AgroFresh is a company that sells 1-MCP, a chemical that helps slow down the ripening process of fruit and vegetables. You know how you can eat apples all year long? Did you ever think that’s strange given harvest season is September-October? With 1-MCP, apples can be stored for a year. That’s right – sometimes you are eating year-old apples. I’ve been following AgroFresh for years and there are certain times when the skew on the stock becomes very interesting.
This is a quick idea today and I need a disclaimer upfront. This is not investment advice and I use this blog as an investment journal. The subject company today is very risky. You should expect that I may invest in this company and then quickly move on if I see a quick return. You should do your own due diligence.
Anyway, back to AgroFresh stock. The issues have always been:
- They were bought by a SPAC, which raised red flags given SPAC deal dynamics. AgroFresh stock has not been a good performer since then.
- It was a carve-out from Dow Chemical, who knows a thing or two about chemicals. So their choice to sell a high margin business was odd (Dow later re-invested in the company through the open market).
- They have a decent amount of debt (recently refinanced, though expensive).
- This typically was viewed as a 1 product, 1 market company (viewed as only Smartfresh 1-MCP product with apples).
- One patent had rolled off in 2015 and more were coming in 2019 and 2020. It was unclear whether earnings would collapse or not
Each of these are valid issues with AgroFresh stock. The last issue is the most important one in my view. As you can see below, the gross margins and EBITDA margins are super high. They do about $71MM in EBITDA, with 42.5% margins, and only have $3MM in capex (less than 2% of sales) so have extremely high FCF conversion.
Excluding the intangibles assets from their buyout and cash, they have $153MM in assets, but do $71MM in EBITDA – that’s a super high ROIC and highlights the intellectual property and high service model is creating a barrier.
So why is this worth a look?
Frankly, I think the risk / reward is getting very compelling. I’ve made a decent amount of money in stocks the rest of the market thinks is going bankrupt, but where I think the odds are more likely it does not.
First of all, they generate a lot of FCF. Despite a new onerous debt restructuring entered into last year (their prior term loan matured in July 2021, so it was about to become “current”), I still think we’re accruing cash to equity at around 20%. As mentioned a lot, I like good companies with bad balance sheets. This may just be an OK company with a bad balance sheet, but thats OK.
The debt deal was entered into because the company had an upcoming maturity. They got a new $275MM term loan at L+625bps with a 1% floor, which foots to about $20MM of interest per year. I think they’ll be able to refinance that at a better rate, but the loan does have 101 hard call protection until July 2021.
More importantly, they have a seriously onerous convertible pref equity that was put in place by Paine Schwartz Partners (PSP). It accrues at 16% (half cash / half PIK in year one). Call protection is determined by a multiple of invested capital, which also seems aggressive:
If they can take this pref out before July 2021, Agrofresh will need to pay 1.5x the pref amount of $150MM, which is ~$225MM (it is actually less than this, because MOIC includes original issue discount + coupons, but you get the idea).
Otherwise, Agrofresh has to pay 16% interest while this thing is outstanding. For me, I’d want that out of here as fast as possible. On the other hand, if AGFS takes it out in year one, it’s basically like paying 50% interest. I guess that’s the cost of capital during a pandemic when you have a maturity coming due.
Here’s how the pref shakes out, assuming they PIK the minimum amount each year (the PIK interest is added to the balance). As you can see, the PSP pref is brutal because the high rate incentivizes a refi, but the make-whole is large too so it is actually better to wait a bit and execute on your business plan.
There are some other green shoots. Agrofresh won an IP lawsuit against UPL, one of the largest ag chemical companies, and was awarded over $30MM. They can actually use this to paydown the preferred at more favorable terms. Obviously there are two good outcomes of this that I don’t need to directly spell out for readers.
Smartfresh is the flagship product for Agrofresh. Fortunately or unfortunately, the patent that still applies to a bulk in revenue still lasts until 2022. So unfortunately, it is still a wait and see story.
And what does management say about competition, otherwise? It’s not really new. Here’s a quote back from 2016 (by the way, this TruPick product they are talking about it what they won the lawsuit for):
The last thing I’ll say is there is other optionality in this investment. Essentially, take this chemical and apply it to other fruits and vegetables that could be preserved. Man, avocados go from too hard to too ripe way before I’m even ready for it.
So far, they’ve actually done a decent job. Back in 2014, the company was 88% apple-related sales. Now it’s just 60%.
It seems like the company wants to aggressively expand here. Part of the management teams bonus is tied to it (25%).
Speaking of bonuses, I like that mgmt has a decent amount of options that are way out of the money at $2/share. Mgmt was also in the open market in 2019 buying at $2.35/share.
However, I’m not super thrilled that total comp is around $2MM / year for a company doing $71MM in EBITDA with abysmal stock performance so far.
So why now?
AGFS stock has been a value trap to some extent.
- Refi that expensive preferred capital and potentially the term loan.
- Fortunately or unfortunately, the credit market is aggressive right now and many companies will be able to survive this cycle that wouldn’t have survived past ones.
- In reality, perhaps they should come to market with a 9% unsecured bond. It’d be juicy in this market (and HoldCo PIKs are trading at lower yields)
- AgroFresh could do a $375MM deal to takeout the pref + TL and still come out with cheaper cost of capital all-in.
- Doing this would free up capital for the common shareholders
- I think they may be able to do something by July 2021. But thesis isn’t predicated on that.
- Sentiment feels bad on it. Stock seems completely washed out. I like that. Slightly positive news would send it higher.
- I like the skew: If I see patent weakness or too much competitive threat, can likely exit before losing the whole position. If they surprise to the upside, even modestly, the stock will re-rate very quickly (especially with the leverage).
- Small wins are meaningful: If AGFS gets a $10MM win, that’s much more incremental to them because they are a microcap.