Distressed Debt Analysis - TRX

Earlier in the week, we started looking at the distressed debt of Tronox. What I want to do today is to show readers today in a step by step fashion how to create a valuation recovery model in Excel.

I will note that the bonds have moved up since our last post and are currently quoted 81.5-83.5

The first thing we need to do is pull the plan projections. These can be found from the Tronox disclosure statement on page 97. I have thrown them into an Excel spreadsheet (maybe some rounding errors here)

Next we need to pull, again from the disclosure statement, the estimated total enterprise value, as determined by the financial advisor, which is Rothschild in this case:
As a result of such analyses, review, discussions, considerations and assumptions, Rothschild estimates the total enterprise value (“TEV”) of Reorganized Tronox at approximately $975 million to $1,150 million, with a midpoint of $1,063 million. Rothschild reduced such TEV estimates by the estimated pro forma net debt levels of Reorganized Tronox (approximately $510-$517 million) to estimate the implied reorganized equity value of Reorganized Tronox. Rothschild estimates that Reorganized Tronox’s implied total reorganized equity value will
range from $458 million to $640 million.
So let's also throw that bit of data into the spreadsheet:

As you can see, using the 2010 plan, TRX is being valued at 5.1x-6.0x.

From here we need to figure out how that enterprise value and equity valuation residuals gets parsed down by the various claimants in the case. And this is where Tronox gets complicated because the company is in negotiations with the government to try to get this case out of bankruptcy as soon as possible.

The current government offer (July 5th, 2010) asks for:
  • $165M in cash
  • $130M in 15% Preferred Stock Convertible to an equity value 10% greater than plan value
  • 7 year warrants convertible into 16.7% of reorganized Tronox at an implied equity value of $1.05B
  • Certain Nevada assets
I will note of that $165M in cash, the company had already earmarked $145M in cash:
"Up to $145 million in Cash in the form of the Funded Environmental Amount (subject to decrease if total funded debt under the Exit Credit Facility on the Effective Date is less than $510 million, provided that in no event will the Funded Environmental Amount be less than $115 million in Cash as contemplated by the current committed exit financing)"
So using the Enterprise Values above, here is what we get to (no one really has any idea what Nevada is worth so I skipped that part:

How did I get the GUC (general unsecured claim?): The disclosure statement of course: $470.6. And how did I get the warrant value? It was a conditional statement - the warrant only has value when enterprise value is over a certain threshold, in this case $1.05B, and thats why it kicks in in the mid and upper case. I will note, if the government plan gets confirmed and either Tronox's multiple or EBITDA is substantially higher (or lower) the valuation changes dramatically.

What about the current disclosure statement?

In that case there is $50M of convertible preferred stock, and three different warrants, to different claimants based on enterprise value. They are struck at EVs of $1B, $1.2B, and $1.2B effectively. Why two at a valuation at $1.2B? Because the C warrants go to old equity holders and the B warrants go to the environmental claimants.

Because our EV above maxes at $1,150, we will only consider the A warrants:

I will note that these recoveries are in essence recoveries to the unsecured class. And because some part of that class claim is accrued interest, the recoveries I note above will be lower than the equivalent trading bond price. I.E. 97% * $370 = $359 / $350M face value = 103 dollar price.

As you can see the different plans come up with significantly different valuations. The recovery to the class as a whole is 65%-115% translating into bond prices of 69 to 122. Pretty big range.

Now this gets even more complicated when you start to consider that if the current plan is not agreed to by the torts, they also become unsecured creditors. As noted in the previous post, this number approximates $2B. Those claimants were supposed to get 12% of the Anadarko litigation $7M in cash and insurance claims.

Given the fact that comps in the space are trading at 5.5x-6.0x, I would lean to the higher end of the valuation spectrum...call it 75-120. And I think some arrangement gets made so that the tort claimants come onboard - but for that I would have to discount the recovery call it 10%. With that, the bonds at these levels are probably fair value - if they got back to the high 60s I would be buyer of these distressed bonds.


Ankit Gupta 7/18/2010  

Excuse my lack of knowledge. When we start with the plan numbers, isn't there inherent risk in that?

They're in bankruptcy because someone's original plans didn't work out, so why would this be any better? With 21% margins, even a small changes in sales can drastically impact the valuation.

We can obviously apply a margin of safety here in both the multiple and projection numbers, is that basically how to handle for our plans not being correct?

Josh4580 7/19/2010  

Kronos is a direct compareable that has 532,000 metric tonnes of TiO2 capacity. At an EV of 1.591 billion, the market is valuing TiO2capacity at $2,990 per metric ton
At 370,000 metric tonnes of capacity, Tronox's facilities have a value of $1.106 billion. This is at the high end of the POR EV valuation but still within the given range.

persistentone 7/19/2010  

Normally these Chapter 11 emergence plans are conservatively framed, particularly when there is an equity committee trying to grab for as much as they can. The management normally has an incentive to keep bondholders happy and get them on board for the plan since they are typically the majority holders of the new equity.

I'm sure there are exceptions, but the above seems to be a common case.

Josh4580 7/20/2010  


"Given the fact that comps in the space are trading at 5.5x-6.0x, I would lean to the higher end of the valuation spectrum...call it 75-120. And I think some arrangement gets made so that the tort claimants come onboard - but for that I would have to discount the recovery call it 10%. "

What comps are you using that are trading at 5.5x-6.0x? KRO is the only public "direct comp" out there and is trading with an EV of 1.591B and TTM EBITDA of 73.6M, for an multiple of 21.5. HUN & DD are trading at 2010E EBITDA of around 8.

Why are you using a 10% discount rate for the risk of the tort claimants voting against the plan. If they do vote against the plan, it would add anothe $2.05 billion into the equity pool, and could reduce the Notes recovery to around 22%. This seems like a much larger risk that just using a 10% discount rate, right?

Josh4580 7/20/2010  
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About Me

I have spent the majority of my career as a value investor. For the past 8 years, I have worked on the buy side as a distressed debt and high yield investor.