Business advisor: 16 ethanol plants filing bankruptcy, many more to come

Cattle Market & Farm Reports, Editorials
Jun 27, 2008
by DTN

Business advisor: 16 ethanol plants filing bankruptcy, many more to come

The U.S. ethanol industry is in trouble and can expect to see a rash of bankruptcies and dismantling of at least some production, according to a specialist who helps companies in distress.

Alex Moglia, president of Moglia Advisors based in the Chicago area, said he knows of at least 16 ethanol companies that are filing for bankruptcy, and there will be at least two to three times that number filing within the next year.

Though he declined to give the names of companies involved, Moglia said, "There’s a whole host of them we’ve either looked at or handled."

If Moglia is right, a U.S. ethanol industry shakeout that started last year is about to shift into high gear, potentially threatening the ability of the industry to meet mandates laid out in the Renewable Fuel Standard.

Companies come to Moglia Advisors and similar firms to help save their businesses, which often can result in filing for bankruptcy protection.

"Investors are just pulling their hair out in trying to restructure debt with lending institutions," said Moglia, who was hired early on to help the Central Illinois Energy ethanol plant in Canton, IL, prior to the company’s decision to file bankruptcy.

"Everybody is stuck in this industry," he said. "Equity investors are stuck, the lenders are stuck, the producers are stuck, and even worse, with farmers who had supply contracts and marketing contracts, they’re stuck. The reality is that most of the players that are going to be active here are going to be funded by foreign investors."

Moglia has led numerous corporate restructurings, acquisitions, workouts and bankruptcies in the past 25 years. Before founding Moglia Advisors, he held senior management positions with Continental Illinois National Bank and CNW Corp. Moglia currently serves on the board of directors of the Corporate Finance Association Foundation.

The weakness of the U.S. dollar makes it possible for foreign investors to acquire ethanol plants "at a deep discount," he said.

"They can buy as low as 20 or 30 cents on the dollar," Moglia said. "That should scare the hell out of anyone in the biofuels industry. I’ve worked with plants that are incomplete, others that can’t operate profitably so they’ve all shut down. This will shake out most of small- and mid-sized players. Larger players will survive because they have buying power."

More ethanol producers will continue to file bankruptcy, he said, because of high feedstock costs and a "limited upside flexibility in terms of how much you can sell ethanol for."

"The demand for ethanol is not there," Moglia said. "The same thing happening to ethanol is happening in the biodiesel business. It will be the Wal-Mart-ization of the ethanol industry. It’s just a mess."

For the record, since 2007 there have been just four ethanol bankruptcies documented in the media and/or in court records, together accounting for 60 to 80 million gallons of production capacity.

They include the following: Ethanex Energy Inc. based in Basehor, KS, an ethanol-development company that never did operate an ethanol plant, filed for Chapter 7 liquidation bankruptcy at the end of March; E3 BioFuels LLC in Mead, NE, filed for Chapter 11 bankruptcy protection in November 2007; Central Illinois Energy in Canton, IL, filed for Chapter 11 in December 2007 and was bought at auction; and California-based Convergence Ethanol Inc. filed for Chapter 7, also in December 2007.

Christopher Grooby, an ethanol financing attorney with Washington, D.C.-based law firm Baker and McKenzie, said bankruptcy is becoming a possible solution for struggling ethanol plants.

"My guess is bankruptcy is a very strong word," he said. "There are many plants now that are either under construction or in the early stages of their operation that still have debt and so are in restructuring talks with their lenders so that formal bankruptcy proceedings can be avoided."

Joseph Peiffer, a bankruptcy attorney with Day Rettig Peiffer in Cedar Rapids, IA, said the number of ethanol plant bankruptcies Moglia cites is "about right."

Peiffer said many ethanol plants are and will be folding because "the business model they were built on doesn't work."

Farmers and their cooperatives have either borrowed money or pledged their land as collateral in building ethanol plants, he said.

"Now they’re getting bought out on cents per dollar," he said. "Equity investors and people who made secured loans are not able to recover their investments either. Investors are losing and creditors are losing. Banks are looking at their losses and trying to minimize their loss."

Julia Pettit, a biofuels attorney with Stoel Rives LLP in Salt Lake City, Utah, said while the number 16 seems "a little high," it is difficult to track ethanol companies going bankrupt.

"I would say that’s probably a little high based on what I’ve been watching the last six to nine months," she said. "What’s also difficult is that sometimes a company doesn’t use the word ‘ethanol’ in their name, they use ‘energy’ or something else. It’s always difficult to track these companies. As to whether you're going to see numbers double, that’s somewhat difficult to predict. I think that there are certainly some projects that got financed way back during the heyday when ethanol was hot. It may just be that those projects don’t really have all the components to make them successful or viable."

Pettit said Moglia "certainly has his ear to the ground and is very sensitive to the economics of these projects."

"If you sit back and take a look at the whole industry, there’s no doubt there's a shakeout occurring," she said. "For what it means to the industry as a whole, it is not as bad as it seems. That's my perspective."

Pettit said companies are either shutting down operations altogether or are still in the process of being constructed and deciding whether to finish.

"We’re going to see targeted mergers and acquisitions," she said. "My guess is it’s going to be a company that put in a lot of equity up front and has a lender who just doesn’t understand an industry to work with them to get over the hump, or know how to venture into hedging arrangements. In those situations you have the lender really putting the screws to that company. These might be the kind of companies that need to seek bankruptcy protection to give them some breathing room."

There are going to be times when ethanol producers "just don’t produce" to get "supply/demand in the place where it needs to be to operate," Pettit said.

For every 10 ethanol and/or biodiesel plants "you read about in the media, there are probably 50 to 100 others that are in financial difficulty and are contemplating shutdown," Moglia said.

"Lenders are restructuring the debt so the plant has a chance of servicing the debt on a monthly basis through the financial institutions," he said. "The investors, lenders and operators are holding hands and trying to ride out this economic cycle. They are suffering quietly because there are public policy implications also."

Since ethanol production is mandated by the federal government, he said they are already "operating outside free-market fundamentals."

"And when you are having activities operating outside free market, there are public policy implications," Moglia said. "There is an enormous reticence to allow the market to adjust. There are a variety of economic, labor or similar strategic reasons, which is why people pushed biodiesel and ethanol so hard. You have a homeland security issue affecting business enterprise."

When it comes to the work Moglia Advisors does, he said, bankruptcy is usually a last resort. Moglia said that’s because it is expensive and full of time delays, and the "stigma of bankruptcy" could hurt a company for years to come.

"Most businesses—biofuels or not—they get into trouble and they never see the inside of a bankruptcy court," he said. "Most of these settle outside of court. We tell people they just slash expenses to a minimum. In most cases, we suggest plants be mothballed for the next two to five years to see what happens. I spoke at an ethanol producers’ conference. Somebody raised a hand and asked, ‘What is the biggest problem facing ethanol plants today?’ I looked him straight in the eye and said, ‘Management.’ Unless you’re talking about a bomb hitting your building, or a meteorite hits your building or an act of God hits your building, management should have prepared and anticipated for such an eventuality."

Moglia said many ethanol plants were started or funded by people "who did not have a background in process industries."

"Just because you’re a good farmer doesn’t make you a good judge of a manufacturing enterprise," he said. "Too many people forget that making ethanol is different from growing a crop. Most ethanol operators could benefit from contacting a turnaround firm, for technical and refinance side. The minority will contact us; the majority will try to make things happen on their own. Most of those home-spun remedies will fail. Then they contact us when it is impossible to restart the plant or complete the plant." — DTN