Today I was looking at the list of companies in the Chemicals - Major Diversified industry to see if I found any good investment candidates. Although there are many interesting names in this industry, only one of them caught my eye because it seemed deeply undervalued simply based of the assets it owns. That company is Rentech, Inc. (RTK), a supplier of nitrogen fertilizers and wood chips and pellets for the utility industry. The company was formerly engaged in the research and development of alternative energy technologies designed to produce synthetic and renewable fuel on a commercial scale. However, the company recently changed its strategy due to the inability in finding a commercially viable way to implement their technologies and is refocusing on projects that can provide positive near-term returns. Thus, all research and development activities related to alternative energy projects were essentially discontinued. Their acquisition of Fulghum Fibres and two facilities in Canada to be converted for the production of wood pellets are two of the projects that management believes can provide positive returns in the near-term and beyond for the company. The nitrogen fertilizer business is conducted by its majority-owned and publicly-traded subsidiary, Rentech Nitrogen Partners, L.P. (RNF). RTK owns approximately 23.25 million, or 60%, of the common units that represent limited partner interests in RNF.
In my opinion, the value of RTK's shares comes from three sources:
- The value of the company's controlling ownership in Rentech Nitrogen.
- The value (if any) of the new lines of business (Fulghum Fibres and wood pellet mills).
- The value (if any) of the company's intellectual property for development of alternative energy technologies and knowledge of the implementation of these technologies obtained from running their Product Demonstration Unit (PDU).
As mentioned earlier, RTK owns approximately 23.25 million common units of RNF. Taking the value as of today (July 2, 2013) of RNF's shares, the approximate value of RTK's holdings is $667 million. Dividing this amount by 226 million shares outstanding as of March 31, 2013 (Form 10-Q) yields a value of $2.95 per share. This would be the value of RTK's investment in RNF at current market prices. If one assumes that the value of the new lines of business and of the company's intellectual property is zero, then this would be a logical value for RTK's shares, which would imply a potential upside of 42.5% from its current price of $2.07. This would be the same as buying a dollar for 70 cents. However, I believe there are a couple of problems with simply estimating RTK's value in this manner.
First of all, there is the issue with taxes. RTK's basis in RNF is zero. Therefore, for the $2.95 in value to be realized, RTK would have to sell its RNF holdings and pay tax on the proceeds. If we apply a capital gains tax rate of 20% (to account for any state taxes), the after-tax value of these holdings would then become $534 million and RTK's share value would drop to $2.40 per share. As disclosed by management in an investor presentation, the same tax problem would arise in a spin-off of RNF to RTK's shareholders. However, I believe that the probability of this scenario occurring is very slim. This is basically a liquidation scenario and RTK's management (with its recent change in strategy) has made it very clear that they are not thinking about liquidation. On the contrary, they are shutting down cash-burning segments and setting their sights on projects that could generate cash flow in the near term (or at least break even). For this reason, their holdings in RNF has become of extreme importance since the distributions they receive from this subsidiary are a key source of financing for these new projects.
The other problem I see with using RNF's quoted price to estimate RTK's value is that it does not take into account the controlling position of RTK. Remember, it owns 60% of RNF's common units as well as its Board of Directors (four of the seven directors are also RTK directors). Therefore, this controlling position must have some value over quoted prices (which reflect non-controlling interests). If we add a control premium (say 20%) to the current price of RTK's holdings, then their value would become $800 million pre-tax. If we apply the same 20% capital gains tax rate to this value, then the after-tax value would become $640 million, or $2.83 per share. This means that the potential upside, without assigning any value to the other businesses, would be 36.7%.
I like this kind of upside, especially when I still get some pretty interesting assets basically for free that can generate some additional cash and value for shareholders. First, there is the potential cash that could be generated by the sale of the PDU as well as other assets related to the company's alternative energy business. As disclosed in their annual meeting presentation, they already entered into a definitive agreement on April 18 to sell their 450 acre Natchez site for $9 million. If they are able to sell their PDU, this would mean that a significant inflow of cash would be available to fund their wood pellet projects. Also, the potential licensing (or sale) of their alternative energy intellectual property could yield some additional income. Altogether, I think these assets sales (and the cost saving associated with them) can generate at least $35 million, or 15 cents per share in value.
Additionally, the company has a large amount (approximately $100 million) in both federal and state Net Operating Losses available to offset future taxable income. These NOLs clearly have some value since RTK's management went as far as to implement a Shareholder's Rights Plan to avoid any change in control that would limit the company's ability to use them in the future. To this we can also add their recently announced $25 million share repurchase plan, which, at recent prices, can reduce share count by more than 10 million shares.
Finally, we can add the value of the new lines of business. Based on their Form 10-Q for the quarter ended March 31, 2013, Fulghum Fibres was purchased for a total price of $112 million of which $59 million was related to the assumption of existing debt. This means that its equity was purchased for approximately $53 million. Just to be conservative, I will use this same value to add to RTK's value. Also, it was disclosed that the purchase and conversion of the Wawa and Atikokan facilities in Canada for the production of wood pellets would cost approximately $70 million. To be conservative, let's say that purchase and conversion costs goes over-budget and becomes $90 million. My final value estimate for RTK would look like this:
Value of holdings in RNF: $640 million
Value of asset sales and associated cost savings: $35 million
Value of NOLs (70% of $100 million): $70 million
Value of share repurchases: $25 million
Value of Fulghum Fibres: $53 million
Cost of building wood pellet mills: -$90 million
Total Value: $733 million
Shares outstanding (post-buyback): 216 million
RTK's Per-Share Value: $3.40
Rentech is a company that, although it has interesting assets (e.g. Rentech Nitrogen), it always seemed to be brought down by the huge losses in their alternative energy segment. I believe the recent shift in management focus is a step in the right direction. Moving away from the money-losing alternative energy business and refocusing on businesses that promise to generate operating profits should lead market participants to re-value the company's share price and future prospects. As the company has a couple of quarters under their belt, we will get more information about the future prospects of the new projects and of the company as a whole. However, as of this moment, I believe that RTK's shares should at least be worth $3.40 per share.