Last week, ethanol producer VeraSun Energy (VSE) announced it put itself up for sale after blowing its brains out in the corn market. The company's practice of not buying corn requirements far ahead of time hit a brick wall when the June Midwest floods caused a major whipsaw in grain commodity prices.
The company clearly panicked, went long corn during the upswing, and now is riding on an undetermined loss on commodity trading and corn inventories. In its now-cancelled equity offering prospectus filed on September 16, VeraSun estimated third quarter corn costs would be $6.75 to 7.00 per bushel, and the company would record a third quarter loss of $63 to $103 million based on input and output prices and various assumptions including a New York Harbor ethanol price of $2.35 to $2.45 per gallon.
Currently, NYH ethanol is trading 9 cents over $2.24, or about $2.33/gallon which was Chicago's close on September 22.
The question is, how big will VeraSun's loss be? Is the company in a liquidity crisis, and is the company an attractive buyout candidate? My answers are, probably over $100 million but not more than $200 million, No and Yes, but only after an Obama win on November 4th.
On point one: the company said in its September 16 prospectus that it is no longer hedged on corn and therefore future purchasing would be at market prices.
Assume VeraSun experiences level corn purchase prices at local discounts to $5.50 per bushel (Chicago December futures). This is conservative as a bumper crop of 12.3 billion bushels of corn could lower Q4 corn prices. Assume NYH ethanol prices continue to soften a little to $2.25 to $2.35. This is conservative as the disruption of oil refineries in the Gulf which reduced demand for ethanol, could be alleviating. I don't have a number for prices or consumption of natural gas, DDGS, urea, sulphuric acid and other production factors but they are much less material to this thesis than corn and ethanol.
VeraSun would then record an additional $35.5 million shortfall in pre-tax quarterly income according to their September 16 disclosure. I am going to add that to the top of the projected loss range of $103 million and forecast VeraSun loses about $140 million in the Q3 to be announced in mid-November (unless they were bought out).
On point two: The company is indeed in a tight cash situation, but not as bad as much smaller peer BioFuel Energy, which lost $46 million in the corn market , but only had two plants which were still experiencing hiccups in commission. VeraSun has fourteen plants with two more soon to start producing in Q4.
VeraSun had only $28 million in cash as of June 30, 2008. And it has ran up its unutilized credit facilities due to the corn market squeeze and delays in collecting receivables from the Gulf refiners. It needs to receive a $33 million tax refund in Q4 or it will have a liquidity problem. Hence the need to do a strategic "deal" now.
But the company has a large asset base which could support additional borrowing while it looks for a buyer or partner. And VeraSun has a strong advisor in Morgan Stanley (MS) which is still standing in spite of the tsunami that has hit Wall Street.
On point three: VeraSun has 16 state-of-the-art ethanol plants. The oldest is only 5 years old. I toured the Albert City facility last year and it is a corn crunching, ethanol producing machine.
These plants make money under normal circumstances with iron-willed discipline and good management. If you believe Americans will return to their vehicles and gasoline demand will increase as prices have come down from Hurricane peaks, you should believe in ethanol refining. The caveat being, the Republican presidential platform includes reducing subsidies to corn ethanol producers.
At nameplate capacity (most of the plants churn out more than nameplate with some tweaking), VeraSun will produce 1.64 billion gallons of anhydrous ethanol per annum. Overnight, an acquiring company could become the biggest ethanol producer in North American (VeraSun says they will be the biggest in the world by year-end).
Likely interested parties include the usual suspects, Archer Daniels Midland (ADM) and Cargill, although the latter company may have lost its taste for corn ethanol as it helped create Biofuel Energy.
More likely suitors could be two foreign multinationals, both already in the ethanol and biofuel business in the USA. These include Cilion, backed by Virgin Fuels, part of Richard Branson's Virgin Group, and Khosla Ventures. Cilion has two corn ethanol plants under development in New York State.
Another potential suitor is Hong-Kong based Noble Group, which is an international agriculture and commodity trader with 2007 revenues of $23 billion US and $19.9 billion US in the first half of 2008. Noble has interests in several ethanol plants and markets ethanol for ten plants across the US.
If an oil company were to decide to take the plunge into ethanol refining, it probably would be Marathon Oil (MRO). Marathon partnered with The Andersons, a well-run grain handling, rail transport and ethanol production company, to open ethanol plants in Ohio, Indiana and Illinois. The partnership might be interested in becoming a major ethanol producer with a VeraSun acquisition.
Competitors of VeraSun such as Poet, Aventine (AVR) and Hawkeye probably lack the deep pockets required to do a deal. They might hope for a bankruptcy sale of assets.
Valuation:
New ethanol plants cost over $2/gallon of production to build last year. But demand for new construction has disappeared. Yet steel, copper and concrete prices have not ameliorated. So the Verasun plants are worth something. What would be a reasonable price?
VeraSun bought three plants by acquiring ASAAlliances Biofuels for $2.07/gallon in August 2007. They then merged with US BioEnergy last spring valuing 5 operating and 3 almost completed plants, at $1.51/gallon.
Assuming VeraSun could do a deal at $1.25/gallon, their sixteen plants would be worth $2.05 billion. Netting out $1.51 billion in debt as of June 30, $140 million in losses subsequent to that date, and adding back $280 million in working capital, get's us to $680 million, or $4.30 per share.
That's a 139% gain over the current price of approximately $1.80. There were 15 million of 158 million shares short as of August 29. Possibly, some of those have covered since Wednesday's bad news.
As mentioned above, I would expect no company would move on VeraSun until after the 2008 Presidential election, and only after an Obama win. This is because the Illinois Senator is for more corn ethanol subsidies, whereas his opponent is not.
If you are cynical, you might bet on a President McCain continuing to back corn ethanol subsidies due to political pressure, and pick up VeraSun even cheaper. Of course, this is a risky bet. I made money on ethanol stocks in the past, but recognize a "crush" commodity refining business is inherently a low return, high risk endeavour as VeraSun has recently found out.
Disclaimer: long VeraSun, yesterday
