"USEC Judge Questions Company's Need for 'Life Support'"

At the hearing today,

U.S. Bankruptcy Judge Christopher Sontchi said today that USEC has no financial projections and falling sales because of an oversupply of enriched uranium, raising the question of why it would bother to reorganize its balance sheet in bankruptcy. “What’s the point?” Sontchi asked D.J. Baker, a lawyer for USEC, at a hearing in Wilmington, Delaware. A reorganization might only “keep the company on life support for the next six to 10 years,” Sontchi said.

Estimated Recovery Of USEC Notes According to Disclosure Statement $USU

From the disclosure statement filed today.

"Each holder of an Allowed Noteholder Claim will receive, on the Distribution Date and in full satisfaction, settlement, release, discharge of, in exchange for, and on account of such Allowed Noteholder Claim, its Pro Rata share of (i) the New Noteholder Common Stock, (ii) Cash equal to the amount of the interest accrued at the non-default rate on the Old Notes from the date of the last interest payment made by the Debtor before the Petition Date to the Effective Date and (iii) the Majority New Notes.

The Plan defines the New Noteholder Common Stock as 79.04% of the New Common Stock to be issued under the Plan, subject to dilution on account of the New Management Incentive Plan. The New Noteholder Common Stock will be issued in the form of Class A Common Stock as described in the New USEC Charter.

The Majority New Notes are the New Notes in the aggregate principal amount of $200.00 million, to be issued by the Reorganized Debtor under, and having the terms set forth in, the New Indenture, which Majority New Notes will have the benefit of the Limited Subsidiary Guaranty and the Subsidiary Security Agreement.

All distributions on account of Allowed Noteholder Claims with be subject to the Indenture Trustee’s Charging Lien in the event of any unpaid Indenture Trustee Expenses, in accordance with the Plan. A summary of the material provisions of the New Noteholder Common Stock, the New Management Incentive Plan and the Majority New Notes is contained in Appendix B.

Noteholder Claims are Impaired. The holders of such Claims are entitled to vote on the Plan.

Estimated Percentage Recovery: 39% for Cash and Majority New Notes only; recovery for New Noteholder Common Stock is highly speculative and not quantifiable."

The bid on the bonds right now is exactly 39.

"USEC Inc. to Implement Financial Restructuring Plan" $USU

USEC filed Chapter 11 this morning.

USEC Inc. (USU) announced today that it is implementing the agreement reached with a majority of the holders of its senior unsecured convertible notes that was announced in December 2013. This agreement sets forth the terms of a financial restructuring plan to strengthen the company’s balance sheet, enhance its ability to sponsor the American Centrifuge project and improve its long-term business opportunities. The company also announced today that it reached agreement with its preferred equity investors, Toshiba Corporation and The Babcock & Wilcox Company, to support the restructuring plan.

In order to implement the agreement, USEC today filed a voluntary petition and a plan of reorganization under Chapter 11 of the bankruptcy code in the U.S. Bankruptcy Court for the District of Delaware. USEC anticipates receiving Court approval for its prearranged plan of reorganization and emerging from Chapter 11 in 90 to 120 days. None of USEC’s subsidiaries, including its primary operating subsidiary the United States Enrichment Corporation, have filed for bankruptcy protection.

The Company had positive cash flow from operations in 2013 and ended the year with a cash balance of $314 million. During the restructuring process, USEC’s subsidiary, the United States Enrichment Corporation, will provide debtor-in-possession (DIP) financing to USEC that will support continued operations. No third-party DIP financing will be required. After meeting its significant payables in the first quarter, the Company anticipates a cash balance of at least $60 million at March 31, 2014.

This filing has no impact on USEC’s daily operations, which includes the company’s efforts to deploy the American Centrifuge uranium enrichment technology and perform the research, development and demonstration program partially funded by the U.S. Department of Energy. As a non-debtor, United States Enrichment Corporation’s operations, which include the transition of the Paducah Gaseous Diffusion Plant back to the U.S. Department of Energy (DOE) and the sale of SWU from its inventory and purchases of Russian low enriched uranium, continue unaffected.

“By addressing the October 2014 maturity of the convertible notes, USEC will be able to pursue its ongoing business objectives with greater certainty,” said John K. Welch, USEC president and chief executive officer. “The restructuring will strengthen USEC’s balance sheet and enhance the company’s ability to sponsor the American Centrifuge project. Throughout this process our operations will continue. We will continue to make customer deliveries, execute the RD&D program and continue progress on transitioning the Paducah GDP.”

The plan of reorganization, which is supported by those holding approximately 65 percent of USEC’s debt, as well as Toshiba and Babcock & Wilcox, calls for replacing USEC’s $530 million debt and all of its preferred and common stock with a new debt issue totaling $240.4 million and new common stock. The new debt issue would mature in five years and can be extended for an additional five years subject to certain conditions. The noteholders would receive $200 million of the new debt and approximately 79 percent of the common stock, Toshiba and Babcock & Wilcox would each receive $20.19 million of the new debt and approximately 8 percent of the new common stock. Existing stockholders would receive 5 percent of the new common stock. USEC’s board of directors and management team are substantial holders of the common stock and their holdings will be treated exactly as all other common shareholders. In addition, any unvested or unexercised stock awards they hold will be forfeited under the plan.

USEC issued the original notes in 2007 at a time when the nuclear power industry was expected to grow significantly and the American Centrifuge Plant was expected to be completed and producing operating cash flow before the notes matured. In addition, USEC, Toshiba and Babcock & Wilcox entered into an agreement in 2010 for a phased preferred equity investment to strengthen the Company’s financial position for deployment of the American Centrifuge technology. The company’s deployment plans for the American Centrifuge Plant have been affected by delays in obtaining permanent financing for construction and by a global oversupply of nuclear fuel following a devastating tsunami in Japan that resulted in extensive damage to reactors at Fukushima in 2011. More than 50 nuclear power reactors in Japan and Germany were shut down. The resulting oversupply caused nuclear fuel prices to drop to their lowest levels in a decade, which has negatively affected the economics of deploying the American Centrifuge technology in the near term. Other factors that have affected the Company’s deployment plans include increases in the cost of several key commodities, and changes and additions to project scope and schedule.

The current USEC board of directors will oversee the restructuring process until the effective date of the plan when a new board would take its place. B&W and Toshiba each retain the right to representation on the board of directors.

The restructuring plan support agreements entered into by Toshiba and Babcock & Wilcox and other materials related to the filing can be found in an 8-K filed today with the Securities and Exchange Commission and is available in the Investors section of the company’s website, www.usec.com. In addition, documents related to the Chapter 11 filing are available at www.loganandco.com.

In connection with the bankruptcy filing, USEC’s board of directors also approved the termination of the company’s tax benefit preservation plan, which was originally scheduled to expire on September 29, 2014. The plan has been amended to accelerate the expiration date to March 4, 2014, effectively terminating the plan as of that date.

USEC expects to issue its fourth quarter 2013 earnings and its Annual Report on Form 10-K in late March. During the period its case is pending in Bankruptcy Court, USEC will not hold quarterly telephonic conference calls with investors.

USEC has informed and discussed the Chapter 11 filing with the New York Stock Exchange. The Company’s most recent quarterly update on its plan of compliance to meet the Exchange’s continued listing standards was accepted and the stock has traded since the Company’s December 16 announcement that it had reached a restructuring agreement. The NYSE will continue to monitor the Company under its continued listing standards throughout the Chapter 11 process.

USEC’s legal advisor for the restructuring is Latham & Watkins LLP, its financial advisor is Lazard, and its restructuring advisor is Alix Partners LLP. An ad hoc group of holders of USEC's senior convertible notes is advised by Akin Gump Strauss Hauer & Feld LLP and Houlihan Lokey.

The petition is available at the case administrator website.

More About USEC Inc ($USU) Restructuring

A correspondent wrote in to share an awesome writeup of USEC. He has the same take on it that we do. Read on:

In order to establish what the likely value for USU’s equity, we need to understand the underlying dynamic behind the stock and the broader market in which it operates. USU supplies low enriched uranium for commercial nuclear power plants worldwide. The company also performs contract work for the United States Department of Energy (“DOE”) and related contractors. The opportunity with USU revolves around the American Centrifuge Project (“ACP”), which deploys advanced US gas centrifuge uranium enrichment technology to fuel commercial nuclear power plants. To date, over $5 billion has been invested by the American government and USU in this technology (http://www.usec.com/american-centrifuge/what-american-centrifuge). The ongoing cash burn and uncertainty around the ACP is what has lead USU to its precarious position – USU owes $530 million to bondholders on October 1, 2014 and has no resources available to it with which to pay.

USU raised $575 million in convertible senior unsecured bonds in 2007 with high hopes. From this amount raised, $530 million remains outstanding. With only $128 million of cash on hand, and a business that is not generating any cash flow, the company does not have the funds to repay these bonds. Recognizing this reality, bond holders trading in public markets have valued the bonds at 37.0 cents on the dollar. Acknowledging the impending crisis, USU has embarked on the path of restructuring given its inability to refinance at anything approximating similar terms.

So let’s take a look at their proposed plan. The restructuring plan released on December 16, 2013 proposes an issuance of new common stock to each of: existing shareholders, bondholders and convertible preferred holders. The most important aspect of this reorganization is that it will result in a Chapter 11 bankruptcy filing on or before March 7, 2014.

The proposed plan will replace the current $530 million in bonds with new debt and redistribute the majority of the existing equity of the company. Only 5% of the reorganized equity is allocated to existing shareholders as bondholders will attain the majority of the remaining value. Bondholders will receive $200 million in new notes and 79% of the new equity. Convertible preferred shareholders, Babcock & Toshiba, will receive 16% of the new equity. This is not the first time that this has happened to retail investors. Similar situations existed at Excel Maritime Carriers (OTCMKTS: EXMCQ) and Patriot Coal Corp (OTCMKTS:PCXCQ). In both, “hope” buyers bid up the trading values, but inevitably each ended as a donut. USU’s circumstances are even more clearly cut with an “agreed” bankruptcy whereby the key takeaway is that existing shareholders will be subject to 95% dilution.

As can be seen in the chart above, existing equity holders stand to lose the vast majority of their holdings through dilution. These calculations do not even address a liquidation scenario, a non-negligible possibility, where the equity holders would almost certainly get nothing, a 100% loss from today.

As can be seen in the calculations above, equity holders stand to lose significant value when accounting for the planned dilution. The current bonds have a market value of $196 million ($530 million face value of bonds outstanding trading at 37.0 cents on the dollar) and we will use this as a proxy for enterprise value (market cap + net debt). Let us assume the new bonds have a market value of $150 million (issuance of $200 million trading at 75 cents on the dollar). The implied new equity value is worth $58 million (($196 - $150) / 79%) of which existing equity holders will receive 5% or equivalent to $0.59 a share ($58 x 5% / 4.9 million shares outstanding). This represents a loss of approximately 90% when compared to current share price.

If you are interested in investing in a restructured Usec Inc., the best way to do this is the current bonds which trade at 37.0 cents on the dollar. A shareholder is reasonable to take a gamble on the future of the company, but why have an investment with an all but certain ~90%+ loss right away. These bonds will attain $200 million in principal amount of new notes issued by USU and will respectively retain greater security than equity. Further, current bondholders will receive 79% of the new equity allowing you to participate in upside of the company and more importantly, an option on the ACP.

Don’t take it from us, here’s what USU had to say about the ongoing restructuring process. The company indicated the potential for a restructuring over a year ago. On the November 1, 2012 earnings call, John Barpoulis (CFO): “In light of the uncertainties and challenges facing us and ultimately, this is part of our desire to improve our credit profile and ability to successfully finance ACP. We've indicated that we expect to pursue discussions with several key stakeholders regarding ways to improve the capital structure. Currently, we're working with advisors and developing options for a possible restructuring of our balance sheet and how to address our very key liabilities.”

We highlight that at this point USU noted that they were working with several stakeholders (which may have included equity holders). A few months thereafter, USU admitted that its equity could be significantly impaired. On May 22, 2013 (10-K 2012), “In order to increase the likelihood of successful financing and deployment of the American Centrifuge project and our participation in such project, we are engaged with our advisors and certain stakeholders on alternatives for possible restructuring of our balance sheet. A restructuring of our balance sheet could adversely affect the holders of our common stock through dilution or loss in value. However, we have no assurance regarding the outcome of any discussions we pursue with creditors or other key stakeholders.” Management also clearly specified that their liquidity at the time was sub-optimal: “We do not have adequate cash to repurchase the notes.”

USU’s auditor, PricewaterhouseCoopers LLP, noted that there is “substantial doubt about its ability to continue as going concern”. Here is the Public Company Accounting Oversight Board (PCAOB) view on going concerns. Management also noted this as a key risk “Uncertainty about our ability to continue as going concern could have an adverse impact on our liquidity, business and prospects.” With any capital raising activities reducing the value of equity: “Any debt securities or preferred stock that might be issued could have liquidation rights, preferences and privileges senior to those of our outstanding common stock. The issuance of additional equity and other securities could also be dilutive to existing stockholders and we cannot predict the extent of this dilution.”

On the November 5, 2013 earnings call, John Welch (CEO): “Our Board of Directors met at the end of October and we are pleased to have two additional directors join the Board. Michael Diament and Mikel Williams are successful businessman who have extensive experience in corporate governance. Their selection was made in consultation with certain note holders and I expect their experience in restructuring will prove valuable to the board.” The board member additions, selected by bond holders, were added to assist with the ongoing restructuring given Mr. Diament’s prior experience with bankruptcies and restructurings.

Most recently, John Welch (CEO) indirectly hinted that equity does not even have a seat at the table as they made an agreement with bond holders (they do not mention equity as stakeholders). On Dec 16, 2013, “We are pleased to reach agreement with a significant number of our noteholders on a plan to improve our capital structure and enhance our ability to be a stronger sponsor of the American Centrifuge project.”

Finally, USU stated its intended path forward on December 16, 2013 “In order to implement the terms of the agreement, USEC Inc. expects to file a prearranged and voluntary Chapter 11 petition for relief in the United States Bankruptcy Court for the District of Delaware in the first quarter of 2014.” The details of this agreement state that this is even required to happen by March 7, 2014: “USEC fails to commence (A) the Solicitation or (B) the Chapter 11 Case in the Bankruptcy Court on or before March 7, 2014”.

USEC Inc ($USU) Restructuring Plan

From the 8-K describing the restructuring plan, filed in December:
 As described in the Term Sheet, the material terms of Plan include, among other things, that, upon the effective date of the Plan (the “Effective Time”):

• The holders of the Convertible Notes will receive, on a pro rata basis, in exchange for claims on account of their $530 million in outstanding principal amount of Convertible Notes:
• 79.04% of the common stock of reorganized USEC (“New Common Stock”), subject to dilution on account of a new management incentive plan; and
• $200 million in principal amount of new notes issued by reorganized USEC on terms described in the Term Sheet (the “New Notes”), with the New Notes being guaranteed and secured on a subordinated and limited basis by Enrichment.
• Subject to further agreement, as described below, Babcock & Wilcox Investment Company (“B&W”) and Toshiba America Nuclear Energy Company (“Toshiba,” and together with B&W, the “Preferred Investors”) will each receive in exchange and on account of their shares of the Company’s Series B-1 12.75% convertible preferred stock (the “Preferred Stock”) (as of October 1, 2013 there were 85,903 shares of Preferred Stock outstanding having an aggregate liquidation preference of $110.4 million) and warrants dated September 2, 2010 to purchase up to 250,000 shares of the Company’s common stock (the “Warrants”):
• 7.98% of the New Common Stock (15.96% in the aggregate), subject to dilution on account of a new management incentive plan; and$20.19 million in principal amount of New Notes ($40.38 million in the aggregate).
• The Preferred Investors would enter into an agreement to each invest $20.19 million (for an aggregate investment of $40.38 million) of equity in the American Centrifuge project in the future, upon mutually agreed upon terms and conditions, but in any event contingent upon the funding for the American Centrifuge Plant of not less than $1.5 billion of debt supported by the U.S. Department of Energy (“DOE”) loan guarantee program or other government support or funding in such amount (the “ACP Funding Condition”).
• The holders of the Company’s common stock will receive, on a pro rata basis, 5% of the New Common Stock, subject to dilution on account of a new management incentive plan.
• All secured claims will be reinstated and otherwise not impaired and all liens shall be continued until the claims are paid in full.
• All general unsecured claims of the Company will be unimpaired and will be either reinstated or paid in full in the ordinary course of business upon the later of the Effective Time or when such obligation becomes due according to its terms.

The market cap is currently $25.6 million, which is valuing the new equity at $512 million.

The notes last traded at 37, for a total market value of $196 million. If you assume that the $200 million in new notes are worthless, you are valuing the new equity at $196mm/0.7904 = $248 million. If you assume the $200 million in new 8% notes would trade at par then the noteholders are getting paid to take 79% of the company. 

Clearly, the stock is way overpriced relative to the notes.

Current Distressed Universe

Public companies with distressed debt.

GENCO SHIPPING & TRADING LTD, 5s of 08/15/2015, 58 cents.
JAMES RIV COAL CO, 10s of 06/01/2018, 12.6 cents.
JAMES RIV COAL CO, 7.875s of 04/01/2019, 16 cents.
JAMES RIV COAL CO, 4.5s of 12/01/2015, 30 cents.
JAMES RIV COAL CO, 3.125s of 03/15/2018, 24 cents.
PENNEY J C INC, 7.125s of 11/15/2023, 65 cents.
PENNEY J C INC, 5.65s of 06/01/2020, 68 cents.
RADIOSHACK CORP, 6.75s of 05/15/2019, 60 cents.
USEC INC, 3s of 10/01/2014, 36 cents.
Verso Paper Holdings LLC, 11.375s of 08/01/2016, 69 cents.
Verso Paper Holdings LLC, 8.75s of 02/01/2019, 55 cents.

Best guess is that GNK, JRCC, JCP, RSH, and USU are all going to zero in the next few years. Verso was supposed to merge with NewPage, but the deal was contingent on Verso bondholders agreeing to an exchange offer that would basically give them a 50 percent haircut.

Credit Markets Are Not Confirming the Equity Market Rally (Short Squeeze)

When equities go up or down - whether single companies or as a class - bonds are supposed to follow, because both sets of prices reflect an embedded set of assumptions about companies' profitability and solvency. Any exception, or divergence, from this rule is noteworthy because it means that either the equity investors or the bond investors are making a mistake.

Since the low on October 4 there has been an 11% jump in the S&P 500 and closer to 17% in the Russell 2000. But the enthusiasm hasn't really carried over into the distressed corporate credits that I follow. I have two good examples of this.

First is USG Corp, our favorite manufacturer of wallboard. The market cap is $900 million but the company has $1.7 billion in net debt. Over the past twelve months they have earned a paltry $43 million in EBITDA, versus an interest expense of between $150-200 million. As cash gets burned, tangible book value is steadily declining, leverage is increasing, and the bond yields have been rising. All the symptoms of a company that is going to be restructured with more equity ownership going to bondholders.

Since the October 4 low, USG common has rocket up almost 40 percent. Meanwhile, the company's 6.3 percent notes due 2015 have not really budged, continuing to trade in the low 70s with lackluster volume. The wallboard industry added so much capacity during the housing bubble that they can probably only achieve profitability during bubbles now.

Second example is uranium enrichment company USEC (USU). This is a long story but the company is distressed because it has been in limbo on a $2 billion DOE loan guarantee needed to complete a massive new uranium-enrichment plant in Ohio. It's unclear why the DOE would be stonewalling, but that seems to be what is happening.

Just today, the USU common shot up over 50 percent! But the company's three percent note due 2014 was basically unchanged from its mid-50s level, and not that many bonds changed hands.

This is all typical of the structural stupidity (excessive optimism) that we see in the equity market. But it also suggests that the equity moves we are seeing are short squeezes and not fundamentals-driven.

The End of Cheap Uranium (USU)

Working on this paper...

The USU bond is back down to 70, yielding 14%.