Ethanol producers can emerge from bankruptcy

By Bryan Sims | January 12, 2009
Web exclusive posted Feb. 2, 2009, at 10:28 a.m. CST

As a result of the price of corn being high relative to the price of ethanol sold on the market, ethanol producers are experiencing shrinking operating margins leaving them little room for capital preservation to maintain operations. For many ethanol producers, filing for Chapter 11 bankruptcy protection is the only course of survival.

According to data compiled by Ethanol Producer Magazine, there are approximately 1.83 billion gallons of idled capacity. Of that total, approximately 1.5 billion gallons represent plants that have either filed Chapter 11 bankruptcy protection or shutdown operations due to other financial constraints.

One of the most high-profile bankruptcies declared in the ethanol industry came from VeraSun Energy Corp., which filed for Chapter 11 Bankruptcy in late October 2008. The South Dakota-based ethanol producer holds the bulk of off-line capacity in the market with 12 idle plants with a combined capacity of 1.14 billion gallons. The company recently announced it plans to put seven of the 12 idled facilities up for sale. A bidding process will occur between March 16 and March 31.

So, how do ethanol producers deal with Chapter 11 bankruptcy and what are their options to survive and reemerge as a profitable entity once again? There are three ways out of Chapter 11 bankruptcy, according to Rob Carringer, managing partner for CRG Partners LLC, a New York-based firm that offers turnaround management, crisis management, performance improvement and financial restructuring services for a variety of industries, including the ethanol industry.

The first, Carringer said, would be to shut down operations completely and liquidate all assets. If this option were considered, a company would have to convert from Chapter 11 to Chapter 7. "A sale of your assets in bankruptcy isn't a real effective option because nobody can buy right now," he said. "So the only real option out of bankruptcy is to reorganize with your current lenders. You're going to have to be very good operationally to make your plants generate cash flow."

Ethanol producers are trying to avoid this approach as much as possible because many plants on the market would be selling for pennies on the dollar—meaning they would be bought at lower prices relative to the price of how much it cost to build the plants, according to Carringer.

"The challenge you have today in selling your plant is that the credit markets are nonexistent," he said. "It's like if you tried selling your house today, you're going to have a hard time selling your house because the buyers can't get a home loan to buy your house. It's the same thing with ethanol companies today. With the state of the current credit market, they cannot get the capital that they need…they can't borrow money to help finance the purchase of an ethanol plant."

According to Carringer, the second option to get out of Chapter 11 bankruptcy is to reorganize and restructure debt where existing working capital could be stretched out or reduced to operate in bankruptcy as efficiently as possible. In a complete reorganization, the goal would be to reemerge as the same company that went in.

The third option would be to sell all assets and operations to a competing company whereby the corporate entity acquired—or "shell"—dissolves into the buying entity.

If ethanol producers are continually strapped for working capital to maintain operations and Chapter 11 bankruptcy filings persist, this could trigger a "last man standing" paradigm where a consolidation wave in the industry could likely occur and soon, according to Carringer.

When bankrupt ethanol companies put their assets up for sale, Carringer said there are two types of buyers: financial and strategic.

Financial buyers are private equity investors that have raised capital to invest in the ethanol industry, he said. In contrast, strategic buyers are current ethanol companies operating in the industry that might want to acquire an ethanol plant.

"The financial buyers have disappeared and they've all fled the market because they believe the market isn't good for ethanol and, most importantly, they can't access any credit," Carringer said. "If you sell your plant to a strategic buyer, someone who is already in the ethanol business, they also have to raise credit to go buy your plant and they can't raise credit today. On top of that, they're probably operating their business today in a cash flow negative point-of-view because the price spread between corn and ethanol is negative."

Another option for ethanol producers on the verge of bankruptcy would be to "mothball" a plant for one or two years until market conditions improve and demand rises due to an increased renewable fuels standard, according to Carringer.

"In two more years, the demand you would think would straighten out a bit," he said. "Plus, the renewable fuels standards increase so that demand will come on to the market and if you mothball that plant a couple years and go into a temporary hibernation, you would make your available cash last longer."

For ethanol producers currently in bankruptcy, Carringer strongly recommended operating within the parameters of bankruptcy court as efficiently as possible to generate cash flow.

"You're going to have to be very good at managing your commodity risk, which means you're going to have to be a trader," he said. "You're going to have to learn how to hedge and manage your commodity risk on the purchase and sale of the corn and the purchase and sale of the ethanol and learn how to use options to box in your profits on that. Doing this will reemerge a company out of bankruptcy."