American Pacific Corp APFC
March 30, 2006 - 2:34pm EST by
2006 2007
Price: 9.08 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 66 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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Over the last several years as a VIC member stocks recommended had fairly simple
stories. Celadon, Smithway were truckers, Sitel a call center service, Obie an outdoor
billboard advertiser and RG Barry a slipper outsourcer. All were rated poorly (in the
fours) and all did quite well. The current pick unfortunately is a complex story but
with a compelling tale. Hopefully it does as well as the others.

American Pacific Corp (APFC) is a past VIC pick of perspicar744 on 2/18/03 at
7.68. The recommendation should be read to understand the background of the company
and its original core business. While we will review this, our attention will be spent on
the new company that has arisen on the back of its original activities.

APFC is a specialty chemical company with a monopoly position in rocket fuels
supplying Nasa and the defense department with a good deal of their needs. Ammonium
Perchlorate is an oxidizing agent for solid fuel rockets and missiles including the Minute-
man, Titan, Tomohawk and Patriot missiles among others. A greater proportion of
perchlorate found its way into the solid fuel boosters of the Space Shuttle. Thus the
variability of the defense effort and the NASA program played a dominant role in
results. Management has said they are in negotiations with Nasa regarding new contracts
and hope to reach a favorable conclusion during the year. Over the past several years,
chemical sales have averaged $60 million with pro forma profits between $0.50 to $1.50.
This then is the original business.

In Nov 2005, a company changing event occurred. Management purchased from
Gentek, the Aerojet Fine Chemicals(AFC) company for about $128 million dollars
borrowing about $88 million from Wachovia at 4 points over prime and a sellers note of
$25 million and cash. Previously sitting on a cash hoard of over $20 million with little
corporate debt this was a major corporate event. AFC according to a SEC filing of Feb
13,2006 showed net sales growing from 2002 to 2004 from $51 million to $65 million
while ebidta was flat from $1.7 million in 2002,to $4.9 million in 2003 and $2.7 million
in 2004. Not a bargain, it would seem. The $64 question is- Why did APFC leveraged
itself up to buy the Aerojet operations? In essence it would appear to paraphase Groucho-
the company was “betting its life”.

So the obvious question is what is Aerojet Fine Chemicals all about. AFC is cons-
sidered a leader in active pharmaceutical ingredients and registered intermediates
under cGMP (read FDA) guidelines for commercial customers in the drug industry.
It offers specialized engineering capabilities for high potency (dangerous) compounds,
energetic and nucleoside chemistries, and chiral separation.

What is chiral chemistry and why should we care. Many chemicals used in
drugs are chiral in nature- exist in two different forms which are mirror images of each
other and can have very different properties including efficacy as a drug. As a result
the FDA is requesting drug companies to determine if the mirror images are different and
if one image is causing any side effects. If so ,the FDA will request that the desired
molecule be chirally pure( separated from its counterpart). Enter AFC which is the leader
in SMB (Simulated Moving Bed) technology, an efficient continous separation technique
based on the principle of chromatography. Only three other companies have such abilities
all smaller and all outside US.

AFC is an expert in high potency compounds- a very rapidly growing segment of the
pharma chemicals industry. These are highly active, dangerous compounds that find their
way into many drugs the most common used for oncology. AFC believes that there are
currently over 600 anti-cancer drugs in the development pipeline and most used such
high potency chemicals. Because of the dangers in their formulations and levels of
expertise needed, the company believes it has limited worlwide competition.

Energetic chemistry allows AFC to offer higher yield processes to target over 50 drugs
currently on market and is one of the few companies in the world with the capability to
use such compounds under FDA cGMP commercial guidelines . One of the largest and
fastest growing applications for this chemistry is anti-viral drugs- including many HIV
related drugs. The outlook for this sector has expanded mightily with the US in May 2003
passing a five year, $15 billion anti-HIV bill designed to increase the supply of HIV-
fighting drugs to third-world nations. AFC is the sole US supplier.

What makes this story unique is that not only is the current plant sold out to many
drug companies but the plant expansion due on line in the third quarter(ending June) is
also soldout. All on multi year programs. And did we mention that Roche(the European
drug giant) recently disclosed that AFC is one of their production partners in the produc-
tion of Tamiflu- the anti-viral drug to treat bird flu.

Now for the hard part. Trying to put some numbers together, we are skipping the
current fiscal that ends in Sept 2006 as we are in transition. With the second plant up and
running by June, we should have a better idea of run rates. Our early line for 2006/2007
year includes $60 million for historical AFC sales and another $30 million from the
plant expansion. While several of these drug areas are growing 20-30% we are not
including any new growth save the new plant add on. Ebidta in this exotic drug area
could/should be 25% giving us $22 million for starters. From the rocket propulsion
business usually doing $60 million (recently announced NASA flights and DOD
missile awards) another $10 million EBIDTA should surface. Total EBIDTA of $32
million less $10 million interest costs and $10 million depreciation and amortization
results in $10 million pretax or $7.2 million after tax. With 7.5 million shares we have
a very preliminary estimate of $0.95.

And possibly the most exciting part of the story has not been told. Right and left
handed molecules make up drugs, with the right handed molecule accounting for
the curative power of the drug. The left side can usually carry the harmful side effects.
Thru chiral separation we have the ability in many drugs to save the healing part
separating out the bad side effects. Obviously to the extent AFC can execute in this
area, it would prove a potential bonanza to the public and drug companies. And
best of all, by reformulating many of these drugs with only the right molecule, they have
created a new drug- with another 17 years of exclusivity. Sounds like a potential long term windfall.

Another area that we find very attractive but have no time line is the pesticide
market. Methyl bromide is used to control weeds, rodents, insects, etc in over 100 crops.
It is a ubiquitous product but is being phased out globally due to harmful effects on the
ozone layer. EPA says it will be illegal as of Jan 2007. AFC has a potential replacement
product for methyl bromide called SEP100, which has been under review by the EPA
since Sept 2005 for its approval in certain applications. Management believes the poten-
tial for the product is substantial. Obviously this is a wild card.


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