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Talk about getting caught between a rock and a hard place: a spike in supply costs and in the cost of capital needed to pay for them.
Avital Louria Hahn, CFO.com | US
September 22, 2008
Last Wednesday, when a gaping spread between the London Interbank Offered Rate (Libor) and U.S. Treasury three-month-bill rates opened dramatically, Idaho Asphalt Supply faced a change in one of its basic borrowing assumptions, according to the company's CFO and treasurer, Blair Sellers.
When Idaho Asphalt borrows from his credit line, it does so in chunks, or tranches, according to Sellers. At the point of company borrowing, he can choose between a prime-based rate or a 30-day Libor-based rate. Historically, the Libor-plus spread has come out to be slightly cheaper than the prime-based rate, by about 10-15 basis points. But when Libor spreads doubled, he said, "Obviously it will not be now."
The company's current revolving maximum credit line of $80 million, at borrowing rates of 30-day Libor plus 140 basis points, which had been roughly equivalent to the prime lending rate minus 1 percent. But the sharp upturn in Libor, Sellers said, represents a classic time to go with the prime-based formula.
The company has been caught in a squeeze between the soaring cost of capital and the increased cost of asphalt products, which are derived from oil, making the credit-line call just a part of a bigger set of decisions.
To be sure, Idaho Asphalt Supply has, until now, thrived in its feast-or-famine, fiercely cyclical business for 30 years. In the winter, when frozen roads in the Pacific Northwest make paving impossible, the Idaho Falls, Idaho-based company has no revenue. Using its credit lines, it stockpiles asphalt throughout the winter and bids out work in preparation for the paving seasons. Come April, as towns and municipalities begin to coat their streets and mend their potholes, the company goes into its high gear, selling asphalt to contractors of all stripes and refilling its bank accounts.
This spring, however, oil prices jumped to $140 a barrel from $60 and the price of asphalt, a byproduct of crude-oil refining, soared to an unprecedented $750 a ton from $160, throwing the entire system off balance. "This created a significant issue," says Sellers. "Our capitalization requirements have tripled."
Until now, Idaho Asphalt, with annual revenues in the range of $100 to $250 million, managed its finances by tapping about $43 million a year out of its $50 million revolver, which can be extended to $80 million. But the current high cost of asphalt means that it would need nearly three times the cash just to keep up with current volumes. The recent drop in oil prices has been a small consolation: Even after a drop of $100 a ton, current asphalt prices still represent a roughly 375 percent increase since last year, Sellers says.
What to do? Before last week's crisis, Sellers said the company has three choices: stay with the current borrowing arrangement, a working-capital based line of credit that would mean scaling back the purchasing capacity of the company because of limits under the existing formula. A second choice would be an asset-based facility of $85 million to $100 million, and a third choice would be a syndicated credit line of $100 million to $150 million.
Idaho Asphalt’s board plans to come up with a decision in early October, at its regularly scheduled meeting. "At that point we will decide as a company whether we want to borrow up to $80 million and stick with our current terms and conditions or take an additional $20 million in financing and what the implications of that would be in costs and also in significantly more reporting to the bank because they are extending an additional level of risk,” he says.
By the middle of last week, however, Sellers said syndicating a loan to a number of banks--which could have provided up to $150 million--would prove too expensive. At the same time, the second option, an asset-based facility that would provide $20 million more than its current borrowing arrangement, would also entail higher fees, higher interest rates and more reporting, although less so than a syndication.
Either choice will mean a belt-tightening. "It would be easier to live within our current borrowing framework and potentially downsize the company," Sellers said. "We will have lower revenues because we will not be able to buy as much asphalt. We will have to significantly control our costs and implement some cost cuts."