GY 2.25% converts analysis 03/24/10

March 24, 2010

Near term catalyst

On 3/19/10, GY amended their credit agreement to allow the company to refinance their outstanding unsecured bonds. The agreement allows GY to issue up to $438m in debt but the company has to use the proceeds to retire either the term loan or the unsecured bonds. In exchange, GY will pay L+325, 100 bps higher than the old rate for the term loan. We bought some 2.25% bonds at 92.75 (7% yield to put 11/20/11). We feel that the company is likely to take action to refinance either the 2.25% converts or the 9.5% straights, which could lead to a tender offer for the 2.25%.

I feel very comfortable about GY credit. The company is a defense contractor with long product cycle including a funded backlog that covers 1 years worth of sales. The company is free cash flow positive, fresh off a Moody’s review for upgrade and a credit agreement amendment

GY Analysis

Cash = $158m

Term loan due 2013 = $51.5m drawn ($75 capacity)

Revolver = $65m undrawn

Letter of credit = $85m drawn ($125m capacity)

2.25% sub convert due 11/20/11 = $132m

9.5% sub straights due 8/15/13 = $75m

4.0625% sub convert due 12/31/14 = $200m

Total debt = $477m

Environmental remediation and postretirement liabilities = $520m

GY should generate about $140m EBITDA in 2010 for a leverage of 3.4x.

EBITDA/Interest expense is 5.3x. These metrics are consistent with a BB rating. Moodys currently rates it B3, on review for an upgrade.


GY is a manufacturer of aerospace and defense systems with a real estate segment. Aerospace  includes Aerojet-General, which makes propulsion systems (mostly for missiles) for defense and space applications. GY is one of the largest providers of such propulsion systems in the US. Customers include the major prime contractors (LMT, RTN, BA) to the US government, the department of defense, and NASA. GY also owns about 12,200 acres of land adjacent to US Highway 50 east of Sacramento. GY is seeking to change zoning rules to optimize its value. The land is estimated to be $200m at the low end.

Aerojet has been an industry leader in propulsion systems for 60 years. It is the only domestic supplier of all four propulsion types – solid, liquid, air-breathing, and electric. Competitors include Alliant Techsystems (solid, air), American Pacific (liquid, electric), Astrium (solid, liquid), Northrup (liquid), Pratt & Whitney (liquid, air, electric) and SpaceX (liquid). Aerojet is number 2 in solids behind ATK and liquids behind Pratt.

Prime contractors Raytheon and Lockheed Martin account for 31% and 26% of 2009 sales, respectively. About 51% of sales were fixed price contracts, 37% from cost reimbursable contracts, and 12% from other sales. Many products have life cycles of over 10 years. These contracts are initially small during the development phases that can last two to five years, followed by low-rate and then full rate production.

GY’s funded backlog is $811m and unfunded backlog is $379m. Funded backlog is the amount of money that has been directly appropriated by the US congress and unfunded backlog is the amount for which funding has not been appropriated.  GY’s annual sales are $800m, so funded backlog covers 1 year of sales. Most of GY’s R&D are funded by customers so the company does not have much R&D expense.

Steel Partners owns about 7% of the company and in the past have pressured the company to make strategic changes. On January 6, 2010, the company appointed a new president and CEO Scott Seymour from Northrop Grumman. In December 2009, Moody’s placed GY on review for upgrade from its current B3 rating.

March 26. 2010

Met with GY management today.

The company has $230m in cash (there is $30m restricted that has to be used to buy back debt). The 2.25% converts are the next maturity $132m. The company just amended their credit facility so that any new proceeds from a debt issue have to go directly to repaying debt. The company says they are looking hard at all options and reducing debt remains their top priority. GY hired a new CEO about 6 months ago and I believe he would like to right size the capital structure as soon as possible. This includes terming out maturities to give the company a more stable debt structure.

Prior to the credit agreement, the company could only issue a bond that had lower coupon than the debt that they were retiring. This restriction is now gone. Also in the prior agreement, GY was only able to buy back $10m of bonds. Now they can buy use any cash to buy back bonds as long as their net debt leverage ratio is below 3.0x. It is currently below that.

GY has a backlog that covers 1 years of revenues and about $20m FCF per quarter. GY is a defense company that makes missiles for government programs. They have long product cycles and 1 year visibility into their order book.


GY never did tender for the 2.25% converts or do a large buy back. Instead, they will wait until maturity. However, the trade still worked as the bonds traded up to 98 from 92 in just a few short months.

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