With two big investors in the past week taking stakes that control more than 25 percent of Navistar’s stock, bankruptcy would appear to be the last thing that could happen at beleaguered Navistar.
After all, Mark Rachesky of MHS Fund Management, who took a 13.9 percent stake—and his former boss, Carl Ichan, who boosted his stake to 11.9 percent—did exhaustive research, right?
No doubt, but Gimme Credit analyst Vicki Bryan doesn’t believe bankruptcy is as far-fetched as it may seem, even with Rachesky and Icahn on board.
In reports to clients after they took their stakes, Bryan raised and reiterated numerous red flags over the truck and engine maker, including coming flat out and saying that “bankruptcy increasingly becomes a credible risk for Navistar...”
Rachesky and Icahn have declined comment, but Bryan says she believes they are betting that Navistar eventually gets the EPA’s blessing for the controversial so-called Exhaust Gas Recirculation, or “EGR” technology that Navistar has, in effect, bet the ranch on. The rest of the industry uses more conventional Selective Catalytic Reduction, or SCR, technology.
Which gets to the heart of this story: Navistar’s EGR engine has never been able to get EPA certified, instead using emissions reduction credits as a stop-gap. But those credits, which Navistar earned from 2007 to 2009 by taking various environmentally friendly actions, were set to run out this year. The EPA’s solution was an interim fix to let Navistar pay a $1,900 fine per engine, leading its rivals to sue the EPA.
Last week Federal Judge Janice Brown ruled against the EPA, writing that “Navistar’s day of reckoning is fast approaching: its supply of credits is dwindling and its engines remain noncompliant.”
Navistar said it plans to seek a rehearing—and this is where it would be foolhardy to ignore the bankruptcy option: In a court hearing defending its actions, the EPA extrapilated if Navistar didn’t catch a break on compliance, the upshot would be a “significant loss of Navistar's estimated $3 billion in revenue from those trucks and engines, and layoffs of nearly 4,000 employees who make those trucks and engines.”
Did they say a loss of $3 billion?
Indeed they did—a number that appears to have only been disclosed in court documents.
According to Bryan, such a loss would result in “wiping out most of the manufacturing segment revenue reported in the second quarter and more income than Navistar generated in more than a decade—and could even be forced to leave the U.S. marketplace. That would be the end of the line—Navistar doesn’t have the cash or the borrowing capacity to absorb such a catastrophe.”
While Navistar won’t address the possibility of bankruptcy, a spokeswoman told me that “it’s important to the future of the company to either get a final ruling in place by the courts (presumably in its favor)” or EPA certification “in a timely manner.”
Adding to the the company’s woes: The company is on the hook for an unknown amount of warranty claims on the new engine. Last quarter alone warranty costs were $112 million.
What about a sale of the company?
Bryan doesn’t believe any buyer would step up until this mess is fixed—if it’s fixable.
And as for Icahn and Rachesky? Bryan was warning that WCI Communities, an Icahn investment, was at risk of bankruptcy in 2007. In 2008 it filed for bankruptcy.
My take: Bryan has about as much of a chance of being right here as Icahn and Rachesky. Remember—her research starts with the balance sheet.
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