Description

OCI has been a popular name on VIC with three write-ups since 2017. 

The last write-up by zzz007 in January 2024 was already written after the company started its “solvent liquidation process”. However, we believe that, given recent developments, it is worth updating the story and current economics (which remains very interesting in our opinion).

Most importantly, however, we want to also present a credit investment idea which we have not seen discussed so far.

We will split this post into different sections for ease of reading (particularly for the readers who are up to speed on the name and familiar with the equity thesis and would like to skip to the credit part):

A. Latest updates on OCI and PF capital structure;

B. Equity Thesis;

C. Credit Thesis;

A. Latest updates on OCI and capital structure:

A1. Disposal announcements (summary):

• Over the last 10 months, OCI announced over 4 separate transactions the disposal of all its businesses except for European nitrogen.

  • Disposal of the 50% Fertiglobe stake to ADNOC for $3.6bn (Dec’23)

  • Disposal of IFCO to Koch for $3.6bn (Dec’23)

  • Disposal of the US Blue Ammonia Plant to Woodside Energy Group for $2.35bn (Aug’24). OCI will keep the obligation to deliver a fully operational plant (expected by Jun’25) and will need to incur the remaining CAPEX (likely exceeding $700m)

  • Disposal of the methanol business to Methanex for a headline EV of $2.05bn (Sep’24).

• All these transactions have been done for good valuations that showcase the recent disconnect in share price compared with the SOTP valuation.

• As of today only the IFCO disposal has closed. OCI expects to close the Fertiglobe and the US Blue Ammonia plant in H2’24 and the disposal of the methanol business in H1’25 (the natgasoline part is still contingent on the resolution of a legal dispute).

• We expect net disposal proceeds from those 4 transactions to be ~$9.25bn (plus a 13% stake in Methanex worth ~$370). Of that, ~$8bn should be received in 2024 and the balance in H1’25).

A2. Updated capital structure:

• Adjusting for the ~$9.25bn of net cash proceeds to be received, OCI optically would have a net cash position of $7.05bn (net debt of ~$6.2bn) and a negative EV of ~$-750m (market cap of ~$6.3bn).

• The above figure, however, does not include the large cash burn still ahead (particularly in CAPEX to finish the US plant). Adjusted for that, we believe that OCI trades for a PF EV slightly >0 (for a company that will still own the European nitrogen business and the 13% stake in Methanex).

• From a deleveraging perspective (gross debt), OCI will repay half of its net debt by YE’24 (already announced) leaving the gross debt at $1.1bn. We believe that OCI will want to further reduce this balance (as it is too high for the size of the remaining businesses).

A3.  Distributions to shareholders / debt repayments:

• OCI has communicated that it expects to distribute ~$3.4bn (€14.55/share) to shareholders by Nov’24 (after the Fertiglobe transaction closes). These distributions will be made through a capital repayment (to avoid tax leakage). However, in its latest call,  management communicated that there would be no more room for this type of distribution (creating concerns over the tax-efficiency of future distributions). In our opinion, this was the main reason behind the almost -5% decline in share price after the call.

• From its two first disposals (IFCO + Fertiglobe), we expect that OCI have excess cash of >$1.25bn. This is after the $1.1bn of already announced debt repayments, the $3.4bn distribution to shareholders, and the purchase of methanol minorities (est. at ~$300m). The amount of excess cash will likely be >$2bn by year-end 2024 (after receiving the first tranche of the US plant disposal and fully adjusting that for remaining CAPEX).

• As such, we expect that OCI will communicate during Q4’24 (likely during its Q3 results in Nov’24) its plans for further capital returns (both quantum and how it will do that). We believe that a second installment of capital return could be done before Mar’25 (potentially still in 2024). The company may also choose to provide more disclosure regarding its plans for debt repayment.

• Once the methanol transaction closes in H1’25 and OCI receives the second tranche for the US plant (after delivering it operational), OCI should receive a further ~$1.2bn in net proceeds.

• As a result of the methanol transaction, OCI will receive a ~13% stake in Methanex (initially worth ~$450m, but with a current market value of $~370m). OCI has a lock-up on the shares of 4 months. It is unclear what OCI intends to do with the shares but we believe that it would make sense to distribute them directly to shareholders (this could also remove part of the overhang on Methanex which, in our view, caused the shares to decline by >17% with the transaction announcement).

• Finally (and already touching on the next section), a final distribution to shareholders could be done once the last business (European nitrogen) is sold.

• All included we expect OCI’s shareholders to receive their capital back with a weighted average time of 6-8 months (heavily skewed by the first distribution of >50% in less than 2 months).

A4. Going forward:

• We expect OCI to continue disposing of its last assets and fully liquidate. Management may be able to achieve this still in 2025 as it only has two assets remaining: i) the European nitrogen business (which is likely the hardest asset to sell given its current profitability) and ii) the stake in Methanex (which we think could be distributed directly to shareholders). OCI also has an earn-out on Fertiglobe covering the period of 2024-2025.

B. Equity thesis:

B1. Thesis summary:

• We estimate that PF for the disposals announced net disposal proceeds (adjusting for net debt and expected cash burn) are €26.1 to €26.6 per share which are just 1-3% below the current share price. 

• Besides those proceeds, the company still retains its stake in Methanex (worth €1.6-2.0 per share) and the European nitrogen business (€2.8-4.5/share).

• While the absolute discount to fair value is not very high (likely 10-20%) we believe that the margin of safety is very significant (given net disposal proceeds) and the cash will be distributed quickly (on average 6-8 months).

• Gross of potential taxes (see below on main risks) we expect this situation to have an IRR of >25% (likely still >10% even with full tax leakage).

B2. Sum-of-the-parts (below):

B3. IRR sensitivity (gross of taxes):

B4. Main risks:

• OCI not being able to distribute the cash in a tax-efficient way.

• Failure to close on recently announced disposal transactions.

• Significant cash burn, particularly driven by the US plant (e.g. large delays or even higher over-run). This is a real possibility and we tried to account for it by adding some extra buffer in our SOTP (of course could be higher).

• Significant delays in selling the EU nitrogen business (double impact of cash burn and impact on IRR of a longer time to liquidate). Given the relatively small size of the final distribution, the IRR is not very sensitive to its timing.

• The company not selling its remaining assets (and potentially even using the cash proceeds to buy new ones). We believe this is a low probability risk (even though it would be high impact).

C. Credit thesis:

C1. Opportunity and returns:

• The OCI 6.7% 2033 bond trades at 106.8% which is a 5.6% YTW (200bps spread). The bond has no par call until 2032. As a result, an early redemption would need to be done at the make-whole call price (+45bps spread).

• The make-whole call price is ~8-10pts above the current price (depending on when it is done). This call premium + the coupon would result in an 11-16% return if the bond is called in 2025 (with a >12% IRR). If that happens before H2’25 the IRR is 18-45%.

• As detailed above we expect OCI to continue progressing towards a full liquidation and believe this will likely be completed by the end of 2025 (potentially 2026). For the reasons discussed above, we think there is a good probability that this bond will be repaid before the end of this process (likely in the next 10 months).

C2. OCI’s liquidity/ability to repay the bond:

• After closing the disposals of IFCO and Fertiglobe, OCI will have >$1.25bn of excess cash and that amount will increase to >$2bn by year-end (see point A3 above). 

• We expect OCI to communicate during Q4’24 its plan to return that cash to shareholders and also potentially how it will address its 2033 bond maturity (which will be the last bond outstanding). The bond is $600m and could be paid from excess cash starting in Q4’24.

C3. Main reasons to call the bond

• Once the company is sitting on a large cash position, the 6.7% coupon becomes a drag on cash generation (higher rate than the one received on cash balance).

• Although it would make sense to keep some debt in the business (and had indicated it wanted to do so), our view is that the amount of debt kept should be proportional to the size of the continuing business. At $600m this bond would be too big to be supported by just the European nitrogen business.

• The bond has a covenant (very standard for IG bonds) preventing the company from selling “all or substantially all of its assets”, which is meant to prevent shareholders from emptying a company of its assets (which provide coverage/recovery) for the bond.

  • In our view, the language in these covenants is generally very vague/weak (for e.g. there is no definition of  “substantially all”) and, as a result, the bar for enforcing them is high. However, we think that in this case the almost full liquidation of OCI significantly strengthens the legal argument (particularly after the methanol disposal closed in H1’25). We believe bondholders will put pressure on the company.

  • The company has tried to avoid discussing this issue on calls but has so far said that they believe this covenant would not be triggered. We think that it is very ambiguous and note that they are incentivized to downplay the matter (particularly if they intend to do a tender as we discuss below).

  • We have seen other cases in the past where this discussion took place (e.g. the Solvay spit in 2023). In this case the company initially took the view that it did not have to repay the bonds (and communicated that it would not) but after receiving pressure from bondholders called the bonds at make-whole in Q4’23. To note that in this case “only” 55% of EBITDA was being spun-off (so it was considerably harder to make the case for “substantially all”).

  • In other past cases there was also the difference that those entities were not fully liquidating (i.e. the plan was to continue existing past the maturity of the bonds in question). This means that in those cases there was a bigger incentive/advantage for the company to keep the bonds and avoid paying the make-whole call. In OCI’s case, one could make the argument that, if the plan is to fully liquidate, the bond will in any case need to be repaid prior to maturity (with the make-whole premium) and, as a result, delaying it by a few quarters is not worth the legal risk / dispute.

C4. An intermediate step: the case for a tender

• Although OCI may choose to just call the bond, we believe there is a high probability that they introduce an intermediate step - a tender - to save on costs. We think this is consistent with their most recent communications on the matter and believe it could be announced as soon as Q4’24.

• This tender should be done at a premium to the current price (but still lower than make-whole) and could save OCI up to $60m (more likely $20-30m). 

• Although we think that the tender price will have a premium over the current price, it would likely be a non-optimal outcome. The introduction of this step could reduce some of the timing pressure to call the bond earlier (particularly if they get a high participation). Significantly reducing the size of the bond will result the drag of interest paid and may leave the size of the bond outstanding more appropriate to the size of the remaining business. This could also weaken the legal argument around the covenant (although we don’t think it would).

C5. IRR sensitivity:

C6. Bond fair value (if not called) / Downside Scenarios:

• This exercise borders a bit on divination given all the moving parts and the amount of uncertainty regarding the PF capital structure (disposals, size of distributions, any potential acquisitions, etc).

• Just from the disposal of IFCO (already closed) the company will repay ~50% of its gross debt ($1.1bn) and be in a net cash position (even after fully reserving for the cash needed to finish the US plant).

• In its Q3 results, OCI said that it expected to finish the year in a net cash position (after the other transaction proceeds expected in H2’24 and the $3.4bn distribution).

• As OCI continues to proceed with its liquidation, we expect the company to keep a net cash / low net debt position (great from a bondholder perspective). The main risk for the bondholders would be if OCI decides to interrupt its liquidation (and/or re-launches the company through acquisitions).

• OCI has expressed commitment to keeping its investment grade rating (currently BBB-).

• The most comparable credits in the chemicals space (Celenase and Huntsman, which are also BBB-) trade at 165-175bps (inside of OCI’s current spread of 200bps). 

• Still within the chemicals space, but looking one notch below in the high-yield universe: Olin (BB+) trades at 220bps and Methanex (BB+) trades at 240/260bps (2029/2044 maturity).

• Below is the sensitivity of price / return and IRR by year-end 2025 for different credit spreads in case of no liquidation (which illustrates a very limited downside potential).

Disclaimer:

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

There is a large number of catalysts/announcements in the near term in this situation (some of which are more relevant for the equity thesis and some for the credit). Please see them below ordered by expected timing:

• Closing of Fertiglobe transaction (expected Oct-Nov'24);
• Announcement on plans for capital distribution/return to shareholders and bond redemption (potential tender) (expected Nov'24);
• Closing of the disposal of US plant (expected H2'24);
• Second distribution to shareholders (expected H1'25);
• Closing of the disposal of methanol (expected H1'25);
• Announcing of bond redemption (expected H1'25);
• Third distribution to shareholders and/or distribution of Methanex shares (H2'25);
• Announcement of sale of European nitrogen (expected 2025) / last distribution to shareholders (expected 2026);