Grace, Weschler, 20x Earnings
Grace, Weschler, 20x Earnings
Asbestos claimants, Icahn, overthinking
In a 2002 interview about W.R. Grace, Ted Weschler simplistically describes the Grace bankruptcy process. Weschler bought shares in the open market of a theoretically insolvent business that belonged to asbestos claimants and creditors and made something close to a billion dollars for himself and clients (10.5mm shares, stock peaked at $100~ before GCP was spun out and taken private at $32; GRA was taken private at $67~, he paid $2.54).
This is one of my favorite case studies in public markets because it combined several unique circumstances that created a mispriced opportunity that might not have been mispriced in a pure theoretical sense, but was apparent to a shrewd guy who understood the opportunity set. Public markets investors frequently spend days banging their collective heads against walls retreading the same time-tested filters for searching for mispriced opportunities. Public markets are a pattern recognition business: quant filters, owner-operators, corporate actions & restructurings, beaten down industries, heavy insider buying, M&A or management changes, one-of-a-kind businesses that have changes to their model or just simple happenstance (“I know this business personally” or “I know this manager personally”) can all present something that requires evaluation by the shrewd market participant.
What is fascinating about the Grace trade was how many of these idea genesis avenues coalesced around one guy who actually worked for the company in a real capacity. Grace has a fascinating history as a family business that morphed over the 20th century into a conglomerate that would eventually concentrate itself in its leading chemical catalysts business that sold into major refining partners. It’s a commodity business as a chemical additive to the “cracking” process, but its a low component cost to the refining customers and refining is a capacity-driven game; switching to a different catalysts provider would involve shutting down the refinery for a period of time which refineries cannot afford, generally speaking. This allows for Grace, BASF, Albemarle et al. to take price on limited volume growth.
Weschler had worked directly for CEO Peter Grace in the 1980s before launching his public markets career. The linked interview above walks through Weschler’s high level analysis of the situation but the sequence of events roughly runs as follows:
1.) Grace files for Chapter 11 bankruptcy protection in 2001 after 130,000 asbestos litigants filed suit against the company for asbestos products and an asbestos mine Grace owned in Libby, Montana.
2.) Weschler, knowing the core business of Grace after having worked there, buys his shares for himself and his partners in the open market.
3.) Weschler petitions the bankruptcy court for representation on the equity committee, and an equity committee is formed despite the company holding a net debt position. Weschler is appointed head of the equity committee.
4.) The subsequent 11 years led to around $4bn claimant settlements; Grace’s 2001 EBITDA was reported around $190mm~ with $388.2mm of net debt. Said another way, Weschler bought his shares at around ~24x “eventual EV” to EBITDA (my napkin math). That asbestos liability debt would be termed out and “refi’d out” by other loans throughout the process, smoothing out the future 11 year journey.
At virtually every turn of this trade there’s a very rational reason for Weschler to move past this stock and move on to other opportunities. Chapter 11 bankruptcies are notoriously fickle and driven completely by the whims of the Court. Bankers, consultants, and attorneys would take their turn picking the bones of the corporate carcass. Employees would be dejected and leave for competitors. Capital markets would shun a company with this uncertain of a future. Add to this: Weschler was totally biased analyzing a company for whom he worked- he worked for the guy with his name on the door! How could he remain objective about the business?
Equity committees are typically the refuge of desperate penny-stock owners; this gives ample reason enough to move on from a stock. The company might have been “hopelessly insolvent” (official legal term!) and the interests of equity holders probably could have been considered moot by a court. What’s more- the eventual bankruptcy settlement took 11 years to work out! How could an analyst possibly make that determination?
“Mr. Weschler estimates that Grace's shares could be worth nearly four times the current stock price. He first looks at what the shares would be worth without the asbestos taint. "It's a great core specialty chemicals operation, relatively non-cyclical and led by a great management team," he says. "Last year they had earnings per share of $1.20. If you put a long-term market multiple on $1.20, which Grace would certainly have without the asbestos taint, that's a $24 stock." Estimating around 50 percent dilution through the bankruptcy process as debt holders and asbestos plaintiffs get a large share of equity, he arrives at fair value of between $12 to $13 per share.”
Weschler made an estimate of forward dilution and threw an arbitrary 20x “long-term market multiple” on the stock. Of course, there’s plenty of academic reasoning or formulaic approaches that can tell you why Grace deserved that multiple due to its ROIC or long-term growth prospects or whatever, but that’s not even close to important- he just knew the company could be reasoned to have that sort of multiple by market participants. It had consistently traded at that multiple in the past and nothing had fundamentally changed with the core thesis. If you approached META with this same intellectual laziness, you could simply say “the stock earns $10-15 per share, it’s not a bad business and it’ll be around” you’d probably have purchased some stock at around~ $100 on the theory that you’d have a good shot at the business re-rating and earnings stabilizing.
The principle differences between Grace and Meta in this respect were the operating business’s impediments (among a plethora of others). Grace operates their business in an oligopoly with rational players and captive customers. Meta possesses similar characteristics, but with the added monkey wrenches of potential governmental intervention, technological obsolescence, or profit contraction in the face of intense threats to the META/GOOG digital advertising duopoly from TikTok and others.
Weschler correctly identified that there were no real business impediments outside of what would become a bizarre capital structure overseen by a bankruptcy court. As equity committee chairman he himself would ensure that equity holders would retain interest in a potentially solvent business. I’ve talked about 13-D filings in NAV discount scenarios in the “be your own catalyst” realm; Weschler bet on himself and it worked. First ballot BYOC hall-of-famer. He didn’t spend hours re-litigating earnings multiples with sell-side analysts, he just found what he perceived to be a mispriced call option and bet the farm on it.
As an aside- Carl Icahn is mentioned in Weschler’s interview (he was involved with Federal Mogul’s asbestos bankruptcy). Icahn invested in Lyft in 2015 at a $2.5bn valuation while Uber was valued at $5bn on the theory that they simply do the same thing. He ended up doubling his money in 4 years or something close to that. Some people just get it!
I say this quasi-tongue-in-cheek; accurate and complete analysis is table stakes for trades such as these. But it’s always better to be lucky than good.
great read, what is the email address in order to join the discord?