Our stock is up 100% since last summer and we think we've created some pretty good value over that period of time. - D. Hunt Rambsbottom Jr., on the March 16, 2012 conference call
Here's a tale of corporate management that is so bad, the company might be a good investment.
Rentech Inc. (NASDAQ:RTK) is an "alternative energy" company with a simple business model: spend hundreds of millions of dollars on projects that generate zero revenue. Since Ramsbottom took over as CEO in late 2005, Rentech has posted net income of negative $295 million, and the shares are down 48% (yes, they've lost nearly half of their value in spite of recently doubling). Meanwhile, Ramsbottom has collected a total of roughly $4 million in salary and bonuses, not including roughly 6 million shares of restricted stock, warrants, and options. The compensation of company management is nauseating in light of the large operating losses.
Rentech has done one big thing right in the last ten years, and they just spun-off part of it: Rentech Nitrogen Partners LP (NYSE:RNF). Rentech Nitrogen, a fertilizer business with actual revenues and large positive cash flows, went public in November 2011 and is still 60.8% owned by Rentech, Inc.
Largely because of the Rentech Nitrogen Partners IPO, Rentech Inc. now has net cash less debt of $139.5 million (not including cash held at RNF), and a stake in RNF worth roughly $612 million at current prices.
So, you'd expect that Rentech has a market capitalization of at least $751.5 million, right? Wrong. Investors are basically pricing the stock as if Ramsbottom and friends will generate another $300 million in losses. At $2.01 per share, the company trades with a market cap of only $453 million.
Is the market stupid to expect that management is going to create $300 million worth of negative value in the future? That is the key question.
If this management team wanted to, they could sell or close all of Rentech's money-losing alternative energy assets, and have at least $100 million of cash available to buy back roughly 50 million shares of RTK in the open market. The resulting RTK would have only 175 million shares outstanding, yet still own 60.8% of RNF (a stake worth $612 million). Assuming RTK stock didn't get the message, and was still trading well below the $3.50 a share it would be worth under such a scenario, RTK management could use their ongoing large cash distributions from RNF to buy back even more shares in a virtuous circle of shareholder value creation.
Rentech Inc. could then either (1) sell more shares of Rentech Nitrogen to the public, and use the proceeds to buy back even more RTK shares, or else (2) distribute the remaining RNF shares directly to RTK's remaining shareholders.
In either scenario, quick profits to RTK shareholders of 75% or more from current levels would be likely.
What seems less likely is that management is willing to do the right thing for RTK shareholders. On Friday's conference call, in spite of multiple shareholders urging management to take a more shareholder-friendly approach to the company's cash, management discussed, at length, acquisition possibilities.
Do shareholders want the company to pursue acquisitions with a possible "mid-teens" return on capital when the company could earn five times as much overnight, just by purchasing shares? Of course not.
This is the crux of whether Rentech is a good investment or a bad investment going forward. If the status quo of burning tens of millions of dollars per year on alternative energy dead-ends continues, then RTK is a bad investment. If management changes their strategy, or if management itself is changed, RTK will be an excellent investment.
Encouragingly, according to data compiled by Bloomberg, hedge funds increased their net holdings of Rentech by nearly 35 million shares in the fourth quarter of 2011, and now own 18.3% of the outstanding shares. (That doesn't include our fund, or any others like us, who are too small to file a form 13-F.) I'm not aware of any of the current owners having a reputation for shareholder activism, but all of these funds are smart enough to know that five birds in the hand is better than one in the bush, and all would likely support a shareholder-friendly slate of directors, should one emerge. Heck, at this point, I suspect even the Vanguards and TIAA CREFs of the world would support a change.
That, of course, is easier said than done. Proxy fights are expensive. But, in this case, with the differential between RTK's share price and the value of its assets being so large, we are hoping, and betting, a firm will come along ready to fight. Perhaps if the firm is big enough and mean enough, management will even do the right thing for shareholders without losing their jobs first or spending any capital in the battle. I'd call that a win-win.
Disclosure: I am long (RTK). Though the author of this article holds no equity positions individually, he is the Managing Member of the General Partner of a hedge fund which is long RTK, and which is, to a lesser extent, short RNF. The fund may change any of its positions at any time.