Monday, September 14, 2009

Ternium Update

OK, it's become a running joke. Ternium keeps showing up on this blog. To be fair, it was the company that got me motivated to start this site. And it is up nearly 40% since it was recommended in these pages. I'm not going to make a habit of patting myself on the back, but that's a big deal even in a rising market.

In fact, I urge you to look back. From Lexmark to Jo-Ann Stores and Forest Labs to Arkansas Best, there are ideas on this site that you just won't find elsewhere.

And they are paying off. Did you see Vivendi today?

Anyway, enough of the shameless plugs. Today's topic is Ternium. I had the pleasure of speaking with company representatives last week and got some interesting information. If you thought the news could not get any better, think again.

When Ternium reached agreement with Venezuela regarding Sidor, there was some interesting language related to the price of oil. Since I'm not that bright, I asked the company for clarification. At the time, I got the following feedback:
(The) mechanism roughly works as follows: if the price of the WTI goes higher than the close of May 6, 2009, then we get a proportional acceleration of the second tranche payment (a prepayment). This is measured quarterly. So, if the WTI goes up 10%, we are prepaid $62.5 million (10% of $625 million), and we have left $562.5 million to be paid on October 2010. This “mandatory prepayment event” is measured every quarter. If the WTI goes down or doesn’t move relative to the close of May 6, then nothing happens and we have to wait for the payment of the second tranche until its original maturity on October 2010.
Thanks to Wikipedia, you too will learn that WTI stands for West Texas Intermediate (WTI) aka Texas Light Sweet. It is a type of crude and is a benchmark in oil pricing. Essentially Venezuela agreed to accelerate cash payments if oil prices trended higher. It makes sense considering the country's revenue is so tied to oil. The higher the price of oil, the higher their ability to pay off this debt.

It turns out that the "base price" set on May 6th was $56 a barrel. And we're a lot higher than that now. The original schedule of payments (base case) was s as follows:

upfront payment = $400 million
6 quarterly payments = $158 million
final payment = $625 million

So here are the quarterly payments Ternium was expecting:

$400 million (May 6, 2009)
$158 million (Aug 2009)
$158 million
$158 million
$158 million
$158 million
$783 million (158m + 625m)
Total: $1,973,000,000

The expectation was that TX would collect $558 million by this point in time. The actual amount collected to date is $666 million. The $108 million difference is due to the acceleration clause and the rise in the WTI price. More specifically, $108 million is 17.3% of $625 million, meaning that the average WTI price during the quarter was 17.3% higher than $58 a barrel.

If the price of oil stabilizes at this level, I calculate that actual quarterly payments will look like this:

$400 million (received)
$266 million (received)
$288 million
$255 million
$231 million
$212 million
$321 million (due Oct 2010)
Total: 1,973,000,000

The final payment drops from $783 million in the base case to $321 million in the predicted payment schedule. Given the $108 million accelerated payment (so far), the final payment has already fallen to less than $65o million.

Admittedly, the total cash received isn't going to change. And given the current interest rate environment, the cash today isn't worth much more than it would be in 2010. My intrinsic value calculation for Ternium hasn't changed, but when someone like Hugo Chavez owes you money, get it as fast as you can. Any acceleration in payments is a good thing.

In short, TX continues to under-promise and over-deliver. It is going to get the $1.97 billion and it will arrive quicker than anyone thought. The question remains: What will Ternium do with all of the cash?

There are many possibilities. Ternium could pay off all of its debt (and then some). The company has indicated that this is going to be one use of cash. They could pay a huge dividend (or reinstate its quarterly payout). Stay tuned. The company could also use the funds to repurchase shares or buy out minority shareholders entirely. My discussions with the company lead me to believe that this is unlikely. They said the motivation for being a public decision is a very long term one. Regardless of how undervalued the company's shares are, they are probably not going to repurchase shares. Be reminded that only 15% of TX shares trade publicly. Total value: less than $800 million.

Whatever the decision, TX will have the money. It is flowing fast and furious. I'm still mystified by the current quote even after a 205% ytd gain.

In hindsight, Venzuela may have done Ternium a favor by monetizing its Sidor stake prior to the economic meltdown. The resulting cash will ensure TX's survival through the turmoil. With a market capitalization of barely over $5 billion, Ternium still looks cheap. Especially when you figure in the $1.3 billion in cash it still expects to collect from Sidor. $666 million has been collected so far from Mr. Chavez. Strange irony, that number.

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