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The Curious Case Of Cereplast

Cereplast started out as a good idea when it was founded by Frederick Scheer 10 years ago. The company would compound biobased and compostable resins such polylactic acid. The companies developing biobased resins are, for the most part, focused on agricultural processing or biotechnology. There would be a place for a specialist sorting out the nitty gritty of making the plastics work in real-world applications.

But something, if not many things, have gone wrong for the company. And earlier this month, the Cereplast filed for chapter 11 bankruptcy protection.

What happened?

It’s hard to tell. The Cereplast story is a little vague.

2011 seemed to be a good year for Cereplast in terms of revenues, which climbed to a high of about $20 million. However, the company managed to lose $14 million on those sales.

The company might have been in the red, but CEO Scheer was securely in the black. He earned a more than $1 million: about $500,000 in salary, $400,000 in bonuses, and nearly in $100,000 in stock awards.

A year later, things were pretty unpleasant for Cereplast. The company had to write off $12 million in accounts receivable in 2012. (Can’t tell if these were booked as part of the 2011 sales.) It is tough to figure out what exactly happened here, but the default explanation is that some customer stiffed the company for $12 million worth of compounded plastic. Conference calls allude to efforts to get the inventory back. The company lost $30 million on $911,000 in sales in 2012. Scheer earned a mere $336,077.

The company delisted from NASDAQ in 2012. It picked up, earlier in the year, Paul Pelosi, Jr. as a director, who wanted to lend one of America’s most recognizable names to team Cereplast for some reason. As far as I can tell he was an uncompensated, outside director.

Cereplast also ran the stock certificate printing presses in 2012 to stave off bankruptcy. Ironridge Technology bought $5 million in Cereplast preferred shares. Some outfit named Magna promised to pay off $1 million Cereplast debt in exchange for common shares. Cereplast is suing Magna for breach of contract.

Last year brought new ways for Cereplast to lose money. The company had $2.1 million in revenues for the first nine months of the year. It lost $34 million. The biggest item on its income statements is a $21.6 million loss for “change in derivative liabilities.” Cereplastcs explanation is as follows:

“Our derivative financial instruments consist of embedded and free-standing derivatives related primarily to the convertibles notes. The embedded derivatives include the conversion features, and liquidated damages clauses in the registration rights agreement. The accounting treatment of derivative financial instruments requires that we record the derivatives and related warrants at their fair values as of the inception date of the agreement and at fair value as of each subsequent balance sheet date. The recorded value of all derivatives at September 30, 2013 totaled approximately $15.1 million. Any change in fair value of these instruments will be recorded as non-operating, non-cash income or expense at each reporting date. If the fair value of the derivatives is higher at the subsequent balance sheet date, the Company will record a non-operating, non-cash charge. If the fair value of the derivatives is lower at the subsequent balance sheet date, the Company will record non-operating, non-cash income. At September 30, 2013, derivatives were valued primarily using the Black-Scholes Option Pricing Model.”

The Chemical Notebook doesn’t know either.

In any case, the bankruptcy was filed, in response to a lender’s efforts to sell off its assets, which aren’t insignificant. The value of the company’s property and equipment amounts to $11.2 million.

Breaking Bad: A Clueless Review

The biggest thing to happen in the world of chemistry this week was the final episode of Breaking Bad. The Chemical Notebook never saw the show, and for the last several years has felt left out of the fun that most of the chemical world was having watching it every week. I considered seeing the show before, but getting caught up would take more than 50 hours. It doesn’t seem important enough to invest that kind of time.

Instead, I just jumped into the final episode. Technically, I watched a little bit of the second to last episode, but most of that time was spent telling the kids to stop playing in front of the television.

I don't know what bromine and barium have to do with anything.

I don’t know what bromine and barium have to do with anything.

Here’s my review of the last episode:

[[SPOILER ALERT: People may have recorded the show on VHS or whatever.]]

The main character is Walter White. He’s played by the dad from Malcolm in the Middle. I’m pretty sure the shows occur in different universes. Walter White makes drugs, probably methamphetamine, using science. In fact, many references in the final episode leave me with the impression that he was once a reputable scientist. Most likely he was a chemist because I know chemists enjoy the show and they wouldn’t like it as much if it was about a renegade geologist.

White may have done other bad things besides making drugs, but that isn’t 100% clear from just the last episode. He seems like a nice man, as far as drug makers go, so I have my doubts.

Walter has some kind of disease that makes him cough a lot. Also, he’s a fugitive.

He has a wife. I didn’t catch her name. She smokes. He also has a son, who walks around with crutches. He is very angry with his father about the drugs and other things he may or may not have done. Oh, and a baby. There’s a baby in house. I’m not sure how it got there. The wife smokes in the house even though there’s a baby. Maybe she just smokes in the kitchen.

I should mention Jesse. I think he used to be friends with Walter White. He was making drugs while tethered to a thing. He used to make nice boxes out of wood.

The show has a lot of characters. I can’t get into them all. A woman who drinks tea a lot seems like she was important for the last few episodes at least. Walter kills her with chemistry. Also there were two rich people with a nice fireplace, apparently two former businesses associates of White. They said bad things about him on Charlie Rose. This upset Walter White even though nobody really watches that show. Walter White makes them set up a trust for his family by threatening them with laser pointers. This scene left me wishing there were cats in the room. It would have been funny to see cats trying to climb up their legs to get at the laser pointer dots.

Walter does lots of other stuff during the episode. He steals one of New Hampshire’s many Volvos and drives it all the way back to Albuquerque. He manages to find every working payphone along the way. He has a nice breakfast. Because the police are looking for him, he’s sneaking around the all the time.

To set up the finale, Walter makes a contraption with an oscillating motor, which he attaches a machine gun to and hide the trunk of an old De Ville. (He had ditched the Volvo a while back.) He infiltrates a bad guy place under a ruse. (I thought it was a chop shop at first, but it soon becomes clear that he’s been there before.) They take his wallet and keys from him. Then they threaten to kill him. It really seems like Walter is a goner.

But no.

Now for the important part: the keyless entry thing that was taken from him controls the machine gun contraption. They don’t think it’s strange that a 30 year old Cadillac has a keyless entry system. In any case, he grabs the keys, tackles Jesse, activates the thing he made, and all the bad guys in the room get shot…almost. One guy survives because the writers needed him to stick around so Jesse can kill him with the chains he was bound with. Another guy lives long enough to finish his cigarette. Jesse drives away at an irresponsibly high rate of speed.

Walter dies in a factory of some kind. It was probably his old drug factory, judging from the Badfinger music playing the background. Then AMC showed a bunch of interviews I didn’t really understand.

Berkshire Details Sokol’s Lubrizol Scandal

Berkshire Hathaway has put out a report on top exec David Sokol’s resignation in March over shares he purchased in Lubrizol before Berkshire’s takeover was announced.

At the time, I was wrong on this blog when I said:

“This seems to me a case of an appearance of conflict of interest rather than a real conflict of interest. Sokol thought Lubrizol was a good investment. He suggested that it would be a good investment for his company, too. Engineering an entire deal to make a tidy—albeit $3 million—profit would be the tail wagging the dog.”

Turns out, according to the report, there was more to the story than that:

He did not disclose:

* the amounts and timing of his purchases;

* the fact that he bought the shares after discussing Lubrizol with Citi and after Mr. Sokol had narrowed the bankers’ initial list of 18 chemicals companies to one, namely Lubrizol;

* the fact that Mr. Sokol had bought shares after Mr. Sokol (acting as a senior representative of Berkshire Hathaway scouting acquisition candidates) had asked for Citi’s help arranging a meeting with Lubrizol’s CEO to discuss Lubrizol and Berkshire; and

* the fact that Mr. Sokol bought shares after learning that Citi had discussed his request for a meeting with Lubrizol’s CEO, who told Citi that he would discuss Berkshire Hathaway’s possible interest in a transaction with the Lubrizol board.

Though, the report suggests that Sokol won’t have to exchange his pin stripes for prison stripes.

We appreciate that at the time Mr. Sokol traded, he did not know whether Mr. Buffett would support, or reject, the idea of an acquisition of Lubrizol. We also recognize that Mr. Sokol did not know how Lubrizol would respond to an acquisition proposal if Berkshire Hathaway were to make one. We recognize the view that those uncertainties might have kept Mr. Sokol’s information below the level of probability required to support a finding of materiality for purposes of finding a violation of federal insider trading law. But the Trading Policy requires a higher standard of conduct than what is required to avoid being charged with a federal securities violation.

I like the last sentence. It reminds me of the old Hebrew National commercials.

My take: Why would someone blow their chance to be Warren Buffett’s successor for a measly $3 million? Berkshire doesn’t disclose Sokol’s salary or stock holdings in its proxies. In any case, I’m sure he’ll land on his feet.

Berkshire Exec Resigns (Apparently) Over Lubrizol Bid

Some of you may have heard the news that Berkshire Hathaway executive David L. Sokol has resigned. Sokol bought 100,000 shares of Lubrizol and suggested to Buffett that Berkshire buy the whole company. Here’s the Lubrizol-related excerpt from Buffett’s statement about the resignation:

Finally, Dave brought the idea for purchasing Lubrizol to me on either January 14 or 15. Initially, I was unimpressed, but after his report of a January 25 talk with its CEO, James Hambrick, I quickly warmed to the idea. Though the offer to purchase was entirely my decision, supported by Berkshire’s Board on March 13, it would not have occurred without Dave’s early efforts.

That brings us to our second set of facts. In our first talk about Lubrizol, Dave mentioned that he owned stock in the company. It was a passing remark and I did not ask him about the date of his purchase or the extent of his holdings.

Shortly before I left for Asia on March 19, I learned that Dave first purchased 2,300 shares of Lubrizol on December 14, which he then sold on December 21. Subsequently, on January 5, 6 and 7, he bought 96,060 shares pursuant to a 100,000-share order he had placed with a $104 per share limit price.

Dave’s purchases were made before he had discussed Lubrizol with me and with no knowledge of how I might react to his idea. In addition, of course, he did not know what Lubrizol’s reaction would be if I developed an interest. Furthermore, he knew he would have no voice in Berkshire’s decision once he suggested the idea; it would be up to me and Charlie Munger, subject to ratification by the Berkshire Board of which Dave is not a member.

As late as January 24, I sent Dave a short note indicating my skepticism about making an offer for Lubrizol and my preference for another substantial acquisition for which MidAmerican had made a bid. Only after Dave reported on the January 25 dinner conversation with James Hambrick did I get interested in the acquisition of Lubrizol.

Neither Dave nor I feel his Lubrizol purchases were in any way unlawful. He has told me that they were not a factor in his decision to resign.

Dave’s letter was a total surprise to me, despite the two earlier resignation talks. I had spoken with him the previous day about various operating matters and received no hint of his intention to resign. This time, however, I did not attempt to talk him out of his decision and accepted his resignation.

This seems to me a case of an appearance of conflict of interest rather than a real conflict of interest. Sokol thought Lubrizol was a good investment. He suggested that it would be a good investment for his company, too. Engineering an entire deal to make a tidy—albeit $3 million—profit would be the tail wagging the dog.

When Shareholders Attack!!!

These are usually the kinds of stories I don’t pay much attention to. Last week, I received a press release from Eastman announcing a few changes to its board.

CEO James P. Rogers is becoming chairman at the beginning of next year, replacing former CEO J. Brian Ferguson. No surprise there.

Independent director Gary E. Anderson is coming lead director of the company. Who would be better in such a position than the former CEO of Dow Corning?

And, Eastman plans to “declassify” its board. That doesn’t mean that some secret directors will now be known to the public. It means that Eastman’s eleven directors are divided into three classes. Each of the classes is elected to staggered, three-year terms. The class of three directors elected in 2010 is up for re-election in 2013; the class of four directors elected in 2011 will be up for re-election in 2014; and so on.

At its 2011 annual meeting, Eastman shareholders will decide whether they want to elect all of the directors each year. The move would ostensibly make the board more accountable to shareholders. It is sort of like the difference between the U.S. Senate and the U.S. House of Representatives.

“The board believes these latest actions are in the best interests of Eastman and its stockholders, and are further demonstration of the company’s ongoing commitment to strong corporate governance,” the company said in a statement.

The board hasn’t always thought that.

At the annual meeting back in May, Eastman was fighting a proposal to declassify its board. Gerald R. Armstrong submitted the proposal. He’s a Denver retiree who owns 98 Eastman shares. He has submitted shareholder rights proposals to a number of different companies in recent years. There are many people like him nowadays. I suppose you can call it a kind of hobby.

Back then, Eastman said “a classified board structure remains in the best interests of Eastman and its shareholders.” To Eastman, a classified board meant stability and a greater ability to maintain a long-term strategy in a cyclical environment. Eastman also argued that the classified board is a defense against hostile takeovers. That isn’t a silly argument. The biggest obstacle to Air Products’ bid for Airgas is Airgas’ staggered board.

But never underestimate a Denver retiree. Some 41,292,223 shares voted with Mr. Armstrong, 75.24% of Eastman’s total. He won big. The proposal was adopted.

So, is Eastman just doing what it is being forced to do anyway? Not quite. As Eastman spokeswoman Tracy Broadwater pointed out to me, the adopted proposal was non-binding.

I suppose Eastman was just nagged into doing it, really.

Industrial Gas Companies Face Brazilian Fine Muito Grande

The Brazilian antitrust authority, Conselho Administrativo de Defesa Econômica (CADE), is levying fines totaling about $1.7 billion against Air Liquide, Air Products, Linde, Praxair’s Brazilian subsidiary White Martins. It has also implicated seven managers of those companies.

CADE says it found evidence, through wire taps and searches, of an elaborate arrangement to divvy up the market by assigning customers to particular industrial gas companies.

“CADE understands the actions of those companies that were investigated resulted in grave damage to industry and the public health of Brazilians,” the regulator said in a statement. (Warning: I translated that myself.)

White Martins faces the largest fine, $1,273 million. Air Liquide is on the hook for $143 million. Air Products is looking at $130 million. And Linde may be responsible for $137 million.

The fines made Praxair mad. “Praxair strongly believes that the allegations of anticompetitive activity against our Brazilian subsidiary are not supported by valid and sufficient evidence,” the company said in a statement. “We further believe that the fine represents a gross and arbitrary disregard of Brazilian law.” The firm promises that it will “prevail on appeal.”

To Laurence Alexander, an equity analyst that covers Praxair for Jeffries & Co., the fine isn’t a shocker. “The threat of potential sanctions has been apparent since 2004, when CADE announced an investigation into alleged price fixing on public tenders as part of a broader government initiative to ‘help tame inflation’,” he wrote to clients. Alexander expects appeals to drag out five to ten years.

Airgas Attacks Air Products Bid On All Fronts

Airgas has rejected Air Products & Chemicals’ offer, version 4.0.

I was a little surprised. Analysts have been talking about a potential deal for Airgas happening at about $68 to $70 per share. I thought that Air Products raising its offer from $60.00 to $63.50 might entice Airgas to the negotiating table to screw down the details.

Nope. Airgas’ reaction was a full on assault.

Using wording now familiar from the rejection of three previous offers, Airgas founder and CEO Peter McCausland, said the deal “grossly undervalues Airgas”.

Airgas message to shareholders was, “we do have a backup plan should the Air Products offer be torn asunder”. The company timed the rejection to coincide with its quarterly earnings announcement. In February, Air Products put out its $60-per-share bid a week after Airgas reported dismal earnings for its fiscal third quarter. Since then, Airgas has bounced back. Its fiscal first quarter adjusted net income of $0.83 per share is the second best quarterly performance in company history.

Moreover, Airgas raised its fiscal full year guidance from $2.95-$3.05 up to $3.15-$3.30. The company now says it is confident that it can grow earnings to $4.20 for fiscal 2012.

McCausland painted Air Products as a Johnny-come-lately. “Airgas-stockholders-not Air products—should reap the benefits of our increased earnings power and bright future,” he said.

McCausland also noted that because Airgas has been reducing debt, the $63.50 per share offer is no different than a $62 per share offer in cash and stock that Air products made back in December.

Finally, Airgas is throwing some cash back to shareholders by raising its quarterly dividend from $0.22 to $0.25 per quarter. Dividend yield at today’s prices, however, is still only about 1.5%.

Airgas was trading at levels of about $45 before the deal was announced. That’s a price Airgas shareholders don’t want to see again now that $63.50 in cash has been on the table. When Hexion sued to get out of its deal with Huntsman in 2008, Huntsman shares immediately lost half of their value, down to about $10. Before Hexion’s $28 per share offer in mid 2007, Huntsman was trading at about $20.

There were reasons why Huntsman was so severely punished by shareholders. The Huntsman drama was playing out amid the housing bubble and financial crisis. Hexion filed lengthy documents in the Delaware Court of Chancery talking about a deterioration of Huntsman’s financial condition.

Still, Airgas shareholders must know that they will have a huge haircut—and a long wait to recoup their gains–if Air Products walks away.

John E. McGlade, Air Product’s CEO, has hinted at this but he hasn’t really been coming right out with it. “We believe Airgas shareholders today face substantially more uncertain market conditions than when we commenced our offer for Airgas in February,” he said. “The certainty of a fully financed all-cash offer at a substantial premium is more attractive than ever before.”

Some Thoughts On PEMEX v. BASF

BASF doesn’t steal, it just makes stealing better for criminals.

PEMEX’s sentiments, not mine. As you may have heard, Mexico’s national oil company is suing BASF over BASF’s purchases of natural gas condensate pilfered from PEMEX’s natural gas fields in northern Mexico.

My first reaction seeing headlines about this was “say what!?” This is a rather serious accusation being leveled at the largest chemical company in the world. The court filing clarifies matters somewhat. For instance, Pemex isn’t accusing BASF of knowingly buying the condensate, which BASF used as a feedstock at a Port Arthur, Texas, cracker. And BASF halted the purchases as soon as it found out. But I still have some questions and observations.

How did Trammo Petroleum, which apparently knew that the condensate was stolen, represent the material to BASF? Was BASF suspicious? What questions did BASF ask? What were Trammo’s answers to those questions?

How much did BASF pay for the condensate? How do these prices compare with the going rate for condensate and other feedstocks at the time (round about early 2009)? Should these prices have raised red flags?

Did BASF test the condensate’s composition? Might that have told BASF where it was from?

Usually when one deals with criminals, something just doesn’t feel right. A little spider sense starts to tingle. There are some with the ability to interpret this sense right away. They are called “street smart”. For everyone else, it isn’t until it’s too late—such as when law enforcement gets involved or the national oil company of Mexico sues you—that it becomes clear that something illegal has been afoot.

And what about Verbund? This is BASF’s mantra, like Fahrvergnügen is for Volkswagen. Verbund suggests that everything that BASF does is very deliberate and integrated—all of the molecules coming into a BASF plant are nurtured into being the best compounds they can possibly be. This idea doesn’t seem to square of the thought of BASF buying feedstocks off a truck hijacked in Mexico. (A little poetic license needs to be granted here. The condensate from the hijacked trucks was transferred to other trucks to cross the border.)

BASF has fairly extensive operations in Mexico, especially around Altamira. It and many other chemical companies have been trying to get more feedstocks out of PEMEX for years. PEMEX, which needs to pay a lofty tax bill to help maintain Mexico’s federal budget, can hardly afford to increase capacity. This is why the country has a massive deficit in chemical trade. Guess how much $300 million in condensate being stolen from PEMEX helps BASF and other chemical makers in Mexico? Answer: Not at all.

I can make excuses for BASF. Early 2009 was a time when a lot of people in all aspects of business were liquidating inventories. Remember the rock bottom prices at Stein Mart? I’m sure that back then all sorts of spot volumes of feedstocks and chemicals could be had around the Gulf Coast at attractive prices.

Nevertheless, I do expect better from a company that has been an industry leader in measuring itself according to social, as well as economic and environmental, performance.