Surviving the Economic Storm

The ethanol industry isn't immune to the economic downturn and some wonder if consolidation is imminent. But, how would financially distressed plants be valued?
By Bryan Sims | January 03, 2009
Declining ethanol and oil prices, a tightening credit market and volatile corn prices have thrown some ethanol companies for a loop. "These issues that ethanol plants have been facing started happening well before the credit crunch, and the tight credit market has just added more fuel to the fire," says Michael Masterovsky, director and renewable energy team leader for SJH & Co., a Boston-based firm that provides independent, third-party consulting services to project developers and financial institutions operating in the ethanol, biodiesel and biomass sectors.

Corn and natural gas prices have fluctuated wildly the past year along with prices for ethanol and distillers dried grains. Analysts and financiers agree that all commodity price fluctuations within the industry are interrelated and that some are more sensitive than others, according to Cory Garcia, senior alternative energy research analyst for Raymond James & Associates. "It's still going to be a bumpy ride for the next two to three years," he says. "The margins right now are still very, very thin. What you're probably going to see are a couple smaller companies that just won't have enough access to capital to continue. There will be more bankruptcies, but it will depend on how long this downturn in ethanol lasts."

Not even VeraSun Energy Corp., one of the largest publicly traded ethanol producers in the country, was able to fend off instability in the marketplace. Its inability to obtain capital coupled with unprecedented moves in the corn market forced the Brookings, S.D.-based company to file for Chapter 11 bankruptcy protection in late October 2008.

The seven-year-old company said it locked in hedging agreements to buy corn when prices were high. In the six months ending June 30, corn costs represented 67.3 percent of VeraSun's total costs of goods sold. In July, VeraSun decided to exit some of its short positions and lock in the current cost of corn. As corn prices sank to $4 per bushel in the fall, VeraSun said it faced a loss of millions of dollars.

The company ran headlong into the credit crunch, just as it needed cash to sustain operations. As a result, VeraSun was temporarily removed from trading on the New York Stock Exchange. It later reappeared on the NYSE after receiving interim debtor-in-possession funds (DIP).

At press time, the U.S. Bankruptcy Court of Delaware gave VeraSun approximately $215 million in DIP financing to pay its bills, $40 million of which was interim financing, and grants access to cash collateral for immediate use. In the company's Chapter 11 filing, VeraSun officials confirmed it would continue producing ethanol at its 16 plants in eight states while the company attempts to reorganize.

"Most plants were trying to secure the cheapest corn they could and the market was moving higher so they were trying to get as much coverage as they could in a reasonable manner," says Tom Wapp, commodity price risk manager for United Bio Energy, which provides consulting and market advisory services for ethanol producers. "Now, what you see is less of trying to take a position on any one particular commodity and more of just trying to manage both commodities to lock in some sort of margin when they have that opportunity."

As the industry struggles to find financial equilibrium amid difficult economic times, it's likely only a matter of time until consolidations start to occur. If that happens, what would these financially distressed ethanol plants or assets be worth to a potential buyer?

Assessing Value
Despite its financial position, VeraSun would be an attractive purchase because it still has efficient operating assets with the ability to produce about 1.64 billion gallons of ethanol, which accounts for about 15 percent of the domestic supply, says Kyle Althoff, project analyst for BBI International's engineering and consulting division. Whether a buyer would be willing to acquire VeraSun in pieces or in aggregate, they would have to evaluate if the operating assets could provide solid returns. In addition, a potential buyer would have to consider the risk of inheriting the company's debt, which is more than $1.5 billion; much of which it obtained after acquiring ethanol plants from rival US BioEnergy Corp. in March 2008 and ASAlliances Biofuels LLC in 2007. "If you look at VeraSun, and its debt commitments totaling 96 cents per gallon, it has one of the lower debt per gallon ratios of publicly traded ethanol companies," Althoff says. "From a debt versus total production capacity standpoint, VeraSun looks attractive."








One method used to determine the value of an ethanol company is to calculate the enterprise value. The formula for figuring out the enterprise value is adding a company's total debt level and market capitalization then dividing that by the total production capacity held by that company, which provides a value per gallon of ethanol produced.

According to Althoff, VeraSun's enterprise value was calculated at about $1 per gallon before its suspension on the New York Stock Exchange at the end of October. Just prior to delisting, the company was trading at about 28 cents per share and had 157 million shares; multiplying the two equals out to a market capitalization -or value- of $44 million.

The value of VeraSun's stock fell sharply as its financial problems mounted. Over the past year, its stock pricewhich had traded as high as $18 per share in January 2008 with a market value of $2.8 billionhad fallen 98 percent before trading was suspended due to its bankruptcy.

"VeraSun's core assets can still make ethanol and they're some of the most efficient assets in the industry, so you just need someone to come in with the right amount of capital to make sure those assets can maintain operations over the next two to three years," Althoff says. "A large potential buyer could probably acquire those assets with only a moderate capital infusion given the current credit cycle in the United States."

VeraSun isn't the only publicly traded ethanol company that's seen its stock price plummet. Others such as Pacific Ethanol Inc. and Aventine Renewable Energy Inc. have faced marginal to negative net profits. According to Althoff, the average publicly traded Midwest ethanol company was trading in mid-November at a total enterprise valuation of under $1.15 per gallon, much less than it took to build the original facilities over the past two years.

"Enterprise valuations are composed of the debt and equity portions of the calculation - the drop in ethanol stock prices over the past few years has significantly reduced the valuation for these companies," Althoff says. "The valuation is correlated with the expected earnings that each company is expected to produce on each gallon of ethanol - as the industry gross margin has declined, the valuation of the stocks has followed suit. These stocks are an attractive buy in today's market if the gross margins improve."

If consolidation is in the ethanol industry's future, it's not certain yet who would be willing and able to acquire financially distressed ethanol plants, and at what cost pursuant to the valuation. Likely candidates could be agri-business giants such as Archer Daniels Midland Co. and Cargill Inc. Both companies would also be better positioned to mitigate the price risk in commodities as they manage much of the grain supply chain in the United States for other food-based products.

"Asset values across the board - public or private - are very cheap right now," Garcia says. "It's hard to take any valuation stance on a company, and you might not see that until merger and acquisition activity starts to pick up."

Bryan Sims is the Ethanol Producer Magazine staff writer and plant list manager. Reach him at bsims@bbiinternational.com or (701) 738-4950.