Headwaters in Need of a Bailout?

Not long ago, I said there were 29 reasons to buy Headwaters (NYSE: HW  ) , a coal recycling and construction company that recently joined the Motley Fool Rule Breakers portfolio. Now, I'm not sure.

Tuesday, the firm announced that it would seek $150 million in new debt to help pay down a senior secured credit facility. It's a good idea. Headwaters had $587.8 million in debt on its books as of the end of March. Interest expense equaled more than 47% of net income during the first quarter.

And that burden could grow. Headwaters has been subject to higher rates in recent months. Indeed, its weighted average cost of interest rose from 5.2% in September to 5.3% in March. And continued Fed rate hikes won't help control costs.

Enter the refinancing. A Headwaters spokesperson told me that the new debt would allow for the bulk of a variable rate credit facility -- which requires a balloon payment of roughly $155 million in 2011 -- to be repaid and replaced with a lower-rate, fixed-interest balance, due by 2016.

Sounds great so far, right? Of course it does -- it is. But I fear that Headwaters has been forced into this position. Large customers have recently idled synthetic fuel facilities, which could materially hurt Headwaters' alternative energy business. Accordingly, in May the company cut earnings guidance for the full year, from $2.60 to $2.75 per share to $2 to $2.70. Color me nervous.

It's even more nerve-wracking that the so-called section 29 tax credits -- on which Headwaters' alternative energy business has come to depend -- appear to have lost all support in Congress. Without them, Headwaters' 2005 tax rate would have been 38.5% instead of its reported 26%. Accordingly, and as the most recent annual report says, a phase-out of the credits could severely crimp Headwaters' net income -- and thereby, its cash flow.

Perhaps I'm being paranoid. If so, great, we all win. But if not, yesterday's announcement could be the first in a series of needed structural changes to Headwaters' business. And that's not likely to be good for anybody.

Headwaters isaMotley Fool Rule Breakersselection. Ask us for anall-access passto Rule Breakers to get a backstage look at all of the stocks in David Gardner's rebellious portfolio, which is beating the market's average return by nearly 5%. It's free for 30 days.

Fool contributorTim Beyershasn't ever seen coal waste, but he's pretty sure his oldest son -- a wannabe construction worker -- would love it. Tim owns shares of Headwaters. You can find out what other stocks he owns by checking Tim's Foolprofile. The Motley Fool has an ironcladdisclosure policy.


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