[Off-topic] Bill: Please click "Next". ;-)
MDR Downside Risk: Readers Digest Version
Ed:
Is the "realistic worst case" here, that MDR just pulls the plug on their B&W sub?
Yes, IMHO. The absolute worst case, of course, is that McDermott International, Inc. (MDR) goes Chapter 7 and liquidates (i.e., 100% loss of MDR's equity, or MDR = $0/share). However, this is probably not realistic unless one of the Babcock & Wilcox (B&W) litigants is successful in piercing McDermott's corporate veil. IOW, the corporate veil should protect MDR, and B&W should sink or swim on its own. Reasonable downside valuation, IMHO, assumes that B&W goes Chapter 7 and liquidates it's assets (i.e., 100% loss of MDR's B&W equity).
If so, any ideas as to the book value of B&W?
Well, let's look at the numbers. It's kind of difficult to decipher McDermott's balance sheet make-up by subsidiary because McDermott reports its results under business segments rather than subsidiaries. Nevertheless, you can estimate the subsidiary value of Babcock & Wilcox using some reasonable assumptions.
According to the last 10-K, the Babcock & Wilcox entities that operate under the McDermott umbrella are:
- BWICO for Babcock & Wilcox Investment Company, a Delaware subsidiary of MI;
- B&W for the Babcock & Wilcox Company, a Delaware subsidiary of BWICO, and its consolidated subsidiaries; and
- BWXT for BWX Technologies, Inc., a Delaware subsidiary of BWICO, and its consolidated subsidiaries.
The 10-K also implies that Babcock & Wilcox operates in two of MDR's four business segments:
- Power Generation Systems includes the results of the operations of the Power Generation Group, which is conducted primarily through B&W, and provides services and equipment and systems to generate steam and electric power at energy facilities worldwide.
- Government Operations includes the results of the operations of BWXT, which supplies nuclear reactor components and nuclear fuel assemblies to the U.S. Navy and various other equipment and services to the U.S. Government and manages various U.S. Government-owned facilities.
According to the 10-K, these two business segments accounted for the following proportions of MDR's balance sheet prior to the J.R. McDermott acquisition:
Segment Assets at 3/31/99:
Power Generation & Government Segments: $770,634,000 (18%)
All Other Assets: $3,534,886,000 (82%)
Total Assets: $4,305,520,000 (100%)
Therefore, assuming a Chapter 7 liquidation for the B&W subsidiaries, there are only $770 million of assets on the MDR books available for liquidation.
Note: This $770 MM estimate is for total assets, not book value, yet this value has already been almost completely discounted by the market!!! Specifically, MDR's market cap has already declined by $580 MM in the last two trading days [59.5 MM shares X ($18.50-$8.75)].
Unbelievable, to say the least!
But there's more! IMO, it is much too pessimistic to use total assets as an estimate for B&W's value in the MDR portfolio because you don't just wipe away total assets without also wiping away total liabilities in a bankruptcy proceeding. IOW, you really need to look at estimated net asset value of the equity of B&W for a more realistic scenario.
According to the latest 10-Q, net asset value for MDR at 9/30/99 can be calculated as follows:
MDR's Total Assets: $3,895,008,000
Less MDR's Intangibles: ($448,447,000)
Less MDR's Current Liabilities: ($1,251,040,000)
Less MDR's Long-term Debt: ($323,162,000)
Less MDR's Other Liabilities & Minority Interest: ($1,500,796,000)
MDR's Net Asset Value: $371,563,000
Since the 10-Q (unlike the 10-K), doesn't give an asset breakdown by business segment (only by revenues and net income), and MDR's consolidated balance sheet from the 10-K (fiscal year end 3/31/99) has changed due to the acquisition of J. Ray McDermott, the net asset value of the B&W subsidiaries must be estimated by adjusting the fiscal year end segment breakdown at 3/31/99 to account for the post-acquisition balance sheet at 9/30/99.
Specifically, an estimated net asset value for the B&W subsidiaries can be calculated by multiplying 18% (B&W's segment asset percentage at 3/31/99) times $371,563,000 (MDR's net asset value at 9/30/99). This yields an estimated net asset value for the B&W subsidiaries equal to only $66,881,340 (18% X $371,563,000).
Therefore, IMO, $67 MM ($1.13/share) is a much more reasonable downside estimate for MDR assuming that the litigants are unsuccessful in piercing MDR's corporate veil.
IMHO, the big unknown here is whether or not the corporate veil can be pierced. If the corporate veil can be pierced, then MDR's share price meltdown may very well have been justified. If the corporate veil can't be pierced, then the recent blow-off was quite possibly overdone to the tune of almost $10/share and the current price ($8.75/share) could represent a great buying opportunity!
All of the above is, of course, just my honest opinion. I've run the numbers, and that's what I've concluded.
Comments and questions are welcomed!
Please do your own DD and keep in mind that there are a lot of unknowns here which will soon play out.
Best of luck to all.
Razor |
