CVR Energy (ticker CVI) operates in two segments, petroleum refining and the manufacture of fertilizers. The petroleum segment includes a 115,000 barrel per day refinery in Coffeyville, Kansas, a 35,000 barrel per day pipeline network and a 70,000 barrel per day refinery in Wynnewood, Oklahoma which CVR acquired in December for $593.5 million.
CVR’s fertilizer segment has a 69.8% ownership stake in CVR Partners, ticker UAN, which CVR Energy runs. The plant has a capacity of 1,225 tons per day of ammonia, a 2,000 tons per day urea ammonium nitrate (UAN) unit, and a coke gasification system. A bit more than half of the ammonia output of this facility is used in the creation of UAN. The plant uses petroleum coke from the Coffeyville refinery as its nitrogen source, which gives it a cost advantage over other nitrogen fertilizer plants in the US, which use natural gas, although that advantage is fairly small at current natural gas prices. Carl Icahn’s IEP Holdings just increased its stake to around 80% of the company.
rookie964 did a fine write-up of the company in October (http://www.valueinvestorsclub.com/value2/Idea/ViewIdea/58724), with an especially good discussion of why inland refiners in the US have a cost advantage over refiners in other areas due to the WTI/Brent spread. I agree that HollyFrontier is the closest comp. Here, I take a different route to valuation and also discuss the current significance of Icahn’s position.
Sum of the Parts Valuation
Valuation of the fertilizer business is fairly straightforward. CVR Partners has a market capitalization of $1,523.4 million. CVR Energy’s 69.8% share has a market value of $1,063 million. Giving that a 15% holding company haircut gets us to $904 million. Because CVR Energy pays taxes on income distributed to it by CVR Energy, this structure is not tax efficient. One possible source of value would be a tax-free spin of the rest of CVR Partners, though I don’t expect that for several years, and it’s not in my model.
For the petroleum segment, I scaled last year’s EBITDA to project this year’s EBITDA using the EBITDA ratios for the first quarter. 1Q11 petroleum EBITDA was $91.7 million, versus $144.9 million in 1Q12. This actually represents a slowdown in EBITDA on a comparables basis, since 1Q12 includes results from the Wynnewood refinery that CVR Energy purchased late last year (EBITDA on a comparable basis was $68.6 million, or 75% of 1Q11 EBITDA). Scaling up full year results, I multiply $144.9 / $68.6 by 2011 full year petroleum EBITDA of $581 (this is the Adjusted EBITDA presented in the company’s 10-K, but backing out the $8.7 million in stock compensation, which is a real expense). This gets me to a 2012 EBITDA projection of $918 million.
EV multiples for big US refiners are running between 2.9 and 3.8 for US refiners (it’s 3.1, for example, for HFC). I’m using the bottom of this range, 2.9, for CVR Energy, mostly because I’m concerned about the level of capex that CVR may need to spend to upgrade the Wynnewood refinery. Note, however, that the planned capital expenditures of HFC are roughly in proportion to those planned at CVR. At 2.9 times $918 million of EBITDA, I get a petroleum segment EV of $2,662 million.
CVR has cash and equivalents of $276 million ($551 million consolidated cash, less $225.6 of cash in CVR Partners. Debt, excluding debt of CVR Partners, is $756 million ($86 million outstanding on a line of credit, $447 million of first lien notes, and $223 million of second lien notes).
Adding the EVs of the fertilizer and petroleum businesses to cash, and subtracting debt, gets me to a market capitalization, at fair value, of $3,085 million. I estimate the equivalent of 88.62 million shares outstanding, from 86.8 outstanding on March 31, plus 1.7 million in phantom units and 170,000 in long-term incentive plan units, which I assume vested when Icahn’s tender was successful. That gives me a fair value per share of $3,085 / 88.62 = $34.81 per share. That’s 42% above closing market price of $24.62.
On May 21, IEP closed the second offering period of its $30 per share tender offer. My real thesis is that Icahn is a smart guy who was willing to pay $30 per share, so he’s got to know something that I don’t.
As part of the deal to get the CVR board to remove the poison pill, Icahn agreed that he would shop the company for 60 days, and support any all cash deal with a price of $35.00 or more. The go shop period will end on July 23; Icahn has hired Jeffries & Company to market the business. Should the company be sold before August 18, 2013, IEP would have to give up any excess of the sale price over $30 to the shareholders who tendered to IEP earlier this year pursuant to a contingent value right issued at the time the tender offer closed (the “CVR CVR”). While my best case would be for a buyer to emerge at $35.00 during the go shop period, I doubt this will happen—if there were a $35.00 buyer out there, they easily could have stepped forward with a competing tender offer. I also don’t expect that Icahn will accept any offers that would close before August 18, 2013, since he’s not in the business of giving away free money to holders of the CVR CVR. So, if we buy now, we’re going along for the ride.
I see two major risks here. The first is that the stock will probably drop a bit if there is an August announcement that no offers emerged at $35.00. I doubt that move will be big, given that I don’t think the market expects Icahn to find a buyer there, but I could be wrong there.
The second is that Icahn may try something to screw over CVR holders. For example, IEP could acquire shares in the open market to boost it above 90% ownership and then do a squeeze-out tender offer at a low price. Two pension funds today sued in Delaware Chancery Court to force the company to adopt a poison pill that would prevent Icahn from acquiring more shares. I don’t make many firm predictions, but I guarantee that the courts in Delaware, under the business judgment rule, are not going to force a company to institute a poison pill.
Should Icahn acquire more shares and do a squeeze-out merger, we tag-along shareholders will have a remedy, asking for appraisal rights rather than receiving the merger consideration. Given where I think the fair value of the stock is, I feel pretty good about that appraisal, though it would be a pain to have to go through the lawsuit and wait to get our money out. The other factor that mitigates this risk is that, to execute it, Icahn would have to buy shares equal to around half of the float to get from 80% to 90%, which would undoubtedly drive the price up.
Note that the price of CVR traded above the $30.00 tender offer after the expiration of the tender offer. I wasn't interested at $30 to $32 (there's enough uncertainty in my valuation that I wanted more upside). The price fell below $24 intraday on Monday. I don't know what the dynamics were that caused the price changes, but the stock is a lot more attractive below $25 than it was at $30.
Finally, while my fund is just long CVI right now, I think that the strategy rookie 964 suggested in October, selling CVR Partners against CVR Energy and hedging the stub with HFC makes sense.
Possible, but unlikely, sale quickly. Otherwise, sale of company by Icahn in 2013 or 2014.