Introduction | Up more than 250% on no news
USEC Inc. (NYSE:USU) popped up on my radar today. As background, I have limited prior understanding of the uranium space or of USU the company, but I do have some knowledge of how bankruptcies work. In such cases, debt holders more often than not walk away with the lion's share of the value that remains. Based on simple math, with holders of equity retaining less than 5% of the company in a proposed plan, the drop in share price is unavoidable.
The stock is up more than 250% on news released over the weekend whereby USU will receive an additional $2.5 million of funds through its ACTDO agreement. From some quick work, USU needs an incremental $4 billion to complete its critical American Centrifuge Project and as such, $2.5 million does little to assist with this project. When considering the company's upcoming bankruptcy, $2.5 million moves the needle very little in context of refinancing the $530 million of bonds outstanding. It is my view that the recent appreciation in the stock is backed by misplaced excitement and that the stock will revert to fundamental valuation in no time. Other than this, nothing has changed with the stock or the company in the past few days.
From my read, the completion of the bankruptcy based on latest filings should happen within two to three months. I note that there is a disclosure statement hearing on Monday, which is a key step in the bankruptcy process. In my opinion, USU equity holders are going to see their stock plummet 95% and this checks out based on simple math that I provide below.
USEC Inc. | A quick background
USU "supplies low enriched uranium to commercial utilities for use in nuclear reactors worldwide. Low enriched uranium is a key component of the fuel used by nuclear power plants to generate electricity." Most of the work conducted is done for the US Department of Energy. The key upside with USU circles around the American Centrifuge Project ("ACP") which "is an advanced US gas centrifuge uranium enrichment technology for fueling commercial nuclear power plants in the United States and around the world." This project is expected to cost $9 billion over the course of its life ($5 billion of sunk costs plus $4 billion which is needed to push the project through completion) USU has entered bankruptcy due to its inability to repay or refinance its current outstanding bonds of $530 million and its inability to push forward the ACP or fund its completion.
The company first hinted at a bankruptcy almost 2 years ago on November 1, 2012 "We've indicated that we expect to pursue discussions with several key stakeholders regarding ways to improve the capital structure. Currently, we're working with advisors and developing options for a possible restructuring of our balance sheet and how to address our very key liabilities."
Significant Indebtedness put the company into bankruptcy
With $530 million of outstanding debt that has been defaulted on, the company entered a formal chapter 11 bankruptcy process on March 5, 2014. Its bonds are currently trading at 28 cents on the dollar.
As is detailed in its announcement of a definitive agreement on March 5, 2014, in the best case "holders of the Company's common stock will receive, on a pro rata basis, 5% of the New Common Stock, subject to dilution on account of a new management incentive plan." Receiving 5% of reorganized equity compares with 79% of the new equity to be received by holders of the convertible notes. Based on current trading value of $54 million ($11.11 per share at 4.9 million shares outstanding), the implied valuation of the company is roughly $1.1 billion ($54 million / 5%). I also note that the convertible notes' trading value has not changed in the last few days.
This link provides a detailed overview of the plan in a disclosure statement, which is slated to be approved by the bankruptcy court this coming Monday, July 7, 2014.
Equity holders to be left with almost nothing
As previously noted with a bankruptcy, the debt holders will end up owning most of the company. As such, holders of the debentures will attain $200 million in new notes along with 79% of the reorganized equity.
I stumbled across this article, which does a great job of laying out the math on what equity holders will be left with. To start, it provides a succinct illustration of the distribution of value post reorganization:
Next, it lays out the math, which suggests that as of February 22, 2014, equity's remaining fundamental valuation is $0.59 / share. Here is the updated math based on my calculations:
This effectively says if the current bond pricing is an indication of the value of the company that implies that the new enterprise value will be $148 million ($530 million x 28 cents on the dollar). If the new bonds trade at 60 cents on the dollar, which I deem to be low, that would leave $36 million of value for the entire amount of the new equity ($148 million less 60 cents multiplied by $200 million new bonds divided by 79%). If current equity holders are going to get 5% of this, that will leave them with a 97% loss on their current investment ($2 million is what they will receive which is 5% of the $36 million and the current equity is valued at 4.9 million shares multiplied by $11.11/share meaning $54M).
Timeline | Bankruptcy in the next two to three months
The disclosure statement hearing will take place on July 7, 2014. The voting period will open up five days after that and be open for 30 days. Confirmation is often imminent after this point but can take up to a week or two. This is all aligned with management guidance of a bankruptcy by the end of summer or by September 18, 2014. Recall that the bonds are due on October 1, 2014.
Conclusion | Irrational
With bankruptcy expected to be all but sewn up by the time the $530 million bonds are due on October 1, 2014, the drop in equity value is expected in short order.
So essentially the value attributable to the common stock will be all but eliminated in the next 2-3 months. It is unfortunate that the company has not made a clear statement about this and retail shareholders and others, have bought stock in the company (with 20 million shares traded), and stand to lose a significant amount of money.
Disclosure: The author is short USU. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.
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