ACAS: What is WRH, Inc.?

Earlier the Jaded Consumer posted about some apparent duds in ACAS' portfolio. The idea was to identify companies whose listed fair value wasn't holding after investment, the better to understand what was going on with the valuations and to shed some light on whether ACAS' investments were terrible or whether, instead, ACAS' pricing environment was terrible but its investments were not.

ACAS' last 10-Q shows another such company whose data invites inquiry: WRH, Inc.

ACAS lists the industry of "WRH, Inc." as "Life Sciences Tools & Services". Depending whose Google links you trust, the private company WRH Inc. is either an Iowa company with $15m in annual sales involved in water & sewer system construction, or a New Mexico company with revenues between $2.5m and $5m in an industry described by NAICS Code 532412 ("Other Heavy Machinery Rental & Leasing"). The moniker "life sciences" seems a bit closer to water and sewer systems than to heavy machinery leasing, but who knows? If you have a clue, please post. ACAS' site seems bereft of detail. Based on the quarterly interest payments ACAS gets from the company (described below), I think it's clear that if either of these companies is our man, WRH, Inc. has to be the $15m/y water treatment tools and services company.

Two ACAS vice-presidents of buyouts – the Stanford MBA graduate Scott Kauffman, and former KPMG manager Justin Dufour – are observers on the board of WRH Holdings Inc. As of September 30, 2009, ACAS had invested $353.3 million in its "non-control/non-affiliate investment" WRH, Inc. in the following manner:

• $4m in senior debt (4% coupon and $4m face value, due 9/13, pledged as collateral and not non-performing, for an apparent quarterly income of $40,000 or $0.04m; this is valued at $4.0m which is both the investment's face value and its cost);
• $86.5m in subordinated debt (14% coupon and $87.1m face value, due over the period 7/14-9/15, pledged as collateral and not non-performing, for an apparent quarterly income of $3.0485m; this is valued at $87.1m or face value, which is above listed cost);
• $213m in convertible preferred stock, listed as not income-producing and valued at $$86.9m; and
  
• $49.8m in common stock, listed as not income-producing and valued at $0 (nil).
  

ACAS is required to value the investment at $178.0m, approximately half its listed cost of $353.3m. At the listed value of $178m, the still-produced quarterly income of $3.0885m is 1.7%, for an annual yield of about 6.9% (this ignores potential for capital appreciation; based on ACAS' listed cost, the yield is 3.5%). According to the 10-Q the preferred stock had been income-producing as of December 31, 2008 (in some undisclosed amount), and at that time the whole investment was valued at $332.3m. Between the two measurement points, however, the current valuation was not the only thing that changed: ACAS' cost changed. ACAS' cost of preferred stock was reduced by $13m and its cost of senior debt was reduced by $0.3m, and its cost of subordinated debt (the fat 14% notes) climbed $5.5m from $81m to $86.5m. What happened?

I haven't looked at ACAS' internal accounting, but one scenario suggests itself: when WRH informed ACAS that it wouldn't be able to pay dividends on the convertible preferred, ACAS converted some of the preferred (reducing its basis in the remainder of its convertible preferred holdings) to increase its holdings in still-paying sub notes. The reduction in "cost" of ACAS' holdings of WRH's senior notes suggests something similar occurred in the senior notes, but the transaction isn't as easy to guess as in the case of the convertible preferred, which was almost certainly converted to sub debt under the shares' conversion feature at whatever rate applied to the shares. The fact that the change in costs doesn't equal zero means that ACAS realized a loss at the time it exited the non-performing convertible preferred. The face value of the sub debt increased $5.4m in the transaction, quite close to ACAS' change in cost (the least-significant digit's off-by-one issue could result from rounding; or the other digit could represent something having to do with the change in senior debt).

So, ACAS converted preferred into sub debt, and did something with its senior debt that's less clear. ACAS gets $3,088,500 per quarter in interest, could potentially convert more preferred to debt, and holds common stock. Assuming that water treatment is still a valuable industry in Ohio or the nation, it's expected that the long term value of the zero-listed common stock isn't zero, and that the currently-nonperforming preferred stock may have future value either on conversion to debt or after reinstatement of dividends. At currently-listed "fair value" the interest payments are rather better than many of my own holdings, though presumably ACAS entered the deal to profit from equity increases (hence, the equity investment).

Anyone know anything solid on the company? My understanding was that infrastructure was considered a sexy industry and that efforts to improve greenness and sustainability had strong support. A company that provides water treatment tools and services seems well-positioned to benefit from increasing water demands as populations grow and their associated ecological concerns become infrastructure plans.

Is this really a long-term loser? Is the company reinvesting in growth rather than paying dividends in order to capitalize on some present opportunity? Was business horrible after the end of 2008 but picking back up? If ACAS didn't think the preferred shares had value, why would it not have converted them all to get paid interest?

WRH Inc. will be a holding to watch: both for listed fair value and for evidence of ACAS converting investments into different holding types as performance changes. In the meantime, several million a quarter in cash doesn't hurt ACAS' prospects.

If you have insight into WRH Inc. or any other ACAS holding, please post.