Description

Here is a follow-up of ujp916’s original WXCP idea ($7.45) almost a year ago (09/27/06). At that time, WXCP had not filed its 2005 10K or its 10Qs for 2006. The company emerged from bankruptcy but was behind in its filing deadlines. As a result, disclosure statement projections (dated March 2005) were the only way to value the company. As we stand today (08/30/07), the company has done the following since the write-up:

 

(1)     They are current with all the filings, which includes all the 10Qs and the 10K for 2006, and the 10Qs for first two quarters of 2007.

(2)     They made a roofing fastener acquisition for $26 mn in December 2006 funded by debt.

(3)     They made a $126 mn acquisition of Bairnco, an industrial company, again funded by debt.

 

We don’t need to provide descriptions of WXCP’s businesses because ujp916 has done in his initial report. But we can share our observations with those (perhaps few) of you who have followed the company since the original write-up. To us, it continues to be a unique under-followed opportunity that has complexities of fresh-start accounting and effects of large acquisitions. Last traded price ($7.25) is slightly below original write-up price of almost a year ago. Although risk has increased with higher debt and economic slowdown, we think original thesis of ujp916 is still intact. Stock is illiquid and 50.3% of the stock is held by Steel Partners.

 

Comparison between 2006 actual results and bankruptcy projections for 2006:

 

In its disclosure statement projections for 2006, WXCP projected $461.1 mn revenue for 2006 and EBIT of $31.3 mn. When added to the $14.8 mn D&A projected in the cash flow statement, it implies an EBITDA figure of $46.1 mn.

 

When the company filed its 10K for 2006, we saw that actual revenue for 2006 was the same:  $461 mn. The company registered growth in all of their three segments: precious metals, wire and tubing and engineering materials. Our EBITDA calculation is as follows:

 

EBITDA = Rev ($461 mn) – COGS ($376.4 mn) – SG&A ($63.6 mn) + D&A ($12.4 mn) + Payments for environmental liabilities ($18.7 mn) + Payments for pension Liabilities ($13.1 mn) = $65.2 mn

 

One needs to carefully go through the description of cash flows to identify the payments for pension and environmental liabilities. So, we found in-line revenues and higher EBITDA as compared to what was projected in the disclosure statement. But the total debt of the company went up to $215 mn (from $150 mn in 2005) due to higher working capital requirements. Interest expense in 2006 was $22 mn ($17 mn in 2005) and Capex for 2006 was $8 mn ($20 mn in 2005). FCF for 2006 (Cash flow from operations – Capex) was negative $26.4 mn, but if you disregard the combined payments for environment and pension ($31.8 mn), the company generated a small positive free cash flow of $5.4 mn.

 

Overall, not too bad. Let’s go to 2007 now.

 

Analysis of 1Q07, 2Q07 and impact of mergers (OMG Midwest & Bairnco):

 

1Q07

During 1Q07, WXCP registered revenue of $117.8 mn, up about 4.5% compared to 1Q06 revenue of $112.8 mn. OMG Midwest, the roofing fastener business, was consolidated this quarter, which had annual revenue of about $27 mn and EBITDA of $4 mn. So, net of that, revenue was somewhat stagnant in the original WXCP business due to the housing sector slowdown.

 

Adjusted EBITDA = Rev ($117.8 mn) – COGS ($98.4 mn) - SG&A ($18.8 mn) + D&A ($3.1 mn) + Pension payment ($4.3 mn ) + Environment payment ($3.3 mn) = $11.4 mn.

 

This result compares with EBITDA of $9.5 mn in 1Q06. Interest and Capex for 1Q07 were $7.6 mn and $1 mn respectively (against $4.6 mn and $2.2 mn in 1Q06). FCF (CFO – Capex) for 1Q07 was negative $11.4 mn, but, after subtracting the $7.6 mn payments for environment and pension, it was negative $3.8 mn.

 

Total debt at the end of 1Q07 was $213.8 mn, similar to $215 mn at the end of 4Q06.

 

2Q07

In April 2007, Steel Partners bought an industrial company called Bairnco and made it a fully owned subsidiary of WXCP. While acquisition added more debt to WXCP, it also added to revenues, EBITDA and reduced exposure from housing and auto. The price was $101 mn and assumed $25 mn debt, for a total consideration of $126 mn. Bairnco has two divisions: (1) Arlon (manufactures electronic materials like components for Printed Circuit Boards and coated materials) and (2) Kasco (manufactures meat room and deli products like band saws, chopper plates, saw blades etc and also provides maintenance services for meat and deli department services of over 30,000 retail grocery stores, restaurants etc.).

 

During 2006, Bairnco generated revenue of $179 mn (Arlon $128 mn and Kasco $51 mn). Based on company’s 2007 EPS guidance (prior to being acquired) of $1.1 to $1.2, and using their 2006 financials, we estimate the company will have at least $20 mn EBITDA in 2007. So for the $126 mn total price, the company paid about 6.3x EBITDA, similar to what they paid for OMG Midwest. Hence, we believe that a 6.5x EBITDA multiple is a reasonable way to value the entire company (see valuation below) given their 140 years of track record and diverse customer base.

 

For 2Q07, WXCP’s revenue rose to $176.9 mn (from $125.2 mn in 2Q06). The difference is $51.6 mn or a growth of approximately 41.2%. Of this, about $43.1 mn revenue came from Bairnco. So, original WXCP revenue (without Bairnco) for 2Q07 was $133.8 mn, 6.8% higher than $125.2 mn recorded during 2Q06. By segment, Precious metal revenue was about same ($39 mn), Tubing revenue was slightly less ($30 mn vs. $32.3 mn in 2Q06) and Engineering Materials division recorded significant improvement in revenue ($63.4 mn vs. $53.5 mn in 2Q06). Operating income had a significant improvement y/y at $7.7 mn vs. $3.5 mn because the loss at tubing division was reduced from $4.1 mn to $0.4 mn (due to the company closing some their tubing businesses last year).

 

Adjusted EBITDA for WXCP in 2Q07 = Rev ($176.9 mn) – COGS ($136.7 mn) – SG&A ($30.7 mn) + D&A (4.7 mn) + one-time Bairnco change of control charge ($5.7 mn) + one-time Bairnco tender offer cost ($1.4 mn) + payment for environment liability ($1.6 mn) + payment for pension ($2.8 mn) = $25.7 mn.

 

Because of this acquisition and increased working capital requirements, total debt of the company increased sequentially from $215 mn in 1Q07 to $367 mn at the end of 2Q07 (includes short-term debt of $72 mn compared to $52 mn short-term debt at the end of 1Q07). The difference is an increase of $152 mn, explained by (1) $126 mn acquisition of Bairnco and (2) Increase in working capital, payments of fees and other charges ($26 mn). From working capital section of the cash flow statements between 1Q07 and 2Q07, you will reconcile a usage of $16 mn during 2Q07. Probably the balance was the Bairnco issue costs and payments of pension and environmental liabilities ($5.7+$1.4+$1.6+$2.8 = $11.5 mn). These cash outflows are not specifically outlined in the cash flow statement, but we’re in the ball-park.

 

FCF (CFO-Capex) during 2Q07 was a negative $8.7 mn. But if we adjust it for one-time fees and payments we just mentioned above, FCF should be a small positive number of $2.8 mn.

 

Interest and Capex for 2Q07 were $10 mn and $3.6 mn (against $5.4 mn and $4.8 mn)

 

So, where do we stand today?

 

We have a limited sense about the seasonality of the entire company. But if we go back to 2006 and add EBITDA of WXCP ($65.2 mn), estimated EBITDA of Bairnco ($20 mn for 2007) and estimated EBITDA of OMG Midwest ($4 mn in 2006), we arrive at a combined company today with $90 mn EBITDA (assuming no synergy or businesses improvements).

 

Total debt of $367 mn is about 4x our estimated EBITDA. As much as $204 mn of this debt has come from Steel Partners, some of which are in the form of Bridge loans that should (hopefully) be refinanced at lower interest rates.

 

At this point, it appears the company accumulates working capital in first half and generates cash in the second half. So, probably during the second half, we are going to see positive cash flows. The company has spent only $3.6 mn in capex during 1H07 against their disclosure statement projection (pre-acquisitions) of $15 mn each in 2007 and 2008. Although the company has not given guidance, we are assuming a normalized capex level of $20 mn per year for the combined company. Interest cost during 2Q07 was $10 mn, or almost $40 mn a year if these costly bridge loans continue. The company will pay about $10 mn in pension contributions, and environmental payments will be negligible. Without federal income taxes due to NOLs, using $90 mn EBITDA gives us FCF of $20 mn (before working capital).

 

Valuation thoughts

 

If we use $90 mn EBITDA and apply a 6.5x multiple, then subtract $362 mn of net debt and $40 mn of outstanding pension payments to be made over next 4 years, we arrive at a price target of $16 per share on 11 mn fully diluted shares (with warrants). Alternatively if we use $20 mn FCF and give it 10x and divide by 11 mn shares, we arrive at a price target of $18, also considerably higher than current price of $7.25. Real upside to our analysis can arrive as the pension payments go away after 2011, as the industrial businesses show signs of continued growth, as we see savings from cost reductions and as the company (hopefully) attempts to reduce interest costs.  

 

Risks

 

1. The company has significantly added to existing debt. In the event of an economic downturn or a liquidity crisis, the higher debt could be a problem.
2. The main shareholder Steel Partners is also the major debt-holder. In the event of a bankruptcy, Steel could retain control while equity shareholders would lose out. However, we believe that Steel Partners would fight any potential WXCP bankruptcy because Steel Partners could lose its equity investment in WXCP, lose the benefit from the large NOL and lose its control of WXCP’s pension plan (part of which is likely being fed back to Steel’s hedge funds).
3. Despite a diversified customer base and a long operating history, the company’s operations have some exposure to housing and auto sectors.

Catalyst

Company achieves $90+ m in EBITDA or $20+ m in FCF in 2007
Company refinances debt
Integration, cost cutting and growth of acquired businesses
As cash flows become apparent, company could reduce debt
Potential sale of the company