In an earlier article about GenCorp (AJRD), I told you about the strong business prospects of the company and also shared my confusion about the fact that close to 40% of the company's floating shares have been shorted. Now, I want to share a few possible arguments that may explain the heavy short position in GenCorp, and to discuss the merit of those arguments.
Long-term debt
The long-term debt may seem to be a big worry for GenCorp. Quite possibly, it could be one of the reasons that attracted heavy shorting of the company's shares.
|
Feb. 28, |
Nov. 30, | |||||||
|---|---|---|---|---|---|---|---|---|
|
(In millions) |
||||||||
|
Term loan, bearing interest at variable rates (rate of 3.66% as of February 28, 2014), payable in quarterly installments of $0.6 million plus interest, maturing in November 2016 |
$ |
44.4 |
$ |
45.0 |
||||
|
Total senior debt |
44.4 |
45.0 |
||||||
|
Senior secured notes, bearing interest at 7.125% per annum, interest payments due in March and September, maturing in March 2021 |
460.0 |
460.0 |
||||||
|
Total senior secured notes |
460.0 |
460.0 |
||||||
|
Convertible subordinated debentures, bearing interest at 2.25% per annum, interest payments due in May and November, maturing in November 2024 |
0.2 |
0.2 |
||||||
|
Convertible subordinated debentures, bearing interest at 4.0625% per annum, interest payments due in June and December, maturing in December 2034 |
188.7 |
193.2 |
||||||
|
Total convertible subordinated notes |
188.9 |
193.4 |
||||||
|
Capital lease, payable in monthly installments, maturing in March 2017 |
0.8 |
0.8 |
||||||
|
Total other debt |
0.8 |
0.8 |
||||||
|
Total debt |
694.1 |
699.2 |
||||||
|
Less amounts due within one year |
(3.0) |
(2.9) |
||||||
|
Total long-term debt |
$ |
691.1 |
$ |
696.3 |
||||
Source: GenCorp Annual Report 2014
The company acquired its competitor Rocketdyne last year, thereby creating a monopoly in a specialty area of the missile market called "Liquid diverts and attitude control systems". However, this resulted in creation of huge debt for the company. The acquisition was cleared by Federal Trade Commission, but only after a Pentagon intervention on GenCorp's behalf.
Despite the creation of long-term debt due to the acquisition, the company may be in good financial strength because of the 11,900 acres of land it owns in Sacramento. As per news reports, all necessary clearances have been obtained by the company for the development and sale of 6000 acres of the land, which has been valued at roughly $400 million by external agencies.
Convertible debentures: How much?
One of the prominent arguments in favor of shorting GenCorp shares is the expected dilution of earnings per share. As given in the above table, the company had earlier issued "convertible subordinated debentures, bearing interest at 4.0625% per annum".
This convertible status of the debentures is bit tricky. When the convertible debentures mature in December 2034, it would convert to 21.3 million common shares of the company. The company has 59.9 million floating shares; the maturing convertible debentures will increase the number of shares by 21.3 million. Investors might be scared that such increase in number of shares would drastically reduce the earning per share.
Are the convertible debentures really so scary?
In discussions about the company, dilution of earning per share due to the convertible debentures is often quoted as the reason for the huge short position. But I think that the market had mostly priced in this information when the company announced its plan to issue the convertible debentures.
If the stock price continues to climb despite such a heavy short interest, doesn't it mean that buyers are stronger in number than sellers?
Convertible debenture holders may have locked in a profit by borrowing GenCorp stocks to build short positions equivalent to their convertible debenture holdings, and once the debentures mature they can cover their short positions.
Litigation and other matters
The company is contesting 132 asbestos cases filed in different states alleging personal injury or death. These cases could cause some trouble for the company, but a clear picture is yet to emerge. Also the company has serious expenses in different environment-related issues and it has earmarked funds for the same.
Another drag on the company's prospects is the pension liability of more than $1.5 billion, but it is mostly covered either through pension assets or is recoverable through U.S. government contracts.
What now
I have failed to find a prominent reason that could herald a collapse in the company's stock. It would be interesting to know about any possible explanation which I might have missed, to justify the huge short position. For now, I am with the bulls, but would love to hear the opinions of bears in the comments below.
