGHI should at least receive the currently expected fee for the following reasons: (a) I understand that work on the project has been proceeding well, and (b) Kaiser-Hill is discussing with the DOE the possibility of early payment of the portion of the fee that is being held back until completion of the project. KGHI is not big on press releases, so watch the 10-Q filings for changes in KGHI’s fee status.

2. The size of the Nova Hut Claim settlement – KGHI is actually owed more than $6 million – this is just the amount that KGHI believes is collectible. An additional $3 million from the Nova Hut Claim increases the future value of KGHI by about $2 per share.

Other less significant factors are:

1. The level of KGHI’s operating expenses – it is worth noting that this company has only 13 part-time employees and that most operating expenses relate to resolution of bankruptcy claims and the Nova Hut Claim. These expenses should decrease over time.

2. The amount of cash actually used to resolve bankruptcy claims, the Insurance Claim and the OPEB Liability.

3. Repurchases of preferred stock at a discount.

4. Any mechanism that reduces the amount of taxes the company pays – KGHI recently considered, but did not complete, a debt for preferred stock exchange offer that was motivated by the opportunity to reduce taxes.

Words of Caution

The principal risk of investing in KGHI relates to the completion of the Kaiser-Hill contract. Much of the riskier work, such as the removal of plutonium, has been completed. That being said, something unpleasant could happen.

Catalysts

1. The award of increased fees on the Kaiser-Hill project.
2. Favorable or early resolution of the Nova Hut Claim.
3. Early receipt of fees for the Kaiser-Hill project.

Catalyst

1. The award of increased fees on the Kaiser-Hill project.
2. Favorable or early resolution of the Nova Hut Claim.
3. Early receipt of fees for the Kaiser-Hill project.