Looking For Liquidity
In good or bad times, there’s always a certain number of shareholders looking for liquidity. Whether it’s due to a death, divorce or some other need for cash, FNC AgStock LLC or AgStockTrade.com help ethanol plant shareholders by listing all stocks available for sale from participating nonstock-exchange listed or limited liability company (LLC) ethanol plants.
Positive ethanol plant margins in recent months have pushed the price of ethanol plant shares up to levels not seen in years. In the second quarter this year, some prices have doubled from what was seen in the first quarter, says Jayson Menke, president and CEO of FNC Ag Stock. One example is Cardinal Ethanol LLC, one of 15 FNC-listed ethanol plants. In mid-July, the ethanol plant had two shares available at a price of $13,000 each, and the most recent sale of Cardinal Ethanol shares was for $12,500 per share. That’s about double what the plant’s shares were going for in January, at $5,780 to $6,200 per unit. “There has been increased sale activity,” Menke says, “but, in general, for the 16 companies that we work with, we’re not seeing as many sellers for all companies.”
Glacial Lakes Corn Processors, a company listed with Ag Stock Trade, had 15,000 shares sell for $1.51 per share on July 15, according to data posted at AgStockTrade.com. (The variation in share price is due to differences in pricing structure at different ethanol plants.) The plant’s shares hit a high point on July 11, when 40,000 shares were available for sale at $1.79 per unit. The prices have made sellers happier, says Greg Wilson, president and CEO of Glacial Lakes, especially considering that shares were available for sale at 60 cents per share in the beginning of the year. The last time shares for the South Dakota-based ethanol producer were over $1 per share was January 2008. In comparison, in 2006, shares ranged from a high of $6.10 to a low of $3.73. “Our market is fairly stable, as far as buyers and sellers,” Wilson says. “Sometimes it’s a buyer’s market, and sometimes it’s a seller’s market. But the transaction numbers fluctuate about 20 percent in a good or bad year.”
Wilson recalls attending meetings back in 2000, when developers were asking community members to become shareholders. The scenario played out with someone at the front of the room asking people to put up money in exchange for dividends paid to shareholders. “There’s always a guy at the back of the room and he raises his hand and he says, ‘You know, this sounds like a good idea, I’m all in support of it but what’s my exit strategy?’” Wilson says. “’I’m 60 years old, what I am going to do when I want to get out?’” The reality is, in most cases, emphasis was put on bringing shareholders in without any plan for liquidity for members. And, until enough members make that need known, that probably won’t change, as the focus is on managing the plant, not managing the members, he said.
Wilson and Menke both say there is opportunity for additional ethanol production facilities to sign up for their services. According to Wilson, all LLC ethanol plants should be offering members liquidity, which is required by the U.S. Internal Revenue Service. “Every one of them that isn’t on my trading system ought to be.”
Working with what the IRS terms a qualified matching service (QMS) has advantages. One big one is that ethanol producers can trade up to 10 percent of outstanding units in a taxable year without tax implications, Menke says. Without using a QMS, doing it internally, the limit is 2 percent. “Within the IRS rules, it allows these companies the greatest amount of liquidity and it allows the companies to have transactions at arm’s length,” Menke says, adding that it protects companies from crossing a threshold and becoming publically traded entities and also from insider trading.
The topic of alternative trading systems came up at the International Fuel Ethanol Workshop & Expo held in early June. Speakers addressed the topic of how companies can increase shareholder confidence by increasing plant value as well as providing liquidity opportunities. James Eiler of Eiler Capital Advisors LLC said he has talked to ethanol plant boards about providing minority shareholders opportunities for limited reduction on a periodic basis. He suggests boards allocate a certain amount of money to repurchase minority shareholder’s shares at a certain percentage of book value, possibly 75 percent, on a quarterly basis. If requests to sell exceed the funds set aside for this, the company could conduct a lottery for that buyback, he said during his presentation. “It creates a win-win,” he said, adding that minority shareholders are able to get cash while the remaining unit holders have accretive value, with the buyback set at below market value. However, it’s important that companies protect themselves by getting a third-party fairness opinion at least annually and consulting its tax advisor.
Although it can be complicated, if it is done correctly, implementing a company buyback program can result in tax advantages for an LLC by reducing taxable income, said Donna Funk of Kennedy and Coe LLC. On the other hand, because the purchases are made after taxes, it can be a cash drain on a company. “Which is why you would want to set parameters around how much you would want to do each quarter or on an annual basis,” she said.
Funk also mentioned employee stock ownership programs, or ESOPs. Although it’s not commonly utilized in the ethanol industry, there are companies getting to the point of age, liquidity and other factors that could make it an option to consider. It can be very expensive to implement but some of the advantages include using pre-tax dollars for the program as well as a way to offer employees ownership in the plant to create a family type atmosphere as well as an effective incentive for best performance. While it’s worth considering, it’s not an option that will work for all companies. “That’s one of those that can be very complicated and would be something that you would want to look at in a lot more detail before saying we’re just going to do this, because it doesn’t fit for every situation,” she said. “But it is certainly something that can be utilized as a liquidity option for some of your investors and it can benefit your employees and also can be a retirement plan vehicle or tool.”
Funk also talked about an often overlooked method of selling shares, which is simply asking. “I think sometimes we fall into the mentality of, well, nobody wants to buy units. Well, have we really asked or made known that there might be shares available for sale?” she said. “Ask around, be more proactive.” In cases where someone has a block of shares larger than others want to buy it could be split with no impact on the overall value. Or, people with smaller numbers of shares can combine to create a larger block for someone interested in buying more shares.
Scott McDermott of Ascendant Partners Inc. talked about liquidity in the context of positioning the company for the best future possible with strategic and capital planning. With healthy margins, ethanol producers need to think about preparing for future downturns. He also talked about making sure the company has a vision or a story to tell its investor base. “All of these things help give shareholders confidence to stick with you in good times and bad,” he said, adding that if the industry falls on hard times, lenders may or may not provide funds to keep the plant afloat. “Then we’ve got to go to shareholders,” he said.
There are many different strategies for success, McDermott said, adding that hope is not a strategy. “If you are not working toward a plan for success, you are almost certainly planning for failure,” he said. One tool ethanol plants can use as a performance metric is valuation. When he brings up assessing the value of the business some board members assume that means he’s talking about selling it. But valuation is really just a method of keeping score. “The best disciplined businesses out there use valuation to think about the return they are giving shareholders, and almost as a measuring stick on how they are doing as a business,” he said.
Some plants sell for four to six times company earnings before interest, taxes, depreciation and amortization (EBITDA) multiples. That means that if a 55 Mmgy facility with an average EBITDA of 15 cents can improve that number by 5 cents, the plant’s valuation increases 33 percent or $11 to $17 million. “Not only is the plant more valuable, but it is much better positioned to endure the inevitable market downturn,” he said.
Essentially, a company is falling behind if it isn’t moving down the cost curve or up the EBITDA curve. That drives higher earnings, which translates to higher dividends and better stock value. McDermott has found it interesting to watch the ethanol industry evolving in this area. Boards used to think in terms of the annual budget cycle. Now, however, with nearly a decade or more of experience and with most debt paid off, a different way of thinking about the budget cycle is being utilized. “We now begin to think about the capital cycle, the budget cycle, as a more strategic way of how to align the capital of the business to support some combination of my growth objectives or my positioning in the industry but also to give a return back to shareholders in dividends,” he said.
Author: Holly Jessen
Ethanol Producer Magazine