Description

Verso Corp. (VRS) is the leading coated paper manufacturer in North America, with a 40% market share. The company filed for Chapter 11 bankruptcy in 2016 after they consummated a huge transaction while already levered at 9x EBITDA, buying NewPage, which added an additional 4.5 turns of debt. They did so at just the wrong time, as secular headwinds combined with a cheap Euro and pricing pressure lead to poor operating results in the first 9 months post-acquisition. VRS emerged post-bankruptcy with a much more sustainable capital structure.

It’s a crappy, capital-intensive, melting ice cube of an industry, but it’s been that way for long enough, and after marginal mill closures and consolidation we think that the dynamics have changed (or at least stabilized). The marginal players are mostly out of marketplace, including a few mill closures in the VRS portfolio. The company trades for $13.00, could generate more than $1.00 in FCF on a normalized basis, and has about $9.50 of cash on the balance sheet (as of mid-February, per their last 10-K filing) that won’t show up on screens until next week after they report Q1 results.

Since the company emerged from bankruptcy in 2016, the global coated paper market has shrunk from 39 million tons to 35 million tons, and the North American share has gone from 6 million to 5 million tons. During that time gross margins for Verso’s business peaked at around 13%, and after poor operating results and an oversupplied market in 2016-17, they’ve posted two consecutive years with margins right around those peak levels. Meanwhile, Verso has managed to cut quite a bit of SG&A expense, run-rating around 6% of sales pre-bankruptcy to under 4% of sales for 2019. 

In November, VRS announced an asset sale of two of its specialty paper mills, Androscoggin and Stevens Point. Specialty paper is the darling product line in the paper industry because it’s the only product line with some structural tailwinds as consumers and producers continue to demand more innovative packaging, labeling, and ecommerce continues to grow in popularity. These two mills represent the bulk of Verso’s specialty paper capacity. At the time of the transaction, the two mills made up 22% of Verso’s sales and 17% of EBITDA, and the co. netted $346 million in cash (plus an assumption of $35 million in pension liabilities), which at the time amounted to about 60% of the company’s pre-transaction enterprise value. Today, the net cash is north of 70% of the market cap, and the plan is to return the bulk of that to shareholders. There’s currently a $250 million buyback in place as well as a plan to instate a dividend that would amount to an additional $14 million per year. I suspect that the company has taken advantage of the market dislocation and that we will find out that it has already eaten into the authorization when they announce next week.

Activists Blue Wolf, Lapetus, and Atlas stepped in around the time of transaction with complaints of lack of disclosure around the sale, and the stock sold off around the time they announced a proxy fight, threatening to vote against the deal, which on the surface, seemed to be a clearly shareholder friendly transaction. In late January, VRS agreed to give up a few board seats, and the activists agreed to vote for the deal, which closed in February. We think shareholder value creation is certainly a priority for the enterprise going forward.

On December 31, 2016, VRS had $290 million of net debt, and in 3.25 years, they’ve gone to a net cash position of $320 million, after using some of the asset sale proceeds to pay down a part of the pension obligation, for net value creation to shareholders of $610 million. The market cap, in that time, has increased by just $200 million.

VRS currently trades at 0.06x trailing EV/Revenue today. That compares to about 0.20x immediately post-bankruptcy, 0.45x at its peak in 2018, and 0.50x for its larger competitor, Sappi. If it gets back closer to my fair value, 0.40x, that gets you to a share price around $21.50.

Assumptions to get to a breakeven 2020

Revenue: $1,710mm (-10% from remaining business 2019 performance)

Gross profit: $171 (10%--stable prices, lower demand)

Ongoing net pension expense: $40mm

Maintenance capex: $60mm

SG&A: $68mm (4% of sales)

FCF to equity holders: ~$0

2021 est, assuming business normalizes

Revenue: $1,800mm (halfway back to 2019 levels)

Gross profit: $216mm (12%--stable pricing environment, slight pick-up in demand, but not back to 2018-19 levels)

Ongoing net pension expense: $45mm (increased from impairment of pension assets)

Maintenance capex: $60mm

SG&A: $72mm (4% of sales)

FCF to equity holders: $40mm ($350mm still left in NOLs)

2021 FCF yield to EV: 31%

Risks:

Pension—We treat it as an expense, but depending on your assumptions around underfunded liabilities, one could argue that the 2020 market dislocation could result in a meaningful and permanent impairment. Current mix of pension assets as of 12/31/19 is 3% cash, 31% fixed income, 56% equities, 10% alternatives.

Coated paper business—Depending on your base assumptions on the long term decline of magazines and paper marketing materials, this melting ice cube may not be for you.

Catalyst

Q1 earnings release with anticipated cash on balance sheet

Pandemic eases up

Share repurchases