Horsehead Holding Corp. (ZINC) filed for bankruptcy on February 19th, 2016. Senior Lenders provided the company with a $92MM DIP Facility and the Pre-Petition Capital Structure ($427.8MM) is below:

Macquarie Credit Facility: $32.7MM
10.5% Senior Secured Notes: $205MM
Zochem Secured Credit Facility: $18.5MM
9% Unsecured Notes: $40MM
3.8% Convertible Notes: $100MM
Banco Bilbao Credit Facility: $17.4MM
NMTC Loans $14.2MM

The company creates zinc from recycled dust, which is the residue left a certain steel making process. The $205MM from the 10.5% secured notes was used to build a state-of-the-art zinc plant in Mooresboro, N.C. The company touted the plant’s potential as transformational, stating it would boost EBITDA from $50MM to $150MM, if the plant was producing close to capacity (155,000 tons of zinc / year). However, after the plant opened in May 2014, management had to replace many anodes, pouring millions more than anticipated into the plant. Production never came close to management estimates - and before filing the company mothballed the plant in January 2016, citing additional capital improvements needed and low ZINC prices.

However, since bankruptcy ZINC prices have started to rebound:

zinc

In the Second Amended joint Plan of Restructuring by the Debtors, the Debtors are claiming a valuation of around $255-$305MM for the company, which values the Mooresboro Plant at Zero. Management and the secured creditors are clearing talking down the value of the company as they desire to own all of the post-reorg equity which has a tremendous amount of leverage to higher zinc prices. Equity holders were not granted a committee initially but had been arguing a value of around $700-$800MM, which would give them some value.

In the plan, all Claims and Interests, other than Administrative Claims, Professional Fee Claims, DIP Facility Claims, priority Tax Claims, Other Secured Claims, Other Priority Claims, and the Macquarie Credit Agreement Claim would be unimpaired. The 10.5% bonds would own most of the post-reorg equity (93.29%), the unsecured would get 6.71%, and the converts get warrants:

Secured Notes Claim, each Holder thereof shall receive such Holder’s Pro Rata share of (i) 93.29% of the New Common Equity (representing 347,380 units), subject to dilution only for the UPA Units and any New Common Equity to be issued (a) pursuant to the Warrants, (b) pursuant to the MEIP and (c) in connection with the Additional Capital Commitment

Allowed Unsecured Notes Claim, each Holder of Allowed Unsecured Notes Claims shall receive such Holder’s Pro Rata portion of 6.71% of New Common Equity

Allowed Convertible Notes Claim each Holder thereof shall receive such Holder’s Pro Rata share of the Warrants

“Warrants” means those certain warrants to acquire 70,213 units of the New Common Equity (which will be equal to six percent (6%) of the outstanding and reserved units of New Common Equity as of the Effective Date), which warrants (a) shall be exercisable, as of the Effective Date, at a price per unit equal to $737,500,000.00 divided by 1,170,213, (b) shall expire on the six (6) year anniversary of the Closing Date (as defined in the UPA), (c) shall be evidenced by the Warrant Agreement, and (d) shall be subject to dilution by any units of New Common Equity to be issued on account of the Additional Capital Commitment Units at any time on or after the Closing Date.

Additionally, the secureds and unsecureds have the right purchase UPA units of up to $160MM, which the company will use for working capital needs and to restart the mothballed Mooresboro plant. These units will be very dilutive to the warrants that the converts receive and any secured or unsecured creditor who does not participate

“Additional Capital Commitment” means that certain right pursuant to which Eligible Holders may elect to commit to purchase the Additional Capital Commitment Units, in each case, pursuant to the terms of the UPA.

  1. “Additional Capital Commitment Amount” means cash in an aggregate amount equal to the lesser of (a) $100,000,000 and (b) the aggregate amount committed by all Additional Capital Commitment Participants.

“UPA Units” means the New Common Equity to be issued pursuant to the UPA in an aggregate amount equal to 62.762% of the New Common Equity (representing 627,620 units)

Additionally, management receives a MEIP to potentially own own 10% of the new company, giving them an incentive to jawbone the valuation down as well:

“MEIP” means the management equity incentive plan to be determined and implemented by the New Boards after the Effective Date. Ten percent (10%) of the New Common Equity shall be reserved for issuance pursuant to the MEIP, subject to dilution for any New Common Equity to be issued (a) pursuant to the Warrants, and (b) in connection with the Additional Capital Commitment.

Currently, the converts are quoted around 2-3 cents on the dollar ($2-3MM through the $100MM converts, although they are illiquid) and the equity (ZINCQ) is trading at ~0.49 ($27MM market cap.). The equity is dominated by speculative retail investors who are hoping to convince the judge to give them some value, even though the converts which are ahead of them are receiving virtually nothing and trading at a much lower level through the structure. Penny stock equities are usually mis-priced and stay mispriced as there is no catalyst (management usually slowly dilutes shareholders instead) and retail investors mistakenly assume that there is less risk with lower equity prices, but in this case there is a catalyst as the company is insolvent.

Owning the unlevered post-reorg equity in this business is a great investment. The Mooresboro facility is built (even though it may require some capital improvements) and ZINC prices are ripping. There is a real scenario in which the company could be doing $150-200MM in EBITDA and generating ~$70MM in FCF assuming the Mooresboro plant is fully operational in 2-3 years, which could put a value of almost $1.5BN on the company.

While it is difficult to put the trade on in size, we propose buying converts vs. selling common stock at a 1:1 ratio. The potential outcomes are as follows:

  1. If the judge does ascribe a higher value to the business, the thin tranche of converts should benefit the most (the unsecureds before the converts only have $40MM notional), potentially receiving 5-10% of the new equity in a new plan, while the common most likely will still be a zero. $500MM of value would have to flow to the equity to outperform the converts at current levels, an outcome we ascribe little chance of occurring.
  2. If the plan is confirmed as is, the equity goes to zero and the converts own warrants for 6% of the business with a strike price seemingly dependent on the Additional Capital Commitment, which will be diluted. Still, at current levels you are creating these warrants at $2-3MM, which have some value (even if they are diluted to 3%) and if the company executes and is valued at $1.5BN in a few years, the warrant position could be up 4-7x.