Pacific Ethanol: Potential Buyout Target

PEIX is an operator of a handful of ethanol plants in the western states. They are trying to emerge from bankruptcy, and have recently arranged a line of credit to become a credible ethanol producer. Their current stock price is about $1 per share and they have about $80M in debt:

Stock Price	$ 1
Shares Outstanding	83,000,000
Debt (Bal Sheet)	$ 25,000,000
New Debt	$ 53,000,000
Total Cost to Buy Co	$ 161,000,000
Capacity Gal/Yr	240,000,000
Capacity Gal/Day	657,534	gallons per day
Capacity Barrels/Day	15,656	barrels per day
Acquisition Cost	$ 10,284	$ per BOD

A couple of things on this: The acquisition cost of just over $10K per BOD is right now about twice that of the average cost of petroleum refining capacity in the US.... however, keep in mind that on average, the margin for ethanol is about twice that as well, so as an investment, someone would be equally likely to get into the ethanol business as they would the petroleum refining business....

Stock Price	$ 1
Shares Outstanding	83,000,000
Market Cap	$ 83,000,000
Debt (Bal Sheet)	$ 25,000,000
New Debt	$ 53,000,000
Total Cost to Buy Co	$ 161,000,000
Capacity Gal/Yr	240,000,000
Capacity Gal/Day	657,534
Capacity Barrels/Day	15,656
Margin@.25/gal	60,000,000
Acquisition Cost	$ 10,284
One year ROR	37%

The potential buyout scenario suggests that if Valero or some other refiner wanted to, given the margins that exist in the industry and knowing what the investment per BOD of capacity is, you could expect a really attractive ROR.... In fact, to make this an equal investment to a greenfield oil refinery project, Valero or someone else would be willing to pay up to $6 per share, and still get the same rate of return....

So based on the current margins in this industry, the really interesting way to look at PEIX is as a potential takeover target..a buyer of PEIX could make on the order of 37% in the first year on such an investment. This is comparable to the ROR that Valero could see when it did its original ethanol deal at the end of 2009. Valero, or anybody else that wanted to get into ethanol, would be delighted to get this deal done.

Chances are the management knows this. They recently took on some debt with the idea of buying back some of their stock, and the debt itself will make the potential takeover less likely....

However, at the current margins for ethanol, and the current price of refining capacity in the oil industry, PEIX is a potential opportunity, of course much more so than it was when the plants were originally built.

Western Refining Debt Restructuring

We wrote in a previous blog entry about the epic catastrophe that befell WNR's decision to buy a 72Kb/d refinery in Yorktown VA.

To recap, these fellows borrowed $1.12B and bought this refinery at the absolute peak of the market, paying on the order of $20,000 per barrel of capacity. This spring, they finally gave in and shut the doors on the place, they are going to use the location as a terminal, and they are going to "monitor conditions", with the idea that they could restart the place.

In the meantime they have the ongoing problem of the $1B of long term debt.

They had a stock offering this spring which managed to raise $150M thus paying off the current portion.....

Their interest expense is $34M per Quarter, as of the most recent quarter. this amounts to approximately $2.75 per barrel of refined product....

So....

As long as the refining margins stay high enough so that they can continue to service the debt, plus provide a little profit, they can make the current situation last for a long time. This is obviously not a desirable situation, but they have some prospects to make it work.

Their strategy also involves rolling out the long term debt that is coming due by issuance of five-year notes, at high interest rates. The notes issued in the first quarter this year had a face value of more than 11%, so on that basis, if you really, really had confidence in this business, this would be a pretty interesting way to play it.

The question comes up: Could the sell the plant for some amount of money, and based on the analysis we did earlier on the current value in the marketplace for refinery capacity, it is unlikely they could get more than 4000 per BOD of capacity, or about $280M for the plant. This is so far below the value of this place on WNR's books that the likelihood of it happening is practically zero.

WNR has also been quite successful with working with their bankers using a revolving credit arrangement to roll out the remainder of their long term debt as it comes due. I suppose if you look at it from the bank's point of view, as long as WNR is able to service the debt, it makes no sense to pull the rug out from under them under the theory that if you owe someone $100 you and cannot pay it back you have a problem but if you owe someone $1B and cannot pay it back, THEY have a problem.... so as long as the margins are strong enough that WNR can continue to service the debt, the game will continue.

At some point, in theory, refining margins will go back up to some reasonable level, the light/heavy crude oil differential will re-widen again, and they will be able to start this refinery back up, and at that point it will have some value in the marketplace.

Until then, nothing is going to happen on this, the situation is not good, but it is stable, and a plan is in place for the medium term survival of the company, until such time, if any, that the margins get back to where they were.

Note: If we do have a double dip, or even worse, if we get into a situation where the feedstock costs go way up but the refining margins stay stable, then these guys are going to be in a heap of trouble, like they used to say.

In the meantime, Morgan Stanley likes their plan, they have upgraded the stock, and that is another interesting development. We will see what happens.

MRO: What to do with $900M

Marathon Oil (MRO) recently unloaded a lot of gas stations and a small refinery up in Minnesota, and now have on their hands $900M. There are a few alternatives as to what to do with the extra cash.... and MRO being the conservative types that they are have no doubt considered the following alternatives:


Share Buyback

709,000,000	Shares Outstanding
$ 2,390,000,000	Current Anticipated Earnings
$ 3.37	Current Anticipated EPS
$ 36	Current Stock Price
684,000,000	Shares Outstanding After Buyback
$ 2,390,000,000	Anticipated Earnings
$ 3.49	EPS after Buyback
13.5	PE
$ 47	Anticipated Stock Price after Buyback

Currently at 36 the market is anticipating earnings of about $2.3B for the year, and by reducing the number of outstanding shares to 684 million by buying back $900B at the current price, at the current PE, should result in a stock price of about 47 per share.

Increased Dividend

Current Dividend Yield	2.8%
Dividend	$1.00	per share
Stock Price	$35.71	Current Stock Price
Current Yield	2.8%
New Dividend	$1.25	per share
New Stock Price	$44.64	After Dividend Increase

At the current stock price of about 36, and a current dividend of about $1 per share, the yield on this conservative stock is about 2.8%. The question is: how much, if any, to increase the dividend? An increase of 25 cents/share would be sustainable with the business currently like it is for 4 years (at the current number of shares outstanding) and at the same yield, should result in an increase in the stock price to about $45 per share. Note: At the current price and yield, the market is assuming that MRO will have zero growth going forward, with the economy in its current state. Any growth prospects in this business could be factored in for some additional pricing improvements.

Acquisition

Shares Outstanding	709,670,000
Investment	$ 900,000,000
Investment ROI	0.1
Increased Earnings/Yr	$ 90,000,000
Increased Earnings/Share	$ 0.13
PE	13.2
Increased Mkt Cap	1.67
Current Stock Price	$ 36.00
New Stock Price	$ 37.67

Using the optimistic assumption that MRO could buy some business that has a 10% ROI in the first year, which is a wildly optimistic assumption, the value in increased earnings for the company will be $90M per year, which at 709 million shares comes out to a mere 13 cents per share. At the current PE, 13.2 times earnings, the increased stock price from this type of investment would only be $1.67 per share.

Note: Using the $900M to pay down their long term debt would theoretically have exactly the same impact on the stock if, and it is also a big if, the reduced interest expense by retiring the debt made its way similarly to the bottom line....

Note: Using the $900M to do some sort of debottlenecking project in their current operations will be evaluated on exactly this basis as well: If it is a more attractive investment, relative to the stock price, than just buying back their own shares, they will do so rather than make the investment internally.

The second question comes up: What ROI would an investment need to make in order for the impact on the stock price to be the same as buying back shares, and the answer is, something on the order of 50 percent ROI, which tells me, at least that the likelihood of this alternative happening ought to be next to zero, unless they are really confident..... for that matter, if they can find an investment that will return 50 percent, I hope sincerely that they tell us what it is, so we can invest in it ourselves.

The Bottom Line

Either the stock buyback or the increased dividend could happen, more likely the stock buyback, because the conservative management will correctly not want to get the widows and orphans accustomed to the extra 25 cents per share....

In either case, it makes sense for this stock to be trading up around 47, from its current 36.

Note: The world is chaotic, and there are no guarantees on anything.....

Side issue: What kind of an economy are we in where the management will be greatly advantaged to shrink the company rather than position itself for growth in some way....