Analysis: Why bankrupt W.R. Grace is thriving

By Ernest Scheyder and Nick Brown

COLUMBIA, Md./NEW YORK (Reuters) - A company stuck in bankruptcy for 12 years may not seem like much of a catch, but investors have fallen in love with U.S. specialty chemical manufacturer W.R. Grace & Co (GRA.N) and its surging sales to the energy sector.

One of the longest bankruptcies in U.S. history, Grace filed for Chapter 11 protection in 2001 after an asbestos leak at one of its mines led to thousands of lawsuits against the company.

Through bankruptcy, Grace was able to pause debt repayments, survive two recessions and take advantage of a U.S. shale energy revolution that is fueling demand for its fine-powder catalysts, which help refiners process crude oil into gasoline, heating oil and other products.
The company's stock has more than tripled in the past three years and counts 46 hedge funds among investors as of March 31.

"Bankruptcy has been a great place to hide out," said Scott Baena, an attorney who helped negotiate the settlements on behalf of property damage claimants. "It has for all intents and purposes been business as usual."

Grace closed its mine in Libby, Montana, in 1990 after discovering the process it used to extract vermiculite - a mineral used in commercial insulation - caused the release of asbestos. More than 400 residents died from asbestos exposure.

Early in the case, plaintiffs claimed Grace's personal injury liability topped $7 billion, 14 times what the company had estimated, said Peter Lockwood, a lawyer for a committee of Grace's personal injury claimants.

Had the matter gone to trial and the plaintiffs prevailed, it may have crippled Grace.
Instead, Grace settled for about $4 billion and agreed to set up trusts for the victims, and took similar measures with its property damage claimants.
Grace's bankruptcy was akin to hitting "pause" on its liabilities while it figured out the most efficient way to address them. Most companies struggle to make money while in Chapter 11, but Grace continued to thrive. It is erecting a $20 million building on campus for executive offices, funding the project through cash flow.

Creditors of most bankrupt companies would object to such expenses because they could eat into recoveries. Grace's creditors and shareholders have let it slide.

"As long the company is not in danger of being unable to pay the money it's going to owe, creditors take a more relaxed attitude," said Lockwood.
RIDING ENERGY WAVE
Technically, there is no court-set limit on how long a company can remain in bankruptcy. However, the process is designed to help craft a plan to repay creditors, and courts look down on companies that do not make a good-faith effort to restructure. In such cases, courts usually allow creditors to present their own plans for how to restructure the company.
Executives at Grace have said for years that an exit from bankruptcy is just around the corner, only to have dates come and go. Now, with a court hearing on Monday and rulings not expected until the fall, an exit may not come until 2014.

"Obviously, we're all eager to come out of bankruptcy," Chief Financial Officer Hudson La Force said in an interview at Grace's Columbia, Maryland, headquarters. "There are a few steps that need to happen first."

Leaving bankruptcy protection will allow creditors to be paid, asbestos liabilities to be met, and give the company access to debt markets and let it dispense cash to shareholders, Grace said.

Grace tailor-makes catalysts for Tesoro Corp (TSO.N), Citgo Petroleum Corp (PDVSAC.UL) and other refinery customers to match the chemical makeup of the shale oil that will be refined, a step for which the company charges a premium.

Sales of the product constitute roughly 32 percent of Grace's 2012 pretax profit, and the company earned $94.1 million last year, up 20 percent from 2001 when it entered bankruptcy.
"Whether we're out of bankruptcy one day or another, the reality is that it's not affecting our earnings. It's not affecting our cash flow," La Force said.
Surging catalyst sales have boosted Grace's stock price to $82.69 as of Friday's close. That is vastly higher than the $1.52 per share when the company filed for bankruptcy on April 2, 2001.

Yet the stock is widely overvalued and should be trading at an intrinsic value of $56.37, based on expected growth rates over the next decade, according to Thomson Reuters StarMine.

That "might not be taking into account the full scope of Grace's performance and some of the intangibles around management effectiveness and management credibility," said Mark Sutherland, Grace's director of investor relations.

RESTRUCTURING PLAN

As part of its bankruptcy, Grace filed a restructuring plan that will channel all current and future injury and property damage claims to trusts, pushing the liability off books.

Grace will receive help in funding the trusts from third parties, including Sealed Air Corp (SEE.N), that shared in the alleged asbestos liability.

Grace had promised shareholders it would use $1 billion after bankruptcy for either buybacks or a dividend. Yet roughly $490 million will have to be used immediately to redeem stock warrants held by one of the asbestos trusts, limiting payouts to stockholders.

Still, with $453.6 million in annual cash flows and no debt, shareholders stand to reap rewards, said Chris Shaw, an analyst with Monness, Crespi, Hardt & Co who tracks Grace.

"That's always been a positive about Grace: they're a strong cash generator," he said. "They want to reward the shareholders who have stuck with them through the whole bankruptcy process."

Grace's bankruptcy could stretch at least into next year as creditor objections to its exit plan wind through the courts.
In oral arguments at the U.S. Court of Appeals in Philadelphia on Monday, a bank lending group led by JPMorgan Chase & Co (JPM.N) will claim the plan does not pay its members enough interest, while a South Carolina hospital will argue that its pending property damage claim would not be fairly adjudicated under the plan. Other objectors include the state of Montana, the Canadian government and Garlock Sealing Technologies Inc.
If the court rejects the appeals, Grace could take another two to three months to exit bankruptcy, in part because it still needs to secure a bankruptcy exit loan, La Force said.
That does not take into account possible appeals at the U.S. Supreme Court, which could further delay its exit from bankruptcy.
Doug Roll, mayor of Libby, Montana, said his town has been "trying to get beyond" the asbestos-related problems.
"As far as we're concerned, Grace is gone," Roll said. "And good riddance."

(Editing by Tiffany Wu and Matthew Lewis)