Sunday, October 4, 2009

Georgia Gulf Corp (GGC) and Olin Corp (OLN) Pair Trade Idea

I have been meaning to post about this for months; here it is.

An extensive restructuring of Georgia Gulf Corporation (GGC $29) involving a distressed debt exchange, convertible preferred stock issuance, and a 25:1 reverse split has caused confusion and led to a huge mispricing of GGC equity. Enterprise value for GGC is 14x management’s estimated 2009 EBITDA versus ~5x for its closest competitor Olin Corp (OLN $16.50).

GGC is an Atlanta-based manufacturer of commodity chemicals and vinyl-based building and home improvement products.[1] The company operates in four segments, Chlorovinyls; Window and Door Profiles and Moldings Products; Outdoor Building Products; and Aromatics. It markets its vinyl-based building and home improvement products under the Royal Group brands.

In October 2006, GGC vertically integrated by buying Royal Group, a downstream consumer of chlorovinyls, for $1.6 billion, “transforming Georgia Gulf Corporation into one of the most highly-integrated companies in the residential repair, renovation, and remodeling markets.” The 2005 EBITDA for Royal Group was $224 million for a transaction multiple of 7.1x. This transaction was nearly the ruin of the company as the outdoor building products and window and door profiles and moldings products segments of the company have been performing worse than the commodity chemicals segments, and even had negative gross margins in the most recent quarter.

Olin Corporation is also a commodity Chlor-Alkali chemicals manufacturer, which represents 72% of 2008 sales, with the balance (28%) consisting of the fantastic Winchester ammunition business. This is a much better subsidiary to own than the vinyl-siding Royal Group. For one thing, ammunition is a nice oligopoly with almost all production owned by Olin, Alliant Techsystems (ATK), or Cerberus Capital Management (private). [2]

Also, OLN is better managed than GGC, judging by their decision to sell a subsidiary (Metals) to a New York private equity firm in 2007. (On the other hand, they did buy chemicals competitor Pioneer in 2007.)

What I like about this trade is that on their own, OLN is a good long, GGC is a great short, but they are so comparable that they also pair together well.

GGC Capital Structure
A key factor causing the current mispricing of GGC is confusion over its capital structure, thanks to the restructuring and reverse split. The current enterprise valuation is outlined below.

Only a small amount of the notes remain because 92% of them were tendered in July in exchange for stock. Note that Yahoo Finance and other data providers are wrong about the market cap and enterprise value of GGC. The structure I show here is derived from a recent 8-K.

Relative Valuation
GGC has a higher enterprise value than OLN, but lower gross profit, EBITDA, and cash flow. Additionally, OLN has a long history of paying dividends, and currently yields 4.9%.

GGC Valuation
Management has estimated that 2009 EBITDA for GGC will be $110 million. Stretching as far as a 8x multiple would leave only $347 million in value for common shareholders, putting the share price at $9.95, a 66% downside from today's levels. The table below shows value/share available given a number of possible EBITDA multiples. Note that the common GGC shares are a zero if the enterprise is valued based on OLN's current multiple.

GGC Recovery Analysis
Another interesting question is: where should the notes trade? This question is basically ignored by the market given that there are only $64 million notes outstanding now that the the exchange has been completed.

Given the current $986 million market cap of GGC, it is odd for the sub debt to be trading at 63, to yield over 20%. If the current equity pricing persists, I would expect the company to make a huge equity issuance and buy back debt. All of the notes have double-digit yields. They would probably find them the best ROI in the chemical industry right now.

The Trade
I like shorting GGC and buying OLN as a hedge. Also I like GGC debt as a hedge.

[1] Chlor Alkali refers to combination of chlorine (Cl) and caustic soda (NaOH), which are co-produced by the electrolysis of salt (NaCl). These co-products are produced simultaneously in a fixed ratio of 1 ton of chlorine to 1.1 tons of caustic soda. The industry refers to this as an Electrochemical Unit or ECU. As of YE 2008, OLN had a consolidated capacity of 1.91 million ECUs per year, making them the third largest chlor alkali producer.

[2] Olin, by virtue of its Winchester subsidiary, is the most attractive way to gain exposure to ammunition manufacturing. Remington is privately owned by hedge fund Cerberus. Alliant Techsystems, which owns the Federal and CCI/Spear brands, is not as attractively priced.


PD said...

hey great post. i checked out some of the numbers. there is an additional 14mm in secured loans, as well they have 96mm in lease financing that isn't included. it was in the q2 #s corp pres.

comment about mkt cap- could this be like HBC where the exchange just isn't showing up,or mkt is holding up because the debt for equity hasn't hit the market yet.

CP said...

Thanks for pointing this out.

The company filed an S-1 registration statement on September 25. So my understanding is that the SEC needs to approve, and then these shares can hit the market.

I forgot to mention in the report - the new equity is owned almost entirely by bond funds. At current equity trading price they have totally lucked out on the junk debt they originally bought.

Are they going to hold these overpriced shares or dump them ASAP? And, what is going to happen when they go to sell 30 million shares of a stock that trades 350,000 a day?

This thing is going to drop like a rock.

eh said...

Apparently, over 20% of the float is already short. Which is always a concern. Even more so with such low trading volume, i.e. it might be tough to find shares to short.

CP said...

It is hard to find shares to short. You can buy the 2.5 puts.

The 20% refers to the current float, not the 30 million shares that are about to hit the market.

PD said...

CP I checked all the filings last night. you are bang on that the high yield funds will sell right away. Is there a way to track how much these guys bought for, so we can get a picture of their breakeven?

I agree the float will be tough to short, and it is skewed because the market doesn't have the 30mm shares.

Will there be contract adjustments for the equity for debt exchange?

CP said...

PD get in touch with me via email:

There's no way of knowing what the bond funds paid for their notes. The sub notes did trade as low as 2 cents. (I picked mine up at 10 on the way back up.)

Here's the info on the sub notes:

In exchange for each of the 2013 notes and 2014 notes, the Company issued about 47.30 shares of convertible preferred stock and 2.11 shares of common stock, and in exchange for each of the 2016 notes, the Company issued about 18.36 shares of convertible preferred stock and 0.82 shares of common stock.

So that's 49.41 shares for the senior notes and 19.18 shares for the sub notes. Which is worth 1432.89 and 556.22.

So the seniors got a huge windfall - even if they paid par! They'd be crazy not to sell.

The put contract situation is confusing for people too. Some services show two contracts for each month but there is only one series that actually trades, and it's the pre-split series. That 2.5p is actually 62.5 which is deep in the money.

eh said...

The 20% refers to the current float, not the 30 million shares that are about to hit the market.

Yes, I understood that.

eh said...

You can buy the 2.5 puts.

Right now there's no bid/ask quote on the Feb '10 $2.50s.

CP said...

If you aren't seeing the 2.5 puts of any month offered, you are looking at the wrong series.
Here's a link to the Yahoo options quotes, showing the Febs offered at 1.75 right now:

eh said...

Thanks a lot.

When I go to trade options on Etrade, first I pull up a chain. And when I do that on GGC -- which is the normal way, enter the ticker symbol of the underlying -- it shows me another series I guess. Because the Feb '10 $2.50 put has a different symbol. But if I just go right to the options trading page, and enter the symbol from the Yahoo page you gave, then I get the correct quote. A bit odd. How am I supposed to know the symbol if Etrade won't show me the correct chain? Or give me some kind of hint about it. I will email customer service and ask them.

About the puts: I'd prefer to pay less...But I will take a flyer on some contracts tomorrow. Even though in general shorting this market makes me nervous.

CP said...

I personally prefer the Nov and Jan puts. I think this is going to happen sooner rather than later.

PD said...


when you try to execute an options trade for a chain that has been adjusted they will let you know or they will reject the trade.

whenever there is a material change to a security- S-1 document, there will typically be a contract adjustment. the standard is to go to the biggest option market which is cboe and look for contract adjustments to the security. there will be an announcement that indicates and outlines the changes.

eh said...

CP & PD,

Thanks for the tips.

I do get both series on the CBOE site.

Also AOL Finance shows both.

I suppose you are right: ETrade would have rejected the trade. But I think they should at least show the correct series...somewhere. Maybe they do now -- I will take a look later.

I'd also normally think it should tank sooner rather than later. But then I've thought the same thing about the market for months now...

eh said...

Here's the message I got from Etrade when I tried to place an order to buy/open a position in the Jan '10 $2.50 puts (GCPMZ), which unless I am mistaken is the correct series:

The number of shares per contract does not equal 100. Please call customer service at 1-800-ETRADE-1 to place this order with a broker.

What's up with that??

CP said...

Etrade sucks. You need to get interactive brokers or thinkorswim.
That being said, the options have gotten more expensive as you observed earlier. They still have a positive expected value though.
When people are scared to short clearly overvalued companies, that is a sign that bullish sentiment is far too extreme.
Don't forget about the REG trade, although that one has worked so well that it is second best now.

CP said...

Also - the contract is for 100 old shares or 4 new strike shares, which is why etrade is giving you that message.

Thinkorswim handles it by displaying a 4 next to the contract name.

pd said...

pd said...

for ever 100old shares= 4new shares
$1 (old)= $25(new)

mkt cap = $100 (old)=$100(new)

old contract
2.5 strike(old)=62..(new)
1.5 (old)premium= 1.5*100=150
1.5 (new)= 1.5*100=150** no adjustment*

in the end it has to all balance...