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Fair Game

How Bankrupt Is Horsehead Holding? Its Investors Want to Know

Guy Spier, an investor in Horsehead Holding, asked the judge for an equity committee.Credit...Richter Frank-Jurgen

In large and complex corporate bankruptcies, shareholders are usually kicked to the curb, left with nothing of any value to show for their investments. Normally, that’s the way it should be: Bankruptcies, after all, involve companies whose assets are worth far less than their obligations.

But what if those assets are actually worth more than the company contends? Then shareholders are forced to leave money on the table for other stakeholders to grab, particularly the company’s dominant creditors who typically drive the bankruptcy process.

Such a situation may be unfolding at Horsehead Holding, a producer of zinc and nickel products in Pittsburgh that filed for Chapter 11 protection in February. It listed $421 million in secured and unsecured debt obligations.

Like many companies in the commodities business, Horsehead has stumbled. Spot prices for zinc and nickel swooned in 2015, and a new zinc plant it built in Mooresboro, N.C., encountered production problems.

Still, metals prices have rebounded significantly since the company filed for bankruptcy. And some Horsehead shareholders contend the company is lowballing the value of its assets to let leading creditors gain control of it at a bargain price.

The decline in Horsehead’s assets has certainly been precipitous. Just before the February filing, its assets were valued at $1 billion. Six months later, Horsehead’s financial adviser estimated that the company’s assets were worth about one-third of that.

What’s occurring in the Horsehead case has implications for any shareholder whose company faces severe financial woes, some legal experts say. Because of longstanding biases against giving shareholders any say in a bankruptcy, equity holders are often asked to trust the valuations assigned to a company without being able to verify them.

Diane Lourdes Dick, an associate professor of law at Seattle University Law School, said the Horsehead case highlighted a flaw in the bankruptcy process.

“What we have here are equity owners that are functionally shut out of the process, and that provides the opportunity for exploitation by other stakeholders,” she said. “It is yet another example of the unique challenges that equity holders face when the company they’ve invested in is in Chapter 11.”

Horsehead’s valuation history certainly seems odd. Its audited financial statements for the September 2015 quarter show assets worth $1 billion. An unaudited report from early February valued the assets at roughly the same. A KPMG report commissioned by Horsehead shareholders values the company at over $1.1 billion.

But in a July filing with the court, Horsehead’s financial adviser said the company’s assets were worth an estimated $280 million to $375 million. The main reason for the decline? The company’s decision to write down to almost zero the new zinc plant in Mooresboro it built for $550 million.

What accounts for the almost total loss in the plant’s value? Lazard, adviser to Horsehead in the bankruptcy, said it based its valuation on prices of the company’s debt and equity, both of which are naturally depressed by the company’s Chapter 11 filing. Lazard also referred vaguely to its consideration of “the latest 12 months revenue multiples of selected comparable guideline companies.”

This makes some of Horsehead’s shareholders suspicious.

“The major issue is how the company has been urging the court to believe that hundreds of millions of dollars of value vanished into thin air and a brand-new factory was deemed to be worthless,” said Thomas I. Boswell of Boswell Capital Management in Hong Kong, operator of the Intrinsic Value Limited Partnership, which owns 250,000 Horsehead shares. “To say that they’re writing off a $500 million plant basically because the share price of our stock and the prices of our bonds have fallen is ludicrous.”

Horsehead did not respond to an email seeking comment.

Christopher S. Sontchi, the federal judge overseeing the bankruptcy proceeding in Delaware, has raised questions of his own about the steep decline in the company’s worth. In an unusual ruling in May, he allowed the formation of an equity committee, giving Horsehead shareholders a chance to participate in the process. More than 1,000 individual investors own the stock.

“To put it bluntly, something doesn’t smell right to the court,” Judge Sontchi said, according to a court transcript. “There was a certain valuation scenario that existed pre-petition and there’s a radically different valuation scenario that exists post-petition, and there’s a sufficient amount of ambiguity as to what’s right and who’s right, that I believe it’s appropriate in this unique circumstance to appoint an equity committee.”

The judge ruled in favor of an equity committee after an impassioned plea from Guy Spier, a well-known value investor and Horsehead shareholder who oversees the Aquamarine Fund. Mr. Spier declined to comment.

After the committee was formed, it made some interesting discoveries. One was that Horsehead had received, and turned down, attractive bids for some of its assets just before it filed for bankruptcy. Accepting such bids could have kept the company going, the shareholders contend. Court filings indicate those bids far exceeded the valuation of Horsehead assets presented by the company in July.

Still, the court has not given shareholders much time to argue against the company’s reorganization plan. A confirmation hearing is scheduled to begin on Tuesday.

Horsehead will undoubtedly marshal a strong defense of its valuation to the court. And if the judge confirms the plan, management of the reorganized company will receive an unspecified percentage of its shares as incentive awards. There is also the potential for a public stock offering in the restructured company down the road.

Horsehead’s debt holders will be the biggest winners, though. Among them is Greywolf Capital Management, an investment firm that collaborated with Goldman Sachs on the creation of Timberwolf I, one of the most toxic collateralized debt obligations to emerge in the mortgage crisis.

A spokesman for Greywolf declined to comment.

The Horsehead matter shows, Professor Dick said, why it may be necessary in more bankruptcy restructurings to give shareholders a chance to be heard early in the process, so they can serve as a counterweight to the outsize influence of big creditors.

“In a restructuring, a company can be transferred from the shareholders to the creditors for less than adequate consideration,” she said. “There’s no way to correct for that unless you allow shareholders to advocate for themselves.”

Twitter: @gmorgenson

A version of this article appears in print on  , Section BU, Page 1 of the New York edition with the headline: A Bankruptcy Filing That Doesn’t Add Up. Order Reprints | Today’s Paper | Subscribe

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