GenCorp GY
December 20, 2004 - 8:59am EST by
pirate681
2004 2005
Price: 17.12 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 1,063 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

Trading at $17 per share, GY will be worth $31-40 in 2008 (or sooner) and up to $96 per share in 2015 as it develops 12,680 acres of prime California real estate. GY's core operating businesses have grown EBITDA over 20% per annum over the last 3 years.

GenCorp is a sum of the parts story consisting of Aerojet, Real Estate Holdings, and Aerojet Fine Chemicals (AFC). GenCorp will monetize two of the parts and continue to operate and grow the core Aerojet propulsion business. Aerojet is expected to do $75M-85MM in 2004 EBITDA, at 7x the business is worth ~$560MM. GenCorp’s HIDDEN VALUE is owned Real Estate consisting of 12,680 acres or 21 square miles of raw land in Sacramento, CA, the largest contiguous plot of land in the area; which is roughly the size of either Manhattan or Bermuda. Currently, GY has 5,800 acres in the entitlement process which once entitled is worth $1,150MM or $18.51/share. The remaining 6,880 acres will enter the entitlement process over the next 5 – 10 years and has a current un-entitled value of $344MM or $5.54/share. By year end 2004 Terry Hall, CEO, expects to announce the sale of the Fine Chemicals business which he believes will net $112MM.

GenCorp Sum of the Parts Valuation Analysis:
($ millions except land acreage & per share data)
2005 2006 2007 2008 2015
Land Value:
Total Unentitled acreage 12,680 9,930 8,530 6,880 -
$/ unentitled acre $0.05 $0.05 $0.05 $0.05 $0.05
Expense per acre - - - - -
Unentitled value 634.0 496.5 426.5 344.0 -
Total Entitled acreage - 2,750 4,150 5,800 12,680
Newly entitled 2,750 1,400 1,650 1,180
$/ entitled acre 0.2 0.2 0.2 0.2 0.2
Expense per acre 0.002 0.002 0.002 0.002 0.002
Entitled value - 545.3 822.9 1,150.1 2,514.4
Total Land Value 634.0 1,041.8 1,249.4 1,494.1 2,514.4
Real Estate value/share $10.21 $16.77 $20.11 $24.05 $40.47
Aerojet value /share 9.01 9.01 9.01 9.01 9.01
Fine chemical value/share 1.80 1.80 1.80 1.80 1.80
Cash per share 4.92 4.92 4.92 4.92 4.92
Debt per share (8.83) (8.83) (8.83) (8.83) (8.83)
GenCorp Value per Share $17.12 $23.68 $27.02 $30.96 $47.38
# of shares (thousands) 62.1 62.1 62.1 62.1 62.1
Assumptions
-Aerojet valuation at 7x TEV/EBITDA, EBITDA $80MM
-Real Estate
oUn-entitled land valued at $50K/acre
oEntitled land valued at $200K/acre
-Aerojet Fine Chemical sells for $112MM
-Debt & cash balance remain flat

Discussion on the above valuation:
The above valuation is overly conservative. The Real Estate valuation does not project appreciation, while real estate values in Sacramento County have increased at a 6.7% CAGR since 1977. Also, the assumption has been made that the Aerojet business does not grow over the next 10 years and that the Company’s other businesses and capital structure do not change. In actuality, the Aerojet business will grow at around 5% per year and in 2006 the Company will begin generating $50MM+ in free cash per annum. In 2015, the stock would be worth over $95.00 per share and an investment todaywould generate an annualized return of 18%+ over the next 10 years. (see growth valuation below)

GenCorp Sum of the Parts Growth Valuation Analysis
($ millions except land acreage & per share data)
Land Value:
2005 2006 2007 2008 2015
Unentitled acreage 12,680 9,930 8,530 6,880 -
$/ unentitled acre $0.05 $0.06 $0.06 $0.06 $0.10
% increase 6.7% 6.7% 6.7% 6.7% 6.7%
Expense per acre - - - - -
Unentitled value 676.5 565.3 518.1 445.9 -
Entitled acreage - 2,750 4,150 5,800 12,680
Newly entitled - 2,750 1,400 1,650 1,180
$/ entitled acre 0.2 0.2 0.2 0.3 0.4
% increase 6.7% 6.7% 6.7% 6.7% 6.7%
Expense per acre 0.002 0.002 0.002 0.002 0.002
% increase 3.0% 3.0% 3.0% 3.0% 3.0%
Entitled value - 621.2 1,000.5 1,492.4 5,145.7
Total Land Value 676.5 1,186.5 1,518.6 1,938.3 5,145.7
Real Estate value/share $10.89 $19.10 $24.45 $31.20 $82.83
Aerojet value /share 9.46 9.94 10.43 10.96 15.42
Fine chemical value/share 1.80 1.80 1.80 1.80 1.80
Cash per share 4.92 4.92 4.92 4.92 4.92
Debt per share (8.83) (8.83) (8.83) (8.83) (8.83)
GenCorp Value per Share $18.25 $26.93 $32.78 $40.05 $96.14
# of shares (thousands) 62.1 62.1 62.1 62.1 62.1
Assumptions
-Aerojet valuation at 7x TEV/EBITDA, EBITDA $84MM in ’05 with 5% organic growth per annum
-Real Estate
oLand values grow at 6.7% per year
oExpenses grow at 3% per year
-Aerojet Fine Chemical sells for $112MM
-Cash & Debt balance remain flat



COMPANY OVERVIEW
Operating since 1915 and currently headquartered in Sacramento, CA, GenCorp was formerly the General Tire & Rubber Company. In 1984 the Company changed its name when GenCorp was formed as a parent holding company. In a subsequent restructuring, the company exited the tire business by divesting General Tire. In 1999, GenCorp spun off its Decorative & Building Products and Performance Chemicals businesses into a separate, publicly-traded company called OMNOVA Solutions, Inc. In July of 2004 GDX Automotive was divested to Cerberus for $147MM.

Today, GenCorp consists of Aerojet, Real Estate, and Aerojet Fine Chemicals. Aerojet Fine Chemicals is currently on the block to be sold and is considered a discontinued operation. GenCorp is now focused on growing the Aerojet propulsion business and developing a strategy to monetize the Real Estate assets.

Summary
Aerojet: growth of the core business
-Manufacture solid and liquid propulsion, a consolidating industry, in which Aerojet intends to be a consolidator. The Company has discussed the purchase of Boeing Rocketdyne.
-The propulsion business is expected to grow organically at 5% per annum.
-Bush win bodes well for defense spending and commitment to NASA’s deep space exploration program.
-President Bush’s national defense budget: $350B 2002, $375B 2004, and $416B proposed 2005 budget.

Real Estate: entitle and monetize
-The Company has 5,800 of the 12,680 acres of owned land in the entitlement process for residential & commercial development. The land is located 15 miles outside Sacramento, CA (in Rancho Cordova/ Folsom) along U.S. Route 50.
-26% of the regions future population growth is expected to occur in Rancho Cordova/ Folsom County.
-The Aerojet land has the attention of national & local homebuilders and developers due to the regions short supply of land, and the land being the largest contiguous piece of acreage in the region. Currently, there are 6 – 9 months of inventory in Sacramento County. Thus, builders need “lots” (they like 2 years of inventory).

Aerojet Fine Chemicals: sell for $110 – 140MM
-Sale before year-end 2004. GY will focus on the Aerojet business and the monetization of its Real Estate.

Improve liquidity and cash flow:
-The sale of Fine Chemicals will allow GY to refinance the 5.75% convertible notes lowering interest expense while cleaning up the balance sheet for the potential acquisition of Rocketdyne.
-November 2004, the Company completed the public offering of 8,625,000 shares of common stock, priced at $16 per share. In addition the Company closed the private offering of $146.4MM in aggregate principal amount of its 2.25% Convertible Subordinated Debentures due 2024 conversion price $20 per share. This offering has allowed the Company to pay down debt and improve the balance sheet.




AEROJET
Aerojet is a provider and developer of solid and liquid propulsion systems to support national defense, space exploration, and satellite deployment activities for government and commercial applications. Such applications include boosters and propulsion systems for rockets, satellites, and missile defense. The business does about $500M in revenue, has 10-12% EBIT margins and ~$20-25MM in D&A ($75-85MM EBITDA). CAPEX is about $5MM below depreciation and the business is poised to grow 5% organically. Aerojet’s revenues are 90-95% defense and 5-10% NASA. Aerojet’s propulsion systems are used on 95% of all U.S. launched satellites that are currently orbiting the earth. Aerojet is the only U.S. propulsion company in both solid and liquid. The company currently has 200 contracts of which only 2 contracts are over 5% of revenue.




FINE CHEMICALS
Aerojet Fine Chemicals (AFC) manufactures specialized chemicals/pharmaceutical ingredients and is a supplier to pharmaceutical and biotechnology companies. The business unit consists of a single manufacturing facility, and capacity is 100% sold out. In 2003 AFC had sales of ~$60MM and ~$16MM of EBITDA. The Company sees dramatic growth in EBITDA over the next three years and expects 2004E $16M, 2005E $30M and 2006E $60M. However, the current facility has capacity for EBITDA of $16-18MM ($70MM sales). To achieve the
potential growth the Company would have to outlay capital to expand the production capacity. GenCorp management believes that a better use of capital is to focus and grow the Aerojet propulsion business (to take advantage of the Global Settlement) and to monetize the real estate assets.

Sale & NOLs:
GenCorp plans to sell the fine chemicals business unit and use NOLs to offset capital gains taxes. GY has $150-250MM of NOLs and expects to use $60-$70MM to offset such gains from the sale of the AFC.

Fine Chemical Sale terms
-GY is working with Lincoln Partners to sell the business prior to year end 2004
-8-10x EBITDA less CAPEX
-2005E EBITDA of $18MM
-Sale price $100-140MM (because of NOLs it will be proceeds as well)



REAL ESTATE
GenCorp owns 12,680 acres or 21 square miles of land in Sacramento, CA; to put this into context Bermuda is 21 square miles while Manhattan is 23 square miles. The land is on the Company’s balance sheet for $49MM. The land was purchased in 1953 by GenCorp from Natomas Gold Mining Company to manufacture and test solid and liquid propulsion systems. This land, while once surrounded by fields, has now been encroached upon by civilization. As suburban sprawl continues in Sacramento, so continues the appreciation of the GenCorp land. In the summer of 2004, Aerojet conducted its last propulsion test on the site. All further testing will be conducted at government test facilities or at other GY owned test facilities.

In response to the valuable property GenCorp has created a Real Estate division. This division’s responsibility is to create a strategy to monetize and develop the vast land bank owned by the Company. Currently, only a small portion of the land is in use for aerospace research, GY’s corporate offices, and for AFC. The Real Estate division pays for itself with $5-6MM in leasing revenue. The division leases a portion of GenCorp’s headquarters to the California Department of Corrections and HealthNet. This revenue not only covers all corporate overhead for the Real Estate division but also covers all costs associated with the entitlement process.

In Sacramento County, Rancho Cordova and Folsom have had the largest suburban residential growth, and Rancho Cordova is the largest office market after downtown Sacramento. The major employers to the area are Intel Corporation, EDS Corp, Catholic Healthcare West (Mercy Hospital) and Vision Service Plan.


Location:
The land is located in Sacramento County and is situated along a ten-mile stretch of U.S. Route 50 (the main thoroughfare into Sacramento, 14 miles), and is about 100 miles from Lake Tahoe.

Rancho Cordova was built in the 1950s and 1960s when GenCorp became the main employer to the area. The City of Rancho Cordova has had a long time affinity toward GenCorp, and given the added tax dollars, is seeking to annex the entire 12,680 acres of land. Currently, it has been agreed that the western portion of the land will be annexed into Rancho Cordova. The western portion consists of 2,750 acres known as Rio del Oro and 1,500 acres known as Westborough.

The unaffiliated portion of land will either be annexed into Rancho Cordova, Folsom, or remain unaffiliated land in Sacramento County. The unaffiliated land is known as Easton’s (Glenborough) 1,250 acres and Easton Place’s 300 acres.

The City of Rancho Cordova is eager to annex the Easton (Glenborough) site to increase the tax revenue base of the City. Sacramento County is also supportive of GenCorp’s efforts to clean up the land and redevelop to higher and better use. The remaining 6,880 acres of land in Figure 1 depicted in yellow and two blue parcels in the southern and eastern portions of the site are planed to enter the entitlement process in 5-10 years, and are unaffiliated.

Water source is secure
One of the major development hurdles in California is securing an adequate water source for any proposed development. GY produces water from its manufacturing operations as well as from of its environmental clean-up initiative. Aerojet has a considerable amount of water flowing through its property. The Company is remediating 17 million gallons of water per day. Aerojet has made an agreement with Sacramento County to supply the remediated water to the region, and the County has committed to make water available, to GenCorp, for the development of the land.


Land Valuation:
GY is currently carrying the 12,680 acres on its books for $49M ($0.78/share). Market value for this land, un-entitled, is about $50K per acre or $10.00/share. Entitled land is worth $200K per acre or $40.00/share. The value increases as more money is invested and infrastructure (water, sewage, electricity, and roads) are built. Finished lots are worth $450-$1,000K/acre. To create a finished lot the Company must invest $150,000 per acre. Finished land is priced on a percent usable basis, which is typically 65% or 8,255 acres of GenCorp land. As finished land the site is worth $40.00-$113.00/share.

Currently, 5,800 acres (only 45% of GenCorp’s total land holdings) are in the entitlement process. If the Company decides to invest the necessary infrastructure for finished lots, the Company will finance a portion of the project through Mellaruse bonds (municipal project financing bonds) and the remainder through GenCorp. GY also has NOLs of $150 - $250MM and post the sale of AFC will have NOLs of $100-150MM, to shelter the initial gains from land sales. The company anticipates that land sale gains will begin to contribute to the income statement in late 2005 or early 2006.

Scenarios
Land Value:$MM ex. acre & /share
UnEntitled Entitled Finished Low Finished High
Number of acres 12,680 12,680 12,680 12,680
Value per acre $0.05 $0.20 $0.45 $1.00
% sellable 100% 100% 65% 65%
Gross value $634.0 $2,536.0 $3,708.9 $8,242.0
Expense per acre - 0.002 0.15 0.15
Total Expenses - 21.6 1,236.3 1,236.3
Total Land Value 634.0 2,514.4 2,472.6 7,005.7
Value per share $10.21 $40.47 $39.80 $112.77
# of shares (millions) 62.1 62.1 62.1 62.1

Land Value: Real Estate value by 2008
$MM ex. acre & /share Not Entitled Entitled Total
Number of acres 6,880 5,800 12,680
Value per acre --- $0.05 $0.20
Gross value $344.0 $1,160.0 $1,504.0
Expense per acre - 0.002 -
Total Expenses - 9.9 9.9
Total Land Value 344.0 1,150.1 1,494.1
RE value per share $5.54 $18.51 $24.1
# of shares (millions) 62.1 62.1 62.1

Previous GenCorp Land Sales
2003
$15MM or $1.4MM per acre-- 96,000 sqft office complex on 11 acres
$6MM or $300K per acre—20 acres of undeveloped land

2001
$28MM or $25K/acre—1,115 acres sold to Elliott Homes
Elliott Homes will begin to develop this land in the Spring of 2005.


Strategy for monetization:
Entitling the land will bring four times more value to the property than selling the land today as un-entitled land. Thus, the number one initiative prior to selling any land is to gain entitlement or paper lot status.


Development Breakdown:
5,800 acres or 45% of the total land holdings (12,680 acres) are in various stages of the entitlement process.

Entitlement Process in California
Preliminary step
-Submit application for entitlement
-6-8 months the local agency reviews and asks for more information to make the application complete
-Upon submitting additional information a “Notice to Proceed” will be sent and the application is deemed complete.

Year 1 Begin entitlement process.
-Commence Environmental Impact Review (EIR) which takes about one year to complete the first draft

Year 2 Submit first draft
-6-8 months will elapse from the first draft of the EIR to the final draft of the EIR
-At end of year 3 EIR is compete

Year 3 Public hearings
-Public hearings commence to discuss the EIR and negotiations begin with opposing parties
-Typically about 1 year

Year 4 Local agency accepts the EIR and your land is entitled
-Upon entitling the land you have a “paper lot”
-Land is entitled and development must comply with the issues and recommendations of the EIR.

Land Bank
Rio Del Oro 2,750 acres not yet entitled.
-Entitlement filed February 2003 with city of Rancho Cordova
oThe report is drafted but the environmental study is not yet complete
and is expected by year end 2004
oEarly 2005 expect public hearings to commence
oEndangered species the Ferry Shrimp (Sea Horses)
-All land is subject to environmental restrictions by the State of CA. GY will negotiate the cleanup process and the State will lift the restrictions. Not Superfund.

Easton 1,400 acres not yet entitled land. (includes ½ or 150 acres of Easton Place)
-Entitlement filed January 2004 to Sacramento court
oSeptember 2004 began EIR
oEIR expected early 2005
oEIR completed in late 2005
oPublic hearings throughout 2006
oPaper lot expected early 2007
oEndangered species the Long Horn Valley Beetle living in Elderberry
-300 acres are subject to Superfund environmental restrictions of which only about 25 acres is contaminated. The contamination is a surface area landfill which will take 3 years to remediate and is not a concern.
-January of 2004 GY submitted its master plan to the County which called for 542 acres or 38% of the land to be developed as residential. The commercial development plan has not been finalized.

Westborough 1,650 acres not yet entitled. (includes ½ or 150 acres of Easton Place)
-Entitlement filed with Rancho Cordova December 2004
oNo endangered species
oExpect approval by 2008
-200 acres are subject to Superfund environmental restrictions

Other 6,880
This land will enter the entitlement process on a piecemeal basis beginning in 2010 through 2015. The land is largely designated a Superfund site and will be completely remediated.


Sacramento Metropolitan Statistical Area (MSA):
-The region includes six counties: Sacramento, El Dorado, Sutter, Yolo, Placer, and Yuba. Rancho Cordova and Folsom are within Sacramento County.
oThe population by 2005 is expected to be 2,117,000
oBy 2020 the MSA’s population is expected to be 2,696,000
oUnemployment is a steady 6%
oThere are currently 1,059,000 homes in the region
-Rancho Cordova has a population of 55,000 and expected to add 150,000+ people over the next 15 years.
oRancho Cordova will contribute 26% of the total expected growth in
the region.
oRancho currently has 22,000 homes and anticipates to add another
32,000 homes over the next 15 years, to total 54,000 homes.
oNew commercial space includes 600,000 square feet at the Mather
Campus (western portion of Rancho). Rancho plans to add more
industrial and commercial space as the population grows.
oRancho currently has 3 jobs to every 1 house and is targeting 1.5
jobs to every 1 house.

Sacramento home market growth according to the Office of Federal Housing Enterprise Oversight (OFHEO)
-Since 1977, the MSA’s compound annual growth rate (CAGR) in single family home prices, is 6.7%.
-Sacramento is the 13th fastest going MSA (of 331) in the United States.
-In 2004 home prices have increased 18%.
-A strong home market will absorb 1,000 homes per year and in a slow year will absorb 50-200 homes.
-Currently, there are 6 – 9 months of inventory in Sacramento County. Thus, builders need lots (they like 2 years of inventory).

The California home market is unique and land, given its short supply, is very valuable. California communities are very densely populated and land (with water rights) is in high demand by national home builders. Typically communities are built with very little buffer land between homes and in some areas there are as many as 8-10 homes per acre. The GenCorp land we assume will yield about 5 homes per acre. Home builder operating margins average 14-15% and gross margins are around 30%. Land cost is typically 30-35% of sales.




FINANCIALS:

Capitalization :
($mm, except share data)
Share Price as of 12/10/2004 $17.00
Dil. Shares Out. 62.1
Equity Market Capitalization 1,056.1
Less: Cash & Short Term Investments (8/04) 31.0
Cash from equity issuance 131.1
Cash from convertible issuance, 2024, 2.75%, convert at $20 143.6
Total Cash 305.7
Plus: Long term debt:
Revolving credit facility 12/09, $80MM, L+275 ---
Term loan 12/10, $25MM, L+300 25.0
LC 12/10, $75MM, L+300 75.0
Senior Sub 9.5% (2013) 150.0
Convert Sub 5.75% (2007) 150.0
Contingent convert sub 4% (2024), $125MM, converted at $15.43 ---
Convert 2024, 2.75%, at $20 (option to purch. addtl. $56.6MM) 146.4
Foreign credit facilities and other debt 2.0
Total Debt 548.4
Total Enterprise Value (TEV) 1,298.8

Taxes and NOLs
-Currently not a cash tax payer but will be in 3-4 years
-NOLS of $200-$250MM will be used to offset gains on asset sales beginning with Fine Chemicals

Pension
-The pension is over funded by $80-100MM
oTwo pension plans GenCorp and Aerojet. If the Aerojet plan is ever
under funded the government will fund the pension plan.
oWhen AFC is sold there will be only be about 30-50 employees under
the GenCorp pension plan.
oThe Company must continue to take non-cash expenses, as they did in
3Q04, under FAS rules until the investment portfolio begins generating
the necessary returns. The rules state that a Company must take
a non-cash charge if there is a deficiency in what the investment
book was forecasted to return and what it actually made, even if the
Company is over funded. GenCorp’s investment portfolio’s run rate
must be about $45MM per annum.


Conclusion: GenCorp is a cheap play on both the defense industry and the growth of land values in Sacremento, CA. Much like St. Joe (ticker: JOE), GY has valuable real estate that should continue to appreciate over time as the company receives development approvals and proceeds to unlock this value for shareholders.

Catalyst

1. 4X increase in land values when entitlement is received 2006-2008
2. 5% organic growth of Rocket Business, 20%+ historic growth of EBITDA
3. Possible target of M&A activity in 2005
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