Focus Article: CVR Energy, Inc. (CVI)

CVR Energy, Inc. (CVI) $24.70

The Company:

CVR Energy is an independent petroleum refiner headquartered in Sugar Land, Texas. The company was founded and built in August 1906, by the National Refining Company, the second largest oil company in the US at the time.

CVR Energy is in essence three different but complementary businesses rolled into one.

i) The refinery business operates independent refining assets in Coffeyville, Kansas and Wynnewood, Oklahoma with more than 185,000 barrels per day of processing capacity.

ii) The company also has a fuel transportation business with tanker trucks,  pipeline terminals and a crude oil gathering system.

iii) Finally the company owns a majority stake in a fertilizer business through the independently traded CVR Partners LP (UAN). CVR Partners has the only nitrogen fertilizer plant in North America that uses petroleum coke as opposed to natural gas as a feedstock. Petroleum coke generated as a byproduct of CVR Energy’s Coffeyville refinery is used by CVR Partners to generate 1,225 tons of ammonia and 2,025 tons of Urea Ammonium Nitrate (UAN) per day. The company expects to increase production to 3,000 tons of UAN per day by Q1 2013.

CVR Partners has a market cap of $1.46 billion (EV of $1.36 billion), trades for about 8 times EBITDA and grew operating income 87% in Q1 2012. CVP Partners is a Master Limited Partnership (MLP) that pays out 100% of available cash each quarter and hence sports a high yield of 10.5%. With CVR Energy owning 70% of CVR Partners, a big chunk of this payout goes directly to CVR Energy.

Carl Icahn:

“CVR Energy is a gift from Carl Icahn” said billionaire hedge fund manager John Paulson at the recent Ira Sohn conference. John Paulson cut his marbles as a merger arbitrageur but struck it big betting on the mortgage meltdown. Here is why Mr. Paulson thinks CVR Energy is a gift and why a good way to play this situation would be through the contingent value rights issued as part of Icahn’s tender offer.

The legendary activist investor Carl Icahn issued a tender offer for $30 per share for CVR Energy plus a “contingent cash payment” (CCP) right in early May. The CCP would pay shareholders the  difference between $30 and the price at which CVR is sold to a third party. Despite the company urging shareholders not to tender their shares by the May 4, 2012 deadline, a majority tendered their shares and Carl Icahn ended up eventually owning 80% of the company. The recent insider purchases of an additional 1.65 million shares has bumped up his stake to 82%.

If Icahn increases his stake to 90%, he will have to acquire the rest of the shares and take the company private. He may also attempt to sell the company to a third party but efforts to find a suitor have been unsuccessful thus far. On May 24, CVR Energy announced that it has retained Jefferies & Company (JEF) to look for suitors that might be interested in acquiring CVR during a 60 day process that ends on July 23, 2012. Icahn Enterprises (IEP) has indicated its willingness to support an offer of $35 and higher.

There are three possibilities here.

The company might get acquired for $35 or higher through a potential offer by July 23, Carl Icahn might continue increasing his stake in order to take the company private at $30 per share or the company will continue to trade independently.

If CVR Energy finds a suitor through Jefferies or Carl Icahn finds a suitor on his own, the contingent value right could be worth a lot as they are similar to call options with a strike price of $35 or higher that expire 15 months from the May tender offer date. Unfortunately the press release for the tender offer mentioned that these contingent value rights are “non-transferable”. If it is not possible to buy them, then buying CVR stock or options might be the only way to get this purported gift from Icahn. With CVR Energy trading at less than 4 times EBITDA and both the refinery as well as the fertilizer business growing rapidly, owning either CVR Energy directly or picking up a stake in UAN is worth considering.

Business Statistics & Financials:

CVR Energy reported operating income $140.5 million in Q1 2012, up 28.19% from $109.6 million in Q1 2011. Net income for the first quarter of 2012 was however a loss of $25.2 million or $0.29 per diluted share on account of unrealized loss before tax on derivatives of $128.1 million. The petroleum business generated $1.9 billion in revenue and $145 million in adjusted EBITDA in Q1 2012 compared to $1.11 billion in revenue and adjusted EBITDA of $91.7 million in Q1 2011.

The fertilizer business operated by CVR Partners generated $78.3 million in revenue and $38 million in adjusted EBITDA in Q1 2012 compared to $57.4 million in revenue and $25.9 million in adjusted EBITDA during the year ago period. Including the cash and debt from CVR Partners, the company had $500.9 million in cash and $852.9 million in debt.

CVR Energy trades for less than 4 times EBITA, sports operating margins of 9.65% and has double digit ROE and ROA.

Competitors:

Insider Buying:

One insiders purchased stock on the open market over the last six months as listed below. You can view a list of all insider transactions for CVR Energy here.

Conclusion:

In this challenging environment where it feels like everything I touch promptly drops in value, it is difficult to make the case for yet another long position. However CVR Energy is a special situation that reminds me of our merger arbitrage trade on Coca-Cola Enterprises (CCE), which was as close to a free lunch the market could provide. While the risk-reward for CVR Energy is not as compelling as the Coca-Cola Enterprises merger spread was, it is an idea worth exploring if you have dry powder left and have the stomach to ride out the volatility we are experiencing.